Online borrowing and lending site Zopa.com, set up in March 2005, was seeking finance to expand in the UK and to launch in the US. It set its sights on venture capital (VC), laid down a strict timetable and raised just under £2.7m in June this year.
“We knew we needed VC funding. We needed someone who would help us grow the business, work with us to take the company into the US, enhance our reputation and be able to continue funding us over the next two to four years,” explains James Alexander, the website’s co-founder and UK chief executive.
Expanding your business at home or abroad is just one the many reasons you will need an injection of cash. You may recently have won a large contract, be about to launch a new service or product to the market, or are perhaps considering buying a competitor. Alternatively, you may have recently moved to bigger premises or need new equipment – all of which puts a strain on your working capital and cashflow.
The good news is there is no shortage of funding options for businesses like yours, from high-street banks and private equity to a flotation on the stock market. You can even raise cash against unpaid invoices or your company’s wage bill.
But each option has its own set of requirements, and some will not be suited to your business. The time it takes to raise money will also influence your choice. Bank loans can quickly be arranged, whereas private equity deals and a flotation can come at considerable time and cost to you and your management team.
Where to go
Your high-street bank is often the cheapest option. Bank loans vary from provider to provider, so it’s wise to shop around. Lloyds TSB and Barclays, for example, offer a base rate loan from one to 20 years, with capital repayment holidays. They also offer fixed loans and commercial mortgages to help buy a new building or release cash locked up in your existing premises.
According to Rob Donaldson, corporate finance partner and head of private equity at chartered accountants and business advisers Baker Tilly, banks are a trusted form of third-party debt.
“At the moment, finance is widely available in the current low-rate environment for those with a strong track record or significant assets for security,” he says. “However, high-growth situations coupled with losses or poor cashflow are difficult for banks to finance.”
Banks will require a business plan, details of company assets and liabilities and historic financial accounts. As Nigel Le Bas, a corporate finance executive at accountants and business advisers Tenon, points out, one of the advantages of bank funding is that you are able to retain 100% ownership of the business. On the downside, the funding available is limited by security and you may not be able to raise the necessary amount. Most importantly, the bank will require security in case of default.
Despite banks being many business’s first port of call, Zopa’s Alexander warns against going down this route.
“I would never suggest starting with high-street bank funding,” he advises. “Debt finance is an option – but it becomes a better bet once the venture is partially established. Do you really want to lose your house if your business does not perform? Always start with equity finance unless you have a lot of savings.”
Mixing debt and equity
If you are looking to fund the expansion of your business, consider mezzanine finance – a mix of debt and equity. As it is a higher risk than senior debt, mezzanine finance has a higher interest rate, and usually carries a small warrant over the ordinary shares of the borrower company.
“The drawbacks are that it is a more expensive form of debt and it usually comes into play when your company has exhausted all other routes of conventional debt,” says Karen Davies, an investment executive at Finance Wales, which helps businesses based in the country raise funds.
But it does have its advantages – on the balance sheet of a company, mezzanine finance is treated like equity, which may make it easier to obtain standard bank financing.
“Mezzanine also does not involve a significant dilution of the shareholders’ equity. Providers do not receive voting rights, and, therefore, are more likely to leave the running of the business to management,” says John Clifford, from the growth and acquisition finance division at mezzanine provider Investec Private Bank.
Another significant benefit of mezzanine finance over a senior loan is that you do not usually have to repay it for potentially up to eight years. This is similar to the difference between ‘repayment’ and ‘interest-only’ mortgages. In other words, cashflow generated by your company in the early years of a loan can be reinvested in growing the business, rather than repaying debt.
It can also be a relatively quick way to raise money – providing you have done much of the necessary paperwork beforehand, as it involves a fair amount of due diligence on the business and your management team. Investec’s Clifford says that a deal can be done in as little as three weeks, although a six to eight-week turnaround is the norm.