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May 2023

A guide to
non-equity financing

Sponsored by

Produced in partnership with
City Road Communications

May 2023

A guide to
non-equity financing

Sponsored by

Produced in partnership with City Road Communications

Introduction

Raising finance is a critical challenge for many small and medium sized enterprises (SMEs).

Whether to overcome short-term cashflow issues or fuel long-term growth, an injection of capital can transform a business’ fortune. As such, knowing the type of finance to go after, and where to get it, is of utmost importance.

Pros
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In this report we will delve deeper into the world of debt financing, providing SMEs with a guide to the most pertinent information they need to know.
We will explore:

• Why an SME would choose debt over equity financing;

• The factors driving up demand for debt finance in the current climate, and what common challenges SMEs face when seeking it;

• What types of debt financing SMEs have to choose from;

• Best practice when applying for debt finance;

• The role of brokers in assisting SMEs seeking capital.

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In this report we will delve deeper into the world of debt financing, providing SMEs with a guide to the most pertinent information they need to know.
We will explore:

• Why an SME would choose debt over equity financing;

• The factors driving up demand for debt finance in the current climate, and what common challenges SMEs face when seeking it;

• What types of debt financing SMEs have to choose from;

• Best practice when applying for debt finance;

• The role of brokers in assisting SMEs seeking capital.

Why choose non-equity financing?

There are many reasons an SME would opt for debt over equity financing. Most notably, unlike equity, debt financing allows the borrower to maintain control and ownership over their business; they retain decision-making powers without needing to consult with the financier. However, it is important to note that in many instances debt finance will come with restrictions for the borrower – for instance, the ability for the business to take on further debt – while certain company activities, such as making acquisitions, may require approval from the lender.

Unlike with equity investments, when using debt finance, the company has no obligation to share profits with lenders, and when the debt is repaid, the relationship with the financier ends.

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Pros
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However, it will often not be a choice between one or the other. Rather, many scaling businesses will seek out both equity and debt finance options during their early years.

Sonya Iovieno

Head of Venture & Growth Banking
SVB UK​

Sonya Iovieno, Head of Venture & Growth Banking at SVB UK, explains:

“For an early-stage business (seed, series A, series B), debt should be complementing equity. It is not an either/or, rather it is about reducing execution risk by diversifying sources of capital funding.

“For startups, debt finance acts as an insurance policy and source of comfort, such that, if there are any boulders in the road, the debt provides extra breathing room (cash) before equity starts to run out. It gives management teams time to pivot a business and make changes, in order to hit their next growth milestone.

“Layering in debt also gives founders more time to build the company’s valuation before the next equity round.”

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Demand for debt financing

As a collective, the UKs SME community has faced more obstacles in the past three years than at any point in the last half a century, with several converging economic trends contributing not only to increased demand for debt financing, but also heightened challenges in accessing it.

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Covid-19 takes its toll
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The Covid-19 pandemic placed huge pressure on business finances. Many were forced to shut their doors almost overnight and adapt to entirely new ways of working, while simultaneously experiencing a drop-off in customer demand as businesses and consumers alike tightened their spending.

The impact in terms of SMEs going out of business was not immediately clear during the first 12 months of the pandemic. But it has since become more obvious in the past two years.

In 2019, there were 327,975 business closures across the UK – this is defined by the number of businesses removed from the Inter-Departmental Business Register, as reported on biannually by the Office for National Statistics.

In 2020, the number only rose slightly to reach 332,620, with emergency financial packages, such as the Coronavirus Business Interruption Loan Scheme and furlough programme, protecting businesses from the worst of the pandemic's harsh financial realities.

However, as such initiatives were withdrawn or tapered down, more companies began shutting down; in 2021, the UK registered 345,490 business closures, followed by another sharp increase to 367,365 in 2022.

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The cost-of-living crisis impacting SMEs

The cost-of-living crisis impacting SMEs
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In 2022, while the worst of the pandemic had passed, the economic aftershocks it had caused became more significant. Coupled with the Russia-Ukraine war and rising energy and food prices, the disruption caused by Covid-19 has prompted a cost-of-living crisis that is affecting businesses as well as consumers.

SMEs are facing higher overheads, increased supply chain costs and pressure to pay higher salaries as inflation in the UK resides in double figures. In late 2022, poll of small business owners found that over nine in ten (92%) are concerned about the impact of the cost-of-living crisis on their enterprise.

In response to spiralling inflation, the Bank of England (BoE) has hiked the base rate from its record-low of 0.1% in December 2021 to 4.25% in March 2023, with 11 consecutive increases in that 14-month period.

Cashflow issues and growth ambitions

Cashflow issues and growth ambitions
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Inflation and rising interest rates are impacting on SMEs’ operational finances, in turn affecting their growth plans.

A report released by Channel Capital in October 2022, based on a survey of more than 500 UK SMEs, found that 59% required funding to ease day-to-day cashflow issues, while 68% need funding to grow.

