Recent times have been challenging for businesses seeking to raise additional growth funding. Just how tough is the finance market? What are the best options for raising capital? Patricia Moore goes in search of some answers.
The recovery may have been patchy but David Battersby, MARAC general manager, business, says on balance the outlook for this year and beyond is one of gradually improving economic growth. And despite the sluggish economy, they were involved with some real business success stories last year, he says. “The worst, we believe, is behind us.”
Battersby is advising SMEs to focus on positioning themselves for a stronger year. “It will be the wrong time to experience capacity constraints and access to funding will be critical in ensuring that’s not the case.” And there’s the rub; access to funding. Just how easy is it for owners of businesses at the smaller end of the scale to source finance and what do they need to do to increase their chances of success?
The past 12 months were challenging for businesses seeking additional funding, particularly from banks, report Martin Richardson and Catriona Knapp, business advisory principals at WHK. Lenders have tended to look closely at business performance and the history of not only the business, but the individuals involved in running it. And while lending criteria has softened slightly, they say banks in particular are still adopting a cautious approach and options are limited if you’re not able to offer security.
Tony Marlow, BNZ head of retail banking, small business, paints a more positive picture. “Last year was slightly easier and my personal view is that 2011 will be even better.” A major factor in this is renewed interest by banks in the SME sector. “I don’t think it has always been that way, but with SMEs making up around 97 percent of all businesses in New Zealand, it’s fantastic to see the focus on this area. It’s a competitive market and I think this can only augur well.” (WHK suggest this year will also see “an increased appetite from those with funds to start looking for investment opportunities”.)
A clear strategy supported by a robust business plan and financial forecasts are critical if a business is looking to debt fund expansion, says Battersby. “A cashflow financier needs to be convinced that the business plan and assumptions will produce sufficient cashflow to service and repay the debt.”
Business owners and people after start-up funding, also need to be clear on why they want to borrow and the best way to go about it. Refinancing and borrowing for growth are two quite different situations although many of the questions that need to be asked around growth funding also apply to start-ups. “The same fundamental risks are involved but there needs to be greater focus on where the customers will come from,” says Marlow.
And Richardson and Knapp at WHK say it’s important to understand that little or no investment from the owners is very unattractive from a lender’s perspective, in particular in this market. “Most of the main funding bodies – particularly banks – want to see that the owners are prepared to invest in the business themselves and therefore take some of the risk.”
In a general sense, SMEs should look to finance their business against the assets and cashflow of their business, says Battersby. “Finding a cashflow lender is not always easy with many financial institutions favouring bricks and mortar security. That’s where companies like MARAC have a clear market niche.”
Re-financing can be quite simple, usually relying on history from bank statements, trading and financials, says Marlow. “Borrowing for growth is a lot different because that’s raising different levels of risk in the business and understanding those is critical.” Doing the homework won’t guarantee funding, but he says it can certainly speed the process.
Borrowers need to consider:
• Where the growth will come from – existing customers or new ones?
• Can the staff handle growth and if it’s necessary to recruit is there recruiting expertise available?
• Are the business tools adequate – will the IT systems or the support systems behind the financial reporting get flooded by new business?
• Does growth mean a change to distribution?
• Can the premises and the locality handle it? Is the business in the right town for growth?
• Will growth demand new and different advertising and marketing strategies?
Lock Finance CEO, Simon Thompson, says while the past year saw “a reluctance to change anything” and a subsequent drop in demand, interest in factoring has grown. “People have realised it’s a very good tool when capital is tight because it’s a way of self-funding within the business, rather than having to go to external assets like the family home. More and more people are separating business from home and family, wanting the business to fund itself and factoring is one of the best tools to do that.”
Cash-strapped businesses can also benefit from options such as inventory finance products which mean money earlier in the process, trade finance, and import/export products, says Thompson. “Many of these are not well understood by borrowers, which is why getting advice before they start looking is important.”
BNZ’s Marlow is also seeing more non-housing backed lending. There’s more emphasis on identifying the customer’s real need and how best to suit it, he says. “If that means the customer wants to leverage their home to grow their business or finance one, that’s fine, but if they want to use the capabilities of the business then why wouldn’t we want to do that?”
He says while there’s obviously a level of appetite when it comes to not having full security backing, he believes they’re demonstrating a lot more willingness to be involved and do things at the smaller end of the scale for customers that aren’t locking in the home.
