Growth capital for SMEs and Scale-ups: The ultimate guide

Are you the leader of a small–medium business, or one that is scaling rapidly? Do you have your sights set on next-level growth, but are not quite sure how to get there or where you might get the capital from to fund your plans?

Look no further than our Ultimate Guide to Growth Capital for SMEs and Scale-Ups.

In this guide we will cover everything from what growth capital is, how you can use it to accelerate your business goals and the eligibility criteria set by growth capital lenders. We’ll also look at what is involved in the application process, potential stumbling blocks during the fundraising journey and how growth capital pricing might differ from a conventional business loan.

Ready to get growth going? Let’s dive right in…

What is growth capital?

Growth capital usually refers to the form of financing available to relatively mature companies that are at the scale-up stage and looking to expand further. Often, these businesses are more established than those that are venture capital-backed and they’ll usually be at the break-even stage or perhaps already generating some profit.

However, crucially, they do not have enough spare capital to implement transformational changes such as international expansion or merger and acquisition activity – this is why they look to growth capital.

There are several different types of growth capital (you can find out more about growth capital structures and the benefits and drawbacks here), but it is usually structured as either equity or debt.

Growth capital via equity

When growth capital is raised by selling equity, the business owner essentially trades a percentage stake in the business in exchange for the sum, or part of the sum, that they are looking to raise. Selling equity can be a great option for earlier stage businesses, as it means there is no financial pressure to repay the loan and, depending on the investor, they may also be able to offer support and guidance to the management team.

Growth capital via debt

When growth capital is provided as a loan (otherwise known as debt) this enables a business to to raise funds without any equity dilution and loss of control. As such, debt is a more popular option for firms with proven business models that are growing fast – they have strong enough revenue to meet a loan repayment schedule, but they need a significant injection of capital if they are to reach their next growth stage.

These businesses might also be looking ahead and committing to attaining key milestones that will trigger higher valuations in future fundraising rounds, or that will help them to reach IPO stage. It may be that additional growth capital is needed to help them reach these milestones.

Securing the right growth capital for your business

Growth capital is usually provided by specialist lenders, who should tailor each growth capital loan to meet the individual needs of your business. In a strong lender-borrower partnership, you should feel as though the lender truly understands your business and is onboard with your vision for growth.

Working with your chosen lender, the terms of the loan will be agreed. This will include things such as:

Size: With growth capital, the quantum available is usually based on a set metric, such as your business’ value or a multiple of revenue, but it will differ from lender to lender. There are also options to receive the total loan amount in a lump sum or to draw down in tranches, which can have an impact on the cost of capital.
Price: You can find more information on price at the bottom of this guide, but because growth loans should be tailored to each business’ individual needs, it will vary depending on the amount borrowed, the loan duration and your risk profile as a borrower.
Duration: Again, this will vary between lenders and type of growth capital – it is common for growth debt to amortise (pay back at regular intervals) over a predefined period (usually of several years), whereas an equity timeline will be more dependent on your growth profile and the lender’s exit strategy.
Repayment: If opting for growth debt, a monthly repayment schedule of both capital and interest is common, but some lenders may offer bonuses such as interest-only periods at the start of the loan.

Some lenders may also require agreements to help secure the loan, for example: personal guarantees, covenants, or a debenture, while others will want to agree on a warrant or equity kicker, so that they benefit when they make a “good” investment.

How to use growth capital

Growth capital, by its nature, is usually secured by businesses that are looking to invest in growth. The exact activities will differ depending on the needs of the company and where the business is in its lifecycle.

For example, a scale-up that is breaking even, but doesn’t have a stack of spare cash, might use growth capital to scale its operations so that it can take on more clients and grow its revenue.

A more established firm might use growth capital to diversify its offering by buying a complementary business, enabling it to expand its customer base.