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Sonya Iovieno

Head of Venture & Growth Banking
SVB UK​

“It’s currently challenging to access new equity from VCs,” SVB UK’s Sonya Iovieno explains. “So, many SMEs are going to their existing investors for internal rounds. If they did their last round in 2020 or 2021, those rounds are likely being priced at materially lower valuations – in other words, the cost of equity capital is higher. While discounted valuations can be a difficult mindset adjustment for founders and their teams, ultimately, the most important thing is to ensure the company has sufficient cash to operate and grow.”
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Factors driving up demand for non-equity finance

• The economic aftermath of the pandemic has led to a cost-of-living crisis and double-digit inflation → this is impacting SMEs’ operational costs

• Cashflow issues hampering many SMEs in the current climate → others need capital injection to fuel growth strategies

• Meanwhile, UK business valuations are falling, while angel and VC investment activity is declining → so, equity financing is becoming less attractive or attainable for many SMEs looking to raise capital

Piotr Pisarz

CEO and Founder
Uncapped

Piotr Pisarz, CEO and Founder of Uncapped, echoes this point, adding:

Weve seen a significant increase in the demand for lending; however, also a severe deterioration in the quality of applications.

With interest rates rising, and all lenders tightening their credit criteria, loans have become more expensive and harder to obtain. At the same time, the equity market is practically evaporating, making debt an even cheaper option than equity.”

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Different types of debt financing

Debt financing is a broad term that includes many different types of debt and a wide range of financial products. Understanding the options available is therefore important for SMEs seeking capital.

“If an SME has never raised it before, understanding the landscape, the types of debt and providers can be confusing,” says Iovieno. “The terminology in the debt market is not always consistent. Looking underneath the hood and understanding what is available from which providers is very important.”

Indeed, a survey from mid-2022 revealed that while more than two thirds (70%) of SMEs planned to access external funding in the following 12 months, almost a fifth (17%) were unaware of the finance options available.

This issue has become more pertinent in recent years, as the number of non-equity finance options available to SMEs has increased.

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Marvin Fletcher Rogers

Principal Solutions Consultant
Sage

Marvin Fletcher Rogers, SaaS Industry Principal at Sage, explains:

“Conventional wisdom suggests that economic downturns can create opportunities. As the number of opportunities and frequency of equity funding reduces, greater market demand for debt financing is expected to increase – which presents an opportunity to challenger financial institutions – as businesses seek more flexible sourcing of debt.”

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Iovieno echoes this point: New providers and new products have emerged from traditional lenders (such as debt funds, banks) as well as new entrants (fintechs, digital lenders). Weve seen new debt funds launched (often funded by VC equity), and lots of innovation on the credit card and charge card side.”

To that end, here are some of the most common forms of debt financing that SMEs use, with an explanation of how they work and why a business may choose that option:

Business loans
Startup Loans
R&D tax credit loans
Debt crowdfunding and peer-to-peer loans
Invoice financing
Merchant financing
Asset financing
Recovery Loan Scheme

Know your options, be prepared

In 2021, a third of SMEs who sought access to debt finance were rejected[i]. Where business loans specifically are concerned, this problem has become more acute in the past year, particularly when seeking finance from traditional banking institutions.

The aforementioned Channel Capital survey of over 500 UK SMEs found that most (54%) believe big banks are too slow in assessing business loan applications, with 47% feeling high street banks are reticent to lend to smaller businesses. Of the SMEs that had applied for a loan in the past five years (between 2017 and 2022), only 51% said they found the process of finding a lender and product ‘easy’ or ‘very easy’.

 

Pros

Marvin Fletcher Rogers

Principal Solutions Consultant
Sage

Sage’s Marvin Fletcher Rogers stresses this point:

“The current macroeconomic environment has created greater due diligence and scrutiny by financers into organisations seeking funding. Therefore, in anticipation, several considerations must be made by scaling firms when looking to secure finance. These include process governance such as automating operations and systems to improve working capital, satisfy the audit and provide management information as quickly as possible.”

“With interest rates rising, and all lenders tightening their credit criteria, loans have become more expensive and harder to obtain. At the same time, the equity market is practically evaporating, making debt an even cheaper option than equity.”

Sonya Iovieno

Head of Venture & Growth Banking
SVB UK​

Iovieno from SVB UK adds:

“Much like raising equity, the best time to start engaging with lenders is when you don’t need it. Get to know a few lenders in your space, help them understand your business and make it easy for them to understand your strategic vision.

“Do your research to make sure that you are approaching relevant providers and spend your time on those who are the right fit. Cultivate the relationships with potential lenders as early as possible and be as open as you possibly can with a lender when you engage with them. The more information you share about your business the better facility you will get to suit your business.”

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What to do before applying for debt finance

So, what can SMEs do to ensure they have the best possible chance of being successful when applying for debt finance?

Research the options

Research the options
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As outlined in the section above, there are many types of debt financing for SMEs to choose from. However, for each business some of those options will not be applicable or worthwhile.

Again, 17% of UK SMEs admit to not knowing which finance options are available to them, despite 70% planning on securing capital to enable their growth.

As such, business leaders must do thorough research to establish the options that exist – how they work, which scenarios are they best used in, and what are their relative pros and cons.