Angels coming to the table
Colin McKinnon is executive director of both the New Zealand Venture Capital Association and the Angel Association. While both associations represent investors, the focus for the NZVCA, where ‘investors’ are typically fund managers, is usually on businesses looking for funding in the vicinity of $1 million to $15 million, says McKinnon. “The angels are looking to help small start-up businesses with funding from maybe $500,000.” (The first half of 2010 saw angels invest more than $31 million in young companies.)
The key is identifying the right investor for your particular business idea. “I often find people are very knowledgeable about their product, but not so knowledgeable about their business. They really don’t understand who their potential investors may be.” A lot of research goes into the demographics of a target market, says McKinnon. “But sometimes people don’t have the same skill-sets around identifying who their target investors would be.”
Indeed McKinnon believes ‘financial literacy’ is a problem for many Kiwis; “a general lack of understanding of business and investment processes and opportunities.” Kids come out of school understanding accounting but know nothing about business, he says. “Growth in the next decade has to come from the business community, but in terms of understanding how it all happens, we’re relatively ill-prepared.”
Businesses fail because they run out of cash; many of these have great products and a strong market position, says MARAC’s Battersby. “Access to capital, appropriate funding lines and strong professional advice are all critical factors to prevent this.” And while we’re pretty good ‘doers’ Kiwis don’t always seek that extra advice, says Tony Marlow. “From online resources that make it more informative and easy for people, to mentors and bank business managers, there’s plenty of it out there.”
Making it happen
Banks have changed their approach to business lending, believes Allan Pilbrow, managing director at Malcove Distributors. “Their rules are tough but I don’t have a problem with that. Since the recession they’ve started to realise they have to think about business and how business operates. What are you trying to achieve with the money you want to borrow? In my opinion a lot of business owners don’t really know. They haven’t thought it through.”
He advises business owners to begin the process by talking to an accountant or business advisor. “In my case that’s Martin Richardson at WHK. You need to know that what you plan to do is possible. When you’re in business, having an accountant who gives good advice and can act as a sounding board is essential. It also gives you credibility if you want to raise money.”
Malcove is a well established promotional logistics company with a client base that includes many of the country’s leading brands. “That has its advantages; they’re companies people recognise won’t go belly-up overnight.”
Pilbrow believes there are two key areas business owners need to take into account when dealing with lending institutions. The first is transparency. “Being absolutely open and honest about what’s actually taking place. I’ve given my bank every bit of information, warts and all, for the past five or six years. Even if something bad has taken place they know about it.”
The second consideration is having a strong business case, not just a budget and cashflow, he says. “A lot more research needs to go into it. A lender needs to know how things are trading, where the business could be in two or three years. What’s the shelf life of your business? That’s the sort of stuff you need to be thinking about.”
Pilbrow says he’s ‘been there’. “I was once one of those ill-prepared business owners, but I’ve come a long way. And I’ve been lucky in being with Westpac who’ve been open and receptive to this approach. Sourcing business finance should be just like any other business transaction – but you’ve got to have a case that stacks up on its business merits and doesn’t rely on the value of your house.”
With funds advanced to date at just under $2 million, Employment Generation Fund is not a significant lender. But together with a small number of similar funds including Prometheus Finance in Napier, Just Dollars in Christchurch and Nelson Enterprise Loan Fund, they’re making an impact in the area of ‘social lending’.
Not to be confused with P2P lending – still to be legalised here (where borrowers and lenders talk directly to one another), social lending or ethical investment is an area where New Zealand lags behind a number of other countries, says fund manager Phil Hickling. Basically, the funds provide business finance to people for whom the usual sources of funding are not available. “Fundamentally, but not exclusively, we’re a lending institution of last resort. Our lending limit is $20K and the average loan is close to $10K, although that has trended up in recent years.
“Our criteria are not dissimilar to commercial banks – there should be a business plan, financial records, and projections for us to establish the viability of the applicant. This is important because most of our loans are unsecured.” Terms are usually a P&I loan over three years at eight percent, but this can vary, he says. And, while employment creation is important, it’s not a condition of making an advance. (Employment Generation Fund’s $1.7 million has so far seen the creation of around 150 new businesses and 350 jobs in Auckland and Northland.)
Employment Generation Fund has supported enterprises ranging from growing avocado seedlings and starting a driving school, to the manufacture of bed linen and uniforms for health professionals and the development of natural fibres for use in high fashion wear. Their success rate is high and Hickling believes a major driver is the fact that all supported ventures must have a mentor for the duration of the loan.