5 alternative funding options

5 alternative funding options

With the release of mixed data around bank lending seen over recent days, Lee Castledine from RSM Tenon Corporate Finance looks at the broader funding options available to SMEs.

Recently, the British Bankers Association revealed data showing deposit and lending to SMEs by postcode across Britain. This data showed a total increase in deposits from £7bn in 2011 to £126bn in 2012 and a fall in lending balances from £105bn to £100bn over the same period. Separate figures released by the Bank of England show that lending to SMEs has risen between May and June 2013 but with an increase of just £238m, and one data point only, the significance and trend is hugely uncertain.

There is a wide variety of funding options available to SMEs, including government and bank supported initiatives. But SME owners still continue to have a cautious sentiment towards debt, given the challenging economic environment. Generally, but with exceptions, they prefer to de-leverage and protect their positions, rather than look to debt to support investment for growth and development. While the headline trends appear difficult, experiences show that the appetite to provide finance to support the growth and development of SMEs is strong.

Here is a look at the options available:

1) Traditional bank loans
Bank debt has always been an obvious consideration for SMEs and recently the high street banks have faced considerable pressure to lend more. They are working very hard to meet these pressures whilst also ensuring they remain robust for their own stakeholders. There is no merit in banks taking an equity risk for the debt return they receive and there is no question that they will continue to do so.

While banking facilities can provide funding certainty for SMEs in these challenging times, they often have tough criteria, which give the bank an ‘early warning sign’ if the SME is experiencing trading challenges. When it comes to lending criteria, the decision to lend is likely to be driven by how sustainable future cash flows are. Directors’ personal guarantees can also be required, particularly in small borrowing.

2) Asset based financing
Asset based financing has become increasingly popular across the UK and around 43,000 businesses currently use this. Borrowing is linked to assets such as debtors, stocks or property. Asset based funding is available through both traditional high street lenders and a number of specialist providers.

3) Crowd funding
The withdrawal of a number of funders during the downturn has led to an increase in crowd or “peer to peer” funding, where groups of people pool their finances together to fund a business venture. These businesses are very much in their infancy and many would like to see the market develop further before jumping into this emerging sector.

4) Private equity
For strong businesses, there are a number of private equity and venture capital groups with substantial funds available. In addition to financing, the private equity option can provide an SME with management support, access to new contacts and business opportunities and expertise to build and manage growth and shareholder value in a sustainable manner.

Inevitably, the cost of private equity is higher than other funding options and the investor is likely to require board representation and involvement in crucial, strategic decision-making. Within private equity there are a huge mix of providers, some looking for minority stakes and others requiring a majority equity position. Firms will have investment criteria around size, sector and geography.

5) Friends and family
Finally, some SMEs will have family and friends to approach for funding. Whilst this can be attractive in terms of being a quick way of accessing funds - with less hassle - the issues around exiting need to be considered. Having a more diverse shareholder base can lead to strained relationships at a later stage. Issues can arise as a result of differing objectives on investment holding periods and returns, level of management involvement and strategic direction generally. It is better to avoid these conflicts if an alternative funding source can be accessed.

Lee Castledine is Partner, Transaction Services at RSM Tenon Corporate Finance.