“Can you help with business funding and alternative finance for our business?”
One of the biggest perceived hurdles for SMEs today is the perception that finance is difficult to get yet major Government sponsored research indicates that of all profitable SMEs who applied for an overdraft 77% were accepted. The key word here of course is profitable. Of course a lot of companies need money to grow and develop but in these days of ‘alternate lenders’ popping up all over the place where do you start? Who do you select? So what can you do when you may not have sufficient assets, or you are not making a profit?
Understanding the lending basics
I have written numerous articles and blogs on the subject of bank lending to SMEs borrowing and lending and it is important when seeking funding for any reason or project to understand the lender’s needs.
Irrespective of the requirement the principles of lending and borrowing, or taking an advance will always be the same. Lenders will have an underwriting department and they are very cautious individuals who spend most of their working lives locked in a darkened room with a calculator thinking of things that can go wrong for the lender. The risks will be based on a number of factors such as:
- The underwriter’s experience of the sector the money is required for.
- The credit worthiness of the company/individual.
- What assets can be used to reduce any risk.
- What the money is going to be used for.
- Specific product variables such as potential fluctuation of interest rates (What rate is the lender buying the money in at) and so on.
NB: The above list is not exhaustive as to put this list in perspective did you know that in a simple credit card there can be around fifteen underwriting variables alone.
Having identified these risks they then set about putting in place methods of mitigating or managing these risks. Even when there is no risk to the lender they will still of course find a way of making a profit from you. This risk criterion will define the degrees of risk the lender will be prepared to take and as the risk to the lender increases so will the charging structure (Cost to you).
There may be the exception that proves the rule but in general these are the basic principles of risks when lending.
Enterprise Financial Guarantee (EFG)
I have written widely about this Government Guarantee as it has been explained poorly by the banks in the past though hopefully this is changing. The key benefits of the Enterprise Financial Guarantee is that it was introduced specifically to help SMEs who had a great idea or need but did not have the security to get the bank to lend money. So, if you want to borrow money from your bank and you do not have sufficient security then ask about this Government guarantee.
GOOD: In essence the Enterprise Financial Guarantee covers the bank for up to 75% of the amount loaned to your company should your company fail and go into insolvent liquidation.
GOOD: The good news is the bank is not allowed under the terms of the Government underwriting to pursue the family home when pursuing any debt if the company fails.
BAD: The bank will however want a 100% personal guarantee from the director and this will be chased vigorously until the bank can prove they have done everything possible to recover the amount loaned and guaranteed. Once they have demonstrated this they can then make a claim from the Government scheme and they will usually then revert to pursuing the remaining 25% or simply write the debt off.
BAD: If you have personal assets outside of the family home they will be at risk if the company fails.
ON BALANCE: The lender determines the interest rate and charges the same with any other loan but it’s the guarantee from the Government that makes the difference. We say go for it but with your eyes open as to the risks if things go wrong.
RECOMMENDATION: You can learn all about the Enterprise Financial Guarantee here https://www.gov.uk/understanding-the-enterprise-finance-guarantee
Bank of Friends and Family
I have mixed views on borrowing from friends and family as they may be the most apparent cheapest option in the short term but there may be a far greater personal cost at a later stage. Borrowing from family and friends should be approached in the same professional business manner if you were borrowing from a bank. Provide a solid and realistic business plan but be prepared for an argument as if they know you so well they know which ‘buttons to push’ if you get it wrong. You should encourage the use of the lender risk reasoning for your family and get them to find holes in your plan. The worst thing that could happen is for someone to say to you ‘there you go take the money I trust you’. This should be taken as a warning sign not a ‘pat on the back’. You want someone involved who will take an interest and add value not give you the money because it’s you.
Think of how bad you will feel if things go wrong? At least by getting them involved in the business planning they cannot argue later they were not aware of any risks. Remember with any business there is a risk.
If you do agree then get a legal agreement in place to protect all everyone’s interests and get the loan document registered at Companies House. Ensure the loan is secured against the company assets and list everything the loan is secured against including none tangible assets. Also add that the loan is made on a short term basis and renewable every 6 months and the money can be reclaimed at any time in the event of insolvency. This is not concrete but will afford some protection if there are assets remaining in the company if things go wrong.
