A question of funding

Founder of the School for Startups, Doug Richard is at the forefront of entrepreneurial endeavour. Dan Matthews asks the business mentor and original TV Dragon how best to finance growth

How would you sum up the environment for ambitious businesses that want to secure funding?

The environment right now is incredibly challenging. Weaker trading conditions mean customers are paying slower, vendors are asking for stricter terms and small businesses are getting caught in the middle because the need for working capital has increased at precisely the moment that their balance sheet has weakened. And so, though the banks have made public commitments to increase their lending, we are finding that bank lending is actually decreasing as they are finding fewer eligible borrowers.

In your experience as a mentor to startups, have you seen the situation improve or worsen in the last five years?

The last few years have seen a crisis of consumer and commercial confidence. The thing to remember is that it’s not simply a case of businesses being unable to get funding, but of them not looking for it. Well-established businesses that would normally seek to expand by borrowing money on what are currently attractive rates, are choosing not to and are not investing money in their businesses because they are uncertain of the near-term economic prospects. That is to say, businesses that are in good financial shape are acting more conservatively.

To what extent is it the fault of the finance industry, the economic backdrop or the entrepreneurs themselves when businesses can’t get funding?

It is not in the nature of a bank to take risks. As a rule, they make a relatively small profit on lending – usually in single digit percentage points – and will look to secure the loan so that, if the business cannot pay it back, they have other assets which can be taken in lieu. If you run a business that is largely an intellectual property business, such as a marketing agency, software company, apps developer or any of the new age businesses that are creating much of the growth in our economy, the one thing you don’t have is assets. You don’t have machinery, you don’t have buildings, you don’t have equipment – things that a traditional bank would look for to secure traditional lending. That makes it more challenging because either the loan doesn’t get made, or the loan gets made at a much higher price.

What would you say is the best alternative to bank loans and overdrafts?

I think you have to start looking to things like Zopa, a web-based business that allows people to gain unsecured loans by matching individuals with money to lend with those who want to borrow it, up to a relatively modest amount. This is one of the few exemplary and innovative responses to market failure that are providing alternative funding mechanisms based on a 21st-century model. However, the challenge remains that even with these alternative sources you have big gaps in the market and these are largely for the young, balance-sheet light, intellectual property or creative enterprises.

What are the basics that all entrepreneurs should follow when they try to secure third-party money?

To some degree, quality of serviceability will offset lack of assets. If you can show that you’ve got purchase orders from blue-chip customers, it will offset the lack of physical stuff in your business. I would encourage people to look at the quality of their revenue, not the quantity. How certain is it? How good is the company that the money is coming from? This will increase the likelihood of getting an attractively priced loan.

What was your experience of seeking funding – what mistakes did you make?

I’ve learnt that rule number one of funding is, if you’re in a position right now to get a bank loan and you haven’t, there’s a lot to be said for taking one out and not using it. Equally you could consider borrowing a small amount and paying it back perfectly. Banks are really quite mechanistic. If they already have you as a borrowing customer, they’re more likely to lend to you in the future. And if you pay back a small loan perfectly, that will improve your credit score wildly and make you far more attractive than you have any right to be. So you can manufacture credibility quite easily if you’re in a position to borrow at all. And you should if you can, if for no other reason than to lay the foundations for future lending.

Is the funding environment in the US healthier than in the UK?

I think the difference between the US and the UK, when it comes to lending, is the nature of the banking industry. In the UK, we have a few players who have a locked grip on the marketplace. In the US, there are tens of thousands of banks jostling for position. This leads to a lot more liquidity in the market, a lot more competition, and a lot more innovation in products and services. Therefore, there’s inevitably a bank out there that’s willing to do something different to gain market advantage.

Doug Richard is a serial entrepreneur, angel investor and champion of business innovation, both at an individual and policy level. Through his School for Startups, Doug has delivered instruction to more than 10,000 business owners, with help from universities, public institutions, such as the British Library, and philanthropic organisations, like the Royal Institute of Great Britain. In 2006, he received an honorary Queen’s Award for Enterprise Promotion and, in 2010, an Enterprise Educator Award from the National Council for Graduate Entrepreneurship.