1 Accessing Finance: A Guide for Food and Drink Companies
2 2 1 loan bank equity FINANCE GROWTH Contents Page 1 Introduction 2 2 Types of Finance Founder, Friends and Family Equity Investors Crowd Funding Mezzanine Funding Bank Funding Grants Other Sources of Funds 10 3 Why Do You Need the Finance? 11 4 Cost of Finance? 13 5 What Will a Funder Want From You? 14 6 Next Steps 16
3 2 1. Introduction The Food and Drink sector in Scotland is one of the most important sectors of the Scottish economy and what s more, it is likely to be one of the highest growth sectors in the forthcoming years. However, in order to grow, it will often be necessary for Food and Drink companies to access new or additional funding. The raising of finance can be both daunting and difficult. With that in mind, this guide is intended to be a practical introduction to help with the following: 1. Understanding the various types of finance that are available and what each type of finance is generally used for; 2. Deciding what type of finance might be best for your business; 3. Starting the process of securing that funding, including understanding what the providers of funding will want from you. While this guide attempts to provide you with practical help and assistance, if you require any further information, we have included at the back of this document the contact details of various organisations who will be able to provide you with further assistance, should you need it. 3
4 Types of Finance In the same way that you wouldn t use a credit card to buy a house, it is necessary to find the correct form of finance for a business s funding needs. This is essential, not least because the cost of one source of business funding can be much higher than another. Choosing the wrong type of funding can be a very costly mistake. In reality, there is a huge range of funding options open to businesses. However, not every source of funding will be open to every business. We have summarised below the main options available to businesses, as well as providing some detail on their uses and broadly how the cost compares for each source of funding. It should be noted that in most cases, a new funding package is likely to include money from more than one funding source. The following is a brief summary of the common types of funding: 2.1 Founder, Friends and Family This is the most common source of funding for young or new start businesses. However, as businesses grow and funding requirements increase, this source of funding may be insufficiently large to meet a business need. Such funding may take the form of a loan to the company or shares in the business. 2.2 Equity Investors An equity investor is somebody who will provide money in return for which they will receive shares in the business. While the terms of each equity investment can vary, equity investments are ordinarily structured to give the investor a capital gain at some point in the future. This capital gain is usually realised on the sale of the company and as such equity investors tend to have their money invested for a longer period without seeing any repayment or return on their money. Clearly this is different from a loan where repayments will ordinarily start not long after the money has been lent. Most commonly, equity investors are looking to make their capital gain within a three to five year period. However, this will very much depend on the nature of the individual or institution making the investment and indeed some equity investors can remain with a business for a long period. Aside from a capital gain on sale, equity investors may also look to receive a dividend on an annual basis. It should be remembered that a dividend can only be paid once a company has generated distributable reserves in its balance sheet. Equity investors will ordinarily not be provided with any security nor have any guarantee of a return either through dividend or a capital event such as a sale. Therefore equity investors are taking a higher risk than other types of funders and will consequently look to receive a higher return. It should also be noted that equity investors, as well as having voting rights in the business, may look to exert some influence over the management of the business. Therefore, founder shareholders should ensure that they feel able to work with the proposed equity investor on a medium to long term basis.
