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Arbor Capital Tell You Which Funding Is Smart – And Which Is Not

If you want to grow your business, chances are you need finance. But there’s smart funding and funding that could do more harm than good. You need to find the right solution for your needs.

Nadine Todd

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  • Players: Michelle Krastanov and Marthinus Erasmus
  • Company: Arbor Capital
  • What they do: Provide a comprehensive range of integrated corporate finance; capital raising and listing-related advisory services.
  • Visit: arborcapital.co.za

Imagine you are the owner of a business that has been operating successfully for almost two decades. Your turnover is over R50 million, and you’re established in your market.

Now imagine you’re heading towards a wall. Your cash flow is going to run out before a big cash injection in four short months, and you’re desperate to keep the business running until that happens. That desperation leads you to a less-than-scrupulous lender and you agree to incredibly onerous terms: You loan the cash you need at an exhorbitant interest rate, you give a portion of your business away for free, and you hand over all of your securities. You even relinquish management control over the business.

No doubt you’re thinking this could never happen to you. And yet it happens to more established businesses than you’d think possible.

Related: New Ways SMEs Can Find Funding

In this particular case, by the time the owners of the company came to Arbor Capital for assistance, they were weeks away from signing over their business to their funders. Their desperate measures had placed them in a worse position — which had been their lenders’ intention from the beginning.

Had there been a different solution available to them? Absolutely, say Marthinus Erasmus and Michelle Krastanov. Unplanned debt or equity funding can be very expensive. Planned funding on the other hand is structured to suit the business’s real needs.

In this case, the business’s owners could see that their cash flow showed they would hit a wall within four months, but that there was a big influx of cash thereafter. The business was solid but they were affected by seasonal issues. Instead of almost signing the business away, they could have structured a funding package to suit the business’s needs.

The sustainable solution would have been a mix of short term bridging finance and long term debt and equity finance. Their cash window was four months — they just needed bridging finance.

Arbor Capital was able to help them get out of their onerous funding contract, and then secure the correct finance for their business needs, and helped them avoid losing everything.

The lesson? With proper planning and realistic assessments of the business, the correct funding solutions can be found that avoid situations like the one outlined above.

How often do business owners choose the incorrect funding structures for their needs?

funding-structures-for-business

Unfortunately it happens more often than you’d think, but it’s not always because of unscrupulous lenders. Far more common is a situation where business owners just don’t do their homework and end up securing the wrong capital for their needs.

We’ve seen a lot of businesses that secured funding from equity investors or companies looking to expand through acquisitions, and after a few months both parties realise that their values or objectives aren’t aligned, or their expectations of each other weren’t clearly stipulated. The entrepreneur now has a 30%, 40% or even 50% shareholder in their business who isn’t happy, and they’re under even more pressure than they were to begin with.

Related: How to Write a Funding Proposal

How can situations like this be avoided?

Business owners need to carefully assess their business needs before choosing a funding or financing structure. There are so many ways to inject cash into a business, but what you choose should align with your specific needs.

In cases like the one mentioned above, everyone usually did the right thing and followed through with due diligences and so on, but it’s still not working out because it was the wrong funding structure to begin with.

What options can people choose from?

There are so many options for business owners to consider when raising finance. This depends on the size and nature of the business, the short and long term objectives and includes equity, debt, mezzanine finance (such as convertible preference shares), trade finance incentive funding or a combination of different types of funding.

This depends on the business’s needs, what repayments it can afford, how much equity the business owner is willing to give away, and so on. Combination solutions in particular are overlooked by business owners, and yet they’re often the best solution. The sources of such funding include the banks, private equity (includes private wealth) investors, BEE investors, listings and the DTI and IDC.

How can business owners determine which funding solution is best suited to their needs?

Start by answering very specific questions about your business: What type of money are you looking for? How much do you need? For what purpose do you need it? Are you looking at long or short term debt? Long and short term debt in particular serve different purposes.

The next step is to critically evaluate your own answers. How much money do you actually need? We find that business owners often believe they need more cash than they actually do, either because there’s cash sitting in their business that they can unlock, or because they actually need the cash in different stages and not all at once. The converse of not securing enough funding can be equally damaging.

Related: Government Funding and Grants for Small Businesses

Similarly, perhaps you’re looking for debt funding but the business won’t be able to sustain the repayment plan. If you can’t afford the repayments you can’t take debt funding. Interrogate your cash flows and forecasts. Can you afford the interest? What will the cash achieve? Will cash flow and profits improve? Higher sales lead to higher working capital requirements, and costs go up too. On the other hand, you might be averse to equity funding and unwilling to dilute your shareholding. It’s important to be realistic.

For example, a business approaches us and says they need assistance securing R70 million in debt funding. After going through this process, we realise that they actually only need R40 million now, and an additional R20 million in 18 months’ time.

The business cannot afford R60 million debt funding, but it can afford R30 million. By understanding these factors, the business owners are able to secure a loan of R30 million, and find an equity partner for R10 million now, and an additional R10 million in 18 months’ time, at which time the business could take an additional R10 million loan.

