Archive for May, 2008

Investment finance and the economic climate

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Business Link
on 27 May, 2008
in Creative and Finance
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Until recently the prospect of economic downturn was little more than speculation. GDP rose last quarter and employment continues to grow. But looking forward, the outlook is worsening: figures from the International Monetary Fund do not predict a recession, but its UK economic growth forecast of 1.9 per cent for 2008 and 2009 is the lowest since the early ‘90s. In light of such gloom, growth-hungry business owners might wonder what the future holds, and so might investors.

Anticipation of tougher times ahead could spur businesses into seeking investment sooner rather than later. They may feel pressured into securing investment deals before the tide goes out, or anxious to secure finance to weather potentially turbulent times ahead. Credit problems - making it more difficult and costly to borrow - may also lead more businesses towards considering investment finance as a viable option. In the face of a more competitive landscape, businesses might find themselves working much harder to find and negotiate satisfactory investment deals.

Reduced confidence in the wider economic climate does not necessarily equate to less confidence - or less money - from investors. Low-value sources of finance such as friends and family funding may dwindle as individuals shy away from high-risk investments. But managed sources of finance - such as Business Angels and Venture Capital - are less likely to be deterred by economic downturns. Just like any other business they aim to make money, whatever the climate. If anything, an economic downturn could to play to investors’ advantage. They may need to pick and choose more wisely, seeking investments in ‘recession-proof’ markets, or work harder to negotiate better deals. But investors know how to secure good investments in good businesses, so turbulent times may represent less of headache and more of an opportunity to grab a bargain.

At what cost businesses find finance is therefore a crucial question. Just because they can, investors will question business models, critique business plans and more than ever make businesses work harder for investment deals. When seeking investment finance, evaluating current and projected business performance and value are crucial tasks for business owners, even more so during uncertain economic times. Businesses must be sure of their own value - being realistic but confident. It may be easier to settle for less during uneasy and competitive times, but a sense of realism and confidence in current and projected value ensures a strong negotiating point for businesses looking to broker strong deals.

The marketplace a business operates in - and its business model - are two additional factors affecting the perceived value of a company during uncertain economic conditions. Some marketplaces are less susceptible to economic turbulence, such as reductions in consumer spending or rising operating costs. Recession vulnerable business will clearly struggle in times of economic certainty - but businesses operating in ‘recession-proof’ markets could actually become more compelling investments.

Talking about specific markets and business models at a recent Business Link jointly-sponsored event entitled ‘Access to Media Finance’, several investors commented on how a recession could impact investment decisions. Investors reiterated the feeling that valuations might need to be reconsidered, but that ‘more disruptive’ business models are likely to remain strong despite economic fears. The general feeling was that:

“Disruptive businesses are recession proof. Something that’s really going to change the way markets work; the velocity may be a little slower, it may be a little harder to get the cash upfront, but if you’re literally changing the way business is done, it will work in a recession as well as in a big time.”
Alex Hoye, Go-Industry and Seedcamp

So, what could an economic downturn really mean for investors and business owners seeking investment? Investors are likely to seize on the opportunity to challenge company valuations and focus on securing investments in so-called ‘recession-proof’ businesses. They will work a more competitive environment to their advantage, ensuring investment deals are sound and future-proof. As a result, business owners will need to work and fight harder for good investment deals; work harder to justify their value and potential, and fight to ensure that they don’t under-sell themselves because of negative economic conditions.

But remember: investors - whatever the economic climate - are looking for good entrepreneurs with good business models. Even though more disruptive or recession-proof businesses may be more desirable, it does not mean that those falling outside that picture will be left in the cold:

“When the tide goes out, it thins the ranks and really focusses on good entrepreneurs with good business models.”
Alex Hoye, Go-Industry and Seedcamp

Fundamentally, talk of an economic slowdown does nothing more than make this observation more true. Good people running good businesses are going to survive less than favourable economic conditions - and they are going to find the investment they need. The landscape may be more competitive, but that just means business owners will need to fight harder for investment. Confidence (not arrogance) is key: being sure about valuations and performance metrics is vital. Even more so than usual.

The process of getting ‘investment ready’ is more important now than ever. The marketplace for investment finance is still there, but with uncertain economic times ahead, it is likely to become lean and mean - it’s up to you to lay the groundwork that ensures that your business, your proposition, and your potential are so strong that they don’t get left in the cold. The tide may go out, but as one investor put it: that just serves to indicate who remembered to wear their swimmers. In other words, be prepared.

