Raising money needs careful planning, like a military campaign. You should regard it as the biggest sale you are ever likely to make. You need to get your act together to present your case. You need to know how much money you want, who to approach, how long you want the money for and what security you can offer backers. You also need to know the business plan, the financial figures and the marketplace inside out.
But that is not all. You should expect indifference, lack of interest, disbelief and doubt. You have to convince, persuade and excite sober, serious business people about the prospects for your business. This cannot be achieved by overstatement or rash predictions about success. Demonstrations of competence and skill are what is required.
Of course, a few strike lucky. There may be the odd story about bank managers agreeing overdrafts over the telephone, or someone being able to pick and choose from a variety of backers who all want to put up the funds. But for most it is a hard, hard job. Following the global financial crisis, banks seem to have retrenched. They are concerned to restore the strength of their own balance sheets and appear very cautious about lending to small and medium-sized businesses. This has prompted the government to launch a number of initiatives to encourage the banks to lend and to provide alternative sources of funding (p. 307). The one bright spot on the horizon is the growth of peer-to-peer lending and the government’s recent backing of this relatively new sector. Peer-to-peer lending started with individuals lending direct to other individuals, bypassing the banks, but has now expanded into individuals lending direct to businesses as well (p. 315).
This chapter looks at:
Only when you have drawn up your business plan and done your cash flow and profit forecasts will you know how much money, if any, you need to raise. Take a few deep breaths before you rush round to make an appointment with your bank manager to see if you can get the overdraft you need. First, your bank is not always your first port of call, as you can see from later pages in this chapter. Second, you should take a further, closer, more critical look at the amount of money you think you will need.
Being optimistic, as anyone starting a business must be, you naturally believe you are going to make the sales you have projected on the timescale you estimated and keep the costs down to your forecast figures. But supposing things do not work quite as you hope. Going back to your lender and asking for more money within a short space of time does not inspire confidence, and you may find your second request rejected, if it is not part of your plan. And there you are with a new business to which you have committed time and money, which is now short of cash, and you are unlikely to find any way of raising more.
There is a body of opinion that says when you first approach your lender or investor, ask for twice as much money as you think you will need. At any rate, be very conservative and go for more money than you think you are going to use. Obviously, the business plans that you present need to tie up with your request for cash, so adjust them if need be, incorporating more conservative figures.
There are drawbacks. First, if your figures are too conservative, it may make your business proposition unviable altogether; if this happens, you do not need to worry about being forced to go back for more, your business will not even get off the ground in the first place, because you will not get the initial backing. The second obstacle to this approach is that it is the natural inclination of any investor to try to make you manage with less money than you say you need.
The sensible advice is to steer a middle course: be pessimistic, while retaining a sensible business proposal.
At this stage, you know more than ever before about your proposed business and are likely to be very committed to it. But if the business does not look right, do not be afraid of ditching this plan and looking for a better one. You probably have only one chance of raising money for a business proposal, so do not choose a failure because it was your first idea.
For many people, this is the first point at which you are really learning what makes a business tick. One sign of a successful entrepreneur is that you can learn from your information and experience and can adapt. You want to go for calculated, but good, risks. If you have already started trading, your business course is set.
There is another odd fact about raising money: different sums of money can be harder or easier to find, depending simply on their size. Surprisingly, it is sometimes said to be much easier to find very large sums of money for your business (£2 million plus) than sums in the £20,000 to £1 million range (these figures are an indication only; there are always exceptions). This quirk of business funding is of no interest to the vast bulk of people who want to become self-employed or start a business in a small way but, if your plans are on a larger scale, think about being bigger still.
This oddity occurs because there appear to be more people around who are willing to invest in either small businesses that are past the start-up stage (that is, not brand new) and into a big expansion phase or in new businesses that look capable of very fast growth in profits. To achieve either of these objectives, the amount of money invested needs to be substantial to stand any chance of success. Other preconditions for success, apart from large funds, are a very strong management team and a sound market. If you cannot demonstrate that both of these apply to you and your business, your chances of raising very large sums of money are virtually nil.
From your forecasts, you should have an indication of when your need for extra cash arises, how long it lasts for and when you would be able to pay it back or give a good return on it. When starting up, you need money for:
The longer you can get your suppliers to wait for their payment and the shorter the period you allow your customers to pay, the less working capital you need. Your working capital requirements will also be less if you do not need to hold big stocks of goods.