The owners don’t give away too much equity, they don’t take a bigger loan than they can afford and they secure the correct amount of capital for their needs. This can all mean the difference between a rewarding growth experience and a failed growth attempt.

What are the most important red flags that business owners should be aware of?

The incorrect financing solution can do irreparable harm to a business. So many owners fall into the trap of believing that money solves all business problems. This isn’t true. Business owners who need equity funding take debt and end up struggling with repayments, or the opposite happens and too much of the company is given away too soon for too little.

On the flip side, too much cash too early and you may start spending for the sake of spending, burning through cash and irreparably damaging your business.

Find the right solution, only take as much money as you need, and remember that all funding comes with strings attached — always. There are no exceptions to this rule. If someone has invested in your business or given you money, you’re reporting back to them, whether it’s a bank manager, a private equity investor or shareholders in a listed company. Any external funding comes with someone who wants to track how the business is doing.

Related: 10 Tips for Finding Seed Funding

How can business owners make growth funding work to their advantage?

Evaluate your business and choose the correct financing structure. This should be a practical and objective decision, not a subjective one. Similarly, look far enough into the future to make financing preparations as early as possible.

Match your funding structure to your growth curve. If you are comfortable with annual growth of 10% to 15%, you can save the finances you will need and internally fund your growth. If you’re looking for 40% annual growth, you will need external funding.

Remember that long-term capital never comes back. It sits in the business, working. You’ll only unlock it when you sell the company.

Most importantly though, run a good, clean business. Funders and financiers alike will evaluate your business with a fine-tooth comb.

Do This

Match the right growth funding to your needs to ensure your solution doesn’t become your biggest stumbling block.

Nadine Todd is the Managing Editor of Entrepreneur Magazine, the How-To guide for growing businesses. Find her on Google+.

How to Guides

Does Your Business Really Need Funding?

Strategy, risks, and opportunities.

Carl Wazen

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Businesses need capital to grow, and most small enterprises rely on external funding to meet this requirement. While accessing funding can be challenging for entrepreneurs, taking on the financial commitments of a loan should never be taken lightly. Many small businesses fail because repayment conditions are so onerous they impact cash flow, and business owners end up blacklisted, which dampens their future prospects.

First, ask yourself some hard questions

Before you decide to apply for that loan, cash advance or capital injection, make sure that your business really needs funding. Critically evaluate your business. Consider that you’ll ultimately need to give something back for that funding – an equity stake, or interest payments.

Determine how much the extra funding is worth to you, and what would happen to your business if you couldn’t get it.

Define your goals

The type of funding you need (and how you validate it in the application) is dependent on your short- and long-term goals. If you’re not currently on track to achieving your business objectives, determine what stumbling blocks or pain points are holding you back. Ultimately, you should be certain that the capital will help you achieve your objectives.

Related: Government Funding And Grants For Small Businesses

Evaluate your financial pain points

Next, determine which of the identified obstacles can be overcome with extra money. While most could, a loan may not be the answer. Entrepreneurs often use financing to temporarily plug holes, instead of fixing them. Without addressing the root cause of the issue, the business will continue to struggle, while also dealing with the extra debt.

It is also important to consider the nature of your requirements, and the impact this will have on finances. For instance, using a loan to hire more staff requires upfront funds before additional revenue can be generated. The same applies to sales and marketing initiatives.

Expanding your footprint as part of a strategic plan to grow your business also requires funding, but these are usually long-term loans that take more time to pay back. A thorough evaluation is needed to determine the potential return on investment and compare it to other opportunities.

Evaluate if the strategic benefits will outweigh the mid-term cash flow risks.

Consider your options

Before making any financial commitment, first look for ways to optimise your operation to realise cost efficiencies within the business that can free up working capital to fund the fix.

If you determine that funding will address your pain points, by boosting inventory ahead of a seasonal spike, for example, consider vendor financing or supplier credit options before securing financing from a bank.

If you need to expand the business, look for ways to lower the associated costs. For example, franchising a new location to a competent partner can relieve you of some of the financial burden. A product-based business could perhaps generate extra income by selling via online channels, or through distributors or other retailers instead of a new store.

Related: The DTI Funding Guide You’ve Been Looking For: The What And How

Scenario planning

However, should you choose to proceed, before you sign any loan or credit agreement, make sure you consider all possible scenarios:

  • How long will it take before your investment starts covering the costs of your loan?
  • How will you manage repayments if your forecasted growth doesn’t materialise?
  • How can you pivot to reallocate resources if your plan is not working out as initially intended?

The bottom line

Before you start looking for funding for your business, critically evaluate if your business really needs it. If you decide capital is necessary to reach your goals, and you’re willing to take on the responsibility, carefully consider the type of funding that is best for your particular type of business and your specific needs.

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How to Guides

How Investors Choose Who To Invest In

Why entrepreneurs tend to focus on the wrong things when pitching to investors, and what investors are really evaluating instead.

Allon Raiz

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The hypothesis of my book Lose the Business Plan was that great businesses are not determined by Excel spreadsheets and the all too predictable J-curve, but rather by the entrepreneur or entrepreneurial team and their ability to see opportunity, navigate obstacles and make things happen.

