Where to find alternative finance

If banks are reluctant to lend or conventional finance dries up, there are other ways of funding business, as Catherine Wheatley explains

INVOICE DISCOUNTING

HOW DOES IT WORK?

Banks or finance companies buy a firm’s outstanding trade debts at an agreed funding rate. When the business raises an invoice, lenders advance up to 95 per cent of its value immediately and pass on the remainder – less fees – when customers settle. Firms are responsible for collecting debts, but payments received are administered by the lender.

BEST SUITED FOR

Larger firms with poor cash flow, efficient billing systems, established business clients and predictable future income streams.

CONSIDERATIONS

Fast, flexible finance with no borrowing limit, advances are linked directly to sales. Fees and interest can be expensive, and it will increase the finance department’s workload.

ANGEL INVESTMENT

HOW DOES IT WORK?

Private individuals or a consortium put between £10,000 and £750,000 into promising firms for an equity stake. Most angels will also bring contacts, experience and ideas. The investment is unsecured and therefore risky, so backers demand a substantial minority stake and expect an exit in three to eight years.

BEST SUITED FOR

Ambitious entrepreneurs with strong management skills and a disruptive business idea capable of fast growth and market domination.

CONSIDERATIONS

Investments with a personal dimension can flourish or flounder on the strength of the relationship. Check angels are certified as a high-net-worth investor or sophisticated investor.

VENTURE CAPITAL

HOW DOES IT WORK?

Venture firms back startups on behalf of institutional clients prepared to take risks in exchange for the chance of a stellar return. To protect their investment, most backers take a boardroom seat until they exit after three to five years. Typical investments range from £500,000 to £5 million, depending on the firm’s size.

BEST SUITED FOR

Seed, startup and early-stage companies with few earnings, but high growth potential in sectors including media, technology and life sciences.

CONSIDERATIONS

Expect potential backers to take a close look at the company’s books, to be intimately involved in both strategy and management, and to seek co-investors as the company grows.

CROWDFUNDING

HOW DOES IT WORK?

A growing number of online funding platforms offer startups the chance to pitch their business directly to thousands of potential lenders or equity investors. Individuals put in anything from £10 to £100,000. Raising finance can take days or months, depending on investor interest. Typical fees are around 7 per cent of funds raised.

BEST SUITED FOR

Colourful, engaging or ethical startups with mass appeal, three years of realistic financial forecasts and flexible funding deadlines.

CONSIDERATIONS

Write your pitch in plain English and apply for Enterprise Investment Scheme tax relief on your company’s shares. Be aware that most firms do not reach their funding target.

GUARANTEE SCHEME

HOW DOES IT WORK?

Banks unwilling to lend to viable firms because they lack collateral can suggest applying for an Enterprise Finance Guarantee loan. If accepted, the government underwrites 75 per cent of loans between £1,000 and £1 million, which can be used for working capital or refinancing.

BEST SUITED FOR

Firms without significant assets and a turnover of less than £41 million. Export businesses, and firms in finance, transport and certain other sectors, are ineligible.

CONSIDERATIONS

Terms vary between banks, but borrowers remain liable for the full amount of the loan, including an annual premium to the Department for Business, Innovation & Skills of 2 per cent of the outstanding balance, payable quarterly.

VCTs

HOW DOES IT WORK?

Venture Capital Trusts (VCTs) provide a tax-efficient way for investors to back promising enterprises. Typically, fund managers raise between £20 million and £50 million to back 20 to 30 companies. Entrepreneurs must produce a business plan and make a convincing presentation. Investors exit after a minimum of five years by trading VCT shares on the stock market.

BEST SUITED FOR

Riskier enterprises than venture capitalists would normally consider. Firms must be unquoted, have fewer than 50 staff and assets under £7 million.

CONSIDERATIONS

VCT managers must invest 70 per cent of the fund within three years to qualify for tax breaks, so they will listen to promising ventures, but exercise caution as the expertise they offer varies.

PRIVATE EQUITY

HOW DOES IT WORK?

Private equity firms raise investment funds and bank borrowing to acquire some or all of a management team’s shares in the business. They use capital, debt and extensive market knowledge to transform the company’s business model and boost its market value in advance of an exit.

BEST SUITED FOR

Established firms across all sectors that need funds, advice, contacts, restructuring or management expertise to maximise their potential.

CONSIDERATIONS

Expect a lengthy deal process with significant advisory fees. Managers are often persuaded to take on large corporate debts to finance restructuring. Exit opportunities can be scarce in a downturn.

PUBLIC FLOTATION

HOW DOES IT WORK?

Businesses offer a proportion of their shares for sale on one of two exchanges designed for smaller firms. Companies can raise up to £10 million on ISDX or up to £100 million on AIM, which asks for more detailed legal and financial compliance. Nominated advisers, brokers, lawyers and media consultants co-ordinate the process.

BEST SUITED FOR

Firms with strong growth and profits that want to offer investors an exit, create shares to fund acquisitions and boost their profile.

CONSIDERATIONS

Expect roadshows and due diligence to distract from day-to-day management, and advisory fees of up to £300,000 to dent finances. Public scrutiny is fierce. Shares can go down or up.

CASE STUDY

ANGELS SPRINKLE SUCCESS

Automist

Without support from business angels, Yusuf Muhammad would never have turned his design for a domestic fire sprinkler into a profitable venture.

“We had a good idea, but we were straight out of university so we had no experience, no contacts and no revenue. The banks wouldn’t look at us,” says Mr Muhammad, 30, who launched London-based Plumis in 2008 with William Markant and Alan Hart.

The trio pitched Automist, a sprinkler that can be attached to a pump and fitted in homes, to Cambridge Angels, a network of more than 30 high-net-worth investors. Group members have invested around £200,000 over two rounds in exchange for a minority stake in the business.

“Naturally, the money was important, but so was the personal chemistry. We had to be comfortable signing a contract and then picking up the phone to ask for advice,” says Mr Muhammad.

Plumis used the funds to develop their prototype into a product. On the advice of the backers, the trio supply Automist to accredited installers rather than retailers. “Fitting Automist allows homeowners to take out fire doors and alarms, so it’s important it’s done correctly,” Mr Muhammad points out.

Last year Plumis turned over £350,000. “We have a smaller share, but it’s a much bigger company today, thanks to angel investment,” he concludes.

CASE STUDY

GUARANTEED BEDFELLOWS

Furmanac-Symphony-Chaise-LR

When John Hilliard needed capital to invest in machinery for his adjustable bed business, his bank suggested the Enterprise Finance Guarantee scheme.

“We have transformed our business model over the past five years from wholesaling to manufacturing. Our turnover has doubled, but we do not have many assets, which makes borrowing difficult,” says Mr Hilliard, 50, managing director of Dudley-based Furmanac, a family-owned firm.

He was already using invoice finance so the chances of securing conventional borrowing were slim. But last year Lloyds Bank Commercial Banking arranged a £250,000 loan, guaranteed by the government-backed scheme and repayable over ten years.

“We have had bad experiences with other banks, but overall this process was quick and straightforward,” says Mr Hilliard. “I had to give information about my personal assets, but our accountant prepared financial projections for the company and our relationship manager advised us on the application. It was done within 48 hours.”

Since then Mr Hilliard has taken on more staff, refurbished his premises and grown revenue to £11 million.

“It’s a competitive method of borrowing compared to our other sources of finance,” he says. “It’s frustrating that growing firms can’t get finance in the usual way, but if you need to raise capital, I would recommend it.”