In practice, all these things are easier said than done and you need to work out a strategy for controlling your business that meets your need to keep down the money tied up with working capital, coupled with keeping your suppliers and customers happy. This is covered in more detail in Chapter 24, ‘Staying afloat’.
If your business is up and running, you may need funds simply because it is growing and hence the amount of working capital necessary has gone up. Or you may have some specific expansion in mind.
If your need for the money is likely to be fairly short term, an overdraft or some sort of short-term loan is your likeliest bet. Your need for finance in the short term could be to cover a temporary shortage of cash, or it could cover your start-up requirements if these are fairly small.
An overdraft is quick to arrange and relatively cheap, but there will be an upper limit above which you are not to go without the permission of the bank manager. The serious drawback with an overdraft is that the bank can demand instant repayment. While this does not happen very often, you can bet that if the bank does demand repayment or reduction of the overdraft, this will occur when you cannot do so.
If there are no assets, such as debtors, to be taken as security for the overdraft, it is likely that your bank manager will require that you give some personal assets or a personal guarantee as security even if you have formed a limited company. One benefit of getting substantial funding is that as a result of the strong balance sheet, personal guarantees, although asked for, can sometimes be avoided.
As a self-employed person you are personally liable anyway, so no further guarantees are needed. In the extreme, this means that if you cannot repay an overdraft, your bank could take you personally to court to recover its money and your personal as well as business assets could be seized.
Note that banks may be wary of taking stocks as security for an overdraft. The manager may insist on property or debtors as the only acceptable security. Always negotiate about the level of security needed; it is in your interests to give up as little as possible.
Since the recession many banks have moved away from offering overdrafts, pushing their clients towards factoring or invoice discounting. Both of these forms of finance enable businesses to release the funds tied up in unpaid invoices. Both involve a third-party company advancing money against outstanding invoices (see p. 337).
The global banking crisis, subsequent recession and continuing economic difficulties have caused a shortage of bank lending to UK businesses. To tackle this, the government has introduced a number of schemes, including:
Finance terms are from three months up to 10 years for term loans and asset finance and up to three years for revolving and invoice finance facilities..
To find out about these and other funding schemes, contact the Business Support Helpline* (England) or the equivalent organisations in other parts of the UK.
If you know at the outset that you are unlikely to be able to repay the money you want to raise in the short term, a longer-term source of finance might be the answer (p. 314).
If you have formed a limited company, you may be willing to sell some of the shares in return for an investment in the business. If you do this, it means you will lose some of the potential gains you might get as a result of the shares increasing in value as the profits of the business grow. This is what an outside investor is looking for. The aim is generally to get a good return on the money invested through the shares increasing in value, rather than a stream of income from the business in the form of dividends.
An outside investor, such as a venture capital fund, will at some stage want to sell the shares to realise the profits. If you are hoping to raise money in this way, put in your plan that you intend to have your company floated on the stock market, the Alternative Investment Market (AIM) or ISDX*, say, or that you would like to sell the company, as most venture capital funds want to be invested in a business for a fairly short period, typically three to seven years. Other potential outside investors include ‘business angels’: many of these are people who have made money from their own businesses and are looking to invest both finance and expertise in other new or small businesses.
The value you can obtain for your shares, if you are a new company, is a very vexed question. Frankly, they are not worth very much yet, so you might find that you are having to sell a bigger proportion of the shares than you would like to raise the money you need. This can lead to problems about voting control. What the value of the shares is can lead to a lot of haggling.
Opting for this route to raise money needs professional help; you need, perhaps, accountants*, solicitors* and financial advisers*. Ask for references from these professionals to help you to steer clear of rank unprofessionals.
If you have started out as a sole trader but need to raise additional capital, you could do this by taking a partner. What share of the profits each partner gets in return for the capital put in is a subject to be negotiated. There also needs to be clarity about the management role each partner will have. For your own sake, you should do this before you form the partnership. A written partnership agreement is a must (p. 64). A limited liability partnership (p. 64) allows you to work out how you want to divide rewards without making it public, while giving the protection of limited liability.