More info - Getting investment ready

More info - Top 3 investor wants

Top 3 investor wants

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Business Link
on 27 May, 2008
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1. Growth potential and profit

Investors want to invest in businesses which turn over substantial profits and grow significantly in value. They want a regular share of said profits, and eventually, want to exit the business by selling their shares at the most profitable moment.

Business owners looking for investment must deliver not just excellent business performance, but explicit evidence of it. Business plans must showcase past performance, illustrate future profit projections, and demonstrate how growth translates into increased business value.

It is generally not enough to walk through an investor’s door with a unique idea, disruptive business model or vague promise of future success.

An investor’s job is to manage risk and reward. They do this by demanding realistic, tangible and measurable evidence that their investment is going to offer long-term, profitable returns.

In short: they want to see strength in numbers.

2. Strong management

Investors want to invest in great people, not just great businesses. Strong management is what delivers strong business performance, maximises profit, and ensures the potential value of a business is fully realised.

Management teams must show unrivalled motivation, courage, creativity and persistence. They must illustrate to investors how their ideas, capabilities and skills translate into added-value, and deliver consistently strong business performance.

Talking at a Business Link jointly-sponsored event on investment finance, Patrick Bradley from investment group Ingenious Media observed that “what investors are increasingly understanding is that size of investment you make doesn’t necessarily have a correlation to the amount you get out the other end. It’s really whether you believe the people sitting in front of you 1) have an excellent idea, 2) have the right blend of management capabilities, and 3) most importantly, have the ability to execute the idea.”

In other words: a great idea is one thing, a pile of cash is quite another - but crucially, it’s the people steering the direction of these two things that adds the most value to a business proposition.

In short: investors manage risk by putting their money in safe hands.

3. Market opportunities

Investors want to invest in genuine, significant and achievable market opportunities. They want businesses that can capitalise on their investment by seizing said market opportunities more effectively than competitors.

Businesses looking for investment must identify and assess market opportunities and clearly outline their nature, size and potential. What is the market opportunity? How fast is the market growing? Do you have a sustainable and/or unique competitive advantage over competitors? Are there additional, future monetisation opportunities in the market? What makes your company and management team more capable of seizing on the market opportunity than others?

Painting a clear picture of your business’s market opportunities puts your position into context for the investor. For example, if your addressable market is small, an investor may wonder how their investment can increase your potential. Back that scene up with evidence of future monetisation opportunities in the marketplace, and your market opportunity becomes much clearer.

Often investors don’t have intricate knowledge of markets. It’s your job know your market opportunities and make them transparently clear to investors.

In short: turn your vision into theirs.

Getting investment ready

Investors want investment ready businesses that understand the investment journey and are ready and prepared for it.

More info - Getting investment ready

Tool - Assess your finance readiness

Getting investment ready

Published
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Business Link
on 27 May, 2008
in Creative and Finance
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Attracting investment finance and managing your investment journey are important and unique undertakings that require adequate and precise preparation. Here are a few tips and questions to get you started…

Know yourself

Investors are primarily concerned with profiting in the growth and success of your business. If growth and profit are also your key objectives, how do you feel about the prospect of sharing your hard earned rewards? Remember: businesses often grow organically without outside investment; it may be a slower journey, but you’ll remain in control of your business, and its profits too.

  • Given that an investor will own a part of your business, are you satisfied that a smaller share of a potentially larger/faster growing business is what you really want?
  • Are you prepared to be accountable for your actions and results to a board of directors?
  • Are you prepared to lose some independence?

Questions courtesy of: SWAIN Investment Ready Guide

At a recent Business Link jointly-sponsored event talking about investment finance, the investor relationship was described as “marriage without the possibility of divorce” and “easy when it works”. If you are absolutely sure that an investment relationship is right for your business, the next step is to make sure your marriage is as easy as it is everlasting…

Know your potential investor

Knowing your potential investor is a crucial precursor to finding the right one. And it’s vital for opening up effective, constructive dialogue from the word go.

