The first step in finding small business funding is knowing what kind of finance you need…
Debt financing
When it comes to debt financing, most small businesses turn to the traditional financial institutions, such as the banks. They will require collateral in the form of cash deposits or assets. This gives the bank security in case you are unable to repay the loan. There are a number of options here:
- · A business-term loan is a relatively simple way to secure funds (from about R50 000) for any period up to eight years. It is repayable in equal monthly instalments. This can be used to purchase assets, fund refurbishments or buy a small business. The loan period isn’t fixed and is determined by your monthly repayments.
- · An overdraft is quick and easy to arrange, and will help you manage your cash flow as cash is instantly available when you need it. However, the interest rate on an overdraft is high and using it for an extended period adds to your overheads.
- · A business revolving credit plan is a loan where repayments are made in equal monthly instalments. Once you have paid back a portion of the loan (usually around 25%), you can withdraw the funds up to the original limit. The fixed monthly payments make for easy cash flow planning.
- · A medium-term loan has flexible repayment options structured in line with customer cash flow and is paid off over two to seven years (sometimes longer, depending on the bank and what best suits your business and cash flow). This is suitable for big capital expenses and is usually linked to the prime interest rate. The size of the loan depends on how much collateral you have.
Asset finance
Asset financing products and solution enables businesses to benefit from using business assets immediately without having to pay for them upfront and in full. All forms of leasing are basically rental agreements giving you the right to use an asset owned by the finance company for a specific period of time in return for regular payments. The benefits of asset finance include:
- It is cost effective with fixed payments over a fixed term.
- Your assets are sold to a leasing firm but you still have access to them.
- You can rent new or used assets directly.
The cost of the equipment is spread over several years removing the need to make a large capital outlay as soon as the equipment is installed. This will ensure that cash flow doesn’t suffer.
The deal can be structured to be as tax-effective as possible. Monthly instalments are tax deductible and are treated as an operating expense (off balance sheet).
Commercial property loans
Commercial property loans are best suited for financing the purchase of land/buildings for your business. This type of loan can be used to purchase a shop, office, warehouse and sectional title units or complexes zoned for business purposes. It also covers existing residential properties that are primarily used for business purposes and which have business rights. The benefits of commercial property loans include:
- They can be tailored to suit your repayment expectations and budget.
- They also limit your capital outlay and free up cash.
Factoring
Factoring as an alternative method of accessing finance has begun to show healthy growth within the SME sector. Here you would sell your accounts receivable (i.e. invoices) to a third party at a discount in exchange for immediate finance with which to continue business. The benefits include:
- It accelerates your cash flow, as you are paid almost as soon as your invoices go out.
- You won’t have to collect from clients, so your time is freed up.
- As you borrow against your projected income, you will be able to move beyond your overdraft limit.
- You receive payment almost immediately based on your clients’ creditworthiness.
Equity financing
Equity financing for start-ups usually comes from friends and relatives and angel investors. Once your business is established and has a proven track record, there will be more sources of small business financing available. You may be able to attract private equity investors, venture capital, for instance, or sell shares in your company on the stock exchange. Most equity investors are reluctant to give out money without taking a portion of the business in return. Turn to p.42 for the advantages and disadvantages of going this route.
Private equity
Private equity firms pool capital from wealthy individuals and institutions, such as insurance companies, pension funds and university endowments. The firms then look for companies to invest in. Most seek established, profitable companies with proven management teams.
According to Conrad Steyn of SME advisory firm Barnstone, private equity is very suitable for SMEs, but finding the right investor is crucial. “They must offer a value add, whether it be new markets, management capacity, insight, new relationships etc. The business needs to grow significantly in exchange for the funding,” he says.
Steyn says you can approach equity investors at any point in your business’s lifecycle, depending on when and if you are willing to let go of a percentage of your shares. “It is a trade-off between how much of your company you can let go in exchange for capital. You can seek private equity finance once the concept and business plan has been confirmed.”
From the other end of the deal, private equity firms will expect a return on their investment and high capital growth in a set time period.
A good place to start your search for an equity investor is with SAVCA (South African Venture Capital & Private Equity Association). Where possible, contact business owners who have been through this process to ask for information on their experience. You should gain some idea of who has the necessary experience and who doesn’t.
When approaching an investor, you will need to be able to showcase a good business model. If your business plan is approved, a process of evaluation and negotiation will follow. “During this time decisions on the management team and level of management going forward, the number of shares to be exchanged, the amount to be paid for these shares, and the return on investment will have to be agreed upon,” says Steyn.
Private equity vs. venture capital vs. angel investment
Venture capital (VC) is typically provided to early-stage, high-potential companies in the interest of generating a return. These investments are generally made as cash in exchange for shares in the invested company. “A core skill within VC is the ability to identify novel technologies that have the potential to generate high commercial returns at an early stage. By definition, VCs also take a role in managing entrepreneurial companies at an early stage thus adding skills, as well as capital, and thereby potentially realising much higher rates of returns,” explains Steyn. Private equity investors typically invest in companies with proven revenue.
Angel investors, also known as business angels or informal investors, are affluent individuals who provide capital for business start-ups, usually in exchange for convertible debt or ownership equity.
According to Steyn, private equity is available in South Africa, but entrepreneurs often find the terms unacceptable. Entrepreneurs often don’t want to give away too much of the business, particularly if they think they are on to something big. “Private equity does have an important role to play in the market. But you need to assess your position carefully to assess if it is truly necessary to get outside investments,”
he adds.
Published in Your Business Magazine
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