Raising Finance – the fundamentals (Part 2)
Private matters, December 2012
Before an organisation looks towards external debt and equity financing it should consider its own internal ability to generate finance, in particular from cash reserves and asset realisation. A key challenge for managers of any growing business is to strike the proper balance between consuming cash and generating it. Fail to strike that balance and even a thriving company can soon find itself out of business- a victim of its own success. By managing the company’s operating cash cycle- the amount of time the company’s money is tied up in inventory and other current assets before the company is paid for the goods and services it produces- an organisation can manipulate the rate at which it can sustain its growth through the revenues it generates without going cap in hand to financiers.
If external debt funding is required, the company’s balance sheet may have a number of asset sources that can be used as leverage to secure finance. These include:
Asset source finance facility
|Stock||Stock overdraft facility|
|Plant & Machinery||Medium term loan
|Land & Buildings||Long term loan/ mortgage
Sale and leaseback
Some of the main considerations with these types of facilities are set out below:
Invoice discounting is still very popular as a financing tool for funding the working capital requirements of a business and can also be used as a source of finance for acquisition/ corporate transactions. The bank’s security is ring-fenced against the organisation’s debtors and it is administered easily through an on- line banking solution so it is easily set up. Depending on the nature and profile of the customer base a company can draw down a specific percentage (typically around 70%) of discountable debtors in advance of the cash being received from customers. Invoice discounting will currently cost between 5% and 7% (cost of funds plus margin) depending on the profile of the debtor book which will be subject to the completion of a bank survey prior to draw down.
A stock overdraft facility is usually provided in conjunction with invoice discounting and is appropriate to a business that has a seasonal requirement for financing the production of stock. It tends to be sector specific with stringent conditions on when the stock facility is to be repaid back.
Term loans are generally secured loans for a fixed period and are suitable for funding the purchase of a fixed asset between two and five years. Loan to Value lending is currently in the region of 50% to 60% of the market value of the asset. Interest rates will vary but in general are currently 5.5% to 7.5% (cost of funds plus margin) for senior debt facilities.
Leasing describes the process where the bank supplies funds for the purchase of an asset and is then paid instalments over three to five years. At the end of the period the asset is bought outright by the borrower for a nominal value. Lease terms generally match the business benefit of the asset to the finance repayment period. In the current market banks are reluctant to provide leasing for certain traditional asset classes such as motor vehicles and plant & machinery as the value of their security is diminished.
Therefore, leasing tends to be an ancilliary service provided to clients in addition to core debt funding rather than stand alone financing.
Commercial mortgages are usually for the purchase of property and have a repayment period of between seven to twenty years. In the current market the preference for banks is to lend against underlying cash flows of the business rather than against asset/balance sheet values. A company could now expect to raise 50% to 60% on the value of an unencumbered property as against c.80% previously. Sale and leaseback is also an option, however, visibility on sustainable rental income over the long term will be of key concern to the investor and bankers.
Other external debt finance options include bridging finance and supplier /expense financing. Bridging finance is a temporary measure that bridges the period from when the expenditure is incurred to the time that specific income dedicated to fund the expenditure is actually received. Pre-determined supplier / expense finance occurs when a bank discharges large expenses of a business like Insurance costs. Pre-determined supplier / expense finance is expensive but is usually unsecured.
Securing the selected option
The main debt and equity sources of funding available to an organisation in the current market consist of the following:
- Bank finance
- Grant finance
- EIIS (Replaced BES scheme)
- Seed /Angel /Venture Capital
- Private Equity
- Capital Markets
Bank finance is available to most businesses with a trading track record that have the ability to provide an element of personal or corporate security. In the current market, sourcing bank funding is however, more challenging and increasingly more expensive. When seeking to secure bank finance the following core issues need to be considered:
- Business background and track record with the bank
- Personal relationship with the bank manager
- The sector you operate in and the risk profile
- The organisations’ repayment capacity
- Security available to offer
- Conditions and costs of borrowing
Some common symptoms of weakness regarded by banks are as follows:
- Lack of experience
- Lack of own capital
- Unplanned expansion
- Taking too much out of the business
- Growth of sales seen as salvation
- Too few customers
- Too few suppliers
- No management back up
Outlined below are some tips towards securing bank finance in the current environment:
- Prepare a clearly focused business plan to support the finance application
- Be consistent with the information provided
- Know your business plan thoroughly and do a mock interview
- Manage the organisation’s creditworthiness
- Shop around for the best rates – two to three banks
- Don’t be afraid to provide a site visit to bankers as they emphasise business reality
- Try to give away a minimum level of security bearing in mind future funding requirement
- Build on bank manager empathy and emphasise a partnership relationship
- Where possible, try to include some element of equity financing in the proposal
Grant finance is specific to particular assets in a company while EIIS is a good way to raise development capital from friends, relatives and high net worth individuals. It should be said that the current EIIS scheme is not proving as attractive as the government would have liked as the tax breaks for individuals earning over a certain income threshold have been restricted and along with an overall reduction in disposable income this appears to have reduced the appetite for this type of investment in the marketplace.
Seed/Venture and Business Angel Capital are currently hot areas of focus by the government and are of particular interest to high performance/high growth businesses particularly in the ICT and Life Sciences sectors. Bank finance is not as easily secured by these types of businesses due to the IP / Intangible nature of the business. This type of equity finance does provide a solid capital base for the future and brings in shareholders with a network of experience and contacts without a company having to put up personal guarantees or charges over the business. It does however dilute shareholder equity, can be costly and difficult to attract because of particular stringent criteria applied in the investment decision making process. It will suit only certain types of companies.
Private equity finance is similar in nature however can be a good source of finance where a business has a strong management team, established revenues and is seeking to grow internationally but needs the capital and experience of this type of investor to do so. At all times management’s vision and exit strategy for the business must be aligned to its shareholders.
Capital Markets funding is still an option despite the current low level of IPO’s if the business is focused on particular sectors such as mining and resources and ICT however companies need experienced legal and professional advisors as there is a considerable amount of red tape and regulation that needs to be overcome when floating the business, and the financial governance and reporting requirements can be onerous.
There is a wrong way and a right way to raise finance for an organisation. A positive mental attitude to financial matters and knowledge of the funding cycle is critical for an organisation when considering a financing decision. The presence of a well thought out business plan and ability to “best fit” the organisation’s funding needs to appropriate funding sources will facilitate the securing of finance. Organisations should constantly communicate with providers of finance to ensure that there are no surprises when it comes to funding. When raising finance an organisation should not lose sight of its core business strengths or underestimate the level of management time required in the process. Ultimately it is the role of the corporate finance advisor to advise on the type and level of finance required and to add value to the funding cycle through obtaining the right type of finance for the lowest cost in the appropriate time frame for clients.
For more information, please contact:
Director, Corporate Finance
+ 353 1 417 2437
Greg is a Director in our Corporate Finance department and specialises in advising companies and investors on their Merger and Acquisition and Exit strategy and raising finance for the future growth and development of Irish businesses.