To get started, make a shortlist of ‘ideal’ investors. Take a look at their websites and try to gauge their likely level of interest in your marketplace and proposition. Evaluate their motives, their previous investments, track record, the quality of their people, the deepness of their pockets, or simply peruse any other information you can find. Investors may also volunteer a wealth of information on their websites about what they expect from businesses approaching them for investment, so take note.

Profiling investors is an invaluable process which could help tailor your business plan, presentations, pitches, and overall approach to meetings and negotiations. It could also offer a more strategic insight to assist your own selection and evaluation process. Remember: the process of knowing your investor is as much about vetting them for suitability and compatibility with you, as it is about moulding yourself into the perfect fit for them.

  • Have you established what characteristics, attributes and skills you require from an investor?
  • How experienced at investing in SME’s is the investor?
  • How will you orchestrate interest from more than one investor?
  • How will you evaluate any investment offers you receive?
  • Have you calculated the IRR, which will be available to an investor?
  • What controls are you proposing (at all levels)?
  • Have you considered that the investor might require a seat on the Board?

Questions courtesy of: SWAIN Investment Ready Guide

Evaluate your attractiveness

Your attractiveness for investment will be assessed based on factors such as: your business’s past and current performance, unique selling point, projections for future growth and profitability, the strength of your management team, the nature of your business model, your market opportunity, and where you sit competitively within that marketplace.

How many of the following qualities apply to you?

  • The management team is strong and experienced
  • The company enjoys defendable strategic assets
  • There is a strong USP
  • The company is selling into a growth sector
  • The business is scalable, commercial and realistic
  • Market demand is well researched and demonstrable
  • The business is already generating revenues
  • The business model produces high profitability and strong cash generation
  • The shareholding directors are committed to a well researched and credible exit strategy
  • A strong value proposition is available to customers

Questions courtesy of: SWAIN Investment Ready Guide

Write a relevant business plan

The most critical step in getting investment ready is the preparation of a suitable business plan. It emphasises the strength of your opportunity, it outlines your past, current and projected business performance, and emphasises the value of your business, its products, services, and people.

The business plan sits at the heart of your entire investment proposition. Make sure it’s tailored to include the information investors expect to see (you can find sample formats online  or by seeking further advice). Above all: make sure its ‘whole’ paints a clear and compelling vision of your business, its plans and opportunities.

A. Have you completed your business plan?

B. Have you based the plan on a recommended layout?

C. Does it have the following qualities?

  • Not more than 20-25 pages long
  • Includes clear financial projections, with monthly profit and loss, cash flow and balance sheets for the first two years
  • Contains an executive summary of not more than two pages

D. Is the plan clear on the following key areas?

  • The description of what the business does
  • How much finance is needed and for what purpose
  • The ‘value proposition’ to customers
  • The route to market
  • The market demand (supported by market research)
  • How competitive advantage will be maintained

Questions courtesy of: SWAIN Investment Ready Guide

Time it right

Here’s a quick sound-bite from someone who’s been through the investment journey before:

“Raise cash when you don’t need it. It’s a lot more difficult when you’re desperate.”

Ryan Notz, buildersite.com

This comment makes two pertinent observations. First and foremost, it points out that businesses should raise investment in advance of their actual need. Investors are likely to spot desperation, significantly weakening your bargaining position. Second, it supports the argument for effective planning of your investment journey. Take the right steps towards getting investment ready, and you are less likely to find yourself in a rush to find investment.

But remember: don’t let your eagerness not to appear desperate make you feel, well, desperate. Revisit the tips and questions raised in this guide. Know yourself, know your investor, know your worth, and know your business plan. These things should help you determine when the time is right.

Don’t do it alone

You may feel swamped by the magnitude of the task, especially when you begin to negotiate deals and face complex legal or tax issues.

Don’t do it alone: use the framework of colleagues, peers, advisers and professionals that exist around you to get the right kind of help - to make sure you get it right.

More info

For more information on the investment ready process, read the SWAIN Investment Ready Guide or contact Business Link on 0845 600 9966.

Top ten tips for successful copywriting

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on 13 May, 2008
in Sales & Marketing and Top Tips
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Good copywriting grabs attention, gives clarity to your message, and gets you business.

1. Think, then write

Clear thinking is the key to clear writing. Think what you want to say, then write it as simply as possible. Writing, editing and proofing are distractions that muddle your thoughts. Neglect these tasks for a minute and concentrate on what you want to say. Then, simply, say it.

