Money to Grow

There’s no hard and fast rule when it comes to raising business finance. Many new business owners choose to leverage the equity in their personal assets – usually the house if they have one – while others apply for venture capital funding or Government grants, and still more will opt for bank funding if they have a good case. Licensing arrangements, joint ventures and strategic partnerships are other options for securing funding and growing your business. It’s very much ‘different strokes for different folks’ and dependent on the particular needs of the business. If you choose to raise finance through family and friends, or use your own money rather than a lending institution, be very careful. It can make you vulnerable to cash flow shortages down the track. Better to utilise the bank’s money and keep your cash flow position strong. Gay Rankin, general manager business banking for the National Bank, says friends and family will always have a part to play, but be wary that it can impact on relationships. “You could also find yourself focusing too much on the financials instead of growing the business,” she warns. “When you go to the bank, the focus is very much on growing the business, and any discussion is not built on emotion. Also, as you grow your business your bank’s business manager can often spot a potential financial situation before it occurs and can assist you through it.” UDC Finance general manager Malcolm Tilbrook says that getting the mix right between equity and debt funding can be a little delicate at times. He agrees that there is a place for ‘family collateral” at the start-up phase, but cautions that due diligence should still be carried out on the business by family members, as you would for any business investment. He also points out that financiers regard security provided by family as a level of passion and commitment to the business. A case of ‘putting your money where your mouth is’. Some options There really is no shortage of choice when it comes to securing funding to grow your business – the key is to match the needs of your business with the options available. Some options are: Leveraging the equity in your business (eg debtors list, plant and equipment) or personal assets (eg house mortgage). Equity partnerships in the shareholding of your business. Applying for venture capital funding or a Government grant such as the new R&D scheme. Loaning the funds outright using the various finance options from banks and other lending institutions. As for matching your needs, sit down with a finance broker or bank advisor for direction. New Zealand is a comparatively small financial market and don’t be surprised if a trip to the bank leads you to a specialist lender. Many firms are linked through parent companies – for example. UDC Finance is a subsidiary of ANZ National, and UDC is a name synonymous with asset finance – or more specifically; plant, equipment and auto finance – particularly in the trucking, logging and road construction industries (known in the business as ‘yellow goods’). UDC Finance is a natural choice for owner-operators or large family-owned firms looking to maintain a high level of new plant and equipment. And it works with ANZ and The National Bank (its parent banks) to provide the necessary funding. “With us it’s like a hire-purchase loan – our security is against the asset in question. And because we specialise in this space we understand asset values and life expectancy of equipment better than anyone,” says Tilbrook, acknowledging that his company has a higher appetite for risk than trading banks. However, while there are many funding options available to businesses – the logical first step will always be a visit to your local bank. Shop around if you have to, until you find a bank, and indeed a business banking manager, you are comfortable with. Banks can tailor a package to keep pace with your business’s needs – unsecured lending products range from cash advances with revolving credit facility, fixed or floating rate loans, overdraft facilities, and business credit cards which can deliver short term working capital. Gay Rankin says business banking managers (the National Bank has 180 of them) weigh up the whole proposition when assessing a loan application. It’s important that they understand where you want to take your business – and rather than focusing on products, the focus is more on the relationship. “We want to see you succeed – after all, we have a vested interest in making sure your business is successful. And from a business owners point of view it’s reassuring to know that you have that local, community based expertise on the ground – support when you need it.” Maximising your chances Before discussing preparation for a funding application, you should know that the general feeling amongst all the financiers NZBusiness spoke to is that the lending market will become noticeably tighter in 2008 – a result of the uncertainty caused by recent 2nd-tier finance company failures (albeit in the private equity market) and the rising cost of funds. But don’t let that hold you back from seeking finance in any way as there are still plenty of options available if you have a strong business case. Just ensure that the finance company you deal with is not affected by any adverse changes in investor or market confidence. A solid business plan is a good place to start when approaching a lender. And, as Tilbrook points out, the plan must prove that there is sustainable business income well into the future. “In our case, we’re less interested in profit and loss, more interested to see if the financed asset can generate enough revenue to repay the debt,” he says. National Bank’s Gay Rankin agrees that a business plan is vital – “a business plan gives clarity to the bank and to the business.” A set of financial statements is also recommended, but Rankin says they can still look at a business if they’re not available. “It’s a matter of working with the client to get a feel for their level of business expertise.” At the BNZ, Mike Skilling, GM business financial services, says any application for business funds almost always comes down to being adequately prepared. “A business owner demonstrating sound business operating knowledge, along with accurate financials and/or forecasting, will be much more likely to receive funding. “They should also be open and realistic about the risks of their business and