With a detailed plan for how much is needed, how it will be used and how it will be repaid, as SMEs then research the debt finance options available on the market, it ought to become clear which options are best suited to their needs.

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Marvin Fletcher Rogers

Principal Solutions Consultant
Sage

Marvin Fletcher Rogers, from Sage, explains that financial reporting tools can also play an important role here:

“Given the current climate and relatively limited opportunities for financing (both debt and equity), it has become more important to demonstrate reliable financial reporting.

“While the industry literature suggests there are still vast opportunities to secure funding, the overall level of diligence and scrutiny has undoubtedly increased as a result of the environment.

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Research the options

Prepare for applications
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Depending on the type, size and complexity of the request, a lender will want to see some or all of the following from an SME:

· ID and proof of address for all directors and shareholders
· Asset and liability, and income and expenditure, details
· Personal and business bank statements
· A recent credit report
· A business plan
· Cashflow and profit and loss forecasts for three years or more
· CV information for company directors
· VAT returns and self-assessment tax returns
· Final or draft accounts for up to three years, and interim or management accounts that show up to date trading figures
· Other documents such as lease or property information, if relevant

Ensuring all relevant documents are up to date and ready to be shared will help both accelerate the application process and improve a business’ chances of securing non-equity financing.

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The role of brokers and business planners

Just as with consumer loans and mortgages, intermediaries can play an important role in enabling borrowers to seek out the right finance options for their needs.

In the case of non-equity finance for SMEs, brokers, business planners, accountants and other specialists can help guide the company through the funding process and find appropriate options. They will typically take the time to understand the business’ situation, its financial circumstances, what finance is needed and why – from here, the specialist can advise on relevant products and providers.

SMEs would call upon the help of professionals, such as a broker or business planner, to help with:

  • The preparation of an application, business plan and financial forecasts
  • Finding suitable lending options
  • Collecting the information specific to a lender’s requirements
  • Communicating with lenders on the business’ behalf
  • Providing guidance on the process and progress being made

Sonya Iovieno

Head of Venture & Growth Banking
SVB UK​ 

SVB UK’s Iovieno says:

“Brokers and advisors play an important part in this market, which can be challenging to navigate for first time founders. Not all companies have the time, or the network, to complete thorough diligence. Advisors with experience with companies in a similar sector at a similar stage, can be well positioned to provide good advice.

“Be aware that many lenders will not engage directly with brokers or pay broker fees, so it is worth asking your broker who they are going to source debt opportunities from.

“Consider your wider network beyond founders and investors. Speak to your accountancy firm, legal advisors, or your bank, to see who they work with, they may be able to make introductions or recommendations to you.”

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Case studies

Here are two case studies of SMEs that have secured non-equity finance, including some valuable lessons that other business leaders can learn about going through this process.

Ieso: Tech firm uses debt to provide flexibility and optionality to financing options

Since 2010, Ieso has been transforming how the world understands and treats mental health. Through collective research, deep AI analysis and clinical science, Ieso’s technology is continuously improving recovery rates and making effective therapy accessible to new audiences.

Ieso’s clinical service is used widely across the NHS, while it is also a digital technology partner transforming outcomes at every stage of our partners’ patient care pathway.

However, as it looked to expand globally, it needed to consider its financing options. Nigel Pitchford, the companys CEO, explains: Ieso has been operationally profitable for a number of years but with its growth plans and an eye on the international markets we needed to have a flexible finance package in place to call upon funds as and when needed to help finance the business in the most meaningful way.”

SVB UK worked with Ieso to provide a venture debt facility to support growth plans.

“Venture debt has enabled Ieso to add a degree of flexibility and optionality to its financing options,” Pitchford says. “Having the venture debt facility also enables us to choose when to raise further equity and do so only when the company meets key value inflection points. As an operationally profitable business, we are able to service the loan through our income, which means we can really focus investment on our people and technology.”

Current Health: Venture debt for US expansion without diluting ownership

Launched in 2015, Current Health is an enterprise remote care management platform that enables early, preventive treatment to patients in their own home. It helps global health systems and pharmaceutical companies deliver high-quality healthcare at home, leading to better patient outcomes and a lower overall cost of care.

The company’s CEO, Christopher McCann, explains why the company sought debt financing: “At Current Health, our strategy has always been to create best in-class technology that can support novel healthcare models. We want to be the glue that enables safer healthcare at home, which required building a platform that can seamlessly integrate into our customer workflows. Making this vision a reality required sizeable capital funding.

“On top of that we needed further capital to expand our market presence and scale up our offering in the US where there has been increasing interest in technology that can enable value-based care.”

SVB UK worked with Current Health to provide a venture debt facility to support growth plans. “Venture debt has enabled Current Health to invest in our technology, meet our strategic goals and scale up in our key markets like the US,” McCann says.

He adds: “Having the venture debt facility also enables us to keep more ownership of the business by reducing dilution. This means we have extended our runway and can choose when next to raise further equity. It also means we can control the speed of how fast we scale in the US and grow our network of partners in a sustainable way that doesn’t impact patient care or services.”

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