2. Define your key messages

There are two categories of copy: your key messages, and everything else. Everything else is important, but defining key messages first ensures they don’t get forgotten, diluted or buried. Write them down and underline them. Order them by importance. Choose the ones you want to talk about first and last. Do this and you have defined a solid structure to build on.

3. The importance of style

You know what you want to say. How you say it could determine who reads it, engages with it or responds to it. Writing style is a subtle reflection of your own style - as a person, business or brand. How formal do you wish to be? Or put another way: how informal d’ya wanna be? Should you be a spokesman, friend, superior or an equal? Your use of language establishes perceptions - positive or negative - so be conscious of your style and control it. Remember: your company may already have a style guide to adhere to which ensures consistency and clarity of communications. If not (and you have a lot of people writing copy), perhaps it should.

4. Know your readers’ needs

Getting inside the head - and heart - of your audience helps you strike the right chord. People have practical needs (to be healthy) and emotional needs (to look great on the beach). Effectively selling a low-fat cereal might require you to satisfy both needs; the very reason why TV ads often show beautiful people enjoying beautifully healthy lifestyles. There is a saying: “people buy on emotion and justify with logic”, and it illustrates the point that, very often, emotional needs are more influential than practical ones. Even though the practical ones are still important.

5. Let benefits lead

A one per cent fat content is a feature of low-fat cereal. The benefit being that you’ll be healthier and slimmer than if you carry on eating those fry-ups (better still, you’ll look fantastic on the beach!). Features are important, but benefits tend to put features into context for the reader, making their value easier to see.

6. Use headlines

Headlines grab attention and make you want more. Big, bold, underlined, colourful, distinct, quick and easy. Keep them short but meaningful. Usually a sentence or two is enough to make a point. Think need, think benefits, think key messages. Think about intriguing and teasing, but also think about informing: people look at headlines when deciding whether to read on. Remembering that is crucial, because a bad headline can stop your reader before they even start.

7. Get to the point

Every sentence counts, but the first one is crucial. Fowler’s Dictionary of Modern English Usage describes the paragraph as ‘a unit of thought’. If a paragraph is a unit of thought, the first sentence is what makes your point. Again, be conscious of benefits and needs (as discussed earlier), because the quicker you focus on them the better.

8. All else leads to action

Remember AIDA (Attention, Interest, Desire, Action): the four stage sales process. By now your writing should have taken the customer through the first three steps. You have snappy titles and engaging headlines; and succinct, to-the-point paragraphs that highlight benefits and connect with the reader’s emotional and practical needs. The reader is poised and ready for action. Give them an easy, appropriate way to act, and they will do so.

9. Edit

Editing should involve an appraisal of every sentence. What is the sentence trying say? Do you need to say it? Could it be put more shortly or clearly? Are paragraphs properly constructed? Are they clear ‘units of thought’? There are many more questions to ask of your copy. Think back over the previous tips, remember your objectives and the principles of good copywriting, and evaluate everything. As your writing skills begin to improve you’ll find you need to edit less. Remember: if you can, leave a day or two between writing and editing; a fresh mind helps most things.

10. Proof, proof, proof

The odd mistake is sometimes forgivable, but you should aim to make none. At best they undermine the credibility of your voice. At worst they cost you dearly (think mistakes with pricing, event dates, or contact details). Check your copy, word by word, line by line. Again and again. Ask others for help. Take a break and proof with a fresh head. Proof until you stop finding mistakes, then proof again. Everyone usually has their own method for proofing, but however boring or unnecessary you find it, you should do it.

HR Focus - Training Needs Analysis (TNA), recruiting students, manage overtime

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on 13 May, 2008
in HR & People Development
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Performing a Training Needs Analysis

The business benefits of performing a Training Needs Analysis (TNA) go beyond personal development. The process links a business’s people with its wider strategic demand for skills. The end-result of a TNA is personal development, but it also ensures that such development delivers desired and measurable improvements to business performance.

A deep knowledge of your business’s strategic objectives is crucial. HR must know what skills a company needs now, to consolidate and improve business performance in the short term. In addition, HR must be aware of the long-term strategic direction of the business. They must ask: where is the business going, and what additional skills are required to get there?

Establishing links between business strategy and HR is therefore the first and foremost step to take when performing a TNA. Without this connection, and without a TNA, you might wonder what exactly your training bucks are buying you.

