An entrepreneur's guide to raising finance

At some point, all entrepreneurs need some finance for their business whether it be a few thousand pounds or a couple of million. But who can provide it? This is a guide to the options.

Whether you're starting up in business, or looking for funds to expand your operation, the key question of capital is sure to arise.

Put simply, this is the biggest sale of your life. Your business ideas will be tested to the limit, your business plan may be rejected, you will be quizzed on your figures, and all the time, the future of your business is at stake.

BusinessZone.co.uk's guide to raising capital will help you find the right kind of finance for your business.

Why do you want the money?

The first thing you should think about is why you need the money - what is the money for? How does it fit in with your business plan? When will you need it? It's no use asking for money three weeks before you run out of cash - prepare yourself well in advance and, if possible, have potential investors lined up.

Another important question to ask yourself is whether you are ready for the money. Recent government research indicated that many organisations fall down when it comes to 'investment readiness'. Raising capital efficiently is an issue. There are a variety of options available. Not all of them may work for you - the bottom line is, of course, the bottom line. If you are looking for investment, patience and skill are vital. Preparation is even more vital.

Deciding how much money you want, and when you want it, should emerge when you have drawn up your business plan. Cashflow and profit forecasts need to be rendered as accurately as possible - three years ahead if possible.

A professional adviser, such as an accountant, can help you with this. It is always a good idea to talk to an accountant when wishing to raise finance. They have the experience and contacts you need, and can bring an objective view to proceedings.

Asking for the correct figure is also very important. Optimistic sales forecasts may look attractive, but things do go wrong. Budget for emergencies, and be conservative in what you request. The amount you ask for is also significant, and may mean some adjustments in your business plan. Be flexible - you may need to adjust your business plan at every stage, or for every meeting. Don't worry - this can be edifying if taken in the right spirit.

Be aware of the 'equity gap' - businesses can find it difficult to raise between £100,000 and £500,000. Firms may not appear to have the speed of growth or trading history to attract funding of this size. But there are schemes that may help, as described below.

You may want the money for setting up. Computer equipment, legal fees and the like all add up. Or you may want working capital - funds that keep you going while you wait for payment, or to help you expand.

What do you need to remember?

You will have to know your business inside and out - the figures, the forecasts, profit and loss. Your idea will be thrown to the lions and may come back torn to shreds. Don't worry - adjust your plans accordingly.

"I must have gone to hundred different meetings with a hundred different business plans," said one adviser with finance experience. Seventy or eighty may be rejected immediately. The rest may falter at some later stage. Be patient.

How you will repay the money is key to your success. Can investors expect a return on their equity? Can your bank manager be confident of receiving the money back? Put these in your plan and make sure you know exactly how this will work to everyone's advantage.

You may want the security of regular repayments. Or you may want to repay the investment after several years. Again, your accountant will help.

Generally, you can expect investment of, at the very most, four or five times the amount you can raise personally: But there are no guarantees. Be prepared to be flexible in your approach, but retain confidence in your idea.

Investors look for a strong management team, so work out how well your present colleagues measure up. This may involve being brutal, either now or at a later date, and may be triggered by the investor. The influence an investor can bring depends on the amount they invest. The choice - between friends and colleagues, and cold hard cash, can be difficult.

As a brief guide as to what to remember, this checklist may help:

• Wow them with your business plan - make it impressive and around 15-20 pages in length
• Know your onions - you should know your business inside and out, and who you are talking to
• Look the part - leave the parka in the wardrobe
• Get the right skills, experience and insurance
• Role play! Great fun - rehearse the situation with a colleague
• Sell yourself and your idea
• Be positive, and don't give up

Types of finance

A range of finance is available for business. Start-ups may consider using personal assets as security, such as re-mortgaging the house. This could have unfortunate ramifications if things don't go according to plan. Other options are outlined below.

Family and friends
Circumstances may dictate an approach to family and friends for capital, but tread carefully - this could bring heartache if the business goes to the wall. Draw up an agreement between yourself and any family member that invests, so that mishaps are taken into account.

For sole traders and partnerships, interest on such loans is allowable as a deduction against tax when working out taxable profits.

Loans and grants
Grants and loans are available from the government and other organisations. These include the DTI's Small Business Loans Guarantee Scheme, and the Prince's Youth Business Trust for young entrepreneurs.