You will also have something in writing to settle the inevitable family and or friend disputes as it is critical to establish who controls the company. Never ever set a limited company with an equal share with family and or friends it will end in tears. You cannot steer a ship by committee. Agree from the outset who will have the ultimate decision, or what the decision making process will be – if you cannot agree on this forget it.
GOOD: You know the people concerned and they know you so they are unlikely to apply negative pressure from day one so you should get the time requested to repay the money.
GOOD: You should be able to agree a cheaper loan interest rate and more flexible terms than you would with a tradition lender.
GOOD: The investors may well be shareholder and also provide you with someone to discuss matters with.
BAD: The most obvious negative is if things go wrong and you may just lose a family member and or friend who you clearly had a good relationship with in the first place.
BAD: Directors, investors and or shareholders may disagree over the direction of the company at some point. Make sure you have disagreement resolution included in any initial loan agreement, or even if the investor has any say at all.
ON BALANCE: As long as everyone is going into the project with their eyes open and understands the risks then write everything down in an agreement then it can be a very good solution. If your intention is to just to get quick access to money with little questioning – Don’t go there!
This may seem an odd one to add in this area but just because you may not have any ‘assets’ and you are making a loss it does not mean the bank will automatically turn you down. When I ask directors have they asked their bank they will often respond with “you’re wasting your time.” They may be right but if you don’t ask how will you know? You may not have tangible assets but what about your work in progress pipeline and or due invoices? You may be making a loss but that may be for a good reason as you may have been funding the pipeline growth and besides you may only need the funds for a short term.
You will need to put some effort in and provide a mini- business plan and whilst Richard Branson may get away with writing a plan on the back of a fag packet you are unlikely too. Also try negotiating with the bank supported by your figures and have a plan B. if they say no to plan A. this will also show the bank something too in that you have thought the matter through.
By-the-way Richard Branson almost had Virgin wiped out over a weekend as his bank was not sold on the idea of Virgin Airlines so he got music friends to help in the short term and moved to a more ‘interested’ bank. This same bank was willing to lend 60 times more than the original bank. The clear lesson is if your bank does not help then shop around.
BAD: Trying to find what the traditional banks will charge you on the typical comparison sites is not easy as if they were all to be believed every business bank account is negotiable. They have their own parameters they just don’t want to publish them.
BAD: Be aware that the typical unauthorised overdraft rate is around 29.7% APR compared to Metro’s 10% and this is a big potential saving. Only bad thing to say about Metro is they only operate in and around London currently.
ON BALANCE: Keep a watchful eye on your bank and if they do not appear helpful then follow Richard Branson’s advice and shop around.
RECOMMENDATION: Try the Metro Bank at www.metrobankonline.co.uk if you are based in the South East as they are flexible on overdrafts and at 10% on authorised and unauthorised overdrafts (with reasonable explanation) which is market leading –if you know different then please tell us.
Peer-to-peer lending or crowd funding
Peer to Peer or crowd funding acts like an online dating service marrying up investors to borrowers. This kind of borrowing can be faster than a bank and is likely to be more flexible and have lower interest rates. In principle large amount of individuals typically invest relatively small amounts from £25 up over. Money is loaned to individuals/businesses who borrow money at usually more flexible terms and rates than offered by the banks. The process can be very effective in providing businesses with cash because the borrower designs within limits the loan he/she wants and states what they want the loan for. The ‘loan’ is then put at auction to obtain the best investor interest and the rate is set an agreed rate and as there is no middle man in between the rate is usually lower.
There is still an application process with credit checking but overall less red tape than the banks.
GOOD: Relatively fast decision making; flexible and lower rates very possible.
BAD: You will still be expected to sign a personal guarantee and be subject to credit checks. If you have a bad credit rating this will affect the risk to the investor and the rate with be higher and may stop the application process.
ON BALANCE: If you have a clean credit history and you want the money for growth and development then go for it.
RECOMMENDATION: There are quite a few around so if you would like to save yourself some time and you would prefer someone else to find your solution then call 08000 746 757 or arrange a call back by sending us an email in the contact box provided.
Although used by an estimated 42,000 businesses in the UK factoring can be a tricky subject for a lot of small to medium sized companies and a lot will depend on quite a lot of variables as to whether factoring is right for you or not. In effect you sell your debtor book (invoices) to factoring company who will then advance a percentage up front typically 70-85%. Typically you will need around £100,000 is sales to get the benefits of factoring with a spread of debtors so all the risk is one area. Make sure you find the right factoring company for your company and do not simply accept your bank in fact I advise against using your business bank for factoring – keep them separate.
