Getting extra cash into your business can mean anything from a quick top-up from your bank, to involving investors and taking the business to another level. Cameron Bayley considers cash injection options.
It’s a common SME roadblock: the time is ripe for some extra staff, new equipment or perhaps a change of premises for your business, but the bank balance just won’t allow it. Before despairing, take a look at options that may allow for an extra injection of capital. As long as your requirements aren’t unrealistic, and your business is healthy, there’s a good chance financial assistance could be at hand.
"The issue of funding for small business is not nearly as difficult as it was 10 years ago," says Sue Prestney, small to medium business spokesperson for the Institute of Chartered Accountants in Australia. "Organic growth is now able to be catered for fairly well, with normal banking arrangements."
If you’ve exhausted all forms of internal financing (see the ‘Boot Up Your Business’ box), a natural next step is to approach your bank. If you need a relatively small amount for a few months, a short-term overdraft may be all you need, says Stephen Moir, assistant managing director for the Small Business Development Corporation. The main factors to consider are how much you need and for how long, he says. "The golden rule is not to use short-term funds for long-term needs and vice versa."
Prestney explains that invoice and debtor factoring is one of the most useful fundraising products now offered by banks. "Because you can basically fund your sales without waiting for debtors to pay you, that allows cash to flow more quickly and you can obviously use that to grow faster." Banks are also becoming more competitive for the business dollar, she adds. "There’s probably not been a better time for small business being able to fund growth."
Looking for long-term finance involves shopping around. "Compare loans with the same features when looking for the best interest rate. A basic ‘no frills’ loan will generally have a lower interest rate than a more flexible loan which allows you to draw against repayments or offset savings against your mortgage," says Moir, adding that you should also take into account upfront, ongoing, and early exit fees. Some websites (see our breakout box) can help compare loans and other banking products. And sticking with your bank before looking for any sort of outside investment in the business has plenty of benefits, Moir adds. "The amount of the loan required may not be of interest to a private investor, whereas a bank or lending institution will lend smaller amounts," he says. "Debt repayments can be budgeted for and repaid on a monthly or fortnightly basis." Raising funds this way generally takes less time, and can involve lower costs than looking for any form of outside capital.
"Any sort of equity finance is extremely expensive," says Prestney. As banks only lend against assets, they have more security, whereas investors are looking for returns from the business only, so the greater risk means a greater return is required. "They’re basically taking an unsecured position. And the trade-off is that they want a high return."
However, there may come a point when you’ve reached the limit of what is available from your bank. "The end of the line with retail banking is when you’re growing more than just organically," Prestney says. "A business that’s growing very rapidly will get to the end of what a retail bank can provide based on the assets of the business." For example, a large sum of money may be required to market a new product. "So that’s when you are going to need someone to come in with you."
Finding a Business Angel or Venture Capitalist
The two most common forms of outside funding come from business angels or venture capitalists. The decision to take on outside investment from one of these should be well considered as it does involve more than just an injection of cash. "Business angels or venture capitalists become part owners of your business," says Moir. "They carry part of the risk, and share in the profits." The terms of their involvement may vary regarding expected returns and involvement in the company, and on both counts you will need to be prepared to negotiate.
Business angels tend to be "wealthy individuals who want to help out younger people and want to avoid all the fees of putting their money in managed funds," explains Geoff Waring, academic and former lecturer at the Australian Graduate School of Management. They will often give more hands-on help than professional advisers. "They’re usually willing to put more time in because they’ve got more time," he adds, explaining that a business angel may be a retired person who wants to help someone who’s just started out in their field. "If it’s their industry of expertise, that’s fantastic. It’s really one of the best forms of finance you can get." The business angel will invest their money and expertise for a specified time, and will usually sell their share of the business back to the business owner after a designated time.
The next step up is the venture capital route. According to Waring, venture capital firms will only look at investing in companies with a minimum sales turnover of about $5 million. "Most professional venture capitalists are not going to be interested in you if you’re small. They’re mainly looking for medium-sized businesses." For venture capitalists, the relationship will end after an agreed period of time, where the business may be sold, publicly listed, or a management buy-out will take place (where the company management buys the business).