Going to the bank
You may think that the first point of your call would be your bank. Many offer facilities for start-up companies. Take a look around some of their websites, looking for start-up guides and the facilities they offer. Free and online banking can save time and money, and a small business advisor in a local branch can provide that personal touch.

Bear in mind that your first presentation may not be your best. Maybe you could do a dry run with another bank, so that you can approach your own bank manager with a perfected approach. And remember that your bank manager may have a limit on the amount he or she can lend. Asking for substantial funds could mean a deferred, and thus more remote decision.

Factoring and leasing
Factoring and leasing are two ways of releasing capital into your (usually established) business. Factoring sees an agency pay you - on average - 80% of the amount owed to you by customers. The agency then takes a commission on what it can recover. But this may not be suitable for companies with a large number of invoices.

Invoice discounting is a similar measure - short-term finance that gives you 80% of your invoices, and the rest on settlement - less commission. However, responsibility for debt collection lies with you and you must have sound credit management procedures in place.

Charges should be agreed in advance. You can expect a service charge - from 0.75% to 2.5% of turnover for factoring and less for discounting - and a discount charge - worked out from the daily use of funds.

Such arrangements are useful for growing businesses, as it provides cashflow at a sensitive time. Look at whether the cost of debt collection internally is worth the expense. Bear in mind that discounters and the like prefer a history of sound debt collection. Insurance against bad debts may be an option.

Leasing is self-explanatory. Instead buying an asset, why not lease it? With no capital outlay, cashflow figures become all the more presentable. Also, property leasing can have certain tax advantages. Of course, you do not own the asset - the finance company does - unless it is a hire purchase arrangement. Bear in mind you will have to maintain the equipment, but you should be able to deduct the cost of leases from taxable income.

You may not be able to back out of the deal, but the regular outlay is a very manageable proposition. Interest is usually fixed rate, but larger items may have a negotiable rate. With long-term leases, any capital allowances benefit the leasing company. They should pass that on to you, the customer.

Where the piece of equipment is likely to have been used before, be used again, short-term leases may be the answer. Visit the Finance and Leasing Association for the relevant contacts.

Partnerships
A partnership opportunity may arise - a cash-rich investor who may be interested in your business idea, and who is willing to stump up the cash you need to get going. Set out the involvement of this partner at an early stage. They may want to 'help' you in ways that don't fit with your plans. Also, be clear about the share of profits the partner can expect if success is achieved.

Business angels
Business angels are private investors looking to promote young businesses. Often with a wealth of experience, such individuals look to bring their expertise to a business in return for a profit on their investment. Many ally themselves with start-ups, but some will invest in a company at any stage.

As with partners, it is wise to ascertain how much involvement and profit share they can expect. The National Business Angels Network can put you in touch with one in your field. Angels can show a more 'relaxed' attitude to their investment - they may not demand the high rate of return demanded by our next colleagues, the venture capitalists.

Given that a number come from a start-up background, their input can prove invaluable. Angels try to bring ideas and add value to the company and they can be very tolerant as to when they expect a return.

The average investment is around £250,000, but this too can range from a few thousand to seven figure sums.

Corporate venturing
The buzz word for investors is corporate venturing, where a larger company invests in a smaller one in return for a share in the future of that company. Attractive for established players wanting to invest high-risk companies, this arrangement could see a clash of cultures as fast new players come face to face with the old economy's obsession with bureaucracy. The need for defined objectives at the outset is paramount.

There are many reasons for taking the CV route. Whatever the background, in-depth discussions are needed. What return will they expect? Some deals can be done without an equity release - otherwise you could expect to release around 20 to 30%.

The relationship could be based on research and development, or contributions in kind - you may provide them with skills in return for a financial investment.

Define the contract precisely, taking note of performance indicators, and the expected outcome (if any). Is the deal exclusive? There are a number of options to consider. Do so carefully.

Venture capital
This route is suitable for businesses that have exhausted their own reserves or sources of finance, as venture capitalists bring capital and expertise to a business entity in return for a large slice of your company.