The first fact you must come to terms with is that if you do not invest in your business idea, you cannot expect anyone else to do so. As a rough rule of thumb, the absolute most you will probably be able to raise from outsiders is five times as much money as you are putting in yourself, but, needless to say, there are always exceptions. If you are planning a substantial business and looking to raise £1 million or more, say, you may find that investors will put up ten or 20 times as much as you. But normally, you can expect someone to match your own investment, or put up two or three times as much as you do as a maximum. But in the worst case, it could be nothing.
Winston Carpenter has £10,000 to invest in his business. He works out from his forecasts and his business plan that he needs to raise more money. He is unlikely to be able to raise an extra £50,000 or more, but with a good presentation of his idea, he may persuade someone to lend or invest £20,000, say.
The rationale behind this insistence on how much you must invest yourself is that lenders, such as banks, and investors, such as venture capital funds, want you to be committed to your business, to make you work very hard and with great determination to be successful. If you have not risked the proportion of capital they would like, they may doubt your commitment. However, if you can point to the fact that even though it is a low proportion of the total invested in your business, the sum of money you are investing is still a sizeable proportion of your own personal assets, you could be convincing.
If you have money tucked away somewhere, or if you have a lump sum as a result of being made redundant, this is a relatively easy question to answer. Another common source of the money for your stake is to be given or lent it by someone in your family. But being financed by your family can lead to heartache if things start to go wrong. So do not enter on this course without serious thought. Conversely, you are more likely to convince your family than anyone else.
Another possible way of raising your share of the funds is to use your personal assets to act as security (for example, a second mortgage on your home) or by giving a personal guarantee. The drawback with this is that if your business fails, you have to find the money to carry on making your repayments, or you have to sell your home. You must give careful consideration before giving personal guarantees or using your home to raise money in this way for your business, and the bank may insist that you first take legal advice.
It would make sense to have some sort of agreed family plan for what would happen if your business failed. For example, you should discuss openly whether you are ready to sell your house and move to a smaller one should the security be called upon to repay your loan. If you cannot have some sort of strategy in your domestic life that is acceptable in return for the prospect of going it alone, you are likely to have family problems when the inevitable pressures mount on the business.
You can get tax relief on these loans. If you are a sole trader or partner, any interest you pay on a loan for business purposes is allowable as a deduction against tax in working out your taxable profits. If you take on a loan to invest or lend money to a close company (most family companies are) you can get tax relief at your highest rate of tax on the interest you pay. To be eligible for this tax relief, you must either own more than 5 per cent of the shares or own some shares and work for the greater part of your time for the company.
The best advice is not necessarily to start your business straight away, investing your money and subsequently approaching other investors later when you need it. The wisest course may be to prepare your forecasts and your business plans and to approach possible sources of finance before you start your business and before you actually need the extra money. To plan ahead and get a commitment in advance can be crucial.
The reason why this could be the best approach is that investors have a couple of infuriating habits. The first is to ask what money you are going to put in when they put in their share. You may be able to point out that you invested £10,000, say, six months ago and since then have worked without drawing any salary, but investors are likely to be unimpressed. That is water under the bridge and may count for nothing as far as they are concerned. The second is for them to adopt an attitude of ‘wait and see’ how the business develops, while the cash is running out and you are under great pressure to raise more. In this way better deals can be struck for the investor. So do not necessarily rush out and use up your money, if you know you will need extra funds in due course; get your financial backing in advance.
You may be able to get grants, allowances, cheap loans or prizes from a variety of sources, including central government or the local authority for the area in which you are based or wish to locate, charities, such as The Prince’s Trust* (see p. 58) and, to stimulate regeneration in deprived areas, community development finance institutions (CDFIs). Grants and other funding are often targeted at:
All funding bodies receive far more requests than they can meet, so it is essential that you tailor each application to show how your project will meet the specified aims of the particular body.
Business finance and support*, the Business Support Helpline*, Business Gateway*, Highlands and Islands Enterprise*, Business Wales*, Invest NI* and LEAs* have funding directories you can search to find out what grants and other sources are available in your area for your type of business and project. They can also help you to apply.
Better Business Finance* brings into one place a wide range of finance providers across Britain, including business angels, regional funds, government schemes and banks.
There are also various other government support schemes for business. Information about all these schemes and how to apply is available through the Business Support Helpline* and the business finance and support* web site.
