In this practical guide aimed at start-ups and growing businesses in the fashion industry, we examine the funding options that are available to help businesses fund their expansion plans.

Most fashion businesses will seek some form of external funding at some stage of their development whether this is to fund start-up costs, establish an on-line sales presence, refurbish premises or to assist with making acquisitions that will help a business grow and realise its full potential.

There are many different forms of funding available depending on your needs, and choosing between these is not always easy. We will examine some of the more common types of funding with the aim of helping you to decide which one or more of these may be the best option for your business, identify the key points you need to consider and provide practical tips on how you can increase the chances of successfully raising the funds you need.

Debt Finance

Most businesses seek debt (or loan) finance at some stage during their development. Loans are available from a number of different sources and the cost can vary considerably depending on factors such as the identity of the lender, the period of the loan and the degree of risk that the lender perceives it will be taking by advancing the money.

Private Funding

The owners of start-up businesses may be able to persuade friends or family to lend them money and this is often a cost effective and low risk way of funding start-up costs. However, there are, of course, risks involved for the lender and not everyone will want to have a business relationship of this nature with friends or family.

Bank Loans

Bank loans are the most common source of loan funding. Before the financial crisis of 2008, these were more readily available than they are today, although banks are slowly beginning to make more funds available to borrowers.

Bank funding tends to take one of two forms. A business may use an overdraft facility to finance short term cash-flow needs where, for example, it is waiting for payments from customers to be received. These tend to be a fairly expensive way of financing a business and are generally repayable on demand, meaning a bank could withdraw the facility at any time and demand immediate repayment of its money.

Most medium to long term funding provided by banks comes in the form of term loans under which a business will usually agree to repay the amount advanced plus interest in a series of instalments over a set period of time (similar to the way in which you might repay a mortgage) or in a lump sum at the end of an agreed period.

Unless your business is very well established with substantial assets, few liabilities and an excellent credit rating, any bank or other third party lender is likely to require some form of security for any loan it may make to your business. This may be in the form of a charge over the assets of your business or, in many cases, a guarantee to be provided by you personally (meaning your home and other personal assets could be at risk in the event of non-payment). Professional advice should always be taken where personal guarantees are requested (many banks will insist on this) to ensure that you are fully aware of what this entails.

The recent financial crisis led most banks to adopt stringent application processes and there is likely to be little room for negotiation of the basic terms and conditions on which a loan or overdraft and any related security may be provided.

Before considering a request for funding, banks will need to see a comprehensive business plan and be satisfied that your business will be able to repay the loan it is making. If an application for a loan is refused, it may well be for a good reason such as a flaw in financial planning, which would be worth reviewing before seeking funding elsewhere.

Pros:

• Relatively simple form of financing.
  
• Allows owners to retain full ownership and day to day control of their businesses.
  
• Relatively wide range of lenders and loan products available to suit most types of business.

Cons:

• The loan will have to be paid back at some point in the future even if your business is not profitable. If repayments are missed this could have serious consequences for you and your business.
  
• Arrangement fees and interest charges can be expensive.
  
• Borrowing costs on variable rate loans could increase over time if interest rates increase.
  
• If a lender insists on a personal guarantee then your personal assets could be at risk if your business defaults under the loan.
  
• Banks often require businesses to meet financial performance covenants during the term of the loan which may require you to spend time preparing regular updates on financial performance and possibly discussing these with the bank.

Tips

Any lender will want to understand how your business works, assess its past performance and your future plans before making a loan. Ensure this information is to hand by keeping your accounting books and records and all related paperwork up to date and by creating a professional looking business plan showing your projected income, expenditure and profits together with a cash-flow forecast and summary of the way in which the loan will be applied in your business.

Key points to consider include determining:

• Exactly how much cash you need to borrow (there is no point borrowing too much or too little).
  
• What charges you will pay over the term of the loan (including all arrangement costs and interest charges).
  
• The term over which you will repay the loan and the amount of monthly/annual repayments (will repayments begin immediately or do you need a period of time before repayments start in order to build up sales?).
  
• The extent to which the lender will want to have ongoing monitoring rights in relation to your business (will you have to provide monthly accounting information?).
  
• The extent of the security that the lender may want you to give in consideration for making the loan (will personal guarantees be required?).
  
• Most of these elements will be negotiable and may vary from lender to lender so shop around for the best all-round package.