Find out more - Training needs analysis

Train to Gain skills brokers can help you with your TNA.
Find out more about Train to Gain

 

Recruiting students: the benefits

Summer is approaching; a busy time for businesses losing workers to the sun, and a time when skilled and highly motivated students are looking for work experience. Could it be that the latter offers a solution to the former?

Recruiting students - in a temporary or longer-term placement capacity - brings its fair share of challenges: recruitment and training being the most glaring. But what about the benefits?

Students can provide valuable cover for full-time workers jetting off on holiday, relieving the pressure on those left behind, and alleviating the back-to-work pains of returning workers. And despite their lack of experience and potential need for training, students can positively impact your business in ways you might not have considered. Their academic perspective, youthful ambition and varied backgrounds could inject fresh and diverse thinking and insights into your business.

Remember too that temporary and placement positions aren’t necessarily a one-time deal. Establishing strong relationships with students can offer employers a flexible pool of talent that remains available on a longer-term basis. It’s not uncommon for a student studying a three-year course to return to work with a company every summer, and subsequently begin working for them permanently after their course has finished. Such longer-term relationships save on recruitment costs and offer you flexible, highly talented workers.

There are several organisations and schemes around which aim to connect businesses and students. Take EDT, a charity running development schemes for young people interested in careers in science, engineering and technology. EDT’s ‘The Year in Industry’ programme provides paid, degree-relevant work placements for students in the year out before their degree course. EDT explain the benefits: “Students get the experience that recruiters and universities are looking for and improve their degree and employment prospects, and companies get access to highly motivated and talented individuals whilst benefiting from a highly cost effective resource”. The Shell Step Programme is another scheme designed to help small businesses develop their potential by using the skills of undergraduates to work on specific business projects. “Businesses benefit from fresh ideas and the chance to address problems or opportunities for which time and resources are normally lacking.”

If you can meet the challenge of recruitment and view the process as an opportunity rather than a chore, recruiting student and placement workers might be worth considering. Look around, learn more about the organisations and schemes available in your area, and decide if such an approach is right for your business. You never know, it could make your summer a little easier.

Interactive tool - Choose the right type of flexible working

More info - The Year in Industry Programme

More info - Shell Step Programme

Manage overtime

Overtime working is routinely used by many businesses as a way of coping with changes in demand or labour shortages. If you frequently require employees to work overtime, this could be a sign of inefficiency in your business.

Unless there are special provisions in an employee’s contract, you must get their agreement to work overtime.

This guide covers the legal and management issues concerning overtime working, as well as the pros and cons of using overtime to deal with demand changes. It also looks at some of the alternatives to overtime working which may be cheaper or more flexible to operate. Click here to view the guide .

Top-down vs bottom-up

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in HR & People Development and Management & Leadership
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Top-down and bottom-up are management approaches much discussed by business strategists. The latter is usually cited as a criticism of the former: top-down is bad because all power and decision-making is held centrally with managers, and bottom-up is good because an inclusive approach - where workers influence and control the strategic direction of a business - provides deeper customer insight, more informed decision-making and a happier workforce.

Bottom-up is indeed the popular choice. Its democratic and inclusive outlook is more aligned with modern ideals and the logic is sound. It makes sense that workers on the ground hold unique insights into customers and business processes, and thus could help their managers improve business performance. And of course, employees who feel part of the destiny of a business are more likely to be motivated, hard-working and loyal.

It does sound like an enlightened way to run a business and manage people. Even so, there are potential dangers hiding under the surface.

Business historian James Hoopes, author of ‘False Prophets’ - a book discussing the  perils of modern management ideas, explains the pitfalls in an interview with Management Consulting News. Hoopes argues that some of the attractiveness of modern management styles such as bottom-up had “been purchased at the expense of realism about the way managers have to operate”. Hoopes continues:

“The sad fact is that in business organisations where profit, not freedom, is the primary goal, it’s top-down power that often gets the job done best. We all need to recognise that corporations are not little models of democracy. If we cover up this reality, we can create serious problems for ourselves.”

