SME funding adviser scheme

Asset finance is a secured business loan where financiers lend businesses money using their assets as security. For the duration of the contract the lender keeps ownership of the assets.

Lenders prefer to deal with businesses such as manufacturers, distributors and retailers who have highly specialised and valuable assets which have a residual value at the end of the borrowing period.

Amounts raised depend on the value of the assets available but in general terms businesses can raise a similar percentage of the value of the assets that an invoice discounter would lend.

An overdraft is generally a short-term facility (up to one year) usually restricted to supporting the needs of working capital (cash required for day-to-day business operations). The overdraft provided will be determined by factors such as the businesses trading performance and its ability to generate cash.

A loan may provide a more flexible option to the length of time required for pay back. However, banks can sometimes be reluctant to loan large amounts of money to new businesses with no track record. They may also expect the business owner to provide a share of the capital themselves.

For UK businesses below a certain size, government guarantees might be available which encourage a bank to lend money to higher risk businesses. The government guarantees up to 75% of the loan for which the borrower pays a premium on the outstanding balance of the loan, payable to the UK Department for Business, Innovation and Skills (BIS).

The borrower's track record in previous loan repayments and their credit rating are some of the factors that the lender will consider when making their decision.

(A) Internal management plans and budgeting
Many entrepreneurs put together their first business plan when considering setting up a new venture. Budgets are generally more for internal purposes to help the management to run the business, monitor its progress and develop action plans to achieve objectives.

Budgets usually contain the same basic information as plans – covering profitability, cash flow and balance sheets. However, budgets usually deal in shorter timescales and are broken down into weekly, monthly or quarterly periods.

Management financial information is compared with the budget to monitor progress and to decide if changes in planned actions are needed. Comparisons of financial performance figures with budget, together with key ratios, are often the primary source of information for running a business.
There is a wide range of ratios that can be used to help understand the direction a business is going in. The most common ratios deal with profitability (is the business making more or less profit?); balance sheet ratios (how money invested in the business is changing); or a combination of profitability and balance sheet – such as return on capital employed.

Two particular ratios which are commonly used by new business start-ups are gross margin percentage and break-even analysis. The gross margin percentage is the gross margin (sales less direct costs of sales) expressed as a percentage of the sales (also referred to as ‘turnover’).
The break-even point is basically the amount of sales per day/week/month needed to cover the overhead costs (rent, office salaries etc). Sales in excess of this figure mean the business is covering its costs and trading profitably.

(B) Plans for bank finance
Businesses requiring loans or overdrafts in excess of £25,000 (the sum varies according to the finance provider) will have to provide a business plan. The plan will include a projected profit and loss account, cash flow and a balance sheet.

Once the finance has been agreed the business will be asked to provide monthly or quarterly management accounts including a comparison with the plan and an analysis explaining significant variances with a note of actions taken to remedy shortfalls.

(C) Plans for potential external investment of equity finance
When seeking to raise equity finance (from business angel finance to private equity or even floating a business on an equity market) businesses will need to provide a business plan. However, the plan will require much greater detail than for bank finance.

This is because equity finance is ‘risk capital’ (last in line for repayment in the event of the business closing) whereas bank finance is often secured on the assets of the business.

Secondly, bank finance providers often have a long-term relationship with the businesses and can draw on knowledge of how the business conducted its affairs during this time. Equity finance is often provided by investors and institutions which have had no previous contact with the business.

Consequently, the plans will be very comprehensive and include details of markets served by the business, the products or services provided, history of the business, details of the management team, the business operations and the amount and intended use of the finance required including the exit opportunities for investors (where the equity issue is not a flotation).

The financial projections accompanying the business plan will need to be for a longer period than usually required for bank finance – three to five years ahead.

Personal funding of a new business may come from any shares that the entrepreneur has, personal saving, money released from personal assets or from the entrepreneur re-mortgaging their home.

Asking for finance from friends and family may be a sensitive issue that can test relationships but people who know an entrepreneur personally may be more supportive, particularly if they also have run a business.

Drawing up a written agreement of the terms of the financing including how it is intended that the finance be repaid (if a loan) and making it clear that the funding is a business arrangement, may help avoid misunderstandings.

Corporate finance is often associated in the UK with some degree of change of ownership in a business, connected to a corporate transaction that leads to the creation of a new equity structure or shareholder base, and the related issue, underwriting, purchase or exchange of equity (and related warrants) or debt.