Similar types of government support exist in Scotland and Northern Ireland, for example:
The situation if your business is located in Wales is rather different. In mid-2010, the Welsh Assembly Government published a new strategy for its economy. This included shifting the focus of its business support to technology and innovation and concentrating resources on six specific sectors: information and communications technology, energy and environment, advanced materials and manufacturing, creative industries, life sciences, and financial and professional services. Moreover, the Welsh Government has decided to move away from providing direct grants to business. Instead it will focus on creating the infrastructure that businesses need and ensuring access to private-sector commercial funding. At the individual business level, it offers holistic support based on advice, collaboration and fostering networks between business and universities and other research organisations. In general, any funding the Welsh Government does provide will be refundable rather than in the form of outright grants.
Your bank manager is an obvious port of call, but not always the best or the one you should make first of all. Following the ‘credit crunch’ and the recession, banks have been less than cooperative about extending or renewing finance to small businesses – a classic case of taking away the brolly when it starts to rain. The government has introduced a number of schemes (see p. 307) to kick-start banks into lending again. Assuming your bank is willing to lend generally, in more normal times, the advantage of going straight there is that if you have been a creditworthy customer with a good record, your manager should favour your application. And this is what should happen to the vast bulk of people with a good business proposition that is well presented and well researched.
But there are a couple of reasons why you should not head straight there or why you might expect not to secure the money you want. In the first place, the presentation of your plan will improve with the number of times you give it. If your bank manager really is your best possibility and you have not practised your presentation, you might blow the opportunity. It could pay you to approach another bank, simply to practise what you are going to say and be prepared for the questions that will be asked.
The second disadvantage may occur if you are looking to your bank to provide substantial funds. Each branch bank manager has a different discretionary lending limit; above the limit your application may need to be processed elsewhere, so you may lose part of the personal touch on which you were relying for a sympathetic hearing of your case.
The moral is to shop around. Do not be put off by being turned down; try another bank or another branch that you think may be more used to business deals. Following a government review of business banking, banks must now make it much easier for you to carry your credit history from one bank to another, making it simpler for you to prove your creditworthiness. Banks must also ‘unbundle’ their products, so you can get a loan from a bank without being forced to move your current account to that bank. When shopping around, remember to ask what rate you will be charged; compare this with what other banks would charge. Banks can offer money in two ways:
Loans can be very flexible, and the exact terms vary from bank to bank. You can borrow money for periods of between 2 and 30 years. The rate of interest can be fixed, variable – a number of percentage points over the bank base rate – or in some cases at a monthly managed rate. Sometimes for larger loans (for example, £15,000 plus) you can negotiate a repayment holiday from repaying the capital you borrow. So for, say, one or two years, you pay only interest. You may also be able to arrange stepped repayments. The amount you can borrow can vary from £1,000 to £1 million. The type of loan you can get depends on the viability of your plan.
You can get a list of members that offer business loans from the Finance and Leasing Association*. The Internet can be a useful tool to help you to compare loans and see what’s on offer, because some web sites – for example, www.moneysupermarket.com – have comparative tables of loans. Alternatively, use a broker to help you, but stick to members of the National Association of Commercial Finance Brokers*, who must follow a code of practice and have proper complaints procedures.
Most banks also have a factoring or invoice discounting arm, which they may introduce you to.
Peer-to-peer lending works through web sites that bring together people who want to lend and those who want to borrow, bypassing banks or any other intermediary. These sites started with lending between individuals but have now expanded into business loans.
If you want to borrow, you register with the site and fill in an online application form. You decide how much you want to borrow (between limits, say, £5,000 to £250,000 or £1,000 to £1 million) and for how long (say, one, three or five years). You provide details of why you want the loan and submit to a credit check. The site operators assign a risk level to your loan and then lenders bid to lend you funds. Their bids specify the amount they want to lend to you and the rate at which they are willing to do so. The process continues until you have raised the full amount and the rates you pay are the lowest that have been bid. You may have the option to leave the auction open to see if you can get a better rate.
Loans may be unsecured or secured against your business assets or specific invoices. The web site operators administer the loan, so you make one repayment which is then distributed to your various lenders. The site operator takes a fee (added to your outstanding loan) which varies with the size and term of the loan – say, £100 for a £5,000 one-year loan up to £10,000 for a £250,000 five-year loan.
Peer-to-peer lending was given a boost in the Budget 2012 when the government pledged £100 million to promote unconventional forms of business lending, such as the peer-to-peer route. This is part of the Business Finance Partnership (p. 308). Initial investments of £35 million in the peer-to-peer lenders MarketInvoice*, Funding Circle* and Zopa* were made in 2013. Peer-to-peer lenders have experienced increasing participation from large-scale lenders, such as family trusts, stock traders and institutions.
