In a recent survey of US small business owners (with 11 to 50 employees each), 50% of the businesses surveyed listed “cash flow” as their top concern, while over 20% reported theirs as “raising capital/funding” (State of Small Business Report).
It’s no secret that cash flow management and capital raising are among the most important issues for small businesses, especially in the modern economy. And, while these are obviously very different matters, both can and do impact significantly on the ability of a business to survive in the short term and grow over the long term.
This article looks at some of the key issues for small businesses to be aware of.
The key concerns
Let’s begin with cash flow. For most businesses in the SMME category, the single biggest expense lies in salaries and wages. This is a non-negotiable because, in all organisations, staff members are the business.
At the same time, ensuring that one is able to meet these plus other cash flow requirements is business-critical.
If we look at capital raising, the fundamental stressor for business owners is trying to convince investors or banks to supply capital or debt. Investors look very carefully at risk, which is why it can be so challenging for smaller businesses to attract them.
The right avenue
I would strongly advise business owners to consider the multitude of traditional avenues that can be taken for investment, not just banks. These include private equity, venture capital funds, stakeholders’ networks, and even family and friends.
The right approach
Is there a ‘standard way’ to approach an investor? For example, should you only ask for funding once you’ve had five or six interactions with your potential lead investor? Should you only ask if you are at least 50% sure that they’ll say yes?
No. I don’t believe there is a standard way to engage a potential investor. Every interaction is unique and will have its own nuances; there’s no “right time” to ask.
In terms of the pitch itself, most investors will need to understand the business (in detail) and it must come across clearly as both sustainable and scalable. The last thing a potential investor wants is to ask you a question about the business – and these may be wide-ranging – and not receive a satisfactory answer from you.
The right time
If you’re at the stage of your business where you feel you have a sustainable and scalable business, you should prepare to get in front of as many potential investors as possible. But you also need to understand where you are in your life cycle – because start-ups have a different risk profile to companies with a track record.
The right risk
Similarly, businesses in different industries will have different risk profiles. And the quantum of funding required will impact the choice of funding partner. When you understand your risk profile relative to the type of returns on offer, you’ll be able to determine, and strive to seek out, the most appropriate funding source.
The right priorities
Once that decision’s been made, I can’t emphasise enough how essential it is that the investor and the organisation’s priorities and approaches are aligned at the outset; that they are on the same page.
Many things can go wrong between entrepreneurs and financial partners, and the worst outcome is that the investor crushes the entrepreneur’s pioneering spirit. In such a scenario, no one wins.
The right questions
It’s a good idea to ask potential investors the following shortlist of questions:
- What is your (detailed) track record as an investor?
- What is your investment mandate?
- What are the typical returns that you target?
- What is your typical risk profile?
- What are the origins or source of your funding?
The right ingredient
So what’s the secret ingredient that makes the all-important relationship work? Well, billionaire entrepreneur Richard Branson says it’s not the investor’s deep pockets; that these “will [not] sustain the relationship and the business in the long term”.
I believe he means that, into the future, the passion and flair of the entrepreneur is what will sustain both the relationship and the business – not the capital of the investor. If the business is well run, it will eventually expand beyond its need for the investor’s capital. And as it grows, it will require more and more entrepreneurial skill.
How we do it
As an investment holding company for larger businesses, rather than for start-ups, MICROmega Holdings (MMG) tries to remove as many of the subsidiary’s distractions as we can. But the principles remain the same: Provide access to capital and support throughout the business.
Provide mentorship and ideas around innovation. Create an environment in which the entrepreneur is able to focus on innovating, and not on administration management.
In our experience, businesses become more and more administratively intensive as they grow, which has the effect of bogging entrepreneurs down. We work to ensure that this does not happen.
How To Finance The Equipment That Will Build Your Business
Purchasing equipment and machinery is the number one reason why growing businesses require finance. Here’s how you can secure the funding you need.
Growth takes money. This is a simple fact of doing business. The trick is to spend that money in the right way. To protect your cash flow, financing your growth is often the best solution.
There are a number of reasons why growing businesses may need to raise finance, from bridging a temporary cash flow situation to a more long-term need, such as funding a major expansion.
Research from over 5 000 businesses applying for finance reveals that the top eight reasons for raising capital are:
- Purchasing equipment and machinery
- Funding business expansion
- Working capital/cash flow assistance
- Franchise funding
- Buying a building
- Funding a contract
- Property development
- Import financing.
