By Altenburg Advisory

What to consider when comparing funding options

Businesses looking for funding have never had so much choice when it comes to funding options as they do today.

But to ensure they get the right funding option for them, there are several key considerations for businesses to think about.

This article looks at 10 key points businesses need to consider when looking for funding. It will also explain the options available to businesses and how advisers can help them navigate the funding process.

10 Key considerations:

1. Quantum – how much do you need?

Businesses require funding for a variety of reasons. Some of the most common purposes for funding are:

  • Refinancing existing debt

  • Funding for an acquisition

  • To fund (growth linked) working capital

  • To provide a cash buffer against uncertainty

  • To give the business enough cash on its balance sheet for small acquisitions

While a business may desire a particular level of funding, ultimately lenders will determine what funding they will give.

2. Structure – single vs multiple facilities?

The key structural decision businesses need to make is whether they want single or multiple facility funding.

Multiple facilities may afford greater flexibility and funding potential for businesses (for example an invoice discounting line plus a term loan).

Different facilities could be provided by a single or multiple funders, and there are pros and cons to both.

3. Term and repayment plans

The length (term) of the loan will be a key factor for those looking for funding. Typically a cash flow loan is repayable over a four to six year period. However, this may not be suitable for all businesses. Some may need a longer period to repay the loan and so businesses will need to consider what repayment plan works best for them.

The most common repayment options are:

  • A standard repayment loan, which can be repaid over the full period, with a portion repaid at set dates (amortising)

  • A partial repayment loan, where a portion of the loan is repaid over the term and the balance remaining is paid at the end of the term (in a ‘bullet’)

  • A ‘full bullet’ loan, for those who want to ensure maximum cash-flow. A full bullet is where interest is paid during the term of the loan and the full amount is due at the end of the loan

4. Further funding requirement

Businesses need to take a long term perspective on their funding requirements. This is particularly the case if they need additional funding to grow, for example through organic expansion or acquisitions.

There are primarily two arrangements for follow on funding – a committed funding line and a soft commitment.

A committed funding line is where an element of extra funding is allocated to a business and is available for the business to draw down and use. This is subject to certain conditions being met.

Soft commitment is where lenders indicate to businesses that they can provide additional funding if and when required. This has no commitment fee but is less certain and subject to further credit approval. This may be considered instead of a committed line or alongside one.

5. Due diligence requirements

Businesses need to consider what due diligence requirements the lender requires ahead of providing funding. Many lenders may require external due diligence carried out while for others internal due diligence will be acceptable.

With the external option, businesses need to establish what the process and scope of the due diligence will be. They also need to consider whether external due diligence may be needed again in future, e.g. for follow-on acquisitions.

6. Financial Covenants

All funders will require some form of financial covenants which the business will need to comply with. The purpose of these covenants is as security measure for the lender, and they provide a clear expectation of required performance.

When it comes to covenants, businesses will need to evaluate how much headroom the covenants provide – and how much they require.

Businesses also want to calculate what level of downturn in their income would be needed to breach a covenant – and how likely this is to happen.

In addition, businesses need to consider that if a covenant was breached, what options they would have under the loan agreements to “cure” a breach.

7. Restrictions

Lenders will typically put in place (as part of the loan agreement) controls on director and management compensation and dividends.

Some funders will allow “excess” cash to be taken out through an agreed mechanism, subject to covenant compliance.

It is important that these points are discussed and negotiated upfront to ensure that what is required by the lender works for the business and its shareholders.

8. Reporting requirements

Businesses need to consider what reporting requirements the lender will need and whether this differs from reporting that the business currently produces. In some cases lenders may even require a board observer, who may observe board meetings.

9. Cost

Cost will be key to any funding deal and is really a function of the level of risk a funder is being asked to take and the level of flexibility that they are providing.

Typically, the main funding costs businesses need to consider are funding costs (initial and exit fees, interest costs) and any upside share a funder might require (such as warrants or a redemption premium).

All businesses will need to assess the levels of cost that they are prepared to pay in any funding deal and weigh up the cost in the context of the number of the objectives that are being met by the financing and the opportunity cost of not having the right funding in place.

10. Timescale for funding process

The timescale of the funding process is often driven by the lender and how busy they are. When looking for funding, businesses need to be aware of the length of the funding process. They also need to consider their own timing requirements and how many stages there are in the funding process.

One key lending requirement may be external due diligence (as mentioned in point 5). External due diligence can often take three to five weeks and businesses will need to factor this in to their timescale.

How advisers can help

Advisers play an important role in evaluating funding considerations. Advisers’ expertise and connections to funders can guide businesses through the funding process. They will know who to contact and what information is needed.

ACP Altenburg Advisory works with business throughout the entire funding process. Firstly, establishing the need to haves and the nice to haves from a funding solution. Working back from these ACP Altenburg Advisory will help to develop and structure the most appropriate funding solution. ACP Altenburg Advisory will then help source, review, and negotiate funding offers to help the business implement the most appropriate solution.

ACP Altenburg Advisory is part of ACP, a leading independent debt advisory association for SME and mid-market companies, advising clients on the options available to them and providing hands on support from day one all the way through to drawdown.

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