The lack of credit available to small and medium businesses, via traditional funding sources, may have eased slightly since the darkest days of the credit crunch; however, despite the High Street lenders’ protestations that they are “open for business”, no-one is under any illusion that the credit criteria being applied by the banks in this brave new world remain other than seriously prohibitive for most businesses.
This continued lack of credit is forcing businesses to explore a range of alternative funding solutions. With the more structured forms of venture capital funding being generally unsuitable for the smaller end of the SME (small to medium enterprise) market, there are increased opportunities for private individuals and companies to become involved in providing funding. This involvement tends to take two distinct forms.
Firstly, a company with a relatively strong balance sheet will come to the aid of a company with which it already has some connection. This connection could be as a supplier or a competitor, and the purpose of the involvement being either to secure a supply chain, reach a new market, or simply take advantage of natural synergies and open up opportunities for growth.
This assistance will usually be structured as a joint venture, the taking of a direct stake or a straightforward loan. The joint venture need not involve direct capital investment - in many instances the provision of preferential credit terms or access to resources may form the basis of the arrangements.
The second form of involvement sees private individuals (be they angels or dragons) move from the realm of the start-up to that of the established business. The benefits of such a relationship are obvious for both sides. For the investor, an established SME with a proven business model is far less risky than a start-up and potentially offers better returns.
For the business receiving the investment, an individual investor provides a much ‘lighter touch’ compared to traditional venture capital funding, and brings useful additional skills or resources to the business.
Naturally, the investor will want to know that there is sufficient security or degree of control. For the business, it is important that the controls are not so oppressive as to hamper its operations, or so costly (in terms of both compliance and equity given away) that it ceases being viable to the incumbent management or shareholders.
The very size of most owner-managed businesses, and the close link between management and an often small shareholder base, gives them the flexibility and speed of decision that can make this form of funding both viable and attractive.
The key to structuring such a deal is pragmatism and flexibility. An investor, experienced in a particular industry sector, is far more likely to be comfortable with investing into that sector, while, at the same time, the existing management is more willing to accept input and controls from a person who knows the business.
Complicated share structures and reporting mechanisms are not the order of the day. Instead the investor and the business need to establish a real understanding of each other, and the parameters of acceptable risk in the deal structure. If this can be done then a cost-effective and practical funding solution can be put together.
Recent figures show that some 60% of businesses were refused credit by their banks last year. With the banking market probably changed forever, more adaptability and flexibility is needed to produce funding arrangements that previously might not have been contemplated.
Simon Morris is a solicitor and head of Raworths’ Corporate unit. To contact Raworths telephone 01423 566666 or visit our offices at Eton House, 89 Station Parade, Harrogate, HG1 1HF. Alternatively you can email Simon - Simon.morris@raworths.co.uk.