The VC route suits companies that can fulfil the promise of the high returns demanded by backers. Although useful in theory for start-ups, in practice you may have to show that your product is successful before approaching them. Many are looking for businesses of rapid growth within, say, five years. The British Venture Capital Association is the main representative body.

VCs look for a high return (up to 25% per annum) on their investment within three to seven years. They will expect a strong management team, a proven track record, and an 'exit' - a way of realising their money at the end of the investment.

The minimum you should ask for is £100,000. Your business plan should be bulletproof. Forecasts must be realistic, and you must be part of an attractive sector.

The VCs will expect certain things from you, not least footing the bill for the whole process. They may ask for restrictive covenants on management, a board representative, and regular consultation. In short, the rewards are huge, but so are the risks.

The slice of the cake will be subject to strong negotiation - obviously, it benefits the business if you retain as much control as possible.

However, the exit is all important. This could be the sale of the business to another company, a listing on the markets, a management purchase of the VCs' shares, or refinancing by another institution.

Many VCs will provide expansion financing for the next stage of growth, and for management buy-outs and buy-ins. More promising start-ups could win VC funds for marketing and development stocks.

Listing
Listing on one of the many markets is also an option, but involves a whole host of requirements. An audited three-year track record is just one. A full listing is only worth considering for larger firms. OFEX may be right for those just starting up. But for young and growing companies a listing on the Alternative Investment Market (AIM) may prove the right option.

The requirements for the Alternative Investment Market are not as stringent as they are for a full listing, but such a move still requires serious thought. If you value your business at over a million, and are willing to look to the medium and long term, AIM could prove the best foot on the ladder.

If you are looking for a market value of above £1m and you feel confident that you can stand up to scrutiny AIM could be the way forward.

A nominated adviser - one of a number of firms listed on the London Stock Exchange's register - can judge whether it is right for you.

Admission criteria for AIM are less stringent than they are for the main market and many of the benefits can be the same.

As well as providing access to capital a listing on AIM places a market value on your business enhances your status with customers and suppliers and creates a heightened company profile.

A quote on AIM can help fund growth and acquisitions but it is not a short-term measure. The value of shares can go up as well as down to coin a phrase. The whole process can take from three to nine months and then several years before you start to see a return so taking AIM is not to be rushed.

What are the benefits compared to a full listing? There is no minimum market capitalisation, no trading record requirement, and admission documents are not pre-vetted by the Stock Exchange or the UKLA (UK Listings Authority) – all requirements of the main market.

Although a nominated adviser is needed all the time, there is no demand for a sponsor on transactions or prior shareholder for large acquisitions and disposals. The 25% minimum of shares in public hands is reduced to zero.
Your adviser will support the AIM application and ensure that the firm meets AIM requirements on a regular basis.
You will also need to appoint a broker – a Stock Exchange member possibly the same firm as the adviser. And you will need an admission document - relevant financial information and forecasts to enable investors to decide on whether to invest in your company.

Working with someone with AIM experience is highly recommended. A non-executive director boasting such knowledge can offer invaluable advice. Your broker may even request such an appointment. Sound corporate governance and a good track record are similarly expected.

Share option schemes can prove an incentive to staff but common sense dictates that these should be linked to performance where possible.

Other types of finance
Private placings allow private investors to take a stake in businesses before flotation. High risk and high return, such a method may be used in conjunction with other types of venture capital.

Venture capital trusts (VCTs) are often entities available through public offerings. They provide start-up finance for dotcoms and the like as well as traditional enterprises. Shares rarely change hands in public.

Incubators come in a variety of forms – a university may create one to support offshoot businesses or a company may seek to expand in areas outside of their normal field. Such incubators are offering business advice and funding usually in return for equity.

Senior debt is used by a bank where a business is looking for funds to expand or acquire. This term relates to the right of the main lending bank to have first shout on the security (i.e. assets) given.

Mezzanine finance falls between two levels of risk for a lender. A high level of interest equates with a high level of risk as it bridges the gap between equity and senior debt.

As well as these, there are plenty more options, such asset finance which sees machinery equipment and the like used as security against an advance. Vehicle finance sees a fleet used as security with a range of hire or lease packages available.

A veritable money maze awaits those looking for financing. There are hundreds of hoops to jump through – plus you will have a business to run. However, once that cash is in the bank you can face the future with renewed vigour. Good luck!