Buying Equipment or Machinery
When exploring the finance options, the cost of the equipment or machinery you are wanting to buy will help guide your choice of funding.
For smaller capital outlays, amounts under R50 000, it’s often easier to fund these via credit card facilities, business overdrafts or term loans.
Larger capital spends are best funded by dedicated asset funders or funding facilities provided by the equipment/machinery manufacturer.
There are a number of lenders that provide asset funding.
Asset funding options
There are three basic ways formal asset financiers structure their loans — financing for an outright purchase, rental agreements or leasing options. Which finance option suits your specific business need?
Financing an outright purchase of the equipment or machinery is done via a prime-linked loan from a lender you repay in equal instalments over an agreed period plus interest. The period can vary from one to five years, or more, depending on the life of the asset.
The duration of the loan is usually equated to the lifespan of the asset. IT equipment is depreciated over three years and so a shorter-term loan applies. While you’re repaying the loan, the lender owns the asset; if you can’t repay the loan, the lender is entitled to sell the asset to recover the outstanding money.
You can’t sell the asset without the lender’s consent. Once you’ve repaid the loan, the ownership of the asset reverts back to you. When you buy an asset outright, the maintenance and ongoing running cost are your responsibility.
Renting is suited to situations where the equipment or machinery is for temporary use or where the use of expensive equipment or machinery is needed for short periods. Rental prices can be high as the company that rents the equipment to you has to recover their costs and make a profit.
Renting is ideal if you need expensive equipment (e.g. a crane) for a short period. There is no need to buy the asset or even lease it for several years, so a short rental is appropriate, albeit at a higher price.
Rentals suit industries with rapidly evolving technology i.e. computer equipment.
In some industries assets become outdated within a year or two, and a lease could leave you with outdated assets for five or ten-year terms. Rental costs are expensed on the income statement for both accounting and tax purposes.
Leasing is a contract to rent an asset for a set period, with set payment terms. Leases include conditions that govern use of the asset. A typical lease is long-term, ranging from one to ten years.
Significant penalties can be incurred by the lessor or the lessee if either violates the lease.
The asset may revert to the lessee at the end of the lease automatically or for what is termed a ‘bargain purchase option’ where it can be bought for significantly less than it is worth. However, when considering the lease payments, this is often for far more than the asset was actually worth.
Related: DTI Funding
From an accounting and tax perspective, leases fall into two main categories, operating leases and capital leases. If the lease terms meet certain criteria the lease will be considered capital, including; 1) the value of the lease payments makes up most of the fair market value of the asset, 2) the life of the lease makes up most of the effective useful life of the asset, and 3) there is a bargain purchase option.
Capital leases require you to record the leased asset as a fixed asset on your financial statements and the lease obligation as a liability. Over time the value of the asset is amortised and the lease obligation decreases through payments made. An operating lease has no such requirement and you can expense the lease payments as they are made, for accounting and tax purposes.
Rent vs lease
The decision to lease vs rent depends on your needs. If the asset is integral to your business and you need it there all the time, leasing is ideal. The security and guarantee provided by a lease is important, and it ensures your business has what it needs.
For short-term periods where you don’t need an asset in your business year-round, renting is a better option. Renting may cost more over that short-term but the total cost to you will be lower since you won’t have the asset for many years.
From the lender’s perspective
Always do a proper financial analysis before making your funding decision. For example, while owning an asset will add to the value of your business, and the interest portion of the repayments, the depreciation, maintenance and running costs are tax deductible, it will require a large cash outlay upfront that can impact your cash flow.
When lenders assess the merits of an asset loan application, they will expect you to provide proof that the business can afford the equipment.
Asset funders are particular about the type of equipment or machinery they are prepared to fund. The first consideration is whether the asset has a good resale value. Items that are highly specialised and cannot easily be sold will incur a higher rate of collateral. If the asset has a good resale value the collateral will be lower or, the asset can be used as collateral.
Before making a decision consider buying second-hand equipment. If you are in the construction or manufacturing sectors, good second-hand equipment may be a more cost-effective option. However, lenders don’t typically fund the purchase of second-hand equipment and machinery due to its limited resale value.
What asset funders require from you
The type of equipment and machinery needed by the business will dictate the process to apply for asset funding. Highly specialised equipment or machinery is best handled by specialist asset funders or direct enquiries to the manufacturer.
