Why startups should consider alternative funding

This article was written by John Eggleston, IT strategy director at the Business Growth Fund (BGF)

There has never been any shortage of innovation in the UK IT sector. There have always been people with new ideas, and new companies being created to exploit them. But lots of activity doesn’t always equal commercial success.

The good news in recent months is that "growth" is back on the table, not just for start-ups but also among small and medium sized businesses.

In part, this is thanks to more favourable economic conditions – the UK’s GDP is on track this year to be the best since 2007 – which has increased entrepreneurs’ appetite for growth, as well as their confidence to implement plans. Moreover, we’re seeing this resonate across all sectors, from manufacturing to retail, where a robust IT infrastructure is a critical component to supporting growth. This presents a sizable sales opportunity and a further reason for IT businesses to feel bullish about the future.

In equal measure, some of this growth can be accounted for by the need to ‘catch-up’ after a period of conscious cost-cutting and sustained underinvestment. To remain profitable and effectively manage the cycles of obsolescence in products and services, even the more established companies must innovate, adapt and expand.

With these factors combined, we have now reached a juncture where decisions need to be made about how growth can be achieved, and specifically, how it can be funded.

Borrowing money was once the most obvious and exhausted source of funding; today and tomorrow the answer won’t be so simple.

Debt will never again be as easily or readily available to businesses that want to take on additional risk. This means that ambitious companies will either have to put their growth ambitions back on hold or, more promisingly, look for funding elsewhere.

The latter option is increasingly do-able for three reasons.

Firstly, the Government, through its Small Business, Enterprise and Employment Bill, has set out a requirement for banks to refer their small business customers to alternative finance providers in the event they are unable to offer finance. In BGF’s experience, by and large, this is already happening since many of the businesses we meet are introduced to us by their lenders, with whom they have long-standing relationships.

But it isn’t just the banks’ obligation to advise that’s important here. The Bill’s importance is also in its acknowledgement of the value of alternative funding, including equity, and its relationship to debt. In a best case scenario, growth is funded by a combination of debt and equity: the two go hand-in-hand. This can be likened to the running of an engine, which requires both lubrication and fuel – debt should be the lubrication (used for day-to-day financial management) and equity should be the fuel (used to fund growth).

Secondly, there has been a cultural shift in attitude: business owners are navigating towards equity partnerships on their own accord and, in many cases, no longer view this as a last resort. Recent excitement around equity investment (think crowd funding, Tech City and even entertainment programmes like Dragon’s Den) have made entrepreneurs intrigued about outside backing, and in turn, there has been a growing awareness that taking on an equity partner need not be onerous, or result in loss of control. And, when equity investment is properly understood, it begins to stand up on its on merit, with value beyond borrowing in the form of advice, support and new ideas.

Lastly but perhaps most crucially, there is more growth capital available to small- and medium-sized business; BGF, as an independent fund with £2.5m to invest as a longer-term minority partner, is a case in point. More capital is needed, but growing demand should have a positive impact on supply, and vice versa. And this can only be a good thing for the prospects of small and medium sized IT companies in the UK.

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