Small and medium sized businesses (SMEs) are regarded as a critical part of the economy by policymakers but they have faced a particularly tough environment since the financial crisis.
Although the government has attempted to make life easier for SMEs with tax breaks for activities such as R&D and schemes such as Funding for Lending, the banks’ willingness to lend has been hampered by increases in regulation and higher capital requirements.
It is therefore widely accepted by SMEs that bank lending is still hard to come by. This is particularly the case for younger, fast growing businesses that are often short of the cash needed to grow but lack the track record required by banks to borrow.
Even where bank borrowing is available, relying too heavily upon debt can carry inherent risks so it is important to be aware of the other options. Alternative forms of financing are available to SMEs but these come with different considerations.
Equity Financing for SMEs
The primary alternative to debt financing comes in the form of equity investment from external investors. By exchanging shares for funds, business can avoid interest and capital repayments required by lenders along with other obligations such as charges over property or personal guarantees. Within the scope of equity financing there are various options that may be available.
Start-ups and micro businesses often turn to friends and family as their first port of call when it comes to raising funds through equity. This has the benefit of keeping tight control on the ownership of a company but comes with the commensurate risk that the potential losses are also concentrated among that same group of people.
The next level of equity investment can come from angel investors or from venture capital funds. The former are often wealthy individuals with experience in the same industries that simply invest their own money while the latter tend to be more structured organisations that invest money on behalf of third party investors. Angel investors may invest from around £10,000 up to several hundred thousand pounds whereas venture capital firms often invest several millions of pounds.
SMEs seeking funds from either of these types of investors will typically need to prepare detailed business plans with promising but realistic financial forecasts. In return for funds they may have to offer significant amounts of shares and seats on their boards of directors.
Beyond private funds are the public equity markets such as AIM. These are only likely to be suitable for larger SMEs and initial public offers carry significant regulatory requirements and cost considerations.
The Enterprise Investment Scheme and The Seed Enterprise Investment Scheme
SMEs looking to take advantage of equity financing have an additional sweetener that they can offer to potential investors in the form of the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS). Both schemes are designed to help attract investment by offering investors a range of tax breaks when they buy shares in small unlisted companies. Both schemes require that certain criteria are met by investors and the company.
The SEIS is designed for the smallest start-up companies; requirements include limits such as £200,000 on company assets and a £150,000 maximum on funds raised under the scheme. The EIS has similar restrictions but with higher limits such as £15m in assets and a £5m maximum on the amounts raised annually.
Other Forms of Non-Bank Financing for SMEs
In addition to equity financing, there are other forms of financing available to SMEs that may be suitable in certain circumstances. These might include applying for grants local authorities or the EU, or the use of trade credit or factoring to help ease cash flow issues.
SMEs may find that a mixture of financing options gives them the optimal approach for their business. This usually requires an analysis of the business’ capital requirements and a review of the cost and availability of different forms of finance.
For SMEs or SME investors in need of specialist advice regarding SME financing or the EIS/SEIS schemes please click on the following links below: