SMEs are a critical component of the growth of South Africa, especially in respect of job creation. Report after report confirms that creating and supporting a conducive environment for SMEs to thrive is necessary for any economy, developed and developing included. In a 2018 study, it was estimated by the World Bank that 4 out of 5 new jobs will be created by SMEs globally over the next 15 years. The success of SMEs should be of paramount importance to Government and corporates alike.
The challenge for SMEs in growing a business is challenging at the best of times, but growing a business in a tough economy is especially difficult. Business growth demands increased resources – both people resources and equipment resources, and this is costly. It is at this point that most entrepreneurs look to raise expansion finance.
An interesting analogy would be that SMEs are the vehicle that will grow this economy, however funding is the fuel required to keep them going. Because funders possess this key resource required by SMEs to grow, and ultimately create much needed jobs, funders offer tremendous value to SMEs. Whilst they have a reputation cast on them as being withholders of funding from small business owners, the fact is that the growth of their businesses hinges on them providing as much funding to as many businesses as possible. Make no mistake, they are not going to go about this without performing the necessary assessments in making these decisions.
There are a number of finance options available to fast growing companies. These range from a standard loan, to selling shares in the business in return for growth capital (equity finance). The key to raising finance is to start preparing for this event long before it becomes critical. What many entrepreneurs don’t realise is that there is a lot of preparation required before you can approach lenders.
All lenders will require you to submit supporting documents along with the loan application. These documents will be used as part of the risk assessment process. Financial documents are key, as they provide a clear view of the past performance of the company: this includes management accounts for the previous months (balance sheet, income and expenses, debtors’ age analysis and cash flow). Cash flow documents may be required as these show estimates of the inflow and outflow of money, and can confirm that the company will be able to repay the loan. Depending upon the type of finance you apply for, you may also need to provide the lender with budgets that show how the finance will be used and the impact on revenue generation and expenses. In some instances, lenders may ask to see your order book so that they can estimate the value of confirmed future orders.
Lenders will also need to know that the company is up to date with its taxes, so it pays to always have an up-to-date tax clearance certificate on hand.
In the case of equity finance, the investors will conduct an extensive due diligence. The aim of this is to verify everything they have read/heard about the company, and to make sure that it offers a sound and attractive investment.
It is a good idea to make it a habit to always have copies of directors’ IDs, company registration documents, a valid tax clearance certificate, a current business plan and the latest schedules of assets and liabilities (for both the business and the directors) available.
Types of finance
In terms of the types of finance you can consider, it is best to familiarise yourself with the different types of funding options. An excellent resource for this is Finfind’s Access to Finance portal. Not only can this portal match you to finance products according to your needs, but it also includes a useful funding information section that explains the different types of finance products, how they work and what is expected of you. Once you have registered on the site you can go straight into the matching section, or you can opt to use the educational section. The site is accessed via www.finfind.co.za.
The reason for the finance and the amount required plays a large role in determining the optimal finance product. For example, if you are needing growth finance of R5 million, then equity is an option to consider. However, to attract venture capital (equity capital) you need to understand what these investors look for. Their primary concern will be rapid growth that leads to high profits. These investors are in it for the long run, and most only expect to sell their shares after a 5 to 7-year period. One of the advantages of equity finance is that the investors are experienced businesspeople and can provide your company with valuable advice. The key point to remember with equity finance is that you will no longer be the sole owner/decision maker, and this is a big mind-set change. Equity investors will sit on your board of directors as they will want to watch how the company is performing against agreed upon milestones. Many equity investors focus on specific industry sectors, and some will work with you to generate growth plans and other growth-related operational requirements.
For small amounts or finance needs that are short-term, you can then consider raising a standard term loan. From the lender’s point of view, they want to feel comfortable that the company will be able to afford the monthly repayments. To assess the risk of lending, they will interrogate the company financial documents, and the credit ratings of the owners/directors. If an owners or director has a poor credit record, it raises a red flag for lenders that the company is run by people who do not manage their finances well. It really pays to monitor the credit ratings of owners and directors, and to put measures in place to ensure they stay within the acceptable range.
Small businesses are a driving force for social and economic stability in South Africa. They generate much needed employment and add to the country’s GDP. Therefore ensuring that small businesses can access finance is crucial. There is a myriad of different finance products for small businesses, but the terms and conditions of this lending are not always a good match with SMEs. That said, entrepreneurs can do a lot to help themselves by ensuring that they are finance ready. This means, learning about small business finance so that when the time comes to raise finance, the decision as to what type of finance to raise is easy to make. If good recordkeeping processes are in place, then making sure that the company always has up-to-date documentation required to support a loan application, will make the process of raising money quicker.
Source: Robynne Erwin, Consultant, Finfind