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Raising debt finance

Written by: Timur Sultanov

Article Overview: There are many ways of arranging business finance apart from going along to your local high street bank. For anybody who is not particularly financially aware, some good advice is going to be needed. However, bear these two very important overriding considerations in mind from the start: • Financial institutions lend money because they are confident in the ability of the people running the business. • Financial institutions these days are fiercely competitive for good business.

Raising debt finance

Notice the emphasis on good. The important point to make is this. Banks and other financiers are very keen to attract good business, and will be very competitive in their efforts to do so. But, if the business is less than top-rate, they will either turn it down or charge much higher rates. You have to bear in mind that one bad loan wipes out the profit from ten good ones. So what does this mean to you?

It means that you need to convince the financiers you approach that, whilst you may be new to running a business, you are clearly someone who has thought it all through very carefully. You are someone who knows what he is doing, understands the fundamentals of the business being acquired, and is, therefore, probably going to be a success in the longer term.

This cannot be done by handing over the whole thing to an advisor to arrange. Yes he has good contacts, yes using them is a good idea, but you are not going to get the best deal unless you involve yourself in the presentation of the case. You need to check all the information that he is presenting, and be available to answer any questions that may be raised by potential lenders.

Using advisors

For the purpose of this subject we will look at two groups of advisor: brokers and financial/business advisors.

Brokers

Brokers make their living by maintaining good contacts with the hundreds of institutions that provide all the different types of business finance.

They keep registers of the types of finance and the standard terms that the different institutions are prepared to offer, such as:

• Which types of finance they provide.

• Minimum and maximum amounts they offer.

• Which types of businesses they lend to.

• Their lending criteria such as maximum debt to equity ratio, minimum security requirements, valuation requirements; etc.

• Interest rates and length of loan term.

There is no doubt that being able to tap into this data can save you a lot of legwork - indeed you couldn't really do it thoroughly yourself. However, brokers generally do have their limitations:

• Many charge substantial non-refundable up-front fees. Although some institutions pay an introduction fee to brokers, a large number do not. In any event, since so many deals fail to go through, the brokers need to get paid for their time whether they are successful or not.

• Many of them have good contacts but little presentation skills. You generally cannot depend on a broker to prepare a professional presentation for you. They often need the proposition to be prepared for them so they can identify the institutions that are most likely to help and submit it to them. They are rarely able to prepare cash flows and business plans for you.

• Some institutions do not like dealing with brokers. Most notable in this respect are the high streets banks. Although they acknowledge that brokers are a good source of new business, the banks purely regard them as introducers, and do not pay commissions. Whilst they will deal in general terms with the broker at the very beginning, they do so only to establish that, on first look, it appears to be a case worthy of consideration. Once they have established their interest, they will want to see you at an early stage. They know that the brokers do not vet you in any way and they will want your answers to their questions, not the brokers.

If you can get a recommendation, from a friend or from your accountant, then so much the better. If you are buying the business through a business transfer agent, his agency will probably have a finance department or, if not, will have a working relationship with an independent broker.

Unless brokers have been recommended to you, checking them out is not so easy. The first key question, of course, is what they are going to charge you. For the reasons already stated, you will find that most will want to charge an initial fee, whatever the outcome, and probably then a pro-rata fee based on the amount successfully raised once an offer of financing is received. But how do you decide if and when to punt an up-front fee? Mainly you will have to go on instinct as to who seems the most professional, but why not ask them to provide the names of a couple of recent clients that you can speak with?

Financial/Business advisors

Under this heading I include independent advisors who are able to offer business advice, such as developing a business plan, advising on the best way to finance the business, and assisting you to prepare the presentation for the lenders.

Often these advisors are part of a firm of accountants, or they may be individuals such as former bankers who have the necessary experience. If you need an introduction, you could do no better than to speak to your local Business Link.

If, when you have read through the following sections on financing a couple of times, you find it a bit mind-boggling, you should definitely seek the assistance of an advisor before approaching any institutions, because first impressions are all important.

Business transfer agents

All of the leading business transfer agents offer a financing service and will have a department familiar with leading lenders in the same way as the brokers referred to above. If you are buying your business through a business transfer agent, this is probably the best place to start. The institutions tend to have more respect for such departments because obviously they are specialists and, through the parent organisation, have a good knowledge of the business being purchased.

Going direct

If you have the confidence, and there is every reason you should have if you follow the steps in this article, approach the local banks directly, and any other institutions for that matter.

However, before doing so, prepare yourself by going through the different types of financing available. Ask for a preliminary meeting with the business banker. At that meeting tell him that you are proposing to make an application for finance, and ask him for all the necessary forms to be completed. He will no doubt, ask some general questions and give you some good pointers as to what information he will be expecting to receive, as well as an indication in general terms of what he is likely to be able to offer you if your proposal is favourable.

