Funding for IT businesses - where and how to get it

Grant Thornton's Wendy Hart shares her insight on sources of funding for high-tech businesses in the current market and what technology companies should do to get it.

Wendy Hart, technology corporate finance partner, Grant Thornton UK LLP, shares her insight on sources of funding for high-tech businesses in the current market and what technology companies should do to get it.

Hardened bank lending criteria and hikes in debt pricing made it almost impossible for companies, no matter the quality of the business, to find funding in the immediate wake of the banking crisis.

Both bank lending and private equity investment have returned, but the landscape for lending and investment has changed dramatically from the heady days of 2007. Technology businesses seeking funding in the current market must ensure they are well prepared and clearly understand the parameters of what is possible.

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Serviceability is fundamental for banks today. Banks will want to understand how the business is going to service interest and repay debt, and will make very cautious trading assumptions in formulating their view of debt capacity.

The level of formal security in the business is much less important than it used to be. Regardless of the safety net which property or other assets might represent, the bank will only lend at a level which the business can comfortably afford to repay.

For IT businesses, debt capacity is typically defined by reference to a multiple of the free cash (or EBITDA) they generate. At the height of the market it was possible to obtain debt multiples as high as 10-12x EBITDA, particularly from some of the Icelandic and Irish banks. Now debt multiples of 2-3x EBITDA are a more realistic target.

Banks will try to structure facilities as invoice discounting (ID) arrangements. This links the level of debt directly to the working capital cycle of the business and gives an enhanced security position. While ID can be an excellent source of working capital finance in a growing company, if a business has "lumpy" cash flows, or significant customer concentration, the capacity to borrow on such a facility may be limited.

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It is much easier for larger businesses to raise money in the current market. Debt funding solutions such as the Enterprise Finance Guarantee scheme have been used widely by the banks over the past couple of years to bridge the gap and, with government pressure, more lending solutions for smaller businesses are starting to emerge. But the lending and investment market is still far more active and competitive for businesses with net profits above £1m.

For businesses with well-spread debtor books, asset-backed lenders (ABLs) are worth considering. Historically more expensive than the high street banks, they have become more comparable in the current market and can typically leverage higher advances. In addition, many ABLs are now willing to lend against stock and other assets (including software licences), and some will advance funds against a strong contractual cash entitlement.

 Fact box
Technology businesses need to tick the following boxes to become a desirable asset to a funder:
  1. Demonstrable resilience through the downturn - either having maintained revenues or shown an ability to flex cost base in response to reductions in revenue.
  2. Strong management team.
  3. Reliable and regular management information with the ability to track bank covenants monthly.
  4. A genuine need for the finance, driven by positive underlying factors such as growth, acquisition, investment, shifts in business model (e.g. from a licence model to SAAS).
  5. Well-spread customer base - over-dependence on one or two customers will be seen as a material risk.
  6. Demonstrable ability to repay the debt or deliver an appropriate level of return.
  7. Ability to articulate competitive position in context of the wider market and ideally to demonstrate a competitive edge through intellectual property, niche capability or innovative delivery mechanisms.

Mid-market private equity (PE) houses are now very actively seeking investment opportunities within the IT sector. PE provides two potential angles for IT businesses looking for funding. For a strong business of reasonable scale (typically £15m+ revenues and £1m+ of earnings), there is the potential to raise development capital from PE either through selling shares or creating new shares. Valuations within the sector have steadily increased over the past 12 months, with multiples of 7+ achievable for the right business. For a smaller business the opportunity is more likely to consist of a merger or sale to a PE-backed vehicle looking to "buy and build", and for these the valuation multiple is likely to be lower.

Overall, there is funding for IT companies in the current market, but it is important to identify the genuine options and prepare your proposals properly to stand the best chance of success.

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Grant Thornton UK LLP is a business and financial adviser with offices in 28 locations nationwide. It is part of Grant Thornton International Ltd, one of the world's leading international organisations of independently owned and managed accounting and consulting firms.

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