Funding my growing business
In this second part of the series on obtaining finance for your business, we look at obtaining finance from banks and non-bank lenders. This article focuses on working capital finance as this is often the most challenging form of finance to obtain. This is a complex area as there are numerous variables to consider, but let’s look at the basics.
Understanding why you need finance
There are a number of questions to consider when deciding if you need finance.
Why do I need it?
Congratulations – you are more than likely needing working capital funding because your business is growing and you need to fund the additional cash flow costs of a growing business. Ask yourself why you need the finance and if there are any other means for you to manage the working capital requirements without borrowed funds such as negotiating favourable payment terms from debtors and creditors. If your business is not growing and you find yourself requiring loans, it indicates financial distress and it would pay to have a closer look at the symptoms for this lack of growth.
How much do I need?
Don’t become under-funded. Things typically cost more and take longer than expected. It is extremely difficult to get more financing when your business is in desperate need for the funds. A cash flow forecast is critical to quantifying how much you need and when. It will also help you determine if the funds are short term working capital loans or if the business requires long term core funding.
When do I need it?
Applying for loans can take a long time, anywhere from two days to two months (or longer, if it is a challenging application). It is important to understand how quickly you need the funds and whether your request, however simple you think it is, can be accommodated by your lender. Building a good relationship with your banker from your early days, prior to your request for a loan, is a great idea.
What happens if I need more?
As with anything in business, it pays to consider your financing strategy. No lender wants to be tapped on the shoulder every now and then with an urgent request for funds. It is worth thinking about the likely growth trajectory over the next three and five years and then speak to your adviser on what will work best for your business. We often see businesses who plan for the now and do not leave sufficient buffer in place for the future.
What will it cost me?
Ensure your business can afford the cost of the funds it has borrowed and that you understand the extra revenue and cash flow required to pay for the loans.
Does my cash flow indicate that I can comfortably repay the loans?
This is a crucial point. If you are unable to comfortably (and this word means different things for different people) pay down your loans over time, or if it is interest only, ensure interest repayments are serviced when due, otherwise your lender may get more actively involved in your business to protect their investment.
What is my total leverage in the business?
Risk management is an important part of being in business. It is important to understand where the risks are in your business and how you might be able to manage this with additional liabilities on your balance sheet. For example, what would occur if your major customer terminates your contract – will you still be in a position to repay loans taken out to fund expected growth? Don’t let yourself get caught short.
Are the returns worth the additional financial risk?
Part and parcel of running a successful business is to identify an opportunity and make the most of this. At times, this may require you to take substantial risks. However, where you have obtained external finance, the amount of risks you take needs to be managed carefully. Growth funded by borrowed funds will need to be less risky than other forms of growth as a lender will only lend funds when they are confident of receiving a return. Lenders also require various forms of security, which if things turn pear shaped, can result in a domino effect very quickly across your business and personal interests.
What do lenders typically look for?
- Security for the lending – so if it things go pear shaped, the lenders can recover their money. This type of security often includes equipment, debtors and real estate
- Ability to meet repayments – this is usually evidenced by a cash flow forecast showing an ability to fund the interest (and principal) of the loan over the term
- Financial discipline and good operating history – most lenders prefer an organisation to have at least two years evidence of a strong operating history. If you are a younger business, specific financing strategies can get you the funds you need as long as you have something to offer as security
- A business plan – lenders want to know the business model is sound
- Specific need for finance – working capital is typically needed to help fund growth. If you have any other specific needs such as funding specific contracts, the lenders will also look at this
- Personal guarantees – this will help cover any deficiencies for the lender should assets pledged as security end up being deficient
- A strong and competent management team that has been operating successfully.
Typical forms of working capital finance
- Overdraft and line of credit
- Short term loans
- Debtor finance
- Inventory finance
- Asset finance
- Traditional products (business loans, commercial bills etc.) secured by assets, typically real estate or in specific instances, large and valuable equipment.
A few tips to securing finance
- Get access to financing well before you need it. Chances are, you will be in a much better position to secure financing on terms that are favourable for your business. The need for financing is usually highlighted through a process of medium term business and cash flow planning. If you can’t see where your business is going three years out, you should invest some time right now to look at this
- A lender should be a business partner, someone who understands you and your business and is able to see the same opportunities you do. The cost of the borrowing is important, but for a growing business, a strong relationship with your lender is more important than the cost of finance
- There are a number of non-bank lenders that specialise in particular industries or types of finance required. However, always bear in mind the credibility of the institution you are dealing with – non-bank lenders who are not financially robust themselves may not be able to continue to support you long term - buyer beware in this case.
If you carry excess debt, this will place significant stress on you and the business and may contribute to a greater chance of failure. In this instance, failure to plan is almost certainly planning to fail. Consider your financing needs carefully and contact us to help you obtain the finance you need.