The problem, Hoopes argues, is that bottom-up management offers a vision of democracy which is destined not to be realised. Saying no, making unpopular decisions and simply ‘being the boss’ are inevitable aspects of managerial duty. If managers set themselves up as ‘the people’s champion’ they may find themselves in trouble when tough decisions must be made. Hoopes adds:

“If you can create an environment in which people feel free, obviously that’s a wonderful thing. The trouble is, if you oversell the idea that everyone is free and that the workplace is nirvana, eventually there will be a hard landing for some disillusioned people. That can come back and hit a manager in the face.”

Crucially, none of this suggests that the bottom-up approach is inherently flawed or that an authoritarian top-down style is superior. Over-promising the ideals of bottom-up management seems to be the most glaring pitfall, which holds the potential to create long-term management problems. Conversely, a wholly authoritarian approach cuts out the many benefits of bottom-up thinking. There seems to be a happy middle-ground between the two opposing approaches.

You may not be a fan of newfangled management methodologies. Many find their teachings steeped with ideals and lacking enough consideration for practical business realities. One sure reality is that the arguments for and against either approach are, simply, matters of opinion.

The debate about whether top-down or bottom-up is ‘best’ is therefore irrelevant. Every business is different, with different leaders and managers. Strategic management approaches are not to be followed blindly. They are to be thought about, considered within the unique context of your own business, and applied with confidence and precision. That is the job of good leaders.

Interactive tool - Assess your leadership styles and strengths

Three good reasons to recycle IT equipment

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on 13 May, 2008
in Environment and IT & eBusiness
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Recycling may be FREE for consumers of electrical and electronic equipment

Last year we reported on WEEE regulations that make producers of electrical and electronic equipment legally responsible for paying for the treatment and recycling of products at the end of their life.

Producers and distributors of electrical and electronic equipment must by law provide ways for their customers to return waste electrical and electronic equipment. They may do this through direct take-back schemes, for example where they collect waste equipment upon delivery of new equipment, or they can make arrangements with a third-party to do this on their behalf. Either way, the onus is on producers and distributors to make the process transparent for their customers.

Note: Although much of the responsibility for the actual recycling of products falls with producers, business users must obtain and keep proof that waste electrical and electronic equipment was given to an authorised waste-management company.

Recycling IT equipment helps the environment and the people in it

IT equipment often contains hazardous materials including dangerous heavy metals such as mercury. Consigning such items to landfill is not acceptable, environmentally, ethically or legally. This makes the proper disposal of IT equipment that has reached the end of its useful life an important responsibility for all business owners and IT managers.

As well as helping the environment, recycling can aid the people in it too. IT equipment that you no longer have any use for may be valuable to others and an effective recycling policy will see suitable equipment put to good use either in the UK or the developing world.

Since the introduction of WEEE regulations, Brent Council in London has donated 500 PCs, laptops and monitors to Computer Aid International, which arranged for the equipment to be wiped clean of all data, and shipped to Africa, free of charge. In addition to complying with its responsibilities under the law, the council has also found a way to see its equipment re-used in a secure and safe way. An inspiring meeting of responsibility and philanthropy.
 
Not recycling properly may put confidential information in the hands of others

When a computer or server is disposed of improperly it is possible that data held on system hard drives may be recoverable by those with basic IT skills. Deleting data from a hard drive or formatting it does not destroy the data irrecoverably.

Organisations who professionally recycle IT equipment have the technology to render data on hard drives inaccessible - thereby ensuring that confidentiality is maintained and Data Protection regulations are not breached.

Act now

It’s not often that you can help yourself, fulfil your legal and ethical responsibilities, and help others - all at the same time. But these are the benefits of recycling your old IT equipment.

Act now, by finding out more about the WEEE regulations at the Environment Agency website:

Business users of EEE: your responsibilities

Sources of finance : overview

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on 13 May, 2008
in Finance and Strategy & Operations
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Internal sources of finance

Internal sources of finance are often the first to be exploited. But unless a business is cash-rich and extremely profitable, such finance may be insufficient for ambitious growth and development plans.

The main sources of internal finance are:

  • Personal savings - Cash injected into a business by its owners can be paid back if the business succeeds, but there’s an obvious personal risk should the business fail.
  • Working capital - That is, the finance available from current or short term assets, minus current liabilities. This could fund development, but may leave cash-flow tight.
  • Retained profits - Any profit a business keeps as opposed to distributing to owners/shareholders. Balancing the interests of the business and its owners is important.
  • Sale of assets - A business may sell assets such as property, equipment, or Intellectual Property. 