5 6 7 A brief summary of certain types of equity investor is provided below: Business Angels Business Angels are professional investors and ordinarily are people who have themselves invested in and run businesses in the past. They may invest as individuals in a company or they may act as part of a syndicate of investors. One of the perceived advantages of business angels is that, in addition to capital, they may well bring additional management and market expertise to a business. One other advantage of Business Angels, is that they will generally invest smaller amounts than institutional investors. Scotland has an extremely well developed and mature Business Angel community and we have noted the contact details of certain Business Angel syndicates at the back of this document Venture Capital One of the most well-known sources of equity finance is that provided by venture capital businesses. These are well-funded institutional investors who are in the business of providing equity to private companies with a view to those businesses growing, becoming more profitable and then being sold. Venture capital funds tend to have a de minimis investment level which can often be 1m to 2m and therefore tend only to be relevant for larger, better established businesses. Only once a business has achieved a certain size and value, is it likely to be of interest to a venture capitalist. 2.3 Crowd Funding Crowd Funding is a fairly new phenomenon which has only really developed in the last five years. The basis of Crowd Funding is that a large group of individuals invest relatively small amounts and thereby provide companies with access to funding that would not otherwise be available. A couple of the more prominent businesses in this sphere are Crowdcube and Funding Circle. It should be noted that the term Crowd Funding covers a raft of different funding mechanisms. For example, some Crowd Funders may only provide debt to businesses whereas others may only provide equity investment. Again we have provided the contact details for a number of Crowd Funding platforms at the back of this document. 2.4 Mezzanine Funding Where the perceived funding risk is less and indeed security may very well be available, bank funding is normally the most appropriate method of finance. At the upper end of the risk spectrum, equity investment is normally the most appropriate method of funding a business. However, Mezzanine Funding is, as the name suggests, a form of funding which falls between bank debt and equity investment. Mezzanine Funding will normally be used where the risk profile of the funding requirement is higher than that which the bank would ordinarily accept but there is more certainty around the investment proposal than would necessitate equity investment. As you might imagine, the return that a Mezzanine funder would require is higher than that which a bank would seek but lower than an equity investor would seek. Ordinarily, Mezzanine finance is provided in the form of a debt instrument but that debt instrument may carry an equity option (i.e. a right to buy shares at a reduced price in the future). 2.5 Bank Funding Bank funding can take many forms. Some of the more common forms are noted below Loans A bank or similar lender will provide a loan when they are comfortable that the risk they are undertaking accords with the level of risk which a debt provider would normally undertake. The benefit of taking a loan is that the lender will not seek to take any equity in (ownership) of the business. However, the lender will seek to charge interest on the loan and will also seek repayment of that loan, ordinarily quite soon after the initial loan is made. A lender may also seek to secure some form of guarantee or security for that loan. Security may be over a property or other assets and a guarantee may be required from the directors or shareholders of the company. While many businessmen see borrowing from a bank as the most attractive way of securing finance because it is the cheapest form of finance available, it is not always the most appropriate. The business has many obligations which it has to meet. Sometimes the future cash flows are uncertain, and it can be more appropriate to seek equity finance as this type of funding will not normally require set repayment profiles to be met. It is important to note that banks and other lenders of this sort are commercial organisations and in the event of a default on the loan, they may well seek to realise their security or to obtain the repayment of a loan through a winding up of the company.
6 8 9 Applying early for a grant is therefore critical if you have a limited window of opportunity to exploit your proposition Asset Finance As the name suggests, Asset Finance is a loan instrument which is based on granting security on an asset to be purchased. For example, if a company buys a printing press for one million pounds, it may be able to borrow the majority of the cost of this asset by way of a loan which will be secured on the asset itself. The benefit of granting security on the asset is that the interest rate charged by the bank may well be lower and the repayment profile may be longer if the asset has an extended useful life. This can have very many cash flow advantages Invoice Finance This form of finance was traditionally given the generic name of factoring. However, factoring is only one type of Invoice Finance and it is not the only form. Under an invoice finance arrangement, a bank will lend a certain percentage of an