These are questions advisers at BDO are regularly asked. In response we often ask another set of questions:
- Do the existing owners have available resources to fund the business?
- What does your business need the funding for? Short-term working capital, purchase capital assets, acquisition of another business, etc?
- What is your current capital structure? Is your business highly leveraged (i.e. a lot of debt already), is the business debt free but the owners have an aversion to debt?
- What stage is your business at? Are you a start-up, are you expanding rapidly, has your business reached maturity, or are you in decline?
Answering these questions assists your adviser to assess the most beneficial way for you to raise the necessary funds.
Before you proceed
Ideally, before you try to raise capital from external parties you have taken the time to identify if there are any other ways of raising capital. Do you have access to savings that could be used? Are there any surplus assets in the business that can be liquidated to raise funds? Using these “internal” sources will often provide a cheaper source of funds as opposed to an external party.
Once you have completed this exercise, you now need to determine how much more funding you will need.
How much funding do you need?
How much you need depends on what you want the funds for. If it is short-term working capital, cash flow forecasts prepared by management with assistance from your BDO adviser would indicate the cash requirement. If it’s a capital acquisition, there is obviously the core capital cost, but have you considered ancillary costs such as professional fees, training, freight, etc.? Again, cash flow forecasts should be prepared to determine the ability to repay any term debt.
Providers of External Capital
Once you have determined your cash requirement, you then need to determine how you will raise the money from external parties.
Borrowing money or ‘debt’ is used most often to raise capital in SME businesses in New Zealand. Common sources are:
- Banks – are most used for raising capital by small businesses, often leveraging equity in the owner’s house to secure the loan. Where property has been used as security it is almost always cheaper than finance that is unsecured or under-secured. Banks will likely require personal guarantees from owners and/or directors which may reduce the attractiveness. In addition to your standard overdraft or term loan, banks also offer tailored lending, which may be for plant & equipment (asset finance), or lent against inventory or receivables.
- Finance companies - again, often used but usually attract a higher cost than bank funding. This is usually used for a specialised purpose, such
- as vehicle finance, plant finance, funding of insurance premiums and factoring of receivables.
- Suppliers – in some cases major suppliers may offer beneficial payment terms. Or in specific industries, loans to customers for capital purchases to be repaid on agreed terms, e.g. historically pubs received loans from major breweries to install their taps, the loans were repaid from future beer purchases.
- Friends and family – often considered first as they can be easy to approach, and can require less form filling than a bank or finance company. However family and friend borrowing can blur the lines between business and personal lives and these blurred lines can be problematic.
Another option is equity capital, where you sell part of your business, or give up some of the equity in it for capital to help inject funds.
You might want to consider it when you need more funding than you can obtain from your own sources or borrow from banks or finance companies (whilst not over-leveraging yourself and your business), then you may need to consider raising new equity capital for the business. Depending on where your business is at in its lifecycle, there will be a number of providers
- Key employees – often know your business as well as you do and
- may have desires to own a part of it with you. When selling shares to employees there are often taxation considerations that you must discuss with your BDO adviser. The key though is being honest and transparent about the process; the last thing an employer wants is a key employee leaving as they weren’t happy with the process of buying into your business.
- Venture capitalists and private equity – are predominantly investment companies or fund managers who will provide funds in return for part-ownership of your business. Venture capitalists and private equity typically look to invest larger sums to help business growth, and sometimes want to invest more than you immediately require to prepare the business for future growth. You do need to be aware that their requirements may be much tougher as they need to protect their investors’ money. Depending on their view of your business they may also not want to play such an active role in the management of your business, but will likely seek roles on your board so they assist with guiding strategy and corrective actions if required. NZVCA (www.nzvca.co.nz) provides details of venture capital and private equity providers.
- Angel investors – are individuals who see potential in your business and will invest in it at an early stage and often add value through bringing experience and contacts to the table. They usually invest in businesses they’re familiar with, wanting either a return on their investment, some equity, or both. Check out the Angel Investors Association webpage (www. angelassociation.co.nz).
- Corporate investors – larger companies regularly look for bolt on acquisitions or strategic stakes in companies they believe will add value to their own business. Like venture capitalists and private equity their requirements will likely be tougher, and seek to have governance roles within your business.
- Equity crowdfunding – a growing phenomenon in raising capital for businesses, start-ups and mature businesses. Equity crowdfunding platforms are online capital raising forums. In New Zealand this includes PledgeMe (www.pledgeme.co.nz), Snowball Effect (www. snowballeffect.co.nz), Equitise (www.equitise.co.nz) and a number of others. They profile businesses seeking capital and then rely on the online investor network to raise the capital required.
Other Methods of Raising Funds
While we have mentioned equity crowdfunding above, many smaller businesses are turning to rewards-based crowdfunding to raise funds. This is effectively where businesses “seek donations” to launch a product or process that may deliver a reward to donors in turn. Pledgeme’s project-based crowdfunding is an example of this.
Your business could qualify for many different forms of government grant. You can find out more about these grants and whether you qualify by visiting Business.govt.nz (www.business.govt.nz/support-and-advice/grants-incentives).
About the Author
Aaron Titter is a Partner at BDO Wellington.