Did you know that SMEs with access to credit can grow faster and achieve optimal size sooner, while those with limited access to finance potentially remain stagnant and smaller in size? This is according to the Finmark Trust study, released in 2016.
“There are a number of research studies that confirm the link between access to finance and business growth, showing that increased access to funding increases revenue and job growth in SMEs,” says Darlene Menzies, founder of finfind.co.za, a platform that helps SMEs access finance in South Africa.
“Access to finance improves cash flow, which enables business owners to invest in business growth,” continues Darlene. “According to FinFind’s SA SMME Access to Finance Report, business expansion is the number one reason for businesses requesting funding.”
“Working capital is essential for the day-to-day operations of a business,” agrees Shayne Burnstein, director of Swypefin, which offers alternative funding solutions. “More often than not, business owners lack sufficient working capital to meet their daily cash flow requirements or expand their operations. This can ultimately lead to the failure of the business. It’s common for a business to borrow capital and by using the basic principles of leverage, they can invest in assets that generate higher returns.”
“The reality is that growing a business requires money,” says Darlene. “Capital is needed to fund the increased expenses incurred to prepare for and facilitate increased revenue growth. Businesses that secure funding can invest in hiring more staff, secure bigger premises, expand into new markets or new products and services, purchase additional equipment, vehicles and machinery, as well as fund larger marketing budgets, amongst other things.
“Without access to finance the speed of business growth is reduced and, in many cases, the ability to achieve the potential of increased revenues, profits and job creation is jeopardised.”
According to Darlene, businesses that can secure funding and have the guarantee of working capital and cash flow availability are better positioned to employ and retain more skilled and experienced staff, to negotiate more favourable payment terms with suppliers, and to build better trading track records and improve their credit scores, all of which increase their ability to raise more finance and continue to bolster increased business growth and create more employment opportunities.
The challenge of cash flow
Karl Westvig, CEO of Retail Capital, says that more than 80% of business owners have identified seasonal cashflow as the greatest challenge facing the SME sector today. “Restrictions in cashflow inhibit plans for renovation and expansion, but mostly for stock purchasing, which has a direct knock-on effect on the profits and employment rates of the retail sector,” he says. “Giving business owners easy access to working capital allows them to get back to servicing the market while they partner with a financial provider for growth.”
“The biggest challenge that SMEs face is cash flow. Cash flow is king and that’s where finance products play a role,” agrees Linda Fröhlicht, Head of Business Banking, Sasfin. “They enable growth by giving the business owner cash to grow their business.” Of course, there’s always a balance. “There’s a cost to accessing finance, which means it’s essential that you’re accessing it to help you grow your business, rather than to service debt.
“If you borrow money to enable the growth of your business, the finance cost is actually part of the cost of your sales. But if it’s to service debt, or you can’t afford the finance, you’ve got a problem and it will only damage your business.”
According to Linda, it’s important to understand your margins, if you can sustain the cost of finance with your margins and if the product you’re looking at makes sense in terms of your business and your growth plans.
“The upside is that a financier can provide you with growth, because they’re going to give you access to cash, enabling you to grow your business. It’s a working capital solution — it’s not debt. We evaluate businesses and business owners to gain a deep understanding of the entrepreneur’s needs, first to ensure affordability and second to evaluate if the right product is being utilised to drive growth.”
Making finance work for you
According to FinFind’s SA SMME Access to Finance Report, the top six reasons that SME business owners request access to funding are to expand their businesses, for cash flow assistance, buying equipment, working capital, funding a contract and for property development.
There are many ways to use this capital, provided you understand your business needs and have a clear growth strategy. “We advise our clients to use the money on strategic initiatives that will ensure, and have a direct impact on, business growth and profitability, instead of personal expenses and debt management,” says Karl. “We have seen the majority of our clients seeing early profit yields (from four to six months) when funding was used for stock purchasing, renovations and expansions instead of salaries, holidays and debt repayments.”
A strategic deployment of funds can be anything from investing in the right equipment that will help you grow your business to securing early settlement discounts — all of which have the potential to boost growth in your business.
An example of early settlement discounts can be found in the retail industry. “Currently retailers are trading under very challenging conditions. With VAT and the price of petrol increasing, consumers have tightened their belts,” says Shayne. “Under these conditions suppliers are offering retailers trade discounts for COD payments. It often makes sense for them to borrow the capital to take advantage of the trade discounts, enabling the retailer to increase their margins.”
