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  • Nicole

Understanding Why You Need Business Finance

Updated: Apr 12, 2022

If organic growth is difficult, raising business funding may be the best way to expand your business. Determine your needs and the best route for you. If you’ve reached the point where your business requires corporate finance services or an injection of cash, it may not always be obvious whether your first port of call should be a high-street bank or a professional investment house that will take a stake in your company in return for providing funds. By analysing your business – both in terms of where you are and where you want to take it – the most appropriate means to finance growth should become clearer.

If you are seeking finance, the chances are your business has come to some sort of crossroads or pressure point. For a start-up technology company this could mean a requirement for enough cash to pay wages and office costs until the first product makes it onto the market. For a consumer goods producer on the verge of securing its first contract to supply a multiple retailer, cash might be needed to expand production and distribution to fulfil the demands of its prospective customer. On an operational level, you may require a cushion against the peaks and troughs of cashflow. Whatever the situation, it is important to focus on the funding options that not only align with your objectives but also your stage of development.

Debt and equity

Broadly speaking, you can raise money for your business either by incurring debt or by selling equity. There are several fundraising solutions to consider within these two camps.

Forms of debt go beyond the familiar concepts of borrowing, overdrafts and leasing, and include very specific solutions such as invoice discounting. Whatever the debt arrangement, you are effectively purchasing money, usually by paying interest on credit extended to you and on the basis of being able to provide sufficient security.

For equity finance, investors will require a stake in your company based on the size of the sum on offer against the perceived value of the business. Rather than lending, the backer is buying into the company, although investors tend to structure deals with an element of debt too. This ensures some payback over the period of the investment, prior to eventually selling the stake.

Fear of losing control, the expense involved, the timescale and concerns about complex deals deter some businesses from exploring equity finance. But equity investors can also improve your business’s long-term prospects by providing valuable skills and expertise.

Operational issues

Although it is impossible to generalise, businesses often choose debt finance to address an operational issue that may or may not be growth related. A problem caused by cashflow fluctuations, for instance, might be solved by extending an overdraft facility.

Alternatively, invoice discounting (where a lender will pay you whenever an invoice is raised, so you don’t need to wait for the customer to pay) may keep you out of the red.

If the aim is to preserve working capital,
it may make more sense to lease equipment than buy it, while a loan may be used for larger one-off outlays.

Funding growth

Debt-based solutions may be flexible, but there will be times to consider equity finance. Rapid expansion from a turnover of £500,000 per annum up to £10m, for example, may call for increasing production, opening an office in Europe or employing a bigger sales team.

You could, of course, fund this by borrowing against assets – but even if lenders are forthcoming, repayments will be a drain on the business. In circumstances such as this, equity investment can provide upfront cash without the burden or regular repayments.

True, this means reducing your stake in the company – but if all goes according to plan, the real value of your holding will grow. Also important, private investors can actively help you grow by giving advice and recommending executive and non-executive directors.

You will be working closely with your equity investors, so get to know them first: it’s important that the chemistry is right.

Equity finance can come from a number of sources. These include friends and family (personal contacts who have the money and inclination to back your plans with anything from a few hundred to a few thousand pounds), business angels (individuals who specialise in supporting young, growing companies) and venture capitalists. The latter will probably only be interested in investments of £1m plus, and will be looking for a flotation or trade sale within a few years to allow them to achieve a high return.

Whoever you are dealing with, seek sound advice. While your accountant will undoubtedly help you in your relationship with lenders, dealing with equity investors requires more specialist help. A legal adviser should check any deal, and when preparing to talk to venture capitalists, enlist the help of a corporate finance specialist. Mid-tier accountancy firms are particularly strong in this area. Advisers will also be able to help you establish whether you really need to raise finance or whether your problems can instead be addressed in other ways.

For instance, if cashflow is a problem, it may be possible to resolve the issue by raising invoices more quickly or by taking a more proactive approach in chasing unpaid debts. There are always alternatives.

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