invoice to a company when that company raises the sales invoice. For example, a company may be lent 70% of all of its sales invoices and therefore it will be entitled to draw down under that arrangement 70 every time it raises a sales invoice for 100. The benefit of Invoice Finance is that the company is able to obtain a chunk of its sales values before the customer ever pays the invoice. When the customer then pays the 100 invoice, 70 is taken by the bank as a repayment of its loan and the remaining 30 goes into the company s coffers. Invoice Finance can be a very useful tool for companies with a notable working capital requirement and in the recent past Invoice Finance has become much more attractive to banks than the granting of an overdraft. It should be noted that Invoice Factoring is generally disclosed to the customer and commonly under such an arrangement the debt collection and sales ledger credit management is normally managed by the Factoring company. However, under Invoice Discounting the facility will quite often be confidential (i.e. not disclosed to the customer receiving the invoice) and the administration of the sales ledger will normally still be done by the business which is borrowing the money. Banks will usually charge for invoice finance by way of an interest charge and fees. 2.6 Grants Grants can be a valuable source of finance and are generally not repayable if the business is able to successfully deliver the outcomes attached to the grant offer. Grants are typically administered by the public sector; in Scotland mainly through Scottish Enterprise and the Scottish Government and are generally project based. A project can comprise, for example, a start up venture, an expansion plan or the introduction of new technology. Whilst the commercial aspects of a proposition will be considered, the grant bodies also consider other outputs, for instance, the economic impact, the environmental impact and the innovation associated with a project. Regional Selective Assistance ( RSA ) is focussed on jobs created and safeguarded, Training Plus is focussed on the upskilling of the workforce and SMART: Scotland grants are focused on the innovative nature of the project. To be eligible for a grant, the applicant must demonstrate a need for assistance, for example why are they not able to wholly fund this project themselves? Linked to this is the fact that the applicant cannot commit to the project until the formal offer of grant has been made. Applying early for a grant is therefore critical if you have a limited window of opportunity to exploit your proposition. RSA, the Food Processing, Marketing and Co-operation ( FPMC )*, European Fisheries Fund ( EFF ) and innovation grants such as SMART: Scotland and Innovate UK (formerly the Technology Strategy Board) all have a role to play in the food and drink sector in Scotland. To assist you navigate your way through the grants options, SF & D members can gain access to Grantfinder which helps search for funding support in your area. * As of February 2015, the FPMC Grant Scheme ( ) was closed. Work is underway on the successor scheme and users of this guide should check with the Scottish Government as to the latest position.
7 Why Do You Need the Finance? 2.7. Other sources of funds In certain circumstances, there may be other sources of funding available depending on, for example, the nature of the business, the economic aspects of the proposition and the location of the business. For example, as the regeneration subsidiary of Tata Steel, UK Steel Enterprise focus on those parts of the UK that have been affected by changes in the steel industry and can provide: loans from 25,000 for working capital, equipment purchase, premises, relocations, management buy-outs (MBOs), management buy-ins (MBIs), start-ups and other funding requirements across many business sectors including manufacturing and services to businesses. equity investments, usually comprising of shares and loans, up to 750,000 on terms that are individually negotiated for each investment. In most cases UK Steel Enterprise s shareholding will not exceed 25% of the company s equity. We have previously considered what types of finance are available to a business. Now we have to decide what type of finance would best suit your business need. The table below gives a rough guide as to what type of finance would best suit various business requirements. It should, however, be noted that the table is not definitive and is only intended to provide a guide. In many cases, the funding requirement may be filled by a combination of different types of funding. Start up Growing businesses Mature businesses It should be noted that there are certain geographical restrictions in terms of the location of businesses which UK Steel Enterprise can assist. DSL Business Finance ( DSL ) is a Community Development Finance Institution ( CDFI ), and a member of the Community Development Finance Association and the European Microfinance Network. DSL provide business start-up and growth loans for small businesses and social enterprises that can t access funding from banks and other traditional sources. West of Scotland Loan Fund, East of Scotland Loan Fund, South of Scotland Loan Fund and Highland Opportunity Fund can also provide financial support towards a proposition. Founder s Funds Business Angels Venture Capital Friends & Family Venture Capital Mezzanine Funding Grants Mezzanine Funding Banks Banks Grants Grants
