With a thriving entrepreneurial culture, the UK is the third-largest producer of start-ups in the world. People up and down the country are setting up businesses — innovating, disrupting, and having a go.

In 2017 (the last year that data is available) more than 382,000 new businesses began trading. That brought the total number of small firms to 5.6 million, employing 16.3 million people.

But despite this wave of entrepreneurship, the UK struggles when it comes to scaling up those businesses. There are still too few fast-growing companies, even though there are some encouraging signs — the latest ONS figures show that the number of scale-ups (companies growing by 20% per year) grew by 3.7% in 2017.

Part of the problem is that small businesses tend not to use finance (which in this article is taken to mean debt, not equity).

A recent poll by BVA BDRC found that

only a third (32%) of small businesses are happy to use external capital to help them grow.

So why are business owners so reluctant to borrow? Some business owners simply don’t want to — they would rather grow at a slower rate than burden themselves with someone else’s money.

For other SMEs, though, the problem is a lack of information. Many busy business owners simply don’t know about the range of products available to them.

This has given rise to what is known as the ‘perception gap’: a belief by some entrepreneurs that if they apply for finance they will probably be rejected. However, the data shows that

eight out of ten businesses that apply for a loan are successful.

And there are lots of lenders who specialise in working with small businesses, who are used to first-time applicants.

Using finance isn’t for every business. But if approached intelligently and delivered by the right provider, growth finance could help many of the UK’s small businesses.

The growth journey is different for every business, but here are some general tips for business founders who are weighing up whether to take on external capital.

• The first thing a business owner should do is set out its goals in the short, medium and long term to determine whether finance is the right course of action. Does the business want to access new markets, for example, or develop new products? And if so, can it do so through its own cashflow or does it need a capital boost?
• If an owner decides that their business needs external capital, then the next course of action will be to decide which form of finance is the right kind. There’s a rich variety of finance available to growing companies, depending on factors like how its business is structured to the different kinds of assets it can offer as collateral. From bank loans to invoice financing, from asset finance to venture debt, deciding on the right kind of capital will be important.
• Do plenty of research on the different capital providers. There are more lenders available to SMEs than ever before, and each of them will offer something slightly different. A business founder can use their peer network to learn about different finance providers, as well as excellent online resources such as the Finance Hub by the British Business Bank.
• Finally, take every possible step to ensure that the business partners with the right lender. For growing businesses in particular, it’s important to find a lender that understands the needs of the company and is looking for a long-term relationship. Things can change quickly for a small business, especially during periods of fast growth, so it’s important to choose a supportive finance provider.

Summary of the different kinds of growth finance

More and more small businesses have been using equity capital in recent years, but for the sake of simplicity this list only features debt options.

1. Loans & Overdrafts

Loans and overdrafts are the most common source of finance for growing SMEs. They are used for a wide range of reasons — from financing new hires, to buying stock, to developing new products.

Both are typically provided by high street banks, although in recent years a wide range of new providers (often referred to as the ‘challenger banks’ have begun offering them).

To get a loan, a business must show to a lender that it can generate the income it needs to pay back the debt. Lenders usually require security or a guarantee as a condition of providing the loan.

Overdrafts are slightly different. An overdraft is a short-term line of credit that a business can ‘dip in’ to from time-to-time. It is capped at an agreed amount, and a business is under no obligation to make use of the full sum.

2. P2P business loans

In the past five years, peer-to-peer (P2P) loans have become more and more popular among SMEs. They connect businesses to many different investors via an online platform.

P2P platforms are often able to lend when banks don’t. Many small businesses have found that they can secure funds through an online platform after their bank has turned them down.

The process of agreeing a loan from a P2P platform also tends to be faster than from traditional lenders. Many small businesses have reported accessing a P2P loan just a few hours after applying.

3. Leasing & hire purchase

Leasing and hire purchases allow growing businesses to use equipment without having to pay upfront for its full cost.

They are very common financial options for SMEs: a fifth (21%) of businesses with 10-49 employees use leasing or hire purchase, while 43% of businesses with 50+ employees use them too.

The kinds of equipment that can be leased range from small items to the very large. Businesses use leasing and hire purchases for everything from coffee machines or vehicles to large machinery and manufacturing equipment.

Leasing and hire purchase agreements range in size and are offered by a variety of specialist providers.

4. Invoice financing and factoring

Invoice finance is a tool that offers SMEs ‘more than finance’: a solution to the danger of late payments.

Unfortunately for lots of small businesses, late payments are a constant pressure. According to research by BACS, 43% of SMEs face late payments, with many of the delays stretching months. The cost to UK small businesses of recovering that money reached £6.7 billion last year, up from £2.6 billion the year before.

