Using retained earnings as a source of capital

With banks firmly closing the doors and venture capital firms becoming increasingly risk averse, GrowthBusiness speaks to entrepreneurs and business owners who are going it alone.

There is no growth without cash and there is no cash without growth. It’s a conundrum that many entrepreneurs find themselves in when they set out to start a business and build it to critical mass.

Outside of earnings produced by a company there are a number of avenues that entrepreneurs can explore, whether it be loans or overdrafts from banks, credit facilities from asset-based lenders or even through buttering up friends and family.

However, new findings suggest that today’s entrepreneurs are more likely to use retained earnings as a source of capital.

According to Investec, some 79 per cent of entrepreneurs plan to use this system to continue the running of their business.

The finding strikes a cord with Guy Levine, CEO of Return on Digital, a digital marketing agency with offices in the UK.

‘Finally, entrepreneurs have got to grips with reality and stopped relying on family, friends and banks to back their ideas,’ Levine explains.

‘There seems to have been this massive misconception in the .com era that an entrepreneur was someone who carried a MacBook Pro and a Mont Blanc pen, blagged money from a venture capitalist and then ran a loss-making company before selling it for millions.’

For entrepreneurs of today, Levine believes it is much more a case of ‘going old school’ by building up a cash reserve, running a ‘lean and mean’ operation and being self-sufficient.

Levine started Return on Digital back in September 2008 at the start of the downturn with £1000 in his business account. The business now employs 20 people full time and has recently posted a turnover of £1.6 million and a six-figure profit. Despite not planning to look elsewhere for capital, the company is looking to make an acquisition this year.

Bank backing

Looking further down the order of where Investec’s Entrepreneur Confidence Index predicts business builders to be looking for cash, 57 per cent plan to rely on bank loans and overdrafts.

The next two major sources of capital they intend to use are invoice discounting or asset-based lending (28 per cent), followed by venture capital or private equity firms (23 per cent).

The days of looking for, and relying upon, financial institutions are all but gone in the present climate, says Kevin Byrne, managing director of Checkatrade.

Byrne’s business vets and monitors trade companies to help people avoid what he calls ‘cowboys’ in the industry. The company was started back in 1998 when a tornado wrecked his home and rogue traders from around the country descended to ‘rip off’ people trying to rebuild their homes.

Byrne is a firm believer that the only way to fund growth and expansion is from retained earnings.

He adds,’Having a firm hold on financial affairs of your own company with careful budgeting has enabled us to take the Checkatrade service across the whole of the UK with no external help.’

The trade monitoring firm now has a turnover of £5.5 million and has a reported 200 new members joining every month on top of its existing 7,800 base.

‘To me an entrepreneur is very much a self-motivator and having or not having money will have little to do with the actual act of starting,’ he explains.

‘The key is cash flow, not so much to push the company forward as most of this can be done by the efforts of the individual, but to feed the house the start-up entrepreneur and their family. As long as this is covered the real entrepreneur can act.’

Further findings from Investec show that 69 per cent of entrepreneurs expect access to external capital will be difficult over the coming 12 months, with 22 per cent predicting it will be ‘very hard’ to secure.

Twice bitten

The manufacturing market has experienced similar problems with access to capital. Arnab Dutt, managing director at Texane, which manufactures travelator and escalator wheels, says that recent years have seen the removal of existing credit such as overdrafts and loan facilities.

So far the business has solely been built with retained earnings. For Dutt, and many other businesses, the fear is that if they go and talk to the bank, discussions lead to questions and questions put in danger existing lines of credit.

While Texane has not gone out and secured additional capital away from retained earnings, Dutt admits that there could have been an investment that would have put them a few years ahead of where they are now.

One of the avenues that the company is considering is asset-based finance, like 28 per cent of the survey respondents. The funding facility fits well with the structure of Texane, with its existing hard infrastructure giving it lots of leverage to borrow.

The frustration for Dutt is that the money they would look to borrow from asset-based lenders would eventually come from the very banks that haven’t been able to provide them the terms and rates which they see as competitive.

He adds, ‘We have levelled off but we have conserved capital. Our turnover is £1 million and we are now looking to expand and make some good profits.

‘But it’s pointless talking to the banks, we had them in the other day but they just weren’t giving good rates.’

One business which is making hay while the sun isn’t shining is the Fear Group, a business which focused on international and corporate property acquisitions and investments in areas like the US, UK and Latin America.

According to Stephen Fear, managing director at the company, the set up means the business is ungeared and uses its own internal funds, limiting the need for reliance on ‘the volatile banking sector’.

Fear says, ‘The market works for us as we have funds available to invest in businesses, therefore we have lots of propositions as they can’t raise funds elsewhere. It does increase the amount of deals.’

When businesses are shut out of the normal avenues of funding, Fear says momentum takes entrepreneurs to private investors and family and friends. However he believes that unless family and friends deals are structured in a business only way there is likely to be more lost than gained and it is not an option he encourages.

While Investec’s findings point towards a business climate which is making access to growth capital difficult, new forms of funding are emerging.

The rise of asset-based lending as a useful and sustainable way of securing new lines of credit, and the emergence of social platforms allowing businesses to access capital on both an equity and debt front, present new opportunities for business owners.

However, it appears some entrepreneurs are just as happy slogging it out and using the very success of their company to drive growth.

Hunter Ruthven

Hunter Ruthven

Hunter Ruthven graduated from the university of Sussex in geography and politics before joining Vitesse Media. He was the Editor for GrowthBusiness.co.uk from 2012 to 2014, before moving on to Caspian...

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