- You should not allow the bank to have a complete stranglehold on your business cash-flow
- The factoring company including a bank will require a debenture (a charge) on company assets and if things go wrong this affords them even more rights – like closing your company at any time they wish
- They would have complete control of your company if they are providing loans and overdrafts too
- You would be placing too many eggs in one basket – spread the risk around
To determine if factoring is right for you need to consider the variables but be warned there is a tremendous amount of factoring solutions available and you may not know the variable to consider.
As an example and keeping it simple, if you are waiting for 90 days for payment from a Council then factoring on the face of it may be ideal – you get paid a percentage upfront and the factoring company is pretty sure they are going to get paid as a Council is unlikely to default.
If your sector is a high risk sector such as Building & Construction for example do not simply accept increased interest rates and penalties – shop around and find a factoring finance company who have experience in Building & Construction. By finding a factoring specialist who knows your sector they are more likely to offer a reduced rate of interest and advance more.
The factoring company is likely to want to see clear business processes in place too so they can see you are managing your end of the deal. The key is to shop around if not try a factoring broker who will do the running around for you better yet search online for a factoring broker.
GOOD: If you get the right factoring company supporting you it can be a perfect solution.
BAD: If things go wrong the factoring company has a charge over the company assets via a debenture and will almost certainly have a personal guarantee too.
OPINION: If you have firm work contracts in place with good quality clients then as long as you read the small print and enter into the agreement with your eyes open it could be what you are looking for.
If you prefer to talk to someone then call 08000 746 757 for a no nonsense no strings attached opinion.
This is a loose heading used as a catch-all but in effect would cover general releasing equity from:
- Family home
- Company assets
- Plant and Machinery
- Due Invoices (One off advance)
- Boats or other assets
Typically, this kind of loan is used for more urgent and last resort borrowing requirements such as HMRC tax or other creditor debts to stop a winding up petition for example. Another use may be the bank has turned you down and you have exhausted every other route but need cash to grow the company.
Generally re-mortgaging the family home should only be considered as a last resort but if the money is needed then make sure you get the ‘buy in’ of your spouse. You must ask their honest opinion as I have seen too many marriages break over this matter and be aware there is now a legal obligation to ensure this ‘agreement’ happens.
Typically, you are looking around 60% of the loan to value in order for this to work for you and they will want a 2nd charge on the property. Typical secured lending interest rates start around 8%. Obviously if you want to increase your overdraft or are being pressured by the bank on an existing overdraft which is quite common then this may be worth looking at provided you take appropriate advice. In simple terms paying 8-9% back is far better than paying 17% on an overdraft or worse unauthorised overdraft at 29.7% so it may worth considering.
Property remortgage example
Assuming the family home was valued at £250,000 and the mortgage was £120,000 the calculation would go something like this:
£250,000 x 60% = £150,000 providing £30,000 released for whatever reason it is required.
NB: Some lenders require more information than others regarding the purpose of the loan.
A re-mortgage or even a 2nd charge can provide a speedy remedy for urgent cash issues, but you are likely to need a specialist lender if you have a poor personal credit rating. Typically a quick decision in principle can be arrived it often with days or even hours dependent upon the lender.
GOOD: You can expect a speedy decision in principle often within 48 hours dependent on the lender.
GOOD: The bank may well insist on a charge on the family home for additional lending anyway so this way you are more in control.
BAD: A charge will be secured against the family home.
Refinancing of company assets can often provide an unexpected source of finance even if there is finance in place so it is worth checking. In effect you simply replace the existing finance company with another and thereby release sufficient equity to satisfy your needs at the same time. This is particularly the case where there is heavy plant and machinery; cranes, large trucks and so on.
Provided there are sufficient plant and machinery including vehicles then this can be a very attractive option and decisions in principle can be made very quickly.
A manufacturer wants install a paper compacting machine which will cost £1.2m but costs £150,000 to install it. The company has existing plant and machinery which is refinanced in addition to the original compacting machine which allows the installation to take place.
GOOD: Usually a very quick response and decision in principle can be made and reasonable payment terms make for a potentially ideal solution.
BAD: You need the assets in the first place to make this loan possible.
For any of the above specialist needs then you can call 08000 746 757 for a no-nonsense, no-strings attached opinion.
Written by: Mike Smith