All businesses aim to grow and expand, but financing the step up from a small to a medium or large business can be difficult. Nick Gross explains the five most common routes.
Friends and family
Many small businesses will often start with money from friends and family – it is a well-trodden route that works well when relatively modest amounts of cash are needed and a business remains small. Financing growth, however, often demands greater investment than most individuals or families can stomach.
Investment from friends and family can lead to tensions that could easily tear a business apart. Consideration needs to be given to individuals wishing to take their investment out of the business, and how much influence investors can have over the day to day running of the business. A legal agreement which addresses these issues head on before the business attains any significant value can often help.
Funding growth from cash generated by the business sounds the perfect solution, particularly as no debt is taken on. And if the business can afford to do so, it is. For businesses that need significant amounts of money, perhaps to fund new machinery or buildings, this is rarely an option.
Self-funded investment is likely to leave a sizeable hole in a business’ finances that will need to be plugged. This can have a knock-on affect on cash flow, particularly if the business is expanding quickly. We have seen all too often rapidly expanding businesses collapse because of cash flow problems.
The banks have had bad press in recent years over their reluctance to lend to businesses; and whilst lending levels are increasing, banks are always going to struggle with what they perceive as high risk lending.
But that does not mean the banks are unable to help. Banks want to lend on debt, so invoice discounting might be the answer. The company’s overdraft facility is also a valuable form of short term lending that many businesses rely upon.
Private equity investors are prepared to make significant investments, but will want a lot in return. They will want a stake in the business and will set tough targets for the business to meet. They will also have an eye on their exit. On the upside, a private equity investor can bring valuable expertise and can help to increase the value of the business.
Private equity is not for every business. Think first about the support the business actually needs and the skills it lacks, and ask whether a private equity investor can meet those needs. It would be wise to consider all other options before embarking on the private equity route.
Crowd funding is the exciting new kid on the block, allowing investors to club together through an online platform to make investments. Individual investors tend to put up relatively small amounts of money, but the overall investments made into a business can be quite significant.
There are a number of crowd funding models; among the most popular are a loan model under which investors receive interest, but often at a higher rate than the banks’ usual charges, and one where investors take an equity stake in the business in which they invest. Crowd funding is expanding quickly, but is still very much in its infancy. Its risks are perhaps not yet fully understood.
Whatever route a business chooses to follow it is always wise to take advice and weigh up the pros and cons before making a decision.