Alternative methods of raising finance for Middle Market companies

By E.L.Kateb

Posted: 29th March 2011 23:34

At times businesses may need a bit of a helping hand usually in the form of raising finance whether they are expanding or going through tough times.  Finance raised can be used for:

Working capital, acquisition of other firms, R&D, increasing stock, training and staff development or marketing amongst others

The varying nature of businesses means that differing forms of finance may be more attractive than others.  The following article aims to highlight the alternative forms of finance available for the Middle Market.

A recent report from the Department for Business Innovation and Skills, (http://www.bis.gov.uk), has stated companies valued from £25 to £500 million make up the majority of the middle market.  It is a crucial area of business as they count for a significant share of job creation and are generally some of the fastest growing firms in terms of revenue.  Companies in this market employ on average 10-1000 employees who make up one third of the UK’s workforce, and produce up to one third of the UK’s GDP.

The current economic difficulties have caused unstable interest and currency rates along with higher oil and gas prices.  So adverse market conditions make it harder to fulfil customer demand and increase the costs companies have to make.  Along with this come record inflation and less economic growth, resulting in reduced confidence from investors.  The lack of liquidity makes it harder to obtain credit and increases competition for finance along with creating a general lack of trust with banks.  Hard times call for tougher measures and it is becoming increasingly difficult to secure finance through traditional means.  It is not to say banks have no money to lend, more that banks are now highly selective on their terms and who they lend to.  So with credit terms much tighter, middle markets may benefit from other sources of finance.

Creative Finance: Where businesses turn to their client base to raise funds by devising ways in which they can involve them within the business to raise money, for example offering bonds. 

Private equity funds (PEF’S): Good for growth funding into high performance established businesses like blue chip companies and are more risk averse.

May gain a significant portion of the business.  Ideally invest in underperforming companies and offer the necessary experience and expertise to support and restructure successfully. 

Funding may come from wealthy individuals or institutional investors (such as pension funds and hedge funds), some element of debt in majority of deals, so may engage with banks to raise additional finance although this would lead to a lesser return for the Private Equity Firm. 

Venture Capital: Investors acquire a piece of the business through shares.  Usually associated with higher risk businesses like start ups.  Developmental Capital can be used for more mature investments and Replacement Capital for replacing an original shareholder with a new investor. 

Strategic Investors (SI’s): Corporate strategic investors may be large trade companies that want to gain access to different markets to complement their business or use acquisition to gain smaller companies in their own industry.  Have knowledge of target markets and so with a level playing field they can be more aggressive with their acquisitions.

Invoice discounting and invoice factoring: Finance raised against debt due from customers to improve cash flow.  Debtors are the prime security for the lender and borrower can obtain up to 80% of approved debt.  Can also lend against stock and other assets, invoice discounting confidential process normally, where as factoring extends discounting principle by dealing with administration of sales ledger and debtor collection also.

Sovereign wealth funds (SWF’s): Generally associated with larger markets, they are state owned investment vehicles.  Funds come from their countries surplus foreign exchange resources, so less sensitive to market conditions and less dependent on finance from banks.  Normally a very welcome form of raising finance as they are informed investors with large amounts of funds available, e.g. Abu Dhabi Investment Authority and Government of Singapore Investment Corporation. 

Hire purchase and leasing: Finance for acquisition of assets used in a business like purchasing machinery, involves a deposit and payments over time.  Ownership of assets remains with the lessor and title of the goods is eventually transferred to the lessee.

Loans: Medium loans up to seven years and long term loans used for specific purposes, such as acquiring an asset, business or shares.  Secured on assets, variable or fixed interest rates.  Small Firms’ Loans Guarantee Scheme is a government initiative where up to £250,000 can be borrowed as a last resort.

Mezzanine debt: Mixture of debt and equity financing, usually provided very quickly with little due diligence, treated like equity on a balance sheet.  Little or no security left after the senior debt has been secured, may involve a higher rate of interest, 4 to 8%, over bank base rate.  Also may take some equity and repayment over shorter time.

Bank overdraft: Agreed sum by which customers can overdraw their current account, usually short term option for quick finance with variable interest rate. 

Trade credit:  Buy goods or services without making immediate payment, buy now pay later.

Own funds: Assets or expensive pieces of equipment can be sold or leased back.  An increasing number of deals are being financed by available funds alone.  Usually a method adopted by successful entrepreneurs.  Individuals could be sitting on funds through successful M&A deals, for example, just waiting on the right time to invest.  There is the advantage of retaining a higher level of control in the business so they can increase their level of return also avoiding covenants and restrictions by banks.

It’s a wise option for businesses to explore as many sources of finance as possible such as those listed above.  In a difficult market it is even more important for companies to differentiate from competitors.  Taking advantage of the lower valuations of M&A deals or attracting international investors.  However it is important to note that the most successful form of financing may be to reduce the dependency of having to finance in the first place.  Reviewing how a business operates and trying to reduce unnecessary costs is a process many businesses are going through at present and it can improve the figures on balance sheets. 

Other methods of reducing the dependency of finance can include:

Using internal funds, reducing employment levels, improving debt management, increasing loan repayments, selling existing assets, reducing dividends, slowing down rate of growth, increasing trade credit and reducing staff training amongst others

The continuing difficult economic conditions may have shown signs of improvement, however recent natural disasters like the Japanese Earthquake impact on the recovery process.  Therefore, in difficult times it is even more important for companies to take what opportunities come their way.  Using alternative sources of finance can help businesses through difficult times and prepare them for future growth. Pairing these sources with expense and payroll solutions can help ensure businesses remain profitable.  For those that can it is a good time to acquire the market share from weaker companies and expand further.  Also employing measures to streamline company expenditure and the incorporation of risk mitigation measures will prove to be useful in the long run.


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