Types of Finance
A brief description of the key features of the main sources of business finance is provided below.
Venture capital is a general term to describe a range of ordinary and preference shares where the investing institution acquires a share in the business. Venture capital is intended for higher risks such as start up situations and development capital for more mature investments. Replacement capital brings in an institution in place of one of the original shareholders of a business who wishes to realise their personal equity before the other shareholders.
There are over 100 different venture capital funds in the UK and some have geographical or industry preferences.
There are also certain large industrial companies which have funds available to invest in growing businesses and this ‘corporate venturing’ is an additional source of equity finance.
Grants and Soft Loans
Government, local authorities, local development agencies and the European Union are the major sources of grants and soft loans. Grants are normally made to facilitate the purchase of assets and either the generation of jobs or the training of employees. Soft loans are normally subsidised by a third party so that the terms of interest and security levels are less than the market rate. There are over 350 initiatives from the Department of Trade and Industry alone so it is a matter of identifying which sources will be appropriate in each case.
RMT’s corporate finance team is regarded as leading UK grants and soft loan advisors, having secured over £50m such funding in the past five years.
Invoice Discounting and Invoice Factoring
Finance can be raised against debts due from customers via invoice discounting or invoice factoring, thus improving cash flow. Debtors are used as the prime security for the lender and the borrower may obtain up to about 80 per cent of approved debts.
In addition, a number of these sources of finance will now lend against stock and other assets and may be more suitable then bank lending.
Invoice discounting is normally confidential (the customer is not aware that their payments are essentially insured) whereas factoring extends the simple discounting principle by also dealing with the administration of the sales ledger and debtor collection.
Hire Purchase and Leasing
Hire purchase agreements and leasing provide finance for the acquisition of specific assets such as cars, equipment and machinery involving a deposit and repayments over, typically, three to ten years. Technically, ownership of the asset remains with the lessor whereas title to the goods is eventually transferred to the hirer in a hire purchase agreement.
Medium term loans (up to seven years) and long term loans (including commercial mortgages) are provided for specific purposes such as acquiring an asset, business or shares. The loan is normally secured on the asset or assets and the interest rate may be variable or fixed. The Enterprise Finance Guarantee Scheme can provide up to £250,000 of borrowing supported by a government guarantee where all other sources of finance have been exhausted.
This is a loan finance where there is little or no security left after the senior debt has been secured. To reflect the higher risk of mezzanine funds, the lender will charge a rate of interest of perhaps four to eight per cent over bank base rate, may take an option to acquire some equity and may require repayment over a shorter term.
An overdraft is an agreed sum by which a customer can overdraw their current account. It is normally secured on current assets, repayable on demand and used for short term working capital fluctuations. The interest cost is normally variable and linked to bank base rate.