30/03/2009

Securing alternative sources of finance has rarely been more challenging or necessary as companies are increasingly trying to reduce spending and preserve capital yet remain competitive and achieve their business objectives. Funding options for SMEs have evaporated, as lending institutions have less capital to lend - or less capital they are willing to lend – resulting in escalating costs of borrowing for business. Tight lending policy by traditional credit providers means businesses are struggling to obtain the funding they would have raised prior to the global financial crisis.

 

In such an illiquid financial market it becomes necessary for some businesses to explore alternative sources of finance. The key is to determine your exact funding requirements, and then try to match a suitable source of funds to meet your requirements.

 

Sources of finance can generally be categorized as debt or equity funding, and each may be appropriate to different business needs and have very different implications. The following are some alternative sources of debt and equity funding that may be considered by businesses that are struggling to obtain finance in the current environment:

 

Debt funding

Debt financing is appropriate when funds are required to finance a specific asset and you are confident that the cash flow in the business will allow you to service the loan. Generally, you should match the term of a debt to the expected life of the asset being financed. Working capital is often financed by overdrafts or other short-term debt, while the purchases of fixed assets are more suited to appropriate term loans. Unfortunately it is the standard debt financing that is proving difficult to obtain in the current market. The following are some alternatives to short, medium and long term debt.

 

Commercial or Bank Bill

Commercial bills are debt instruments ranging in terms from 30 to 180 days. They are useful for funding inventory holdings and stock purchases. They generally must be repaid at the end of the term, but can often be “rolled over”. Although less expensive than overdrafts, they require similar security, and may sometimes be structured as credit facilities for up to five years (in aggregate), as alternatives to overdrafts.

 

Trade credit

 

A short-term source of finance obtained from suppliers that do not require immediate payment for goods or services purchased. If managed carefully, this can reduce the working capital requirements of the business.

 

Personal loans Where it is not possible to arrange a loan in your business name you could consider arranging a personal loan. This can then be contributed as equity or as a loan to the business.

 

Leasing, hire purchase (HP) and other asset-based finance products

The financier (usually a bank or specialist lessor) purchases the equipment you require and then leases it to you in return for regular rental payments for the duration of the lease period. Useful for funding the acquisition of company assets (e.g. motor vehicles, computer equipment or major production machinery).At the completion of the lease term you are offered the option to purchase the equipment at an agreed residual value. Rent payments are tax deductible.

 

Factoring

Factoring occurs when the firm sells its accounts receivables. The decision to enter into a factoring arrangement may be taken as a conscious decision to sell off existing debtors, or the arrangement may be created when the sale is made – e.g. through credit card facilities. Factoring ensures that proceeds are available to the company as soon as the sale is made. Funds from factoring are injected into the working capital of the business, thereby improving cash flow.

 

Equity funding

Equity funding brings capital into a business by selling equity in the business. The owners of a business are its equity holders. Therefore a person who invests in the equity of a business becomes an owner of the business. The sale of equity can be to the existing business owners or to third parties. If equity is sold to third parties the original owners of the business will generally end up with a reduced portion of the business. However, issuing equity can also significantly enhance an existing owner’s wealth by creating a more valuable business. It may also have the added benefit of introducing new management ideas and corporate synergise to the business. Equity holders can only claim the residual earnings of a business (i.e. after all other claims have been met). These are generally paid out as dividends based on each owner's share of the business.

 

Some alternative sources of equity funding include:

 

Convertible notes are a loan to the company which can, at the option of the lender, be converted into shares in the company at a predetermined price. Often used by Venture Capital or Private Equity Firms, the cost of borrowing tends to be lower for the company since the investor has the optional benefit of converting the notes into equity.

 

Preference shares are special classes of shares (sometimes redeemable at the option of the shareholder or the company) that are entitled to a dividend in priority to the ordinary shareholders, but after all other creditors have received their entitlement.

 

Private Equity

Private equity is offered by specialist investment funds which usually involves the establishment of a syndicate of professional investors. They target businesses with high growth prospects that are usually in the expansion or buy-out phase of the business cycle. Private equity firms invest for fixed terms (typically 3 – 5 years)

 

Venture Capital

Venture capital companies are similar to Private Equity firm but target businesses that are in the start-up and early stage of the business cycle with rapid growth prospects and high rates of return. Venture capital firms can offer large amounts (e.g. minimum of $500,000) for start-up capital, as growth capital for major product/market expansion, or as exit funding for existing investors. In return the venture capital company requires significant equity, board representation and an eventual exit strategy (e.g. a trade sale or public float).

 

Business Angel

There are many services that offer to match well-managed, investment-ready companies with private investors. These private investors are known as Business Angels. Business Angels may be a single individual, a corporate entity or a group of investors. Business Angels may make passive investments, or may require a substantial say in how the business is operated. Small, high-growth companies can raise $100,000-$1 million. Business Angels Pty Ltd and Australian Business Angels provide registers where private investors and businesses can find each other
 

The Australian Small Scale Offerings Board (ASSOB)

ASSOB is a capital raising platform which assists unlisted, high growth companies to attract early-stage, expansion or special project capital. High growth companies wishing to raise capital using the ASSOB platform must access it through an accredited ASSOB Member, an independent business whose Consultants have been trained and accredited to deliver ASSOB’s services within a specific regulatory framework. These services include share capital structuring, Offer Document preparation, guidance on governance, direction with compliance and assistance conducting investor meetings. To find out more visit the ASSOB website.

 

The National Stock Exchange of Australia specifically lists small and medium businesses and may be an appropriate avenue for a small business to raise capital.

 

Other Sources of finance

 

Immediate family, friends, business partners and other contacts may be the least expensive sources of debt or equity funding. They are also often the easiest, most speedy and flexible. Such equity partners may not seek board representation and may be willing to wait for a longer period before realising adequate return on their investment in your business. However, personal family relations can often be strained because of business dealings, and it is advisable to structure your dealings in a professional and businesslike manner.

 

Government funding

In general, the government doesn’t provide finance for businesses. However, in some circumstances you may be eligible for a State or Federal government grant.

Two programs worth looking into are:

1.  AusIndustry R&D Start

This is a Commonwealth program that assists companies with funding for the research and development stage of a new project. Applicant companies should have a turnover of less than $50 million.  This program can provide:

-  funds to employ a new graduate for an R&D project;

-  concessional loans (40% of the banks' indicator rate) for the early commercialisation stages of a project, to be completed within three years.

 

2.  Innovation Investment Fund (IIF)

A federally funded program that leverages private capital on a 2:1 basis to provide access to early stage funding for new ventures. A company seeking "seed" funding (concept, prototyping, company formation), "start-up" funding (staffing, initial marketing) or "early expansion" funding (to launch the sale and manufacture of a product) can receive up to $A500,000.

Ultimately, the key to successful future funding is deciding which type of financing best meets your business’ needs. Ensuring that you are fully aware of all the available options is just the first step.

 
Please contact Mark Dupuis at Townsends Business and Corporate Lawyers on (02) 8296 6222 for additional information.