Shopping for finance

It does not make sense to take out a mortgage to buy a pair of jeans nor to buy a house with your credit card. When it comes to business it is not difficult to find resembling examples of a mismatch between assets and finance. Short-term finance for long-term assets is as likely to cause head-ache as long-term finance for a short-term asset. Finding the perfect match is critical for business success. Amanda Line, Regional Director of ICAEW Middle East, takes a look at some of the options.

Last year’s ICAEW Global Enterprise Report revealed that businesses in the Gulf were the most ambitious in terms of average growth targets compared with other markets. The survey also pointed out that getting finance for growth was a challenge for many businesses.

With the economic crisis, banks have become tougher with businesses as well as consumers. This means that ensuring your business has sufficient finance in place to survive and prosper is perhaps more challenging than ever before. Getting the right type of finance is another challenge for many SMEs.

Long-term investments

Longer term investments include property, acquisitions and expansion into new markets. These investments must be matched by finance that is also long term. If you have to pay back debt in three years but your investment will not bring any returns in the first ten years, you will encounter problems. Long-term finance can be equity or debt. Having the right mix of the two is vital for businesses wishing to grow.

Many SMEs are reluctant to issue equity capital as they are concerned about ‘losing control’. However, many businesses planning major product developments or expansion outside their domestic market will at some point need equity finance.  Banks do not tend to lend for these types of activities, meaning a business has to look elsewhere for cash, perhaps to equity providers.

It is important to be aware that, due to the uncertainty attached to these activities, equity providers expect a high return, sometimes more than 50%. They also typically look to exit the relationship with the business after three to seven years. Business angels are an increasingly popular form of external equity finance. Arab Business Angels Network target start-up and early stage businesses looking to raise $100,000 to $500,000 in seed capital. They can make a business more attractive to lenders and they often bring management expertise and a wide range of contacts as well as risk capital.

Typical examples of debt finance are term loans or leasing & hire purchases. The financing is specifically tied to a particular asset, such as a building, machinery or equipment. The finance provider has a legal interest in the asset and the business cannot sell it unless the finance provider agrees.

The alternative form of financing for businesses with commercial premises is a mortgage. Most banks offer commercial mortgages, but you have to satisfy their lending criteria. Repayments are over longer periods of time and the balance between interest and repayments vary considerably between different mortgages. Loan to valuation percentages can differ significantly between providers. It is therefore important to shop around.

A bank loan is another form of finance where property or some other asset acts as security for the loan. Basically, it is an amount of money borrowed for a set period with an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and rate of interest.

Short-term investments

Short-term finance is usually to provide working capital. There are several types of short-term finance, with short term loans being one. However, there are many other types of finance worth considering if you only need a temporary capital boost.

The first thing worth checking is whether you can get credit from your suppliers, allowing you to generate some income before you pay for the supplies. In the current climate, many suppliers have become more careful with providing credit to safeguard against outstanding bills not being paid by failing companies. They might want some guarantee that you can pay them and many are also likely to ask for some of the payment up front.

Another form of short-term finance is bank overdrafts. Basically, it allows you to borrow up to an agreed limit. If you have bills to pay and expect payment to come in shortly, this might be a good short-term solution to help your cash flow. Overdrafts are popular with businesses because they are very flexible.

Factoring is a short-term finance option that involves you selling your invoices to a third party. It is, however, worth remembering that this type of financing means your customers will be dealing with the factoring company rather than you. With Invoice Discounting you continue to administer the debts yourself and the service is undisclosed to customers. Both schemes will provide you with instant cash. You will lose some of the value of the invoice in charges but at the same time you might save money by reducing administration overheads.

Finance schemes

Governments across the GCC, and especially within the UAE, recognise that the development of a vibrant SME sector is vital to encourage economic growth, to help further the diversification of incomes as well as raising the level of business management skills within their country. There are several schemes available, especially targeted at nationals. These schemes offer both short- and long-term finance.

In Abu Dhabi, there is the Khalifa Fund for Enterprise Development, which is designed to support small and medium-sized enterprises run by nationals, also offering micro financing and investments. In Dubai, there is the Mohammed Bin Rashid Establishment for SME Development and in Bahrain the Business Development Bank exists to promote lending to Bahrain-based businesses. In addition to finance, these schemes also offer advice and support. Finally, for SMEs seeking small-scale equity finance, the Arab Business Angels Network is a seed capital initiative targeting start-up and early stage businesses looking to raise $100,000 to $500,000.

Matching finance and assets

Having the right type of finance for the asset or investment in question is critical. It can be the difference between expanding a business or not, or between business survival and death.

It pays to keep on top of your finances. A growing business should regularly review its financing arrangements to ensure they remain appropriate. There are other finance options available than those discussed here. Business professionals, such as chartered accountants, can help you with valuable insight, advice and information.

ABOUT

Amanda Line was appointed as the Middle East Regional Director of the Institute of Chartered Accountants in England and Wales (ICAEW) in September 2009. The ICAEW provides leadership and practical support to over 132,000 members in more than 160 countries, working with governments, regulators and industry in order to ensure the highest standards are maintained.