Demystifying funding options

Our latest Economic Engine survey of 500 mid-market businesses shows that sourcing new capital is one of the top priorities for more than one in 10 East Anglia businesses (15 per cent) over the next six months.

When you consider that more than half of regional businesses (53 per cent) feel more confident about their business prospects this year compared to the second half of 2023 then the scene is set for potential growth.

But, for ‘mid-market’ businesses – those typically with a turnover between £10 million and £300m – access to capital can be particularly challenging, with securing new funding often cited as an issue. Therefore, identifying the right type of funding, appropriate to a company’s situation and circumstances, is incredibly important.

Additional or replacement funding may be required by a business for a variety of reasons, including:-

• Short term cashflow issues
• Refinancing of short or long-term debt that may be expiring
• Funding of new capital equipment
• Funding the acquisition of another company
• Funding growth in working capital
• Sourcing of replacement equity capital to ‘cash out’ or de-risk the owner(s) of a business and/or funding to support growth.

It’s very common for businesses to use different types of finance supplied by different providers. For example, they may have access to finance from two or three banks, or may have access to further types of finance by virtue of their established record and ability to provide security.

Given there are many different options available to businesses when it comes to securing funding, the question is: what is available in the market and how do the various options differ?

Overdrafts

Business overdrafts provide a company with the flexibility to dip into additional funds (up to an agreed amount) as and when it’s required – and is therefore often used to manage cashflow issues or unexpected expenses.

They’re often more attractive than business loans as you only pay interest on the overdraft balance rather than the facility limit. The other advantage is quick access, giving you the confidence to know that working capital is available for businesses purposes.

The disadvantage is that they’re repayable on demand and will therefore be classified as a current liability (rather than a long-term liability) in a company’s financial statements.

Grants

Depending on the sector, industry and life cycle stage of the business, grants may be available from a variety of different sources for specific projects. This could include a new product or process, job creation or a training programme. Grant funding typically provides between 15 per cent and 60 per cent of the cost of the project.

A recent example of grant funding is the $1.5 million grant awarded by the Bill & Melinda Gates Foundation to Cambridge’s Owlstone Medical.


Bank loans

Money borrowed from a financial institution, such as a bank, is typically arranged over a set period and within an agreed schedule, with interest or finance charges added to the principle value.

Bank loans can either be short- or long-term, depending on the purpose of the loan, whether that’s purchasing assets, such as vehicles and hardware (i.e. computers), as well as covering other major purchases and business ventures, or debt consolidation/ restructuring.

Before agreeing to a loan, lenders will take into account the financial health of a business (typically revenue/profits), as well the company’s credit score and debt levels. Loans can also be secured against collateral, or unsecured, the latter being typically more expensive and more difficult to obtain. It’s also quite usual for bank loans to have certain financial covenants/conditions attached to them – for example, interest cover/ cashflow available for debt service etc.

Invoice discounting/invoice factoring

This method of funding allows a company to access money held in unpaid customer invoices. Instead of waiting for a customer to pay an invoice, particularly those that have longer payment terms, you can take out short-term loans from an invoice discounting company, which typically lend up to 95 per cent of the value of the invoices. Once your invoice is paid, you pay back the loan.

Invoice discounting is an effective way of managing cashflow – something which is vital for well-run businesses. Companies that are well suited for invoice discounting are those that provide tangible goods or services.

It’s commonly used by businesses that have high levels of working capital tied up within debtors. It’s also used by growing businesses which are seeking to manage their working capital. Examples include manufacturers, wholesalers, engineers, transport companies and labour hire/recruitment service providers.


Hire Purchase

Hire Purchase ‘HP’ is a funding option used by businesses looking to purchase assets without the need to pay the full value immediately. Once a deposit has been paid, a company then agrees to a repayment schedule over a period of time to clear the remaining balance and any outstanding interest. This is an effective means of delivering capital expenditure projects, such as maintaining or purchasing physical assets like property, plants, buildings, technology, or equipment. HP typically involves a company taking ownership of the asset at the end of the contract term.

Contract Hire

Contract Hire is a type of finance available to companies involving a lease agreement that helps fund a company’s use of an asset (for example a car or a van). By contrast to Hire Purchase, and as a form of lease, using Contract Hire means a company doesn’t actually end up owning the underlying asset.

Crowdfunding

Crowdfunding is a far less common but popular method of fundraising, particularly in certain sectors, which involves a large number of people who are bought into financing a specific project or business growth. It’s typically used by start-up companies, or growing businesses, as a means of accessing alternative funds.

By crowdfunding you can reach a wider audience, build a loyal community and customer base and, given the large number of people involved who generally invest smaller amounts of money, it provides a lower risk investment option for ‘wannabe’ investors.

An example of a crowdfunding campaign is Scottish craft brewer BrewDog, which undertook various rounds of fundraising from largely customer loyal investors to pay for various projects and expansion.

Venture Capital

Venture Capital (VC) is a form of investment best suited to early-stage businesses that have strong growth potential.

VC has a clear appetite for investing in new companies, taking a minority stake in a business, often alongside other investors. The sector has made a name for itself in innovative sectors, such as life sciences and fintech, backing ‘disruptive’ businesses that have significant growth potential.

Venture capital enables growing businesses, often those not yet making a profit, to focus on growth, whether that’s expanding operations, product development, or recruiting new talent.

Private Equity

Unlike venture capital, private equity will typically target more mature businesses that have been established for a number of years and have a proven track record with strong growth potential.

Private equity funding is typically identified as a potential funding solution in instances where a business requires replacement equity capital to cash out or de-risk the owner(s) of a business and/or funding to support growth.

Private equity houses have a higher tolerance to risk than other forms of funding and are well suited to those businesses with strong growth ambitions. Investors will provide either minority or majority funding for an equity or ownership stake in a business. Typically, PE houses are brought in to maximise growth, adding expertise and funding to help realise a business’ potential.

Private equity funding enables companies to expand capabilities, enter new markets or territories, improve operations, or execute an ambitious acquisition strategy, often referred to as ‘buy and build’.

Tax issues

Whatever funding option a business chooses, there are tax implications to consider, including Capital Allowances, VAT/Stamp Duty, Corporation Tax, Income Tax & National Insurance.

Businesses considering funding options should therefore seek professional advice to ensure they understand the tax and other consequences of the type of funding they are seeking to secure.

There are many options available when it comes to accessing capital or funding, the key is understanding the role each has to play, what your funding requirements are, and then marrying the two to create an appropriate funding package to help achieve your aims.