The same is true when it comes to importing goods. “Importing goods takes time,” says Linda. “From the shipment to bill of loading, three weeks on the water, turning raw materials into a finished article, selling the products, and then waiting an additional 60 days for your debtors to pay you — cash flow becomes a real challenge.
“Finance products and terms that fit in with your cash flow cycle are meaningful. In addition, if you make an upfront payment to an exporter, you can also negotiate discounts. You can then offset a portion of the discount you will receive from the supplier to finance fees.”
Growth capital can be used in any industry and any-sized business, from a dentist or doctor’s business to a clothing manufacturer. “Advancements in 3D printing technology enable dentists that historically relied on outsourcing a technician to make dental crowns, for example,” says Shayne. “This process typically takes a few weeks at a considerable cost.
By borrowing capital to purchase 3D printing equipment, the dentist can bypass the technician and make the crown in an hour, allowing them to see more patients, which would significantly increase their turnover. As a business owner, you need to critically consider what will help you grow your business: Is it new equipment, bigger premises or marketing spend? What can you invest in that will grow your turnover and your profit margins? That’s where financing makes sense.”
Karl agrees. “Any business can benefit from both alternative and traditional funding products when invested in growth initiatives,” he says, adding that businesses in seasonal trade industries in particular should investigate the alternative funding products available to them. “Because of fluctuating cashflow, seasonal businesses usually find it difficult to access traditional business financing channels. The application process can be long and arduous, whereas alternative funding allows quick access to working capital, and repayments are linked to cash flow.”
Karl does have a word of advice for business owners considering their financing options: “Don’t wait too long when thinking of applying for funding.
Once turnover has dropped too much, it affects a business’s affordability, and when funding is obtained it’s then often used as emergency funding and meeting commitments instead of investing in business profit and growth initiatives. It’s also important to deal with credible funding providers that provide consultants and assistance to the business owner with industry advice and economical insights on where the best opportunities for growth exist.”
Alternative financing solutions
Studies such as the CB insights study on fintechs, the World Bank Group (2017) on Alternative Data Transforming SMME Finance and the IFC’s (2010) SME Banking Knowledge Guide show that fintechs are able to reduce many of the pain points and barriers to SME funding and importantly facilitate increased scale.
“Funding aggregators are automating funding matches, generating quality leads for funders and reducing search costs for both the providers and seekers, while online lenders are reducing approvals to less than 48 hours and funding disbursements shortly thereafter,” says Darlene.
“Our innovative funding products provide an alternative to traditional business finance loans,” explains Karl, highlighting Retail Capital’s alternative funding solution. “We determine business affordability by assessing expected future sales, linking payments to your business turnover. We offer fixed or flexible repayment options, linking it to your cash flow cycles and business needs, to ensure affordability.”
The rise of fintechs that are able to provide alternative funding solutions is largely thanks to innovative tech advancements and algorithms that can evaluate businesses based purely on multiple data points.
“By automating processes and gaining more insight into available data, fintech companies are able to make more informed decisions regarding the credit profile of clients,” says Shayne. “We have developed an algorithm that looks at your previous 12 months’ turnover in order to determine an amount of your future sales that we can advance to you,” he continues, explaining how Swypefin’s product works.
“Our repayments are based on a percentage of your turnover, which allows you the flexibility to pay less in the months in which your cash flow is constrained and pay more in your busier months. We do not tie up your assets as collateral. Our fee is fixed, transparent and pre-agreed upfront. You will never be liable to pay more than what is agreed upon. If the advance is settled early we offer a pro rata refund on the fixed fee depending on when settlement takes place.”
Positive cash flow and smart financing solutions
Ultimately, finance should support your business and help you grow. With that in mind, Linda unpacks when you shouldn’t be accessing finance, and how to ensure you remain on the path to growth rather than bad debt and business failure.
“One of the biggest issues we see are companies that overtrade and get themselves stuck in a debt cycle,” she explains. “In simple terms, a business that is overtrading has orders, but not the infrastructure to meet those orders. If there’s a clear growth strategy in place matched with the right financing vehicles, this growth can be planned, controlled and executed, but many entrepreneurs want to run before they can walk.
