BLOGS

Following on from my blog about cash flow, I thought I would discuss the role of banks, investors and how to raise capital. Counter-intuitively, I have always found that the more you need (not want), the easier it becomes. Like so much about business as in life, you need to think about your audience. You have to ask yourself why does someone or some institution want to put money into my business?

Clearly, beyond friends and family, professional investors and lenders have a business model of making returns on their funds. This might be their own money but more often someone else’s. If it is third party funds, they will have agreed investment lending criteria. It is worth finding these out upfront. You may have the greatest idea in the history of humankind but if the lender/investor has a mandate that excludes your sector or they have a minimum (or maximum) investment/lending amount, its best to rule them in or out upfront. Next, and critically, what is their attitude to risk. At one end you have risk averse banks and at the other end start up funds. The returns and security required is in part driven by this attitude. The higher the risk, the higher the required return which will always be double digits.

Conversely, the low risk banks will charge relatively low interest, potentially and currently, hopefully single digits interest but will often or always require a personal guarantee often back up with security. I will return to PGs later.

So why is it easier to raise more money? Again, know your audience. Managing a lending or investment position takes time, it takes energy, it takes commitment. The lender/investor once in, will (or should) devote as much time to their individual positions, almost regardless of the amount. The time taken to manage a £5m position is essentially the same as a £100k one. There is also a lot of money chasing potential deals. The banking director or the investment manager can only manage so much in their portfolio, so to get the best returns, on average, it is easier to deploy larger amounts of capital to one entity. They will also assume that at the lower levels, you will self-invest or persuade friends and family as to what a great opportunity you have. This F&F investment sends a good signal in that you are going to be more committed to looking after your friends and family, to protect their money, to grow the business profitably and to manage cashflow. It also demonstrates belief.

Once you realise that banks are low risk institutions, you will understand why they will so often decline to lend to your business. Single digit interest is not sufficient enough of a return to justify taking any material risk on a business. Offering a PG and/or security is not in itself sufficient to move the conversation on as no bank wants to find themselves in the unhappy position of demanding repayment, calling on a PG and worst, forcing the sale of the security, often your family home. That is why the confidence levels, that you are capable of servicing interest and repaying the loan or overdraft, has to be high and communicated as such. The best way to communicate this is with a well thought out and presented business plan, which you clearly believe in and which you can demonstrate can be robustly delivered. Examples of a lack of deliverability (“execution risk”) might include, “I have successfully run this sandwich shop for five years now and want to expand to twenty new ones in two years”.  Banks will almost NEVER lend on this.

Why? Well, you cannot fault the ambition but the risk of expanding too quickly, the need for competent management to help you deliver the plan, the understanding of what the working capital implications of such a fast expansion and the inevitability of significant additional liabilities means they will be highly skeptical that it will all work out. Even high-risk equity investors will look at this skeptically unless you have a clear step by step plan that demonstrates at every turn why you will deliver on it. So, this is what the plan should be designed to do.

Put yourself in the shoes of the potential investor, what will they ask? What will be important to them? What will be your answers? Using the sandwich shop example above, have you got a robust, repeatable, deliverable menu? (Why do MacDonalds taste the same all over the world?). Where do you fit in in terms of pricing and who are your target market? Is it the “sarnie” market or is it the sourdough and focaccia artisanal sandwich? Have you looked at margins? Have you stress tested these margins? Have you identified all the potential sites? Do you know the likely rents etc? How will you recruit, motivate and retain good staff? What key personnel do you need to hire? Do you need a COO, FD and an HR person?

I will discuss more about business plans in subsequent blogs but for now and as promised, my thoughts about PGs. The standard line is that “well if you really believe in it, put your money where your mouth is. Show commitment…” I don’t buy into this. If you have demonstrated capability and perhaps already put your own money and that of friends and family, then to put your family home on the line with all that entails together with the stress of worrying about failure means your ability to think straight, to make good decisions will inevitably by impacted by the potential loss of your home or being made bankrupt. I believe that there needs to be space in an economy for failure as there is in the USA. According to Fundsquire, a global start-up funding network, 20% of small businesses fail in their first year, and according to the Office of National Statistics (ONS), only 42.5% of new businesses are still trading in their fifth year (2014-2019).

Ultimately, a good idea and plan will find a home so don’t take no for an answer but also listen to what professional investors and lenders are saying. They see businesses day in and day out and whether we like it or not, for a company looking to grow and raise money, these people are the 600lb gorillas in this jungle!