Think about taking professional advice. Where you are thinking about a loan from family or friends, make sure that it is properly documented to avoid misunderstandings. If you are obtaining a bank loan, make sure you fully understand the terms on which it is being made, and the consequences of your business failing to repay when due; you could lose your business if you do not proceed carefully.

Equity Finance

Equity finance is a way of raising capital from external investors in return for a share of your business, and is more suited to funding medium to long term projects and growth. In a company, the provision of equity finance will involve investors acquiring shares and becoming partial owners of your business. An investor's exact rights, and the degree of control that they may be able to exert over your business in the future, will depend on the proportion of their equity stake and the terms on which the investment is made, and so it is vital to consider this at the outset.

You must be realistic about the percentage of your business that you may need to give up to an investor. Sophisticated investors will not generally invest large sums in return for a minority stake in a small business. However, if you give too much away then that could limit your ability to attract further investment in the future and lead to you losing control of your business if your own interest is diluted over time because you need to bring in further equity investors.

One of the main factors you will consider in assessing the percentage of your business to give to an investor in return for their money will be the amount they are prepared to invest. However, this should not be the only factor. For example, it may be better to give an investor who has management expertise, valuable contacts in your industry or access to an established distribution network a higher percentage than you may be prepared to give to an investor who may provide only cash but nothing else.

It is important to discuss and agree with any proposed investor at the outset the extent of their involvement in the future management and decision making of the business and establish whether you will retain full control over decisions which may be important to you, such as the creative direction of the business. It would be very unusual for an investor not to want some say in how the business is run, and investors will usually want the right to appoint directors to represent their interests and have a right of veto over certain key decisions, such as issuing new shares, moving to new premises, disposing of key assets or incurring material expenditure. If you want to retain creative control over your business then you will need to make that clear at the outset and ensure this is reflected in the documents recording the investment terms (in a company the principal documentation will include a shareholders' agreement, articles of association and possibly new service agreements for key staff).

You will also need to agree the extent to which an investor might be able to transfer shares they may hold in your company; clearly you would not want them transferring these to a competitor or to someone you would not want to work with. There are several ways of dealing with this, ranging from placing an absolute prohibition on transfers through to rights of first refusal before transfers can be made. In a similar vein, you may also want the right to require an investor to sell its shares if a third party made an offer to acquire your company, which you wanted to accept - after all, you would not want to find that a minority investor could block this sort of transaction, and deprive you of the right to sell your shares.

To attract investors, you will need to be able to prove that your business has a unique selling point and that you and your management team have the drive, talent and experience to grow the business so that they will be able to achieve a return on their investment.

Investors will be taking a risk by investing in your business and will want to assess that risk at the outset in order to determine whether they are likely to see any returns; this process is commonly known as "due diligence". Initial due diligence will involve scrutinising the past financial performance of your business and considering the projections in your business plan. If an investor is impressed with these, they may undertake more detailed legal, accounting and/or tax due diligence. This will involve a much wider review of your business's commercial arrangements and dealings in order to verify that the historic and projected financial information you have provided stands up, and that there are no unforeseen liabilities or other risk factors that may affect its value. For example, an investor may want to check that your business owns the right to use the brand name under which it trades.

Equity funding is not as readily available as debt funding, although clearly it may be possible to encourage friends or family to invest in your business if they have funds available. External sources of equity finance include larger, established, fashion businesses where synergies may exist. It is becoming increasingly popular for smaller businesses to seek investment from so called "angel investors"; these are generally wealthy individuals with a successful business background who back start-up and growing companies and often provide valuable input into the management of the businesses they invest in. There are a number of angel networks in the UK and we have established links with many of these. More mature businesses with a proven track record and scope for further growth may be able to attract investment from a private equity investor.

Pros

• Unlike debt, equity investments do not have to be paid back and so are a less risky way of financing your business.
  
• Bringing an experienced investor on board could help to grow your business, particularly if they have valuable contacts, skills or experience in the fashion industry or in areas such as e-commerce or marketing.

Cons

• You will be giving up ownership of part of your business and therefore part of its profits and of any future sale proceeds to the investor.
  
• An investor is likely to want a say in how your business is run and so you will have to change the way in which decisions are made and the business is managed. You are unlikely to be able to make important decisions alone after an investor has come in.
  
• You may be restrained from carrying on activities outside of your business if an investor is involved as they will want you to focus solely on the business they are investing in; if you are used to doing one-off consultancy work or commissions for other labels to top up your income then this may no longer be possible without the investor's consent.
  