You can find more detail about how to use growth capital here, but common uses include:

Investment in operations, staff, sales and marketing
Capital spending, research and development, equipment or software purchase
The launch of a new product or service
Expansion into new locations and territories
Investment in new facilities
Working capital finance including stock, trade debtors, or seasonal working capital
Mergers and acquisitions
Management buy-outs or management buy-ins
Investment in growth prior to an IPO (operational spending, working capital or capital spending)

How to raise growth capital

So you’ve decided growth capital is a good option for fuelling your business’ growth. What comes next?

1. Ask an expert

When it comes to fundraising, particularly if you haven’t been through the process before, research is only going to get you so far. It’s certainly worth using resources such as this (and this and this) to improve your knowledge of what is available, but at a certain point it is always worth speaking to an expert.

Not only will they have experience to lean on, which will enable them to assess exactly what you need and recommend a lender that is a strong match, they also have the network and connections to offer you direct introductions to lenders, which could speed up the fundraising process.

If you’ve not yet spoken to an advisor but would like some guidance, our lending experts are on hand to help. Book a completely free, no-obligation call here – once they know a little about your business they’ll be able to offer an indication of the most appropriate next steps.

2. Choose a lender

The stage that your business is at and the scale of your growth ambitions will have a big impact on how many options you have when it comes to choosing a lender.

If you are at an early stage, pre-profit, or have only just broken-even, you will likely have fewer options to choose from – most high street banks have lending criteria that are too strict for your needs, but there are plenty of specialist lenders that will be eager to help.

Even if your business is established, if you are in an emerging industry such as SaaS, where tangible assets are difficult to pin down, or if you require a significant sum to support lofty growth ambitions, major banks will be similarly turned-off. Working with specialist lenders that can offer higher revenue multiples and that really understand your sector will be more conducive to a positive experience.

Ultimately, if you have a proven business model and a strong proposition, there will always be a lender that can support you – it is just a case of finding the right one.

3. Pitch your business

Once you’ve landed on a lender, it’s your turn to impress them.

Explain the basics of your business and why you are looking for funding. Ensure your pitch is compelling, including information about your proposition, sector, market demand and the potential growth opportunities beyond those that you’ve already identified.

Instil confidence in your investors by providing evidence to back up your claims; if you occupy a truly unique position in the market, provide the competitor analysis to prove it; if you believe an injection of capital could unlock new client opportunities, demonstrate exactly how the extra cash would make that happen.

Ensure all information that you reference is readily available and well-organised – the more you are able to provide the more impressed an investor will be and the more streamlined your fundraising process.

4. Win an offer

Once a lender has gained a thorough understanding of your business and been impressed by your growth plans, the next stage will be to make you an offer. They will do this by issuing a term sheet: a legally-binding document that summarises the key terms of your agreement. A signed term sheet from a lender is a strong indication that they are onboard and keen to fund you – the likelihood of progressing to funding is very high.

The next step will be for the lender to conduct due diligence. During DD the lender will work with a legal team to develop a better understanding of your business and ensure that the information shared is accurate. The main focuses will include:

Financial due diligence: a third party looks at your historical accounts and analyses financial forecasts
Research into the market: growth lenders focus on this element in less detail than equity investors but still want to understand key market dynamics
Customer references: the lender may talk to your customers to better understand your product or service and how you’re positioned within the market
Co-investor consultations: the lender will talk to your equity investors if the business is backed by other institutions

5. Funding

The exciting bit – you secure your capital and get growth going!

As with all financial products, the process can be more or less complex depending on the requirements of your business, but if you’d like to know more about the fundraising timeline, from first meeting to first draw down, you can read about it here.

What are the eligibility criteria for growth capital?

Knowledge is power and having an understanding of the criteria that lenders apply when evaluating businesses for growth investment can help management teams to impress investors.

Once again, this will differ from lender to lender, but we’ve outlined the primary factors that we use at Growth Lending to determine a firm’s eligibility for a growth capital loan:

1. Clear growth profile

Growth debt provides capital without loss of equity or business control – an attractive proposition for businesses ready to scale. However, it can also be a comparatively expensive financing option based on the higher level of risk.