“When this happens, the business will invest in expensive fixed assets in order to meet orders, and then the necessary orders don’t come in, or something happens to disrupt the business. Now the business is playing catch-up, and the business owner needs finance to cover debt.”
According to Linda, the biggest cause of over-trading is failing to plan cash flow. “This is one of the first questions we ask: Do you have a strategy in place and a cash flow projection? Not just for this year, but this month, week, and even on a day-by-day basis.
Another key error many business owners make is using the deposit from one contract to kick start another contract. “There’s a domino effect when this happens. The business very quickly gets totally out of kilter, and the owner never quite manages to get on top of his finances. To avoid this trap, concentrate on finishing the job at hand. Ensure that you allocate the funds that you get to where you lent the money from — no matter what.
“This goes back to managing cash flow. Business owners believe that finding a second project from the first (when it’s not finished and the money isn’t in the bank) will help them grow. Instead, it just kills their business.
“Cash is king and never borrowing money can cap your growth, but you need to understand the difference between healthy debt and bad debt.”
While the solutions for cash flow assistance, buying equipment, working capital and funding a contract are similar to each other, property development is specific.
Done correctly, investing in the commercial property from which you run your business can make strong financial sense and result in savings on your bottom line.
“Many business owners who own their premises have two separate companies,” explains Suraj Lallchand, director at Fedgroup Ventures, a division of Fedgroup. “The first is the original company that actually runs the operations, and the second is a ‘prop co’ that owns the property.”
The reasons for this are simple: There are tax benefits, it opens a second income stream, and it keeps the two entities separate, allowing the business owner to one day sell the business while maintaining the property portfolio they have built up. In many cases, if the business is sold but remains in the premises, as the property owner they will continue to draw rental fees from the business.
“It’s a simple process,” explains Suraj. “You would put the property into the prop co, take a loan against the property, and charge rent to the operations company. This then becomes a taxable deduction for the operational company, and the interest you pay on the loan for the building is deductible for the prop co. As a result, you bring your taxable income down to a minimal amount. We see many companies that would rather purchase their own properties and take the tax deductions than continue to rent.”
The key to owning your own commercial property is whether or not the operations company can afford the rental and has strong prospects for the future. “If you can’t occupy the building and you don’t find a tenant, the prop co will end up defaulting on its loan and losing the property,” he adds.
“We always do our due diligence on the borrower and the property in question,” agrees Rick de Sousa, Head of Commercial Property Finance at Fedgroup. “The security we are lending against is determined by the value of the property as well as the owner’s ability to service the loan. If the owner of the business is purchasing the property, then the business’s stability and projected income is an important factor for us to consider.”
According to Rick, there is a completely different level of responsibility involved when you purchase premises compared to rent. “It’s a good example of risk and return,” he says. “Your risks increase, and it becomes your responsibility to ensure the building is maintained, rates and taxes are being paid, security, insurance, health and safety — you no longer have a landlord taking care of any of these things — but the returns should be commensurate with that risk.”
Rick’s advice is that you ensure the yield of the property makes sense. “Property has proven to outperform inflation. It’s generally in the high teens. In addition, commercial property is pretty predictable when it comes to rentals as well. You can bank on a yearly increase of 6% to 8%. This all aligns with whether the property is well managed though, and if you’re the landlord and the tenant, whether your business can continue to pay the rentals for the foreseeable future.”
From a property owner’s perspective, Fedgroup’s terms are flexible. “We can lend up to 75% of the asset value,” says Rick. “We also give interest-only terms. This means you can choose to only pay the interest, and once the business has grown and your revenues have increased, you can elect to start paying capital, or you can continue to only pay your interest and see returns once the property has appreciated and is sold. Those returns can then be invested in the next property.”
Over and above the flexible terms and the fact that Fedgroup does not prescribe how funds are allocated once the loan has been granted, Rick believes their clients benefit from the property experience of the division’s team and partners. “We can talk property with them, which is extremely valuable when making such a big decision.”
“Many businesses keep the company and property portfolio separate. There are tax benefits, it opens a second income stream, and it keeps the two entities separate, allowing the business owner to one day sell the business while maintaining the property portfolio they have built up.” — Suraj Lallchand, Director at Fedgroup Ventures, a division of Fedgroup.
Growth through property
“Owning commercial property is a good example of risk and return. Your risks increase, but the returns should be commensurate with that risk.” — Rick de Sousa, Head of Commercial Property Finance at Fedgroup.