The CFO’s Guide to SME Funding: Maybe you’ve started your business and are gearing up to supply some big new customer contracts. Maybe you’ve recently bought a business. One of the best challenges to have in business is determining the best way to fund growth. Most SME businesses don’t have enough earnings or external investment to fund their growth, so rely on financing. Businesses have been borrowing to fund growth for centuries so there are plenty of options. In this article we’ll explain the most common options for funding your growth.
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How do I arrange funding for my SME?
If you’re going to borrow money from a bank you’ll need to show at least two things: – security and ability to repay.
Security
As nice as your bank’s relationship manager is, they won’t be able to help you unless you have some sort of asset to use as security for the lending. This can be an actual physical asset or a financial one. We’ll discuss the types of assets commonly used as security later in this article where we dive into different types of funding.
Ability to repay
This seems like common sense, right? You’re asking for money to spend on growing your business so of course you’ll be able to repay it. The thing is, you need to show the bank how and when you will be able to repay the loan. Financial forecasts are the best way to show this. Make them realistic though – the credit department making the final decision on your loan sees a lot of these every year so they’re very good at smelling BS.
Equipment Finance
Most businesses will need some type of assets to help them grow. Sometimes called “revenue-generating” assets, these give the lender both security (because they’re physical assets that can be sold to repay the loan if you default) as well as ability to repay (if your business plan and financial forecasts clearly explain how it will support business growth).
Equipment Finance lending applications can generally be processed quickly by lenders.
Debtor Finance
Lending using your customer invoices is a flexible way to fund business growth. The lender’s security is the right to receive customer payments for those invoices (a variation on this is factoring, where the invoices are actually sold to the lender who takes responsibility for chasing payment). Things to be aware/ careful of:
These facilities are either confidential (your customers don’t know) or disclosed (your customers must be told).
Debtor insurance may be necessary to enable funding for customers with a higher risk profile.
Bad paying customers will reduce lending capacity in the long run.
Trade Finance
A lending facility designed to extend your payments for goods is a great tool to fund growth for retail, wholesale and import/export businesses. It allows you to better match your sales income with supplier payments which is good news for cashflow if your business is growing rapidly. Points to note include:
These facilities may also be called Letters of Credit (LC’s), Import Finance, and more.
The goods being purchased are the security in this type of lending, so the lender will need proof that they actually exist before any money is paid. Make yourself aware of their requirements!
Gathering the necessary paperwork to get payments approved by the lender can take time. Give yourself enough time for this – especially if your supplier is overseas. You’ll often need to pay a deposit very close to the goods being loaded onto a container ship so don’t leave it too late to arrange funding.
Supply Chain Finance
AKA Reverse Factoring, SCF funds invoices on the buyer’s side rather than the seller’s. Once the buyer approves an invoice the seller can immediately request payment of the invoice. This helps both parties:
The buyer can access longer payment terms through SCF.
When the buyer has a better credit rating the seller can access a better interest rate than if they had used traditional Debtor Finance.
As a seller you are not applying for lending by entering into your customer’s SCF arrangement – great! Just check first that it doesn’t conflict with your own Debtor Finance facility.
Overdraft
At first an overdraft can seem like the simplest type of SME funding. It’s just paying interest on an overdrawn bank account, right? Actually while it’s very flexible, it’s the most difficult one to access as it has no inherent security associated with it. Because of this lenders will generally seek alternative security, such as property (either from the business or the owner personally). This can mean taking on a much larger risk than the value of the overdraft!
My funding is in place, what’s next?
Well done, securing the right funding to help your business grow is the first important step!
Next you need to stay on top of your cashflow. Minimising your business’s cash conversion cycle (time to convert your inventory into cash) means you have more funding capacity for growth. You do this by managing your debtors, inventory and creditors closely, and monitoring your cash regularly. To paraphrase a wise CFO:
The best time to forecast your cash for the next 3-4 months on a weekly basis was last month. The second best time is now!