However, make it obvious that you regard this as a preliminary meeting and that you will be asking for a further meeting after you have prepared a full presentation.

Preparing the presentation

Even if you are using a business advisor, work on the presentation with him by feeding him with as much of the information described below as you can.

These are the general headings that your presentation should cover. The level of emphasis on each will vary in individual cases:

• Details of the new owners.

• Description of the business.

• The management and staffing.

• The financing plan.

• Cash flow projections.

• Historical accounts.

Details of the new owners

This should include a brief history of your career to date and details of your financial circumstances.

Do not worry if you have never run a business before. The lenders accept that we all have to start somewhere, and are mostly looking at how professionally you are approaching this venture.

Do not exaggerate. If your house may just fetch $175,000 on a lucky day, but is more realistically worth$160,000, put it in at $160,000. If it's important, the manager will check it, and there is nothing that looks worse to a banker than finding statements in a presentation that mislead. It will make him sceptical about the accuracy of the other information you have included.

Description of the business

A general overview of the key elements of the business including,

as applicable:

• General description of the location.

• Type of clientele/customers.

• Turnover and profits to date.

• Price paid.

• The competition, if any.

• Future plans.

• Why you consider this to be a particularly good purchase.

The management and staffing

• General information on staff being taken over, such as experience, length of service, etc.

• Who will manage the business day-to-day?

• What will the owner's involvement be?

• What controls are in place over cash and stock?

The financing plan

• Total investment required.

• The amount of equity being invested.

• Debt finance sought - what types and how much of each.

Cash flow forecast

If you are buying a business with a cash trade evenly spread over the year, the cash flow forecast is less important and relatively easy to prepare. Indeed, provided you have ample finance to make the initial purchase of the business and stock, you will probably never need more finance unless you propose to diversify at some stage, or some totally unforeseeable circumstance arises. In such cases a cash flow forecast at this stage has little value and may not be requested.

However, in other cases, cash flow can vary considerably on a week-to-week or month-to-month basis, and it is important to identify the maximum likely funding requirement to ensure that it is covered. This is the purpose of the cash flow forecast. Undoubtedly it is the hardest bit of the presentation to prepare, particularly if you are acquiring a business that is seasonal. If you have no accounting experience, you will probably need professional help with this. If you have a little accounting knowledge, the leading banks do have free computer programs to take you through it step by step.

The cash flow forecast is essentially a chronological table of cash movements in and out of the business on a weekly or monthly basis. It is not the same as sales and purchases in the same period. If you purchase stock on the first of January and sell it on the second, your cash position will depend on the terms. If you pay cash for the stock, and sell it for cash you are out of pocket for one day. If you buy the stock on thirty days credit and sell it for cash the next day, you will be cash neutral for a day and then in pocket for twenty-nine days until you pay the supplier. That will give you the money to fund other transactions. If you buy the stock on thirty days' credit, and sell it on sixty days' credit you will be cash neutral for thirty days, no cash having changed hands, and then out of pocket for the next thirty days, after you pay the supplier, until the customer pays you. In each case you should eventually finish up cash positive by the profit margin, but, as you can see, in the meantime the amount of cash you need to have available varies. When you prepare the cash flow forecast, the appropriate payment terms are included, as are different sales and purchase volumes at different times of the year, and thus it will take all the variations into account.

The cash flow projection should also include the cost of buying the business at the outset and the cost of any additional capital items that will need to be purchased during the year. It should also include anticipated general expenses such as rent and utilities as and when they fall due. As a result, it shows a prediction of how much maximum overall funding is likely to be needed at any given time over the period it covers.

The presentation should not only contain the cash flow figures themselves, but also the assumptions you have used in preparing them, such as rate of sales growth, price increases in sales and expenses, suppliers' payment terms, payment terms offered to customers, etc.

Whilst all the leading banks have forms for manually preparing cash flow forecasts, the forecast is best prepared on a computer spreadsheet program such as Microsoft Excel, Microsoft Works or Lotus 123, and this is how all professional advisors would do it. Once set up, these programs automatically do all the mathematical calculations for you, making it easy to change assumptions and see what the effects are. For example, you could increase sales prices by 10 per cent and, without having to redo all the calculations manually, see the knock-on effects on profitability and cash flow and hence financing requirements. You can give a copy on disk to the bank and they can do their own 'what if experiments like this.

Historical accounts

You will need to attach the historical accounting information received from the vendors. You should include the accounts for the last three years, along with the management figures covering the period since the date of the latest annual accounts.

The lender will look at these figures in detail to assess the ability of the business to cover the cost of the finance being sought. It is a good idea to write a summary of your findings and adjustments when you reviewed the accounts for the purpose of your valuation (as per the sections on reviewing the accounts in.

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