Alternatives to Debt Financing

The COVID-19 crisis is putting a considerable strain on the working capital of many companies.

The government has stepped in to help those companies via the Coronavirus Business Interruption Loan Scheme (CBILS), which provides support to viable SMEs being businesses with an annual turnover of up to £45million.

Coronavirus Business Interruption Loan Scheme (CBILS)

The quick summary is that there are over 40 approved lenders who can loan up to £5m, where the government covers 100% of any loan guarantees for loans up to £250k and covers 80% for loans over that amount. For loans over £250k the directors/shareholders of the business will normally have to provide a personal guarantee for the remaining 20% however the guarantee will exclude the main residence of the guarantor and recovery under the guarantee is capped.

Terms range from 3 years for overdrafts and invoice financing, to 6 years for term loans and asset financing. The government covers the first 12 months of interest payments.

This is a good scheme, and a welcome step by the government to help businesses through the crisis. It's not, however, right for every business.

For a start, it is proving difficult to access the scheme. As of April 12th there had been 300,000 applications but only 5,000 loans approved. If you need money to cover wages at the end of the month then time may well be of the essence.

Alternatives to debt financing

There is also the issue of debt verses other types of financing.

Debt financing is good when you are confident about future cashflow and know you can service the monthly payments, but what if that is not certain?

Right now it is difficult to forecast how long the economic impact is going to last.

In order to apply for any kind of debt financing it is important to ensure that you have detailed and accurate up to date financial data available and for the CBILS loan scheme you need to be able to prove that the company was viable prior to Covid-19.

The main alternative to debt financing is to sell equity usually in the form of shares in a company.

There is no demand on the company to service a debt - the company gives up part of future profits instead and the investor participates in the risks and rewards of holding shares in the hope that the company will be able to pay dividends and will experience capital growth so that the shares will increase in value over time. Debt is a more secure option and will (usually) have a defined capital repayment and interest payment schedule.

There are a number of ways of selling equity, which include:

• Crowdfunding - using platforms to sell small shares of equity to a large number of investors
• Angel networking - wealthy individuals who want to acquire stakes in interesting companies, sometimes with the intention of also working within the business
• Public equity - floating the business on the stock market
• Venture capital - pooled investments on behalf of wealthy individuals and institutions, managed by the venture capital company, normally focused on early stage businesses
• Private equity - also often pooled investments, but PE companies normally take a controlling stake in the business, if not 100% of the shares.

There are some challenges with these approaches. All of these take a lot of time and you will need to be transparent in disclosing legal, commercial and financial information about the company to the investors and their advisors, and that may prove to be a major challenge. Equity investments can also fundamentally change the nature of the business ownership. Finally, although your company might have looked attractive to investors a couple of months ago, if it is struggling it will look less attractive right now.

If this is a route you want to explore, we can advise you on the best way to approach it.

Debt financing v's selling equity

The other two ways to raise equity are by selling more shares to existing investors, and selling to family and friends. This can be done fairly quickly, but should still be done properly (for example, with updated shareholders' agreements) and you need to decide what rights will attach to those shares and whether in order to raise equity you are prepared to concede the level of control you have over the company.

It might be possible to take advantage of the SEIS (Seed Enterprise Investment Scheme), which offers tax relief to your investors if your company has just started to trade, has not yet started to trade or is a company that carries out research and development in a Qualifying Trade. You can receive as much as £150,000 investment in any three year period. You must have less than £200,000 gross assets, not be a member of a partnership, and have fewer than 25 full time employees.

Most trades are Qualifying Trades provided that they are conducted on a commercial basis with a view to making profits and the trade does not include, to a substantial extent (broadly 20%), excluded activities. Excluded activities include coal or steel production, farming, leasing, legal or financial services, property development, running a hotel, running a nursing home, generation of energy, production of gas or other fuel, exporting electricity, banking, insurance, debt or financing services.

It is worth knowing that HMRC encourages issuing companies to seek advance assurance that the company meets the SEIS qualifying conditions before issuing the shares and this can impact the timetable in which the investment can be achieved.

Alternatively, if your company is less than 7 years old then investors in the company can take advantage of the EIS (Enterprise Investment Scheme) to gain tax relief. With EIS, you can raise up to £5m each year to a maximum of £12m over the lifetime of the company. Again, you need to be performing a qualifying trade, have gross assets less than £15m, and fewer than 250 employees. If the company meets the criteria of a knowledge intensive company then the above time limits and financial limits are extended.

For either scheme, you need to be based in the UK, not trading on the stock exchange, not be controlled by another company and the potential investors can be Directors but cannot be employees of the company or hold a stake exceeding 30% of ordinary shares, share capital of voting rights and must not otherwise control the company or any subsidiary.

Here to help and support you

There is a lot more detail behind all of the options set out above, so if you think any of the options above would be suitable for your company please call us for further advice.

We will listen and get to the heart of the matter to achieve the best outcome for you.

For further information LCF Law's Corporate Law team can be contacted via telephone, email, Zoom, FaceTime and WhatsApp. Call us today on 0113 244 0876.

This article was written by Cathy Cook.Cathy is a Partner in our Corporate Department and is based in Leeds.

Her clients include owner managed businesses specifically suppliers into the large retailers for whom she has reviewed and drafted terms and conditions, framework agreements and outsourcing agreements.

You can contact Cathy 01132 384 042 or email ku.oc1728164633.fcl@1728164633koocc1728164633

Disclaimer: This blog is for general information and general interest only. It is not to provide legal advice on any general or specific matter, and no such advice is given. Should you like to discuss the points raised in this article, please do not hesitate to contact the author.