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23/01/2018

Cash is King - A changing funding landscape?

23/01/2018

Cash is King - A changing funding landscape?

Despite the varying stances on the outcome of Brexit ranging from industrial Armageddon to a brave new EU-free dawn, progress to date would begin to indicate that a workable strategy will emerge. The challenge however is the setting of budgets, strategy plans and growth assumptions for 2018 and beyond as the details emerge.

With many businesses still eager to pursue growth in new markets and increase exports, despite the Brexit outcome, the ability to navigate the complex funding landscape is essential in making these ambitions a reality and unlocking the potential that will deliver crucial contributions to UK industries in the years to come.

Setting aside speculative news and opinions on the how the UK will fare in an independent future, what do businesses need to consider when exploring growth capital investments?

Whether it be debt, mezzanine or equity finance, business and consumer confidence is key if investors are to commit capital to support growth plans.

The capital sought needs to be flexible with supportive lenders or investors willing to have longer term views than short term lends.

Finance provided has got to be both appropriate in terms of cost and be clearly linked to the incremental returns that the business can generate. Put simply the benefits of gaining investment has got to outweigh the cost.

Where equity capital is considered, businesses need to have a clear understanding of the ramifications of ceding equity to external investors and the resultant concessions of having a decision making board control parts of the business.

So, in 2018 how does the funding landscape stand for business owners with ambitious plans?

Debt
Despite their attempts at endearing themselves back to the British public and the corporate world in general, the banks remain at best reasonably consistent in their lending policies. Many are clearly looking to reduce exposure to the SME sector and it’s clear that credit functions are having an increasing influence over the discretion of front-line relationship bankers to lend. 

We have seen numerous examples within our portfolio of lack of willingness from banks to support short term spikes in working capital or growth plans. It is easy however to be critical but the traditional bank debt product is priced at a largely risk free level and therefore their risk free stance shouldn’t be derided as is sometimes the case.

Equity
In terms of equity there are various estimates of the amount of un-invested capital available within growth capital and private equity funds in the UK. The amount certainly runs into hundreds of millions and although this is not all specialist growth capital, the un-invested amount is colossal. In many regards this is good news for businesses; where funding supply exceeds demand, capital pricing will always reduce.

Despite a rise in awareness of “patient capital” equity funds bring a requirement for staged growth and ultimately exit plans to provide a return for the equity investor, equity finance only works for some businesses and the direct involvement in the business plans by external investors is not for everyone.

Mezzanine
There is a “third-way” when considering growth capital. Mezzanine investment is otherwise known as the hybrid,  combining elements of both debt and equity funding to form an agile alternative to its counterparts. 

Using equity as a form of collateral, lenders can offer more finance compared to what borrowers could get via ‘senior-debt’. 

Traditionally a product used in large PE deals, mezzanine has emerged as a viable alternative to either provide a layer of debt in leverage transactions but more importantly as a significant source of growth capital in the SME market. Priced to reflect the risk over the cost of bank debt, mezzanine funding is rising as a flexible source of funds with extended repayment terms and limited involvement compared to equity investment. Given the level of uncertainty around the next 12-24 months, mezzanine looks set to continue to grow.

At Frontier Development Capital, many of our investees have not let uncertainty sway their overall business confidence and have used growth capital to further develop their companies. 

By understanding the different funding options available to them, making use of our flexible finances, they were able to plan for the future and achieve their ambitions. This includes the likes of:

Specialist badge manufacturer Badgemaster, which we supported via our National Mezzanine loan fund, enabling the firm to pursue further expansion plans, including welcoming a new director. 

And, specialist property developer Henry Davidson Developments (HDD) secured a deal through our Regional Mezzanine loan fund, enabling the relocation of their head office to the West Midlands.

No one can predict the future but in uncertain times flexible funding structures and working capital headroom are key to success and business growth. There are other sources of funds such as invoice discounting and asset funding that will continue to be part of the mix available to businesses but mezzanine finance is probably set to become a more established product in the SME market in 2018 and beyond.