Growth debt is therefore best-suited to businesses that can use it to build significant value within the company. The faster a business is growing, the more sense growth debt makes, which is why it is such a strong match for firms in emerging sectors such as technology and SaaS.

The following growth rates give an indication of what you will need to be eligible for growth debt:

Pre-profit businesses — above 30% annual growth
Break-even businesses — above 20% annual growth
Established and steadily growing businesses — above 10% annual growth

2. Proven business model

Growth capital loans are better-suited to companies with a mature business model and an established customer base, where all the fundamentals are in place and the business is ready to scale.

Growth lenders will typically consider a business model as being “proven” when the company has achieved an annual revenue run-rate of approximately £3m, but for businesses where there is good visibility of future revenues, the threshold may be as low as £2m.

Growth debt is not suited to super early-stage businesses or start-ups, partly due to the risk profile of these businesses, but also because of the serviceability of the loan. Firms at this stage of growth need every penny they’ve got and can often not afford the monthly repayment schedule associated with growth debt.

3. Residual value

This is the value that can be extracted from a business in a downside scenario. Lenders prefer businesses with a residual value equal to, or in excess of, the total amount they are borrowing.

A company with no residual value will struggle to raise debt – its risk profile will be better suited to equity investment.

4. Transparent business information

Growth lenders prefer to work with firms that have clean business information. This is a sign of a mature management team and enables a quick and smooth funding process.

5. Straightforward governance and clean corporate structure

Straightforward corporate governance is also crucial, as it enables a faster decision-making process for important matters during the lifespan of a business. Environmental, social and corporate governance (ESG) are now also an important part of the due diligence process for many lenders, so being able to easily demonstrate how and where your business aligns with these values will help accelerate the process.

A clear corporate structure also makes the funding process easier and faster.

Common misconceptions about raising growth capital

Unless you have done it before, raising growth capital is uncharted territory for most business owners and so naturally, some assumptions are made about fundraising that are not entirely based on fact. For example, your prior experience of business financing might only be the relationship you have with your bank. It would be easy to presume that growth capital lenders have similar criteria to banks and that your business is therefore ineligible for funding because your bank has already said no – but this is usually not true.

Unlike bank loans, growth capital is available to businesses that have few assets to use as collateral. This is particularly helpful to tech-enabled businesses, or those in SaaS and professional services sectors, because often these firms do not have tangible assets – their value is in their intellectual property.

Growth capital lenders will also consider the growth potential of a business, taking into account your forecasted revenues as well as historic performance. This means that businesses that have only just hit break-even – and sometimes even those that are pre-profit – could still be eligible for funding.

Oftentimes a business leader will speak to their bank or current lender and feel deflated when their application for more capital is declined, but if the business is high-growth or in an emerging industry, it is more likely that the business leader needs to work with a specialist lender.

Growth capital is available to a wide range of businesses, so have the confidence to look beyond traditional finance providers to those who have a better understanding of your potential.

How much does growth capital cost?

Each growth capital loan is designed to suit the individual needs of a business, so the cost of financing will depend on many factors, including the size of the loan, the planned use of funds and your business’ overall risk profile.

Usually the total cost of capital can be calculated by adding together the sum being borrowed and the agreed rate of interest, however, if you make an agreement for an interest rate “above base”, the cost will of course fluctuate with the Bank of England’s base rate. Many lenders will also implement fees for early repayment of the loan and if the agreement includes a warrant or equity kicker, this will be a cost to the business too.

Growth capital lenders look at a company’s future potential for growth rather than historic factors and are therefore able to offer funding earlier and in larger amounts than traditional banks. They generally require fewer covenants and/or personal liability clauses, however the interest rates of growth capital loans do reflect these higher risks.

If your business is looking for growth capital and you are interested in gaining a deeper understanding of the cost associated with a growth capital loan, download our handy calculator:

Growth Capital Loan Calculator

Download this free and easy-to-use tool to help you budget, compare the cost of different loan providers and to ensure you work with a lender that understands and matches your needs.