• Depending on the complexity of the arrangements professional fees for documenting equity investments can sometimes seem expensive as these are less standard in form and more likely to be negotiated than documents relating to a bank loan. However, it is better for you in the long term to have a clear written agreement outlining the parties' agreement as to how things will work, and your respective roles and responsibilities, so that you have protection if your relationship with the investor breaks down.
  
• The due diligence and negotiation involved in equity investments can be time consuming and distract you from the day to day running of your business. However, if you plan ahead, manage the process properly and take good advice then disruption can be kept to a minimum.

Tips

• An investor will need a clear understanding of how your business works and how he may be able to make a return on his investment over time. To do this, ensure historic accounting information is up to date and presented in a clear format, and that you have a clear and professional looking business plan.
  
• Be prepared for due diligence by ensuring that your books and records are kept up to date, that you have written agreements in place with customers, suppliers, employees, consultants and any landlord, and that any documents relating to trade mark applications or registrations are to hand. The more organised and systematic your books and records are, the simpler the process will be, and the more professional you will look to the investor.
  
• Ensure you reach outline agreement with any equity investor on the key points mentioned above before you proceed to have any long form legal documents drawn up. This could potentially save you a considerable amount in professional fees.
  
• Seek professional advice at an early stage; there may be tax implications of structuring equity investments in certain ways, and if you want to retain control of your business then you need to ensure that the terms of the investment allow you to do this without stifling your creative output. It is much easier to negotiate key terms into an agreement at the outset than at the last minute and so it may be a false economy to only involve advisers later on in the process.
  
• Do not underestimate the amount of time you may need to spend completing an investment transaction. Plan ahead so that you do not put yourself under time pressure and avoid being put in a position where you have to make key concessions to an investor purely because you need money quickly, for example, to fund an upcoming show or make a payment to a creditor.

Grant Funding

Start-up and growing businesses may be able to obtain grant funding from a variety of schemes which are focused on assisting businesses in the fashion industry. Examples include The Centre for Fashion Enterprise and The Creative Capital Fund.

Different schemes provide different benefits and levels of support depending on the nature and experience of the business seeking funding. Some schemes offer loan or equity finance and many provide business support services and advice to help your growing business. These schemes often require applicants to complete detailed application forms and attend interviews and competition for funding can be fierce.

Although these schemes can provide a good source of funding for some businesses, you should take the time to review the exact terms on which the funding is being offered. Although they are intended to help growing businesses, we have found in the past that the terms offered by some schemes can be very strict and in some cases have required owners to give up a significant proportion of their business in return for a relatively small investment. Again, if you are in any doubt then seek professional advice.

Other

Some businesses fund their short term cash-flow needs through factoring or invoice discounting arrangements. Most major high street banks offer these services although some may require that your business achieves minimum annual sales targets.

Under a factoring arrangement a business will sell its right to be paid under an invoice to a third party called a "factor" in return for the factor paying it a percentage (usually not more than 85%) of the value of the invoice. The factor then collects the amount due under the invoice from the customer on behalf of the business and retains an agreed fee from this; this means that your customers are likely to have direct contact with your factor. Different types of factoring arrangements are available, some placing the risk of customer non-payment on your business (known as recourse factoring) and others placing this risk on the factor (known as non-recourse factoring). Factoring providers often offer related sales ledger and credit management services and can assist with the recovery of bad debts.

Under an invoice discounting arrangement, a business retains responsibility for collecting debts directly from its customers but is able to realise a percentage of the value of the invoices it raises when they are issued by means of a payment received from the discounting provider (again, typically but not exclusively a bank). When the debt is recovered from the customer, payment is made directly to the discounting provider which then pays on the balance of the sum payable under the invoice to your business less an agreed fee.

Summary

Making the right funding decisions is crucial to the development of your business. If you get these decisions right, this places you in an excellent position to expand your business, move into new markets and increase its scale and value. However, getting it wrong can place an enormous strain on your business, your relationship with it and any co-owners and, in a worst case scenario, could see you losing your business altogether.

It is, of course, possible to combine any two or more of the above funding options and in reality many businesses do this in order to combine the advantages that each of these bring.

Funding decisions are some of the most important that you will make during the course of the development of your business and so it is important to fully understand the implications of these and the alternatives that may be available.

If you would like to talk to us about any of the above topics or need any further information then please contact Rhys Llewellyn.