Transactions include:

For growing businesses, invoice discounting makes cash available to a business from an invoice discounting firm on receipt of a debtors invoice. The collection of payment from the debtor remains with the business.

This facility is suitable for businesses selling goods or services on credit to other credit worthy businesses and is a cost-effective alternative to overdrafts and bank loans.

Similar to invoice discounting, factors buy business’ trade debts and typically pay the business as soon as they receive a valid invoice. The factor directly collects the debt from the business’ customer but will usually agree collection policies with the business.

Invoice factors and discounters advance around 80-90% of the invoice value depending on aspects such as industry sector, turnover, customer numbers and existing credit controls.

Grants to help with the development of a business are available from a variety of sources such as the UK Government, the EU, Regional Development Agency, Business Link or charitable organisations.

Grants are usually linked to precise areas of business activity such as exporting, new product development or training. Some grants are linked to specific industry sectors or geographic areas, usually those in need of economic regeneration.

There are very strict rules for eligibility and the project must await approval of the grant before work can commence. There are estimated to be 3,000 schemes offering incentives to business in the UK so finding the most appropriate scheme requires an adviser with detailed knowledge of the universe of available assistance.

When acquiring assets such as vehicles and machinery, options other than an outright purchase can help free-up more working capital. Leasing business assets (where it pays smaller amounts to a finance company for its use) costs significantly less and can provide some tax benefits.

Long-term leasing however, can mean that overall costs end up exceeding that of an outright purchase. Another option is hire purchase, which enables a business to buy the asset on credit (with interest) paying off the cost over a specified period of time.

Shares in companies which are not publicly quoted can be valued in a number of ways which can result in widely differing results. The valuation of shares is required for a wide variety of commercial reasons from retirement of a shareholder to pre-flotation valuation as well as for tax planning for individuals or for corporation tax purposes.

Valuation work requires not only financial analytical skills, but also knowledge of the legal framework surrounding the valuation – whether the relevant law is the companies act, articles of association, joint venture or other shareholder agreements.

Share valuation also requires experience of purchase and sale transactions and access to information on current valuations in specific sectors.

This generally covers raising finance from an outside investor, without making a public offering. This might entail raising equity from:

Business Angels
A business angel is an individual who may invest in a business in return for a stake in the company. They are best attracted if the business can show that it can offer an attractive return but the business owners must be prepared to relinquish some control. Business Angels may also want a seat on the board and will want to receive regular updates on the company’s progress. Individually or as part of a Business Angel network they usually provide risk capital in amounts up to £1m.

Venture Capitalists
Venture capitalists, many of which tend not to fund start-ups, provide finance for growing businesses in exchange for a significant stake in the company. As professional investors, they can bring significant financial and management expertise which may make it easier to attract further funding.

Because venture capitalists rarely make investments below £2m (often significantly larger sums) they will need to be convinced that the business has the potential for sustained growth and that it has a sound management team to move the business forward. If things go wrong they are likely to intervene to protect their investment. However there are a few specialist funds that do support seed or start-ups with equity finance, or developed companies with small amounts of equity, depending on the region (see below).

Potential equity investors will require a business plan showing forecast profit figures, cash flow and projected balance sheets. Usually expert advice is needed to help business owners prepare a business plan and negotiate with financier providers.

Regional Venture Capital Funds/Venture Capital Trusts
The Regional Venture Capital Funds (RVCF) are funded by the UK Government and commercial finance and can invest up to £250,000/£330,000 initially in companies promising rapid growth in all sectors and at all stages of development. Sometimes they invest alongside private business angel funding.

A Venture Capital Trust (VCT) is a publicly quoted company with a portfolio of up to 50 investments. Investment in any one company cannot exceed £1m in a single tax year. Investors in VCTs receive tax benefits to reduce the risk of investing in smaller recently established businesses.

Regional Technology Seed Funds
There are a number of specialist funds which support seed/start-up/early stage technology companies with initial sums from £50,000 to £1m. Sectors covered include medical devices, information and communications technology, advanced materials and nanotechnology.

Enterprise Capital Funds (ECF)
ECFs are a UK Department for Business, Innovation and Skills (BIS) initiative. There are five ECFs which provide equity finances between £500,000 and £2m each. Each ECF covers a particular geographic area (some the whole of the UK, others a few regions) and each specialises in different types of companies.