What I’ve learned about… How SMEs can raise capital

Small and medium sized enterprises (SMEs) are the lifeblood of the British economy. They constitute 98 percent of all businesses in the UK, and account for half the turnover of the entire private sector. Yet many struggle with one pivotal growth factor: funding. Research from the British Chambers of Commerce shows that around half of small businesses found that accessing finance has become more challenging. And when funding is secured, it’s often not approached strategically.

To understand how small businesses can fund their growth more effectively, we spoke to HSBC UK’s Head of SME Business Banking, Tom Wood. Wood’s team helps businesses from start-up to scale-up by offering support, resources and advice - especially on how and when to raise money - and is deeply familiar with the challenges and opportunities these businesses can encounter along the way.

Here, he shares five essential lessons for any small business looking to thrive…

1. Don’t underestimate your first major funding decision
2. Don’t wait until you need money to raise it
3. External money can act as a network
4. Prove you’re ready for the worst
5. Always ask for the right amount - even if it seems a lot

Most businesses begin life with funding from the founder, possibly with additional money from their family, friends or contacts. This is known as bootstrapping. But there will come a point where the business needs more and is faced with deciding whether to take on debt or to give away equity. It’s not an easy decision as there are so many factors. Debt funding leaves you with full ownership, but the regular payments can leave you a pinch. Equity too has pitfalls. "I’ve seen entrepreneurs give away too much equity early for not enough value", says Wood. "I’ve equally seen people very nervous around giving away any equity because they see the future value, and they don't want to give that value away - even if high interest rates would make equity preferable."

Making the right choice at the right time - perhaps even finding an optimal combination of both options - is key. Wood recommends leaders take considered advice from professionals, such as their bankers, before making the call.

Business owners regularly get in touch with Wood’s teams - whether that’s in person, by telephone or online - to discuss securing debt. "Often," he says, "they come too late for that discussion." Their business is already running out of money, and ideally they would have raised working capital funding before they got into that situation. That’s why Wood says business owners should consider speaking with the bank even if they feel that their business is running smoothly. He advises thinking of banks as ecosystems of experts that can offer advice rather than simply as places that handle financial processes. "Go in for a regular check-up," he says, “rather than waiting to see the doctor when you’re ill.

There is one key difference between taking money from a bank versus an external investor. "Private equity or external money can accelerate the growth of a business much more than a bank loan, "says Wood. Once an investor has equity in your business, it’s not uncommon for his or her network to become available for advice, business contacts and further investment in the future. This is often what kick-starts fast growth. “That can be really powerful if you get the right investor," he says. "And they themselves may also help with the financial acumen of the business."

When a small business makes the case for funding, they will typically be able to show planning for the success story, in which their product scales and their business keeps growing. But what if something major and unexpected happens? "I would expect clients coming to us to be able to show that they have planned for many eventualities", says Tom. "What happens if a significant event takes place that will impact their business?" He adds that any serious investor - such as a venture capital firm - would likely share that expectation. The most extreme situational example might be something like the Covid-19 pandemic, but planning for unexpected costs, a slowdown in business, or supply chain disruption is the sign of a robust business plan, and will reassure any would-be funder.

Wood occasionally sees small businesses asking for too little. When raising equity, business owners may wish to preserve their share of the business; when asking a bank for a business loan, they might assume that being frugal will be seen as a virtue. Yet in all instances, under-funding a business can make it less viable as it kills momentum.

"Be realistic with yourself. If you’re seeking bank borrowing, you should not try to suppress the number to make an easier-to-approve business case", says Wood. "What actually matters is asking for the money you need at the time, and showcasing the milestones where more funding will be required." A business specialist or relationship manager at your bank can help you plan accurately and realistically.