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So far then, our startups have traversed the so-called “valley of death” and toiled their way to revenue generation and potential profitability. First they took seed funding from friends, family and angel investors to kick start business development, then they looked to professional investors for series funding to provide working capital, strengthen areas such as sales and marketing, and perhaps even facilitate expansion of property and other assets. So now that these startups are past the early stages of the business cycle, where should their directors turn to fund the next phases of business growth and development?
All these companies will now have traded for at least a few years, acquiring a financial track record and hopefully a steady customer base too. This increased business maturity and stability tends to translate into lower risk (and lower reward) for potential investors, an evolution in the risk profile that changes the nature of the available sources of finance.
Some companies with more robust balance sheets will now be in a position to seek out senior debt in the form of loans secured against assets of the business. Senior debtholders are those that are most likely to be repaid in the event that a business gets into financial difficulty. Gaining a loan from a bank at this this stage of development is notoriously difficult however. As such, businesses are increasingly turning to newer sources of finance, such as marketplace lending platforms, to provide them with the credit lines they need.
Others businesses that lack assets against which to secure debt, or the stable cash flows to service it, may look to invoice financing to improve their cash flow. Invoice financing can be split into discounting and factoring, both of which involve the third party finance provider advancing the money owed to a business by its customers, minus a service fee. With factoring, the finance provider takes control of the debtor book, whilst with discounting the relationship between a business and its customers is left untouched.
For those businesses that seek to expand aggressively though, either of these forms of financing alone may not be enough, leading them to seek out mezzanine finance to help them achieve their goals. Mezzanine finance is usually unsecured and sits behind senior debt in terms of repayment priority. Because of this increased risk for the lender, it carries a much higher interest rate and also a clause that converts the debt into equity in the company if the loan is not repaid.
The above types of funding will suffice to meet business requirements of many companies, allowing for growth whilst keeping ownership in private hands. At the end of the financing road though, for those that choose it, is an IPO, or Initial Public Offering. There are a number of reasons why a company might consider ‘going public,’ such as reducing the burden of interest payments or generating publicity. Over and above any of these considerations though is the ability that being publically listed brings to raise large amounts of capital on a consistent basis. That said, firms must take into account the significant costs of the listing process, as well as the increased regulatory requirements that will be in place once public.
And so with IPOs we reach the end of the startup cycle, and the jargon that comes with it. It goes without saying that following the path through from seed funding to listing involves a huge amount of hard work and I dare say an element of luck. But with 99.3% of UK private businesses ranked as “small firms,” it is a journey we must hope many will complete successfully.