There may be risks associated with exploiting internal finance - such as putting personal savings in danger, crippling cash-flow, or frustrating equity holders through retention of profits. Of course, such risks need to be weighed up against the benefits - not least the fact that internal finance does not incur borrowing costs or require business owners to sell part of their business. Such risks and benefits should be considered within the context of a business’s own circumstances, and compared with the benefits of raising alternative, external sources of finance.

External sources of finance

The options for sourcing external finance can be divided into two groups: Ownership capital involves giving up ownership of and possibly some control over the business. Non-ownership capital does not involve such sacrifices, but can be a costly way to raise finance.

Ownership capital

  • Sale of ordinary shares - Otherwise referred to as equity shares, this is a method of raising finance by selling part of a limited company. Ordinary shareholders share in the profits of a business (through dividends). Businesses choose whether to pay dividends, based on factors such as the profitability of the business or its strategic goals. 
  • Sale of preference shares - Preference shareholders are usually entitled to fixed dividend payments, regardless of a business’s profitability, which should be paid before ordinary shareholder dividends. A business may retain the right to buy the shares back at a later date.
  • Alliances or Partnerships - An individual or business may seek to ally or partner with other individuals or businesses to gain access to greater knowledge or skills, and of course increased financial resource. Sleeping partners may invest in a business but take no control over day-to-day operations. Often though, alliances or partnerships are strategic, i.e. the two entities working together offer ‘something greater than the sum of its parts’.

Non-ownership capital

  • Bank overdrafts - Expensive in terms of interest charges and arrangement fees, but often easier to access than other sources of finance. Overdrafts may be offered for a limited time which (in addition to high interest costs) might make them unsuitable for funding longer term investment.
  • Loans - Banks, building societies and other commercial money lenders offer loans on short-term or long-term bases, for a variety of different purposes. Eligibility for a loan or the amount offered may depend on a business’s financial track record, projections of future performance, or availability of security to borrow against. Interest rates vary but loans are not the cheapest way to acquire finance, and regular repayments must be budgeted for when considering cash flow. Schemes such as the Small Firms Loan Guarantee (SFLG) exist to help businesses that have been turned down for commercial loans, but selection criteria still apply, so the scheme is not available to all. Click here for more info on SFLG
  • Grants - Considered by many to be the ideal source of finance, grants do not have to be paid back and no ownership rights are given up. Grants are not free money however, because a grant is often awarded upon condition of a business doing something in return for the money - such as to develop a new idea, concept or product, employ someone or work collaboratively with others. Grants recipients may also need to report back to grant givers on how effectively the money was spent. Grants are sometimes designed to help specific groups such as deprived areas or young people, so access to grant funding might depend on a business’s circumstances or goals.
  • Debentures - Loans that are secured, where the lender has some kind of preferential rights. For example, a debenture loan may be secured for the purchase of a property, which the lender takes a legal interest in, similar to a domestic mortgage arrangement. Debenture holders may also have preferential rights to payment over and above other investors, such as shareholders, and may also have preferential rights to repayments should the business go into liquidation. Because of these preferential rights, debenture finance may impact ownership capital agreements, even though debenture lenders do not technically ‘own’ a portion of the business.
  • Friends and family (and fools) - As the ‘and fools’ appendage suggests, sourcing finance from friends and family can be problematic. Problems could occur when the borrower makes unrealistic promises of success, or when the lender expects a bigger return on investment than they ultimately receive. Such issues can usually be addressed by managing expectations on both sides. (Such funding may also be sought in exchange for ownership rights such as ordinary shares, as detailed in the previous section.)

Choosing between ownership and non-ownership finance is tricky and the decision is subject to some unknowns. For example, an early stage business may be wary of borrowing because of exposure to interest charges and high monthly repayments. Instead, it may choose to sell part of its business. In the short-term this may be an attractive route to finance, but if the business turns out to be a huge success it may regret that decision - if it is forced to share a large portion of its profits or is left with insufficient equity to raise further rounds of finance.

Such an example demonstrates how no type of finance is typically better than another. The choice depends on a business’s current circumstances - and its future potential.  Any business looking to raise finance must therefore think extremely carefully about all the options available, and how their decisions may affect the business’s success in the short and long term.

Further resources

Find out more about government-backed guarantee for business loans: The Small Firms Loan Guarantee