what strengths they have to mitigate these.” Mark Robotham, general manager of the Government supported Escalator Service (see side story) says the biggest issue facing companies looking to raise outside investment is consistently the same – “the inability to concisely explain a product and investment proposition and unrealistic shareholder expectations over the company valuation.” Robotham says most companies declined at the preliminary assessment stage of the Escalator Service have either fundamental flaws in their business model (how they make money) or have an inability to explain what they do. “These issues will haunt businesses whether they are seeking outside investment, a grant, or even raising an overdraft from a bank,” he says. “First time inventors are the other group who’ll struggle to get assistance. This group has an expectation that they will raise money on the back of an idea – yet are not willing to back themselves enough to give up their day job or mortgage the house. “The reality is that there are few options open to entrepreneurs who are pre-revenue or, even worse, pre-product.” Bridging the cashflow gap For an increasing number of businesses debt factoring and invoice discounting are becoming popular as a means to leveraging finance and smoothing out the dips and bumps in cashflow. It’s increasingly favoured by a new generation of business owners. As Dave Cooper of Scottish Pacific points out – the two biggest assets of just about any business is stock and the debtors ledger. “With a bank overdraft you’re limited as to what you can borrow, but when it comes to factoring, you’re really only limited by the size of your debtors ledger. If your debtors ledger stands at around $100,000 a month – you can borrow up to $90,000 through us.” Cooper says Scottish Pacific will look at start-up businesses that show good potential and have a promising market – but generally they stay over the $400,000 turnover mark. Essentially factoring unlocks money tied up in your debtors ledger and allows you to utilise that cash straight away to fund growth. The factoring sector can be confusing with its many variants – but can be summarised under the following categories: One-off factoring is an “as-and-when” option. Used occasionally, it can deliver strategic results, but can be costly in comparison to term factoring. Invoice financing and invoice discounting – after looking into the credit-worthiness of your customer, the factoring company buys the invoice and remits about 90 percent of its face value to you. The balance is paid, less a fee, when the customer settles (on a $50,000 invoice the fee would be about $1,250). Full service debt factoring involves your signing over your total debtors’ ledger to the factoring company. They control and manage your debtors and are paid directly by your customers, who must know of the arrangement. Confidential factoring is similar to the above, but your customers are not aware of the factoring company’s involvement. Co-operation factoring is an arrangement where the factoring company still sends out the statements and manages receipts, but the client is responsible for credit control. ‘Debtor finance’ – essentially a proprietary brand for the BNZ. It offers a confidential invoice discounting programme, which sees the bank lending against the debtors, opaquely. With the factoring market growing steadily, there are now a number of players in the market, catering for different niches. Scottish Pacific and Easy Factors (a sister company to Lock Finance) are two well-known brands, and there are a number of more recent providers such as The Interface Financial Group and Fifo Capital – both built on franchise business models. Fifo Capital director Colin Chisholm says a typical potential customer of theirs may have a weak balance sheet while still generating good gross margin profit. They may have gone as far as they can with traditional lenders, and have little hard core equity, with most equity tied up in stock and debtors. “What happens when the bank or finance company says no, and you have a new contract to supply a customer, requiring additional staff and fixed costs? You can probably finance any new plant, but what about the running costs that need to be funded prior to the customer paying for the goods invoiced? This is where we can help.” Chisholm says their service is unique in that it only uses selected invoices from your debtor’s ledger to support funding, providing up to 90 percent of the GST inclusive value of the invoice, for a set percentage fee. Known as single invoice discounting, you can use the service as little or as much as you like. “If the company can produce and sell more product generating profit while we fund the production costs, it’s a win-win situation,” he says. “We buy current invoices to release cash now, and only as much as is needed to fund the additional production costs.” Chisholm refers to it as providing “situational working capital”. As with most factoring arrangements, a spin-off benefit can often be a tightening of debtor days – perhaps reducing the average from 50 days to 40 days, which is another positive for your bank account. Dave Cooper says factoring is fast becoming an accepted business practice in New Zealand – where it has lagged behind other countries until now. He says the biggest cause of failure in business is cashflow, and it’s important that businesses approach factoring companies sooner, rather than later to address a potential cashflow problem. Then the chances of dealing with it successfully are that much greater. Generally business owners looking to establish secure funding lines must be prepared to ‘open the kimono’, says Kieran Jones, and let their funder know not only the growth story for their business, but also the risks they face. Jones is general manager of Easy Factors International, sister company to Lock Finance, and one that has been in the small business finance market for six years, specialising in factoring, revolving credit facilities and import and term finance. “If the risks are understood by Easy Factors then we can work with the business owner to get through the difficult times and mitigate any issues that may arise – communication really is the key.” Jones also recommends a good business plan – “it shows that the client understands the market they are in, who their competitors are, and what makes them unique.” Glenn Baker is editor of NZBusiness.