8 Cost of Finance 3.1 Start-up Company Generally speaking a start-up company will not have any customers nor any income stream. Normally it will be funded by the founder and often this funding is augmented by funds from the founders friends or family. Given the lack of a trading track record and a general lack of security, other sources of funding are not ordinarily available. Sometimes however, grant funding may be available for start-up companies. 3.2 Growing Businesses As a business grows and secures more turnover, it will become much more credible with funders. However, in order to fund the growth and in particular, working capital, it may well be necessary to introduce new funds to the business. Providing a business is credible and has a sensible business plan, it may be able to go out and secure equity investment from Business Angels or Venture Capitalists. It may also be able to secure some Mezzanine Funding. However, if the risk of the growing business is still quite high, it may be more difficult to secure bank funding. This will be particularly relevant if there is no security in the business. The cost of each type of finance will vary depending on a great many things including who is providing the finance, the risk they perceive in providing the finance, the duration that the finance is provided for, the view they have of you and the reason for the finance. The chart below gives a very rough guide as to where each type of finance ranks and where you can expect the broad cost of finance to be. It should be noted that the cost comparison given below is intended as a broad guide and cannot be relied upon for any other purpose. Required IRR (Internal Rate of Return) 30% However, it should also be noted that grants are very often available to assist the development of a business and in particular, Regional Selective Assistance may be available to fund projects which create jobs and involve some form of capital spend. 20% EQUITY 3.3 Mature Businesses Once a business is established and has a history of on-going sales to customers, it should be much more attractive to potential funders. In general terms it should find the accessing of bank debt easier but if it has a specific project or a plan to grow and develop further, then it should be more attractive to venture capitalists, mezzanine funders and indeed it should find it easier to secure Government grants. 10% BANK DEBT MEZZANINE 0% GRANTS FRIENDS & FAMILY RISK
9 What will a Funder want from you? 5.1 The Business Plan The key document that any potential funder will want is a Business Plan. A brief outline of what should be included in a business plan is given below but it is important to realise that in preparing a plan you should consider whether you actually believe in the plan you are documenting. Quite often, it is easy to become carried away and embellish a plan which may not be sensible nor achievable. Therefore the key question any businessman or woman should ask themselves when preparing a business plan is Do I believe that I can actually deliver this? If the answer is anything short of Yes, then you should probably rethink your plan. 5.2 Content of a Business Plan The main things which a Business Plan should cover include: Background to the Business Details of it s Products and Services Management s Strategy Operational Aspects Management Details of Historic Financial Performance 5.3 Due Diligence If a potential funder sees merit in your Business Plan, they may well make you an offer of funding. However, that offer may well be subject to Due Diligence, a process by which the potential funder will investigate the assumptions which underlie your Business Plan. If they can satisfy themselves, by means of a Due Diligence exercise, that the Plan will be achievable, then and only then will they advance the funds. Some of the key things that you should consider for due diligence are: Can your assessment of the market be substantiated? Do you have the management team that can deliver your plan? Is your plan achievable? Do your projections stack up? 5.4 Personal Guarantees In certain instances, funders and in particular lenders, may seek a personal guarantee from the principals behind the business in support of the business debt. These guarantees can either be supported, whereby they are linked to a personal asset or unsupported. It is imperative that before granting a guarantee, you take legal advice. Markets and Competitors Projected Future Performance
10 Next Steps 7. Appendices This Guide and the accompanying spreadsheet should be seen as just the starting point in accessing finance rather than an end in itself. Things to remember are: Focus your proposal what exactly do you need your funding to do? Build a strong business plan; Consider all the options look at different types and sources of funding; Do your research look around and find the best option for you; Make sure you are investor ready ask yourself challenging questions you can guarantee your investor will ask them; Ask for help look at support and advice that might help you; and Take your time make sure you build in plenty of time to raise the funding it always takes longer than you think. Appendix A: Sources of Funding and advice Click here to view spreadsheet or visit org/industry/industry-support Whilst the contents of this document have been prepared in good faith, based on available information at the time of writing, French Duncan LLP cannot be held responsible for any inaccuracies contained within this document.
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