"Often that will be part of the deal that the venture capitalist is going to want to have an agreed exit. That may or may not suit you, so if you’re thinking about equity capital you’ve got to take those sorts of things into consideration," says Prestney. "Business angels might be more flexible in that sense but they’re still going to want a high rate of return." The sort of return venture capitalists and business angels require could be anywhere from 15 to 35 percent or more.
The extra involvement in the business that outside investors bring is also what adds to their appeal and makes them worthy of consideration says Moir. "[They] will generally contribute time, talent, and management expertise to the business. A small to medium business may need this degree of capital and expertise to grow and manage the business."
The loss of your autonomy does have to be considered, however. "They will put constraints on you," says Waring. Most venture capitalists will require you to report to them, and will look for a return within a certain timeframe, he explains, usually when the business is sold. "You’ve always got to keep that in the back of your mind."
The bottom line is that it’s up to the business owner whether they’re happy to give up part of the business. "Do you want to own 100 percent of a small business or do you want to be a 20 percent owner of a much larger business," says Waring. "If you’re willing to be a 20 percent owner of a much larger business then you get some outside investors involved and you really do something significant, but then you’ve got to give up control and the feeling that you’re on your own."
If you do want to enter into a relationship with a business angel or venture capitalist provider, planning is vital. "There are risks in choosing this route, and the owner should ensure adequate protection of their rights," Moir says. "It is essential to have shareholder agreements covering issues such as dividend policy, director’s f
ees, exit strategies and dispute resolution."
One of the biggest mistakes businesses make is going for equity capital when there are different kinds of debt capital available, Waring says. Instead some businesses go for expensive outside equity that requires 20 or 25 percent return, where a bank will only expect around 10 percent return. "It is important to match the finance, debt or equity, to the circumstances," says Moir.
Getting advice is crucial. Waring recommends business enterprise centres, or accountants. "Ultimately your financing is based on your budgets, and your budgets are what your accountant can help you with," says Prestney, who also recommends getting legal advice, particularly if entering into an arrangement with an outside investor.
The common thread for any injection of capital, be it via banks or private investors, is that your business must be showing signs of growth. "If you’re not a growth business you won’t get any capital from any place," says Waring. "Because you’re not going to offer any kind of return that will justify the risk."
At the same time, you don’t want to be adding too much capital and getting too much debt too quickly. Prestney agrees, and warns: "You can go broke growing fast, easily." Taking a measured approach is important. "A big mistake is to take on too much before you need it," she says. "It all comes down to planning and having a great strategic business plan, with the numbers, with the budgets that actually support that."
Ultimately, there are finance options which can help in the short term, or take the business to a whole new level. Smart business owners will see the potential in their business, and then look for the right resources to address this, says Waring. "It’s been a booming economy and there are many opportunities out there."
Getting your Business ready
Before even considering external forms of financing, Geoff Waring, former lecturer with the Australian Graduate School of Management, suggests looking internally to see if there are any changes you can make to the business to free up some cash. Examples of internal financing (sometimes referred to as "bootstrap finance") include:
• making the most of credit provided by your suppliers
• taking out a mortgage or second mortgage
• credit cards
• outsourcing parts of the business
• leasing rather than purchasing equipment, vehicles, etc
• personal loans
• investments from family and friends
"Try and change the way you do business, so you don’t need as much capital," he explains. "That’s a common source of finance that most businesses use."
Some websites for financial assistance include:
www.vcjournal.com.au — the website where you can order the Australian Venture Capital Guide that lists some 200 sources of private equity, including business angel networks
www.avcal.com.au — home of the Australian Venture Capital Association Limited, this site offers information about the venture capital industry, such as how to get it, selecting an investor, and how the venture capital industry works.
www.businessangels.com.au — while many business angel networks are state-based, this is a national business angels matching network, listing investors looking for businesses, and businesses needing funding.