There are many ways to secure financing, and methods vary from country to country. But the universal challenge that any SME faces – at almost any stage of growth – is to find the method (or combination of methods) that fits its own unique set of business goals and circumstances. Inevitably, factors like company size and maturity, industry niche, credit history, potential for growth, and external market conditions will all play a part. Also important is the cost of borrowing those funds because rates can vary widely from one lending source to another.
Here we take a brief look at some tried and tested methods of financing that can be useful to SMEs.
A traditional bank loan remains the first port of call for most SMEs looking to raise finance.
Ideally, you’ll want to build a business relationship with a bank well before you need to ask them to lend you money. Let the bank get to know your business, and get to know you as a creditworthy customer.
When the time comes to ask for a loan, be sure you are well-prepared and can explain clearly how much money you need, why you need it, and how you will pay it back. Then back up your application with documents that will increase your chances of getting a positive response.
Family and friends
This is often the easiest way to raise money. Start-up businesses often look here first. The costs of borrowing are often lower than other methods, too. However, mingling business with personal relationships has its potential drawbacks, which is why we advise clients to set up the transaction in a formal, businesslike manner.
Give your lenders paperwork that documents their loan, and the terms of repayment. Make sure their rate of return is reasonable (even if you are lending money to yourself). And give the lenders a get-out clause that allows them to ask for their money back whenever they wish.
Borrowing against a home
Remortgaging one’s home is another popular method of raising money. However, this brings with it a level of personal risk that is often beyond the tolerance of all but the most seasoned entrepreneurs.
Government loans and grants
This is well worth looking into. Almost every country represented in the Russell Bedford International network offers some form of government-sponsored grants or loans designed to help SMEs looking to grow, and many local governments sponsor similar initiatives.
Unlike a loan, a grant typically does not have to be repaid. However, there is a significant amount of research and paperwork involved. Grant programmes can be highly competitive, with specific, detailed formats that need to be followed carefully when applying.
Borrowing against business assets
There are several creative methods of financing for established businesses. These include asset-based financing, invoice discounting, and factoring. While each brings its own benefits, drawbacks and costs, what they have in common is they all use a tangible business asset as security for the loan.
Supplier or vendor financing offers another alternative where a business needs expensive capital equipment. Manufacturers and leasing companies will often offer financing, and at interest rates that are relatively attractive.
Perhaps the most difficult financing path for owners to take is working with outside investors. There are many ways to raise money in this way, but all of them involve giving up some measure of control over the business. We advise business owners to tread carefully when considering these types of financing.
Equity financing may be the simplest of these options. Equity is the value of the business, minus any debt the business owes. An owner can raise money by selling a portion of this equity, but the buyer will then be a partner and will have partial control of the business. This arrangement can work well between businesses that complement each other.
When the full equity of a business is sold, it becomes a merger where the seller’s business becomes part of the buyer’s business. Individual angel investors provide financing to early-stage businesses that offer the angel the potential for a better rate of return than more traditional investments. Often, angels may also offer their experience and access to their business contacts. In return, expect to give up some business control. This may take the form of a board position, a formal consulting role or a stake in the business.
The same holds true of a venture capital firm, which is essentially a group of investors who have pooled their funds to finance early-stage, often high-risk businesses that offer the potential for an attractive return on their investment.
Getting it right
Of course, what’s right for one business will not suit another; individual business needs will have a major bearing on the final decision. Before deciding anything you will need to consider in detail all the alternatives. Be sure to seek professional advice.
Established in 1983, Russell Bedford International is a global network of independent firms of accountants, auditors, tax advisers and business consultants.
Ranked amongst the world's leading accounting and audit networks, Russell Bedford is represented by some 460 partners, 5000 staff and 200 offices in more than 80 countries in Europe, the Americas, the Middle East, Africa and Asia-Pacific.
All Russell Bedford affiliates are well-established firms offering international business advice and services to local and multinational clients. Most provide a full range of services comprising accounting, auditing, tax advice, general business guidance and financial consulting. In addition, many have special expertise in particular fields, such as international taxation or information technology.
In January 2008 Russell Bedford International was named one of the first 17 full members of the IFAC Forum of Firms after reporting it had implemented a globally coordinated quality assurance programme, committed to the use of International Standards on Auditing (ISAs), and met other specific ethics requirements.