Other large UK peer-to-peer business lenders include ThinCats*, Assetz Capital*, Rebuildingsociety.com* and FundingKnight*. For a list of peer-to-peer sites, see http://p2pmoney.co.uk/companies.htm
In the creative sector, online platforms such as Kickstarter* provide an alternative. On Kickstarter, creators of projects or start-up companies can launch their idea on the site, set a funding target, and seek pledges of financial backing from anyone who has the belief and enthusiasm to support the project. The creator retains complete control of the project or company. Backers do not obtain any profit but creators will generally give some kind of reward to backers as thanks for their support.
An alternative to raising loans via an online platform is to offer shares in your business by the same means. This is known as equity crowdfunding.
The UK has been an early adopter of equity crowdfunding through sites such as Seedrs*, Crowdcube* and BankToTheFuture*. There are also sector specialists such as Abundance Generation (renewable energy projects). A directory of crowdfunding sites can be found at www.thecrowdfundingcentre.com
Equity crowdfunding has the advantage that investors who buy shares in your business will have a long-term interest in its success and sustainability, and are likely to become advocates for it.
According to industry research by www.crowdsourcing.org and the World Bank, crowdfunding raised $16.2 billion in funding transactions in 2014, and will surpass $300 billion by 2025.
In March 2014, the Financial Conduct Authority* announced new regulations affecting equity crowdfunding. These stipulate that clients of crowdfunding platforms can only invest up to 10 per cent of their investible assets in equity crowdfunding. However, after two investments you are classified as a sophisticated investor and the restriction no longer applies.
There is a growing body of private investors, often called ‘high-net-worth individuals’, who are prepared to back business ventures. Sometimes, these people are called ‘angels’, that is they provide money for risky ventures.
The enterprise investment scheme and capital gains tax reinvestment relief give tax concessions to make it more attractive for private individuals to invest in unquoted companies. With deferral relief, it is possible to put off paying capital gains tax if a private investor sells some shares but reinvests the proceeds in the new shares of a private company.
There is also a Seed Enterprise Investment Scheme (SEIS), giving tax reliefs for investment in small, early-stage companies (25 or fewer employees and assets up to £200,000).
The UK Business Angels’ Association* is a trade body for business angel networks, which are organisations able to back entrepreneurs. Its web site contains a list of members.
With a venture capital fund, money is put up by pension funds, insurance companies, banks, investment trusts, industrial corporations, Regional Development Agencies and private individuals. Some venture capital funds are set up as venture capital trusts (VCTs), which offer tax concessions to investors and invest the fund in growing companies. Not all of the funds will provide money for people who are starting up; most only provide funds for businesses that are expanding. You can get information about VCTs from the British Private Equity and Venture Capital Association (BVCA)*.
Venture capital funds are looking for companies with very good management, operating in a market that is either very large or is growing fast. The funds want to invest in companies that could reach significant profits within three to four years. Many, but not all, want to be able to sell their investment in three to seven years and hope that the company will have grown enough in that time to be floated on the stock market or be sold to another company. This would allow the funds to sell their shares and turn their gains into cash.
If you approach a venture capital fund, the things to look out for are:
An outline of government-backed funding schemes is given earlier in this chapter (see p. 307); for information contact the Business Support Helpline* (England) or the equivalent organisations in other parts of the UK.
The corporate venturing scheme was introduced to encourage established companies to invest in small, higher-risk trading companies. The investing company gets 20 per cent corporation tax relief on its investment in ordinary shares of the trading company, provided it holds on to the shares for at least three years. Deferral relief is given on gains where they are used to invest in another trading company under the scheme. And losses can be set against the investing company’s income.
For your company to be eligible as the target investment, it must be unquoted at the time the investment is made (and with no firm intention to become listed). If, later on, you do become listed, your company does not cease to qualify. The investing company can take no more than a 30 per cent stake in your business.
Large companies often undertake corporate venturing in order to invest in young business that they consider could become strategic in their own sector, with a view to buying them at a later stage.
There are a lot of useful tips on how to present your plan scattered through this chapter and Chapter 6, ‘The business plan’. The step-by-step guide below draws all these tips together.
18.191.240.222