How to unlock small business finance
In this update to his 2005 AccountingWEB.co.uk guide, corporate finance expert Henry Fairpo discusses the barriers facing small UK companies that need investment to grow.
The UK has traditionally a slightly strange view of entrepreneurialism. Maybe it is because of our class system but there is still something slightly vulgar about entrepreneurs. This is in contrast to, say, the US where success is supported and failure is not necessarily seen as making businesspeople unbackable.
Sadly, we are not quite there yet in the UK. The smaller size of our domestic markets and the correspondingly smaller scale of the funding pool make raising capital harder for smaller businesses. The US on the other hand, with a population estimated at over 285m, has the potential to support businesses where the market in the UK would simply be too small.
And that is a very important point as market opportunity and sustainability are two of the key factors in finding finance. These elements underpin the ability to provide funders with the return they need on their investment or lending. Without them, and the keystone of a strong management team, the funding risk simply becomes too great. Pulled together in a simple and well thought through business plan and supported by real addressable market estimates with products to meet the market needs, they are the core of a funding proposal.
The ability to reach out to larger markets was, and is, the attraction of e-business. The logic is that if you can run your business from one place yet have global marketing reach then the economies of scale can kick-in without the need for the global infrastructures that have traditionally been needed. However, a number of the early business models either deferred revenue generation too dramatically, over-estimated domestic Internet take-up or simply were not focused on revenues at all. As a result, funders are wary of this channel to market.
One of the biggest hurdles to sourcing cash is other people being wary. Wary of sectors, wary of business models - even wary of your customers. Equity providers most often fall into the first two areas and the banks, factors and other lenders the second two.
Venture capital, be it from business angels or from funds, is about generating a high return from a portfolio of investments. The return is to repay them for the risks that they take, but they still want to reduce those risks as far as they can. This leads to further hurdles - terms and pricing.
Business Angels often want to be involved directly in businesses. VCs will get involved at least at a non-executive level and will, often, also want strict controls over areas of the business such as capital expenditure, acquisitions, directors’ pay and strategic direction. The level of involvement and the restrictions on freedom of action that may be required can be too much for entrepreneurs to stomach.
And then there is valuation. The inflated values of the mid-naughties have gone away and funders are back to the more traditional approaches of price/earnings ratios for profitable businesses and cashflow valuations for currently loss-making entities.
Debt funding relies on the quality of the underlying assets be they the book debtors or the entrepreneur’s own house – which, with sluggish housing markets, may be less than anticipated. There are schemes such as the Enterprise Finance Guarantee scheme (the spiritual successor to the Small Firms Loan Guarantee scheme) available through the banks but they tend to be cumbersome and of limited value given the small sums that they cover and the security gap they still leave. Financing book debts and stock has become more popular - the stigma attached to using factors seems to have diminished and a number of the lenders are becoming more sophisticated in their approach to the businesses they support.