Please note, this information is for general guidance only and should not be taken as financial advice. Always seek professional advice before making any financial decisions. Your capital is at risk.
The world of business finance is becoming increasingly complex, as new lenders continue to enter the market with new funding products alongside established lenders updating their existing ones. As a result, deciphering exactly what lending partner and finance facility is right for your business is a decision that requires careful consideration and the reason we have written this Business Funding Guide.
As advisers who have helped businesses raise funding in a variety of different sectors for different purposes, the first question we ask ourselves when a business approaches us looking for funding is: “How, when and why does this business absorb cash?”
Good stewardship of a business isn’t simply saying, I need £X amount of pounds, it is understanding the catalyst that creates a cash requirement in your business. In this business funding guide, we dig into 3 common scenarios that create a funding requirement for a business and articulate which finance facilities work well with these scenarios.
Transactional Cash Requirements – Understanding Transaction Cash Requirements – Business Funding Guide
A transactional cash requirement is usually a one-off, infrequent event that necessitates an abnormally large cash requirement.
Examples are:
- Large Capex spends for purchasing equipment, premises fit-outs or R&D;
- Shareholder restructures such as Management Buyouts;
- Acquisitions of businesses; and,
- Acquisitions of freehold or long leasehold properties.
These are transactions that will likely not require ongoing funding and simply need a one-off lump-sum of cash.
Suitable funding options for transactional requirements are usually facilities that let you spread a large one-off payment into manageable chunks, and is, importantly, not reliant on a separate item in your business that is not being funded. Options for supporting transactional requirements are:
- Cash Flow Term Loans.
- This is a loan facility that is typically borrowed based on a business’ EBITDA and cash flows and is repaid over five years. It works well for business acquisitions, management buyouts and short-leasehold acquisitions where a business may not have tangible collateral to offer a lender such as property or assets.
- Asset Finance.
- This facility is borrowed based on the value of the asset being purchased. It works well for asset purchases as some lenders will often offer to pay both the cost and the VAT element of an asset purchase. It allows a business to purchase an asset and spread the cost of that asset over its useful life to better match the cashflows generated by that asset.
- Commercial Mortgages.
- If buying freehold or leasehold property, a commercial mortgage can be a strong option as properties are often one of the most cost consuming investments a business can make, and a commercial mortgage allows a business to spread the cost of a property over a period as long as 25-years.
Working Capital Requirements – How to Manage Working Capital Requirements Effectively – Business Funding Guide
A working capital requirement is often needed if somewhere along the line, your business spends more cash than it is about to bring in for a period. Common examples are:
- If you have to buy or build something before you can sell it;
- Deliver a service before you can invoice for it; or,
- If your business has seasonal cash flows and needs to support overhead costs during low trading periods before it receives cash in high periods.
A term loan is usually not suitable for this type of requirement as once you have spent the money from a term loan, it is gone; therefore, if your cash requirements are ongoing due to the trading nature of your business, you may need a funding facility that can be borrowed and repaid as your business requires it. Funding options for supporting working capital can be:
- Trade Finance.
- If you import goods from overseas or export products to overseas customers, suppliers may demand payment before they sell/send you goods, creating a cash outflow before you receive and sell the goods to your end customer. If this is the case, a Trade Finance facility can finance the purchase of goods and usually does so for a period of 90-120 days to give you chance to sell on the product and pay off the finance once you have been paid, thus matching your cash outflows with inflows.
- Invoice Discounting or Factoring.
- Alternatively, if you sell to customers on lengthy trade credit terms, you absorb cash by paying for materials, salary costs and other overheads before your customer pays you. Invoice discounting can effectively bring forward cash owed from unpaid invoices to match the business’ immediate cash requirements for supplying the product or service that it is selling.
- Revolving Credit Facility.
- If your business’ revenues are seasonal, but overhead costs such as salaries, rent and financing remain constant, you may have a period where your business is loss making and absorbs cash before it generates larger revenues in its peak trading period. If this is the case, Invoice Discounting may not work, as you can’t bring forward cash from invoices if there are no invoices because sales are not yet being made. Therefore, revolving credit facilities provide a product supported by a borrowing base that you can borrow money from when you need it (i.e. in low periods) and pay it back when cash is coming in (high periods).
- Hybrid Asset Based Loans.
- It’s quite possible that your business might have numerous points where it absorbs cash. For example, a haulage business will need to spend capex on purchasing new lorries, often completes work and needs to pay for salaries and fuel in advance of being paid by its customers, could require property to operate from and to potentially top it off, may even have seasonal cash flows. Rather than going to multiple lenders for separate funding facilities for each of those individual requirements, a single lender can provide all these facilities under one loan called a Hybrid Asset Based Loan.
General Growth Aspirations.
If your business is growing but does not yet have the trading performance to receive an adequately sized cashflow term loan to raise cash to invest in developing new products, hiring more staff or entering new markets, you may need a funder who is willing to buy into your vision and provide you with the cash you need to make it a reality.
As your business may not yet have demonstrated the clear ability to service the size of debt you’re looking to borrow, there are options where lenders will offer loans with PIK (Payment in Kind) interest, that essentially means that you can borrow cash now, and pay for the interest later when hopefully your business achieves the forecasts it set out to achieve. For this scenario, there are three main options:
- Venture Debt.
- Provides a cash flow term loan, often with an element of committed/uncommitted loan that is releases in tranches as the business achieves certain milestones. It differs from a standard cashflow loan as it may have elements of PIK interest as the lender understands the client cannot service debt yet and may also have equity instruments attached to it to provide the lender with upside for taking the risk of lending to a company that’s not yet proven trading.
- Community Development Finance Institutions.
- CDFI’s are institutions that lend to businesses because they are creating jobs in a community or making an impact on strong social causes. These lenders will take a view on start-up/scale-up businesses as their primary driver is to help develop the UK economy.
- Equity Finance.
- An alternative could be to sell shares to an investor to raise cash to support growth. This equity may not have interest with or coupon payments attached to it and as such, can provide you with the cash to scale your business without the impact of debt repayments.
As will be appreciated, funding is not a one-size fits all matter; therefore, you need to decide as a business owner exactly what is causing your business’ requirement for cash, and what product might be best suited for it.
