Best Practice Models Regarding SME Financing

Several best practice financing models have been developed within the INBETS project, offering diverse models for financing a business transfers for SMEs.

 Co-financing by the Transferor
 Through this model, co-financing is provided by the transferor him-/herself in order to make the transfer solution possible. Concerning requirements, no hard and
 fast rules exists. The length of the contract and the executive’s role with the company post-acquisition are two issues that also have to be negotiated. If this form
 of financing is accompanied by a loan, the latter will be given priority.

 EU-wide application:  Type (size) of SME business transfer: Financially smaller takeovers, and more likely in the case of family succession.

 Co-financing by the Transferee’s Family and/or Friends
 Co-financing is provided by the family and/or friends of the successor/buyer. In terms of requirements, the length of the contract (the agreement) should be fixed
 in writing to avoid any conflicts between the partners due to different expectations etc. It is also important to remember that you should not mix money and
 friendship!

 EU-wide application:  Type (size) of SME business transfer: Financially smaller takeovers.

 Loan Financing without Guarantees
 An amount of money is borrowed and has to be paid back, usually together with an extra amount of money that the borrower has to pay as a charge for
 borrowing. Unsecured lendings generally attract higher interest rates. The prospective lenders are expected to run a thorough credit assessment, taking into
 account all information available from the company etc. to justify the increased risk undertaken. In choosing this model of financing, one should remember that
 loans in general take time to arrange.

 EU-wide application:   Type (size) of SME business transfer: Different types of business transfers (i.e. internal and external ones).

 Loan Financing with Guarantees
 An amount of money is borrowed and has to be paid back, usually together with an extra amount of money that the borrower has to pay as a charge for
 borrowing. Loans secured against assets are likely to attract lower interest rates.

 Requirements
 The prospective lenders usually run a credit assessment, taking into account all information available from the company etc. The analysis of the management
 capabilities is a critical factor (a clear vision needs to be demonstrated based on a credible business plan).

 Things to remember
 Most banks and non-banks prefer to lend to established businesses with a stable and positive cash flow history, particularly if they can provide collateral or a
 personal guarantee.

 EU-wide application:   Type (size) of SME business transfer: Different types of business transfers (i.e. internal and external ones).

 Financing by Employees
 Financing is provided by individual employees or a group of employees (group of executives/managers). The length of the contract (the agreement) should be
 fixed in writing to avoid any conflicts between the partners due to different expectations etc. Furthermore, one should remember that this creates increased
 pressure on the company (its organization members) to earn money to repay the individuals’ own funds.

 EU-wide application:   Type (size) of SME business transfer: Financially smaller business transfers.

 Partial Public Funding
 Partial funding is provided by the state or a (stately-run) business support organization aimed at supporting companies in different stages of development.

 Requirements
 Financing will depend on a number of different factors (e.g. vision behind the takeover, manager capacities, decent business plan etc.). Programmes and
 requirements vary from country to country. The number of options available depends on the country’s in question attitude towards business support.

 Things to remember
 Takes time to arrange, in-depth understanding and overview of the different programmes available is needed to identify the best one for the business transfer
 solution in question.

 EU-wide application:   (the existence of public funding/business support organizations focusing on SME business transfers assumed)
                                        Type (size) of SME business transfer: Different types of business transfers (i.e. internal and external ones).

Alternative Financing Options

Apart from the 6 best practice financing models introduced above, there exist other alternative options for financing, including: 

 Silent Partnership (also limited or economic partnership)
 A silent partner is an individual whose involvement in a partnership is limited to providing capital to the business. A silent partner is also known as a limited
 partner, since his/her liability is typically limited to the amount invested in the partnership. In this form of financing one or more persons take an equity stake in a
 company, but without assuming any liability to the company’s creditors. The typical “silent” participation affects only the company’s internal affairs and is not
 apparent to outside observers. 

 Requirements: 
 A silent partnership generally calls for a formal agreement in writing. The capital contribution can consist of either money, in kind or services.

 Things to remember: 
 The silent partner has the right to monitor the company’s business and can also be granted rights to be informed and to participate in the company’s decision
 making. However, the details of participation in profits or losses, involvement in the company’s management, supervision and information rights can be
 structured flexibly. As a case in point, usually the silent investor participates in losses up to their invested capital amount, but the parties may remove this feature
 partially or completely from the contract. It is considered a background role that cedes control to the general partner. Thus it requires the silent partner to have
 full confidence in the general partners’ ability to grow the business. The silent partner may also need to ensure that their management styles or corporate vision
 are compatible.

 EU-wide application:  Yes. As the requirements are lower compared with other forms of financing. 
                                       Type (size) of SME business transfer: Medium-risk profiles, all forms of business transfers.

 Asset-Based Lending

 Asset-based lending (ABL) is any form of lending secured by an asset. 

 Typicially, four types of asset classes are secured under ABL: 
   – accounts receivable
   – inventory
   – equipment
   – real estate

 Requirements:
 The amount a firm can borrow depends on the appraised value of the selected assets, rather than on the overall creditworthiness of the firm, taking into account
 the ease to sell off the assets should the borrower be unable to generate cash to repay the loan. The amount of credit extended is linked to the liquidation value
 of the assets, which is estimated and monitored on the basis of hard data. Thus, monitoring and asset evaluation methodologies are of the utmost importance
 for this type of lending, which explains the historical use of ‘tangible’ assets to secure loans and, on the other hand, the limited exploitation of intangibles, such as
 trademarks, patents and copyright. 

 Things to remember: 
 In light of the above risks, particularly of the expected asset value dilution and losses, asset-based lenders typically lend at a discount to the actual value of the
 secured assets. 

 EU-wide application:  It demands a sophisticated and efficient legal system. 
                                       Type (size) of SME business transfer: Low-risk profiles, financially small business transfers. 

  High-net-worth individuals (HNWIs)

 These individuals are looking for investments with reasonable risks and reasonable returns and are focused on long-term capital appreciation. Both of these
 traits are well matched by investing in family businesses. 

 Requirements:
 These individuals are happy to be involved and offer their advice. They would often like to have an equity stake, which (in some cases) could be a barrier to
 investment. 

 Things to remember: 
 The main factor that would deter HNWIs from investing in family businesses is the possibility of conflict among investee family members. Apart from this, the
 main reason given for not making more of these types of investments is a lack of availability and limited information on the opportunities.

 EU-wide application:  Needs an integrated and well-functioning financial system, a diffused culture for risk-taking and social recognition for an entrepreneurial
 career. 
 Types (size) of SME business transfer: Medium-risk profiles, family succession.