Member Article

Private funding for SME’s: pros and cons

Many businesses are struggling to raise the finance they need to grow, take on new employees and purchase capital goods and stock. Whilst the banks say that they are keen to lend, many SME business owners find that the process can be onerous, with no ultimate guarantee of success.

Crowd-funding is causing a stir in the media at the moment, but it isn’t the only option available. Private funding, whereby businesses, individuals or pensions funds act as lenders, can also be a viable option for SMEs. Stuart Stones, partner at Ratio Law LLP discusses the merits of this type of funding, and the potential pitfalls to be aware of.

Whilst crowd-funding is causing a buzz at the moment, owner-managers should realise that it’s not the only alternative source of cash available to SMEs. Private funding, which is the provision of cash and potentially other benefits such as business consultancy, is also an option worth considering. Private funding is typically offered by cash-rich enterprises, individual ‘angel’ investors and pension funds.

In the current market, and perhaps surprisingly, there is plenty of cash out there for businesses to access. However, it isn’t instantly available, and business owners need to put in the leg work before trying to access it.

Private funders invest for a wide range of reasons. They may be attracted by the potential benefits available through the government backed Enterprise Investment Scheme, which allows investors to claim certain tax reliefs. There is also, of course, the hope that the investment will increase in value to provide long term rewards. It’s worth bearing in mind that every lender will have different needs and ambitions. Some, such as pension funds, seek low-risk investments with projected long term growth, others are willing to take a punt on an unproven business with ambitious targets for fast growth.

To ensure they are in the best possible position to secure investment, business owners need to consider a number of different things. They need to be fully up to date with company accounts, expenses, tax due and other day to day liabilities. They must keep clear sales records and maintain a detailed and accurate sales pipeline. It’s fundamental they can demonstrate on paper that their business will make a sound financial investment.

They also need to be clear to themselves, and the potential investor, about what they are seeking. Do they want a silent investor, or an experienced entrepreneur to provide cash and business consultancy or coaching? Each party needs to be realistic about their dealings with, and expectations of, each other. Basic considerations include positions on risk, day to day management of the business, and fundamentally; whether they can actually get along.

In addition, owner-managers should be clear about why they are seeking external investment. Often it will be to fund growth, purchase capital items or to expand into new revenue streams. Investors will expect to see a strong proposal with detailed targets and a route-map illustrating how the business will meet these.

It goes without saying that business owners seeking investment need to be adequately prepared before entering into negotiations. They would be well advised to take professional advice before entering into any verbal or written agreements, and certainly before accepting any monies. In addition to legal advice, they will also potentially require assistance from a specialist tax adviser, as well as an accountant.

In essence, private funding can be a great way for SMEs to raise cash, without having to rely upon the banks or turn to crowd-funding. However, it’s not a quick fix, and owner-managers need to be prepared to do their homework at the outset.

Please see other articles by Stuart here.

This was posted in Bdaily's Members' News section by Ratio Law LLP .