Many businesses will need to borrow at some stage in their development but the need is never greater than for a growing business for which cash always appears to be at a premium.

Funding4Business are advisers to SME businesses and have extensive experience of these inevitable growing pains and access to the many funding sources referred to on this website.

Introduction

There is no right or wrong way to fund a growing business although experience shows that the mix of internal proprietors funds and external and short and long term borrowed funds can have a significant bearing on its survival prospects.

Banks and other institutions will often refer to “gearing” which is the relationship between internal funds (share capital and retained earnings) and external funds (usually from an institutional lender but sometimes taken to include creditors’ money).

A highly geared company is one that has a high proportion of external borrowed money to internal funding; a lowly geared company will have the opposite proportions.

Banks and other lenders favour lower gearing, as they perceive that it lowers their risk. It is probably not an over-simplification to suggest that this is because they expect that if the company runs into problems it will lose its own money before it loses theirs.

Conversely an ambitious business is likely to take the opposite view. Not only are the shareholders / proprietors likely to lose less in the event of failure but the very fact that they are using other peoples’ money to fund their business means that they will hopefully leverage the return on their money if it is successful.

The bank view is backed up statistically by a study of past business failure and bank losses, which goes some way to explaining why banks are so entrenched in their views. In order to limit their risk banks will therefore usually insist on additional collateral to back up their judgement in lending to a highly geared company.

What the largely historical gearing measure does not take into account is:

• The current earnings and potential of a business,
• Its management,
• Its markets
• Its products.

Basically everything that is important to the future success of the business. In reality, most businesses rarely make an informed judgement about the gearing level as the decision is usually taken for them by a combination of circumstances and history. The obvious exception is a venture capital backed buy-out, buy-in or start-up.