Applying for funding is probably the easiest part of the funding process. What comes before and after applying can be quite time-consuming and costly in some cases, and for many it only leads to a rejected application. Small to medium-sized enterprises (SMEs) must not only apply for funding because they can, but they also need to research and leverage data to pinpoint their funding needs.
South African SME founders, lenders and industry stakeholders are all aware of the R350 billion funding gap. And while the gap persists, there are various funding vehicles available for SMEs. Now, the onus is on the SMEs to apply for funding that aligns with what the business needs.
In this article, we look at what funding needs are, how SMEs can identify and secure the right funding, and what funding vehicles are available for them.
What are Funding Needs?
Funding needs refer to the specific amount of capital a business requires to launch, operate, or grow. These needs are determined by mapping out startup costs (e.g., equipment, leasing), operating expenses (e.g., payroll, rent), and growth investments (e.g., expanding into new markets).
Lifecycle of Business Funding Needs
Let’s look at the different types of financing a business might need at different stages of its lifecycle.
1. Startup Phase
The start of the business is always the riskiest, no matter how well you’ve planned. You might come across challenges that you have not faced before, and this usually makes it difficult to get funding through traditional funders like banks. Because banks see new businesses as quite risky, the ideal financial channel is bootstrapping or crowdfunding.
2. Growth and Expansion Phase
In the growth phase, your funding needs will depend on many factors. These could be more money to invest in equipment or having to pay more salaries. You will need to approach traditional lenders like banks or alternative financiers.
Additionally, there is the option of finding an investor. You could be attractive to specialised financiers like hedge funds, venture capital investors and private-equity firms. At this point your business should already be substantial in size and poised for growth to be fuelled by these investors.
3. Established Business Phase
In this phase, you have managed to grow your SME into a large, successful business which puts you in the world of high finance. For most, small business funding is not enough, and typically the business will be listed on a stock exchange. This means that the shares you own in the business acquire tangible value.
It also means that you can hand over the reins, which is called exiting the business. If you’ve made the right choice, your future will be secure because your shares will become more valuable. You can then sit back and enjoy the rewards of your many years of hard work.
Determining Your Funding Needs
SMEs often face a critical point when it comes to funding. Figuring out how much is enough and securing funding while avoiding excessive debt is crucial for the financial health of the business. Here are some of the factors to help you determine how much funding your SME needs.
1. Working Capital Requirements
Working capital is the money needed to cover day-to-day operational expenses. It’s important to calculate your working capital needs by subtracting current liabilities (e.g. accounts payable) from current assets (e.g. accounts receivable and inventory). Maintaining a healthy working capital buffer is essential to cover unforeseen expenses, manage regular operations and reduce the amount of funding you need.
2. Growth Projections
When planning for growth, carefully assess your revenue and expense projections. Determine how much additional capital is needed to reach your revenue targets and whether financing is required to achieve those projections. If you don’t need much, you can bootstrap your own growth funding.
3. Debt Capacity
Before seeking funding, you must consider your SME’s ability to manage debt and capacity to take on more debt. Calculate your debt capacity by assessing your cash flow, assets, and existing liabilities. Borrowing beyond your capacity can lead to financial strain and increased risk.
4. Collateral and Creditworthiness
Most lenders often require collateral or assess your creditworthiness when providing financing. The amount you can secure may depend on the value of your assets or your personal credit score, depending on the financial vehicle you choose.
Fortunately, for SMEs, collateral and creditworthiness are no longer deciding factors. Alternative lenders will still consider your application even if your credit score is low, depending on the financing instrument you have applied for.
5. Industry Norms
Industry-specific benchmarks can offer insights into typical financing needs. Research your sector to understand common financing practices, such as inventory turnover ratios, capital intensity, and equipment investment norms. This will help you align your funding proposal better with the requirements of each funder.
6. Risk Tolerance
Risk is a big factor for lenders when they assess funding applications. Banks have a smaller appetite for risk and will not fund newer businesses. Alternative lenders are more flexible because they offer low-risk financing. You must evaluate your risk tolerance as a business owner. Some entrepreneurs are more comfortable with taking on debt to fuel growth, while others prefer a more conservative approach.
7. Contingency Plans
As a business owner, it’s critical to have a contingency plan. Consider what additional financing might be required in case of unexpected challenges, such as market downturns or equipment breakdowns. Your contingency plan will also help prepare a comprehensive strategy for your funding needs.
Assessing your Funding Needs
So, how can you correctly estimate what the funding need for your business should be? Initially, you should get an accurate view of the current cash position, based on actual historic performance, and then assess what your monthly cash burn is. This will also allow you to have a better understanding of the financial levers you can pull to extend your capital runway when things get tight.
Next, map out the key milestones for your business over the next 12 to 24 months. The exact milestones will depend on your business and can be anything from making a senior hire, developing a product or achieving a larger user base.
Whatever milestones you set for your business must be tangible and quantifiable. It also needs to be something that aligns with your strategy and should demonstrate how it will create additional value in the business.
Applying for funding is probably the easiest part of the funding process. What comes before and after applying can be quite time-consuming and costly in… Read More