Lots of small businesses can’t afford to wait weeks or months to receive payment from a buyer. Cash shortages due to slow payments are a common killer of small firms.

That’s why invoice financing is such a useful tool. By helping businesses to get paid promptly it allows small firms to free up cash and focus on developing their businesses.

Another benefit to invoice finance is that it doesn’t require an SME to have any other assets than its unpaid invoices. For a small firm it can be one of the easiest ways to raise finance.

5. Asset-based lending

Asset-based lending is a way for a growing company to use its assets as security for a loan.

It allows an SME to raise cash against its valuable property, freeing up funds to invest in its growth. Rather than keeping cash tied up in large assets like machinery or real estate, a business can raise debt against them and use the cash to fund its growth.

Traditionally it has been more popular at the larger end of the range of SME companies, although it is increasingly common at the smaller end of the scale.

Asset-based lending tends to be cheaper than unsecured loans because the lender has the right to the assets in the event of a default. Because this reduces the risk to the lender, it can offer lower interest rates to the borrower.

Given that many assets can qualify as collateral, there is a wide range of facilities available. Smaller SMEs can raise modest amounts against lower value assets, while larger SMEs can raise far more.

6. Venture debt

Venture debt is a way for fast-growing businesses that are between equity rounds to boost themselves with extra capital before their next fundraising.

Venture debt is closely tied to venture capital funding, which is a form of equity investment in early-stage businesses. It’s a specialist product that can be highly useful for the fastest-growing SMEs.

Some growth companies use venture debt to ‘lengthen the runway’ until their next planned equity round. They use the capital to scale up in advance of their next valuation, helping them to raise more money in the future.

Alternatively, they might like to secure it as a sort of insurance policy to cover unexpected cash demands or equipment purchases. Lots of early-stage businesses don’t break even in the first few years of operations and are reliant on external capital until they reach profitability

7. Direct lending

Direct lending platforms offer senior loans to growing businesses, usually secured by the company’s assets.

It’s hard to assess the full impact of direct lending funds on the UK’s growth businesses because data collection is sparse in this section of the market.

But there are two things we can say about direct lenders’ relationship with growing companies.

One is that the volume of direct lending to SMEs is growing. The number of companies taking loans and the value of private debt deals have been increasing.

The second feature of direct lenders is that they are more active in the middle and the top of the SME market than at the bottom. They tend to offer larger loans to companies that are well-established with a strong trading history and assets.

8. Export finance

SMEs can use export finance to help them sell goods to customers abroad.

It typically involves a business securing advance or guaranteed payment ahead of goods being shipped, so that it can grow internationally without fear of missed payments.

Export finance is available to both large and small businesses, providing they are making revenue and have export contracts or orders from abroad.

It is offered by high street banks as well as specialists, plus it can also benefit from government support.

Because exporting is good for economic growth, the government has a special department, UKEF, whose purpose is to support export finance. Thanks to the guarantees it provides to banks, export finance can often be offered cheaper to SMEs.

Below is an example from 100 Stories of Growth – How They Did It, that looks at how HIB sorted out its cashflow using invoice finance through Lloyds Bank.

HiB – sorting out its cashflow

Arriving at the optimum point to accelerate scale-up activities is different for every business. For HiB that time came five years ago after 20 years of successfully growing the company. HiB had carved out a niche supplying high-end designer cabinets and mirrors to independent retailers in the UK and the Middle East.

“We have created a niche and have become the market leader,” explains managing director Robert Ginsberg. “Sometimes, you have to create a market to scale.”

HiB sells products that had been traditionally viewed as accessories that people buy last in their bathroom upgrades. “But customers are now choosing a bathroom cabinet or mirror with LED lighting, integrated bluetooth speakers and charging points as a key item when designing a bathroom experience,” says Ginsberg.

The company worked with its long-standing relationship lender Lloyds Bank to roll-out a growth-focused invoice factoring programme, by raising working capital against its receivables. Its regular sales and purchasing patterns supported this finance option.

“We had a cash flow struggle between needing the stock to support growth and having cash to support this,” explains Ginsberg. This strategy helped HiB grow its revenue from the £8 million level to around £15 million. “It provided the boost and energy that we needed for three years until the increased sales generated cash,” he adds.

Having just two relationship managers at Lloyds Bank since 1990, Ginsberg says HiB benefited from this “consistency and stability” and didn’t really need to look around for other finance options.

Case Study by Robert Ginsberg, HiB, Managing Director