Growth finance: funding a business that is outgrowing its cash

Profit and cash separate the moment a business grows. Sales are recognised when invoiced; the cash arrives on payment terms. Costs, meanwhile, go out first. The faster the growth, the wider the gap, which is why accountants talk about overtrading: a business taking on more work than its working capital can carry, and running out of cash while its profit and loss account looks healthy.

Illustration: the cost of adding £1 million of sales

Illustration only, with round hypothetical numbers. A distributor turning over £2 million wants to reach £3 million. Its customers pay in around 60 days, so the extra £1 million of sales adds roughly £165,000 to the debtor book. It holds about 45 days of stock, adding perhaps £90,000 more at cost. Suppliers give 30 days, which funds some of it back. Before a single new hire or van, the business needs well over £150,000 of extra working capital simply to stand still at the higher level. That figure, not last year's profit, is what a growth facility has to cover.

Our guide to calculating working capital shows how to run the same sums on your own figures.

Debt keeps ownership intact but must be repaid from cash flow, usually with a director's guarantee. Equity brings in money that is not repaid, at the cost of a share of the business and, often, of control. Debt generally suits businesses with a trading record and a clear path from spending to income; equity suits businesses investing well ahead of revenue, such as early-stage technology companies. The British Business Bank's guide to equity funding stages is a sensible primer, and our own comparison of debt and equity funding sets out when borrowing is the cheaper route.

Growth finance is usually available to established UK businesses with a year or two of trading, a profitable or near-profitable record and evidence that demand is already rising. Limited companies, LLPs and partnerships can all borrow, and lenders on our panel are most comfortable where the growth is already visible in management accounts, contracts or purchase orders rather than only in a forecast. B2B firms with an expanding debtor book and businesses adding equipment have the widest choice, because the facility can be secured on the invoices or the asset. Early-stage companies spending heavily ahead of revenue, or businesses whose growth depends on a single new contract, usually find debt harder to arrange; for them, equity or a smaller first step is often more realistic.

One SFS relationship shows how the funding need changes shape as a business scales. For a rapidly growing national training provider, we arranged a £600,000 facility, and further transactions followed as the company expanded, including another £400,000 facility. The business later grew to turnover in excess of £13 million and needed a more sophisticated refinancing of its existing debt. The lesson is that the facilities that suit a £3 million business may not suit the same company at £10 million, and it pays to plan for that transition. Businesses reaching that scale should also read our page on finance for larger businesses.

Growth finance typically takes from a few days to several weeks to arrange, depending on which facilities the plan needs. An unsecured term loan can often be agreed within days to a couple of weeks once accounts and bank statements are in, and asset finance on standard equipment usually moves at a similar pace once there is a supplier quote. Invoice finance commonly takes a few weeks, because the funder audits the sales ledger and checks customer contracts before the first advance. A package combining several facilities, or one involving property, a debenture or an agreement between lenders on who ranks first, can take longer again. Starting before the cash squeeze bites, with a forecast already prepared, is the biggest single factor in avoiding delay.

The security a growth lender takes depends on the facility. Invoice finance is secured on the debtor book, usually backed by a debenture over the company. Asset finance is secured on the equipment or vehicles it buys. Unsecured term loans and revenue-based finance carry no charge over specific assets but almost always need a personal guarantee from the directors. Larger term loans and revolving credit facilities often come with a debenture giving the lender fixed and floating charges, and where several lenders are involved they agree in writing who ranks first on which assets; our guide to debentures and charges explains how that works. Where security is thin, the Growth Guarantee Scheme mentioned above can help a lender say yes, but the directors remain liable under any guarantee they sign.

• Forecast risk. Repayments are fixed; growth is not. Test the plan against sales arriving six months late.
• Personal guarantees. Most growth borrowing for SMEs involves director guarantees, so a failed expansion can reach personal assets.
• Short money for long needs. Funding a permanent increase in working capital with a short-term loan simply moves the squeeze a few months forward.
• Cheaper sources first. Tighter credit control, deposits from customers, better supplier terms and grants for specific projects can all reduce how much you need to borrow.
• Growing more slowly. Declining an order you cannot finance comfortably is sometimes the right commercial decision.