How much money? What should you ask for?

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.

The money: what is it for?

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 ‘once-in-a-business-lifetime’ expenses of setting up: these include what you have to spend on your premises, on IT equipment and furniture, on legal and professional costs, and on initial marketing expenditure.
• Working capital: this is what you need to keep yourself going in the time gap between paying out cash for raw materials or stocks and getting in cash from the people you sell to. All businesses need working capital; the amount varies depending on the type of business, the credit terms you can negotiate from suppliers and the credit you extend to customers.

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.

The money: what type do you want?

You and your family

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.

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.

Where are you going to get your share of the money?

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.

When should you put in your money?

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.

Government, local authorities, charities, CDFIs

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:

• Specific types of spending: for example, research and development, property renovation or purchase of equipment.
• Specific areas: particularly deprived rural or urban areas – see Chapter 16, ‘Choosing your workplace’.
• Particular types of business: say, farming or post offices. In areas of high unemployment, funding may be targeted at encouraging micro-businesses (very small firms, such as one-man plumbers or decorators) to start up.
• Particular types of business person: for example, young people, women, people from ethnic minorities, the unemployed, older people.

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:

• Scotland: Scottish Enterprise* administers government finance and grant schemes to promote business. There are several strands with a variety of schemes within each strand. The Scottish Investment Bank supports a number of private-sector schemes for lending to business, including the Scottish Seed Fund which can provide grants between £20,000 and £250,000 for start-ups and young businesses that are launching new products, entering new markets or expanding employment. There is also funding available for premises construction, plant and machinery, marketing and so on, if you operate within specified sectors, such as construction, energy, food and drink, forest and timber, life sciences or tourism (see www.mygov.scot/business).
• Northern Ireland: government support is provided through the government agency, Invest NI* (www.invest.ni.com). Financial assistance is focused primarily on businesses that aim to sell outside Northern Ireland, are actively pursuing growth and can show that they will contribute to productivity and innovation in Northern Ireland. Start-ups may be eligible for financial help with the costs of marketing, consultancy, employment and working capital. To help businesses grow, Invest NI has, for example, programmes aimed at skills development (which can include funding to develop skills projects, hire trainers, and cover materials and trainees’ expenses), business and marketing strategies (which can include funding to scope and develop a business plan and employ non-executives who can contribute to the strategy), and capital expenditure. Other schemes foster networking, knowledge exchange and working collaboratively in order to promote research and development and joint ventures. Contact Invest NI for information and application forms.

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.

Banks

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:

1. Overdrafts (p. 306)
2. Loans.

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

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.

Equity crowdfunding

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.

Private investors

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.

Venture capital funds

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:

• Quantity of shares: the fund will normally want ordinary shares in return for the investment, as well as loan capital or preference shares, although there are exceptions. The percentage of shares varies from fund to fund; a few may want over 50 per cent, but it is unusual for a fund to want a majority stake in the company. The percentage of shares is not always affected by the amount of money you want to raise or by the voting structure.
• Board director: the fund will usually want to have one or two directors on your board, and you will have to bear the cost of this. You will normally be able to approve the choice of director. The yearly fees for a non-executive director can be in the £15,000 to £25,000 range.
• Due diligence: this is the term for the investigation that a venture capital fund will want to undertake before investing in your company. This can include visiting your offices and other work locations, taking up references from customers, potential customers and past employers, studying your accounts and selling systems, and having your product checked technically. The fund will want you to pay for this investigation; you can negotiate on this. How successful your negotiation will be depends on the level of interest shown by other funds.
• Legal and professional fees: there are yours and theirs. You will have to pay the legal costs for the funds on top of all your costs for raising finance. You will have legal and accounting fees, running into several thousands, plus the fee paid to a financial adviser, often based on a percentage of the money raised. In total, your share of the costs could run up to 10 per cent or more of the money you raise.
• Syndication: if you are trying to raise a very large sum of money, a venture capital fund may want a partner or two to provide the funds you wish. This may be because providing the amount of money you want could take up a fairly hefty chunk of the total money it has to invest, or it may just want to spread the risk. You may have to do a lot of the work yourself to bring together funds into a consortium to provide the money. This can prove very tricky and adds considerably to the amount of time it can take you to raise the money.

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.

Other companies

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.

Other chapters to read

6 ‘The business plan’ (p. 49); 8 ‘Off the peg’ (p. 69); 22 ‘Forecasting’ (p. 285); 25 ‘Moving ahead’ (p. 343).