Securing capital for a business startup is never easy, but having found the investment they need to get their business off the ground, entrepreneurs can find the next stage of fundraising, sourcing the finance they need for growth, even more challenging.
It is not just about knowing who to approach for funding, a debt or an equity-based finance provider, but also at what stage of growth they need to think about preparing their pitch.
The development of small firms can be measured in stages, and the first stage at which growth capital is appropriate is when they start marketing their product or service, says Jonathan Price, associate lecturer at the London School of Business & Finance.
He says: "This point, sometimes called first commercialisation, demonstrates an almost Darwinian proof of success in that the company has shown that there is a market for the product. The next fundraising point comes six to 12 months later when the company starts to feel working capital strain because of the sales pressure. After that point, funding tends to be required in steps, as and when the business gets to the next expansion phase."
Aside from the company's individual requirements, SME funding is quite market dependent, both for debt and equity. While VCTs (venture capital trusts) are currently flush with money, making equity finance available for the right company, debt finance is more difficult to obtain, largely because of the reticence of banks.
However, one option that is proving increasingly popular with growing firms is crowdfunding, which as the name implies, draws funding from a crowd of investors - many of them ordinary members of the public.
It was the investment vehicle of choice for gamesGRABR, a social network for games, which has just achieved its £150,000 growth funding target via Crowdcube. This follows traditionally-raised seed funding of £250,000 earlier this year which was used to launch and develop the site.
Founder Tony Pearce says: "As a social network for gamers we wanted to offer our users the ability to actually buy shares in the product they are using. It's a great way to get them really involved. We appreciate the power of recommendation and have added an 'Invest Now' button to the homepage, so all our users know they have the opportunity to get behind a business they love in a simple and secure way."
Since June, the site has attracted more than 100,000 unique visitors, and numbers are growing at a rate that has exceeded forecasts. It's this speed of growth that has led gamesGRABR to accelerate the funding round, choosing crowdfunding over the comparatively slower traditional VC funding processes.
When online recruitment platform Elevate Direct, which operates in the UK contract market, needed £500,000 for their next phase of growth, they turned to business angels and private investors.
The funding was invested in software development and incremental improvements to the system, and also used to employ another salesperson to proactively target new business.
CEO Dan Collier says: "We considered venture capital, assuming, mistakenly, that they would be interested in early stage startup companies. Generally they're not. They like companies that are already turning over £1 million. Angels and private investors were absolutely the right route for us and we found most of these through an angel investment network."
While bank lending is on the rise, according to latest figures from the Government's Funding for Lending scheme, for small businesses, lending remains fairly subdued. However, some banks are providing alternatives, including mezzanine finance, such as that offered by Santander's Breakthrough programme.
Darren Hart, head of growth capital at Santander, says: "For companies with an annual turnover of between £500,000 and £10 million, finance options are particularly limited. Private equity investors tend to be interested in larger companies, while business angel investors are more active in startups. Furthermore, conventional bank lending is often not available for projects that could be classified as speculative.
"That's where mezzanine finance comes in, a type of funding that sits in the capital structure between traditional bank debt and equity, and is aimed at companies that might otherwise find themselves in this so-called 'funding gap'."
The mezzanine finance facilities offered through Santander's Breakthrough Growth Capital programme do not have an equity component. The money is advanced in the form of debt, repayable on maturity, so the bank receives its return through interest, payable at quarterly intervals throughout the term of the loan and a further 5%, plus the capital sum, all rolled up.
"This may be more expensive than a conventional bank loan but, compared to the cost of capital associated with an equity investment, it's a relatively inexpensive way to fund growth," adds Hart.
One business that has benefited is Vital Ingredient, a London-based healthy fast-food retailer, which is set to more than double in size, creating up to 150 new jobs in central London, after securing a £2.75 million finance package from the Breakthrough programme.
Run by entrepreneurs Alex Heynes and Paul Oberschneider, the company was set up in 2001 and the chain focuses on speedy service and low calorie, healthy ingredients in areas of the capital with busy lunch and breakfast trade. It will use the funding to establish 11 new sites across the City and West End of London.
Before considering growth capital, however, businesses need to consider what growth profile and therefore what risk they want to take on, says Jon Coker, investment director at MMC Ventures.
"They also need to consider whether the size of the opportunity in their local market is large enough to facilitate that growth and if not, what that means in terms of expanding internationally," he says.
Growth capital also implies funding to scale a proven model, so businesses should have a very good grasp of the return on spend for both sales and marketing before raising the capital. This means understanding how productive a new salesperson is and after how long, or knowing how much a customer costs to acquire, how long it takes to cover that cost, how long they will stay a customer or how many times they will repeat purchase.
"If you have a good grip of this you can raise funds to increase sales and marketing spend with some confidence that it will increase the value of your business rather than just mean you spending more cash," he adds.
Small firms looking for growth investment face tough competition and must stand out from the crowd.
George Whitehead, chairman of Angel CoFund, says: "There are thousands of businesses looking for funding, but as an investor, I am looking for that rare business that is led by an A-grade entrepreneur and team. By the time an entrepreneur is ready for growth funding, they should already have a strong network of third party advocates, whether a fully-fledged team or seasoned entrepreneurs and angel investors who have helped provide seed money and mentoring."
"For an investor, a company with friends like this is can significantly de-risk an investment decision. Some of the most practical advice I can offer for a business seeking funding is for them to spend more time growing their network and building the best team possible, as once you get the get the team right the investment money will always follow."
Content commissioned by Guardian Professional on behalf of FedEx Express.
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