The truth is that entrepreneurs focus on the wrong side of the coin when meeting with an investor. They focus on the deep detail of the business plan and concentrate on justifying assumptions, predicting and overcoming objections, and emphasising market potential. Yet it’s my experience that the real decision on whether or not to invest in a company is more heavily weighted towards the entrepreneur or team rather than the business plan itself.

Once the ‘numbers’ stack (in other words, the business model makes sense) and the risks have been considered and appropriately mitigated, then the real decision-making can begin. The final decision comes down to four important characteristics of the entrepreneur himself or herself.

1. Is she honest?

You may have the best business plan in the world and you may have mitigated every possible risk but, if you are not someone the investor can trust, no deal will be made. I find that entrepreneurs often underestimate the importance of their reputations and, in today’s connected world, it’s so quick and easy to reference someone’s character.

Related: A Comprehensive List Of Angel Investors That Fund South African Start-Ups

Entrepreneurs who think about the short game and make morally questionable decisions for the prospect of quick profits generally find themselves in an ever-diminishing circle of people who will do deals with them. Your reputation is everything and you should guard it at all costs.

2. Does she work hard?

I am still not resolved around the cliché that you should work smart and not hard. (Perhaps I missed the memo or was asleep during the lecture that demonstrated how this is possible.)

In a world that is changing at an astonishing rate, in an economy that is becoming more and more competitive and in a business environment that is becoming ever more complex, it’s hard work to remain relevant and ahead of the curve for any extended period of time. Every quarter sees a new trajectory that needs to be investigated and navigated. In my opinion, this requires not just smart work but hard work, too.

It’s certainly true that investors like to invest in entrepreneurs who will take their investment seriously, who take their businesses seriously, and who are on top of their games.

3. Is she smart?

Smart does not always mean book smart but it definitely means street smart. It means having the ability to read a room, to see an opportunity, to learn new skills quickly and also being able to apply new learning’s to the business.

Investors look for investees who show agility when adapting to feedback from the market, from their competitors, from their staff and more.

4. Is she ambitious?

Investors do not like investing in ‘mom and pop’ operations. They seek the highest return on investment and that comes from businesses that can scale profitably. Scale is always relative to the investor’s perspective and not your own.

An investor with a couple of hundred thousand rand to invest will have very different expectations of the size of business he or she would like to invest in compared to another investor who has tens of millions of dollars. It’s important for the entrepreneur to authentically resonate with the level of ambition of their prospective investor, and be able to express that ambition through a coherent and cogent vision, as well as a plan to achieve that vision.

Remember, no one starts out as the ideal investee. It’s something that is built up over time and requires constant maintenance and curatorship. It’s essential to continually work on your reputation, to ensure that you are up to date with your industry, and to reassess your level of competence in your market. This is the only way to make sure you become and remain an ideal investee to a potential investor.

Read next: The Investor Sourcing Guide

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Are You Struggling To Find Financing For Your SME? Try Alternative Finance

If you don’t qualify for traditional funding or if it isn’t the right fit for your SME why not explore alternative funding? We specialise in alternative financing options by providing in-depth and custom plans for you and your business needs.

Spartan SME Finance

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Alternative Finance is finance beyond the traditional – it is defined by the financiers’ area of specialisation – by what they specialise in, whom they serve, and how they provide their funding. It does not replace traditional finance but rather functions as a complementary and additional form of funding.

Alternative financiers are specialists – they focus on a particular need and on a specific audience. As a result their ‘how’ is customised to deal with their chosen target market and for this targets unique needs. This applies to the funder’s processes and to their level of flexibility around things such as collateral.

An example of this is that a SME may have an existing R1 million overdraft (their traditional finance) secured by R 1.5 million collateral but suddenly they need R5 million for some kind of contract or bridging finance – they need it fast and don’t have that extent of collateral.

The traditional funder cannot provide what they need, their process is too long and their flexibility is too low. An alternative financier providing bridging finance and specialising in SMEs is ideally positioned to fill this gap.

One of the most significant differences between a traditional funder and an alternative financier is in their process. In the case of the alternative financier, they have often chosen to deal exclusively with a particular customer base, for example SMEs. As a result, this funder has both an affinity and contextually relevant empathy in working with SMEs.

Not only do they speak the same language the funder also has an appreciation for the time and material constraints of the SME and has developed their processes to cater to this market. This applies most notably to the turnaround time of the funding need and to the assessment aspect – where flexibility around things such as collateral is vital in making the finance happen for the SME.

A traditional funder is unable to meet the deadline of a bridging finance need, submitted on an urgent basis, where the finance is needed as soon as 2-3 days from time of application. A specialised or alternative funder is able to do exactly this. A traditional funder is also unable to find creative methods in solving the SMEs lack of high-value collateral in applying for finance.

This SME has generally already used their high-value collateral for traditional credit facilities but now needs funding for growth or resolution of a temporary cash flow challenge. An alternative financier is able to look at such an application in a different way, and has most likely already established alternative ways to make this happen for the SME.

Related: 5 Key Questions To Answer For Raising Funding

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