Most manufacturers of capital intensive equipment or machinery have partnerships with selected lenders and they can guide you on available funding options and the application process. Likewise, specialist asset funders have procurement partnerships and they will assist with the relevant options and the application process.
For other types of equipment or machinery you will be expected to provide quotations that detail the type of asset and the landed costs.
There are three steps to finalising asset funding:
- Evaluate the value of the asset.
- Evaluate the business risk involved in lending finance to your company.
- The financial offer will be prepared based on the assessments outlined above.
Finfind is SA’s leading access to finance solutions for SMEs. This revolutionary online platform links finance seekers with matching lenders, providing easy access to over 200 lenders and over 350 loan options. Finfind is supported by USAID and sponsored by the Department of Small Business Development.
Go to www.finfindeasy.co.za to find the business finance you need. It’s free and easy to use.
Vusi Thembekwayo on How he Financed Growth
Looking for funding to start a new division or launch a new product or service? Just tap into your network.
There are many ways to fund growth. Just ask Vusi Thembekwayo, founder of Motiv8, who has funded his business’s growth by tapping into the wallets of his clients.
Have a great relationship with your clients. If they know you operate with integrity, they’ll be far more willing to listen to your pitch for funding.
Ensure it’s a win-win situation. In Thembekwayo‘s case, the business did high-level strategic consulting for its clients, so it was in the clients’ best interests for Motiv8 to grow and prosper.
Investing in Motiv8’s growth was akin to investing in their own growth.
Put a firm funding contract in place. Thembekwayo put up a stockbroking account worth R600 000 as collateral and negotiated terms of conditions that were clean and interest free. However, as he was being funded by clients, it was important to ensure all parties were covered and in agreement.
Business growth is great — but you don’t want to alienate your clients; they’re even more vital to your overall success than funding.
Bringing Investors Onboard
Post-investment: be prepared for growing pains.
If your business has survived the first two to three years, and you want to continue growing it, there’s a strong chance you’ll be looking for an investor. But be careful what you wish for: The dream investment and the glow of success will bring growing pains, which will be more painful than you imagined.
In many companies I’ve worked with, there is a moment not long after that first big investment when the founders look at each other and think “Was R20 million/R30 million /R50 million worth putting up with this?”
Suddenly they’re being faced with apparently unreasonable demands for new structures and processes that seem like a massive distraction from core business focus. This is the moment when it feels like you’re drowning in red tape, the interfering investor has no clue how the business really works, you’re losing your competitive edge and the whole thing has been a horrible mistake.
If that describes you, take a deep breath. If there’s any chance this could be you in a couple of years’ time, listen carefully: That pain is a normal part of the growth experience. Embrace it.
We South Africans have a fantastic ability to create new stuff out of nothing, sailing off into uncharted waters on “boer-maak’n-plan” makeshift vessels that achieve great things. Our maverick tendencies make us really good at start-ups. But if you want to make it out of the world of plucky pioneers into the big leagues, you’re going to have to adapt.
Adapting means qualitative change, not quantitative: think of it as building the infrastructure that will maximise profitability when growth comes. Proper systems and corporate governance structures, compliance, regular structured forecasting, budgeting and reporting, all the infrastructure that will be needed to support the business safely through the next wave of growth.
In fact, a fair chunk of a typical R20 – R50 million investment should be spent precisely on creating those structures. You can’t become a R200 million or R2 000 million company if you’re still acting like a R2 million company. All that tedious bureaucracy – the board charters, the audit committees, the renegotiated employment contracts – is laying the groundwork for the future.
What an investor should bring
But bear in mind the important point: the actual cash should be the very least of what an investor in your business should bring. Far more valuable in the long run is the active involvement of someone who has been there and done that: the strategic alliances, the operational know how, the connections and the experience and knowledge they bring.
Really tap into the investor’s experience in everything from product efficiency to bonus pool structures. If they have requested a board seat, make them work! Appoint them to the sub committees and involve them in weekly calls. Appreciate their need for reporting and their need for transparency, how else can they give the guidance that will add a zero to your company valuation?
You’ll probably go through a phase of regretting the investor along the way, but that’s ok, if you have chosen the right investor. If you’ve ever seen a martial arts movie the story arc should be familiar: There’s always method in the master’s madness.
There will be sacrifices, notably your complete independence of decision making. But the rewards of growth will far outweigh them. If you can prove that you have the strength and discipline to run a business in which you are the custodian of other people’s money, not just your own, the world is your oyster.