Your business may already have grown through generations by means of bootstrapping or by obtaining investment from family and friends. But, the subsequent scale of the business now requires an injection of finance and so seeking external funding almost becomes a necessity.
There is, however, a general reluctance to borrow amongst family businesses, even at a time when the available finance solutions have never been better.
So, whether you are looking for debt or equity financing, over the short or long-term, there is an increasing number of external funding solutions on offer. They even have the flexibility to be tailored to your business stage and specific funding need.
What’s not to like?
The answer is generally the fear of the unknown and, for family businesses, the trepidation of inviting external investment into the business.
To help you wade through, here’s our take on the five most common types of business funding solutions for families looking to break the mould:
- Bank loan/overdraft
Traditional bank loans (also called commercial loans) are still the number one default solution for family businesses seeking external finance, largely because there has been an established relationship in place for generations. As a debt-based funding solution, they are relatively straightforward and can:
- help to grow your team
- plug a cashflow gap
- fund an expansion project.
Even though the security that comes with a bank loan makes them very attractive to SMEs, the repayment terms are often based on high interest rates over a long term due to a lack of putting the existing bank into competition with other lenders. And, as around half of SMEs have their funding application rejected, traditional bank financing could pose a challenge for innovative and fast-growing family businesses, where their track record is still a tad limited. Gone are the days where bank finance is available based on years of family heritage with the bank manager.
Other finance options from high street lenders include overdraft facilities. However, overdrafts are less reliable as they can be withdrawn at any time. Commercial loans tend to have the benefit of a fixed term making them easier to account for in your financial forecasting, but generally also require a personal guarantee – and are available from alternative lenders.
- Invoice discounting and factoring
Invoice financing is a good short-term solution to bridge the gap between issuing an invoice and receiving payment. It’s a feasible option for businesses with an urgent funding need, but the reluctance for an external financial commitment in the long-term.
A lender will effectively buy your debtor(s) from you, freeing up the capital tied up in those invoices to provide you with a quick-win cash injection. But, because of this benefit of speed, it is rarely the most cost-effective solution.
The key difference between factoring and discounting is who takes the lead in managing the invoice transaction going forward. Factoring puts the finance provider in control and payments are made direct to them. Discounting leaves the communication and payment collection in your hands.
Discounting also retains an element of confidentiality for you as your customers will be unaware of the involvement of a third party funder. This can be crucial for family businesses that rely on their pride and legacy as part of their proposition.
Invoices can be financed on a case by case basis, factoring or discounting one or two at a time as required. This is beneficial if you know that your funding gap is due to a one-off or short-term challenge, such as buying stock or employing staff to fulfil an unexpected large order.
And, because invoice financing is based on the value of the invoice and the creditworthiness of your customers, your own business’ financial situation is not considered in quite the same way. This can be a relief to a growing family business that has proven potential but is simply experiencing temporary cashflow problems.
Have a look at our blog, Your cashflow is only as good as your credit management for some cashflow tips.
- Crowdfunding
Managed via online platforms, crowdfunding is an alternative form of finance that allows you to pitch your business to a group of willing investors. By attracting a crowd of people, each can take a small stake to help you raise the required finance.
Crowdfunding is very popular and the amounts invested range from a few hundred pounds, to tens of thousands. And because multiple individuals are investing small amounts, their risk is reduced making it more attractive to investors.
For family businesses, the key question is around how much external involvement you are prepared to consider because there are two crowdfunding options; equity or debt.
Equity crowdfunding is where people invest in your business in exchange for an equity share, with the risk that their share value can fluctuate as the business grows. Debt crowdfunding is a commercial loan transaction where investors receive a return of scheduled repayments over an agreed period.
- Angel investment
Angel investors are unique in that they offer more than just a financial injection. They generally have knowledge of running a small business or experience in a particular sector which, coupled with their network of contacts, could help to accelerate your business’ growth.
A form of long-term equity investment, business angels will need to become part of your family to develop a genuine interest for the business to succeed. The benefit to you is that they are more inclined to back high-risk business opportunities as long as a sound business plan and solid management structure are in place.
Read our blog on Growing a family business, the key skills required in a management team
Business angels tend to set an investment term of between 3 and 5 years and can stipulate the requirement for a clear exit strategy to be agreed and in place. This means that, as a family, you could benefit from the knowledge and expertise of external resource to fulfil your business’ growth plan, but with a clear end goal in mind, even if that might just be buying out the business angel at that time.
In a family business set-up, however, the decision to seek angel investment could be a complex one requiring the buy-in of all stakeholders. Working with business angels has clear benefits, but it is key strategic decision that will likely change the way you have operated as a family until now; not least because of the significant people impact they will have.
- Leasing and hire purchase (HP)
Leasing and hire purchase allow you to spread the cost of acquiring assets, such as machinery and software, over a set time period without seeing a major impact on your cashflow.
It works in such a way that, as your business grows, you can obtain the additional assets you require to fulfil your business needs by leasing or hiring them through a finance company.
For family businesses, this can be a good solution in that it allows you to carry out off balance sheet transactions without any capital outlay. It is purely a transactional agreement to facilitate certain elements of growth.
In summary, leasing simply allows you to rent plant & machinery, vehicles, software or IT over a fixed period in return for regular payments. Hire purchase operates in a similar way, but once all payments have been made, ownership transfers to the business. You should also consider whether a commercial loan is more cost effective than leasing or hire purchase.
In summary
Once a family business has taken the step to seek external finance, it no longer has to rely on just one source of funding to meet its needs. The key challenges for a family business are weighing up the pros and cons of the impact that each different finance type will have on their business.
A purely debt-based transaction will avoid external resource getting involved in the day-to-day strategic operations, but could come at a higher price, including personal guarantees and debentures. Finance on an equity basis, however, avoids the pressure of monthly repayments over a given period, but potentially allows someone outside the family in.
This in itself is a risk because of the need to not only match an investor with a management team, but with the complexities of family politics (and heritage) too. But an investor that buys into the family way could be the best strategic decision ever.
So, whatever funding option you choose, make sure it is right for your business (and family). Finding an investor isn’t simply a commercial transaction, it’s about building a relationship to help sustain the long-term success of the business too.