In recent months inflation has climbed the ranks of the list of worries for many UK entrepreneurs and business executives. It is reported that inflation is stopping “a third of workers from setting up their own small business” due to higher costs of doing business, dwindling demand and higher interest rates.
In this Hub we collected all the available guidance and resources to help business leaders wade through this period of unfavourable economic outlook, in order to manage their cash-flow and maintain their runway despite the rising costs, find and secure investment if needed and make the appropriate business decision to adapt their strategy to the coming months.
What Is Inflation?
Inflation is defined as the rate at which prices for goods and services increase. The calculations are most often based on the Consumer Price Index, monitored by the Office for National Statistics.
Normally, inflation can be caused by three factors, often connected in a chain reaction:
- an increase in demand for a product in limited supply (the Financial Crisis of 2008 started with an increase in demand for mortgage-backed securities, resulting in house prices skyrocketing);
- supply shortages or rising prices of raw materials, which cause final prices to increase (the current recession is an example of this, with rising energy prices and supply chain shortages resulting in higher prices for consumers and businesses);
- so-called “built-in inflation” which stems from the expectancy for inflation to rise or stay high, which in turn results in higher wages, an increase in spending and a rise in cost of living.
What caused the current high inflation environment?
Economists have identified several causes for the current high-inflation environment.
Several supply-chain shortages following the COVID-19 pandemic, along with sanctions, disruptions and rising prices of energy and farming products such as wheat and grains caused by Russia’s invasion of Ukraine all contributed to the rise in consumer prices, which the Bank of England estimates at 9.4% as of June 2022.
Some, however pointed to pandemic-related economic measures as the triggers for increased spending, like the rate cuts from the Bank of England, the various Loan Schemes available as well as the CJRS, which were all designed to boost consumer spending and avoid business grinding to a halt during the various lockdowns. However, Andrew Bailey—Gorvernor of the Bank of England, pushed back on the criticism.
According to the Bank of England, around 80% of CPI inflation is a result of rising energy prices and supply-side shortages, while domestic labour shortages and changes in spending are to blame for the remaining 20%.
Historical precedents
It is important to remember that inflation is not new, and this level of inflation is not unprecedented by any means.
This retrospective by ICAEW shows the current and projected inflation scenario in comparison with previous levels all the way back to 1950.
The most recent example of inflation rising past the 10% mark dates back to the 1970s and ’80s, when already rising inflation skyrocketed as a result of an oil embargo by Middle Eastern countries and a rigid labour market and monetary policy errors meant that inflation rose above 24% and took nearly two decades for it to return to manageable levels.
However, it is thought that the nature of the current inflation together with a more flexible labour market and the Bank of England’s operational independence will allow policymakers to keep the situation under tighter control, bringing inflation back under 2% within the next two years, according to the BoE.
What’s next?
The widespread opinion is that the economic outlook has to get worse before it gets better. This is because to stop inflation from spiralling upwards, central banks like the Bank of England usually enforce policies that are aimed at curbing demand, often by making things even less affordable.
This is explained very thoroughly in this article by Vox about inflation in the US, which shares many similarities with the British one and has seen a similar response from the Federal Reserve as we did from the BoE. Both central banks, in fact, have raised their base interest rates in an effort to make borrowing more expensive, which should in turn encourage saving and limit spending.
The main criticism to this approach is that it won’t effectively ease the costs of living nor the cost of doing business, potentially (and some would argue intentionally) leading to unemployment, households and businesses struggling and potentially triggering a recession, as predicted by KPMG’s forecast models.
Cash Flow Resources
With energy, labour and supply prices rising, the main concern for companies—especially those pre-revenue or making their first sales—is running out of cash.
Venture-backed businesses normally operate on a 18-24 month runway between Funding Rounds, but the money set aside to support operations for nearly two years could run out much faster in a high-inflation environment.
Sequoia Capital warned founders earlier this year to move quickly to extend their runway, predicting an environment where VCs are not as keen to sign checks as they have been in the past. We are hearing VCs are advising 2 years runway, especially if consumer facing.
For this reason, looking after your company’s cash-flow and making sure that it is stable, cutting unnecessary costs and preventing accounts receivable from turning into bad debt is essential. However, businesses might still need a cash injection to help extend their runway.
The list below includes some of the available options for UK start-ups looking to support their cash flow with non-equity funding.
Director & Shareholder Loans
Director and shareholder loans are the easiest and quickest way to inject funds into your business.
These types of loans are usually flexible on terms and conditions.
It is important to check your articles/shareholders agreement for any approvals required at board or shareholder level.
Note: Care needs to be taken with loans specifically made to the company by SEIS/EIS investors. For investors looking to make a future SEIS/EIS investment into the company, generally, we would not recommend extending a shareholder loan.
Start-up Loans Scheme
The government backs the Start-up loan scheme which is a government-backed personal loan available to directors.
Directors in a business can individually apply for up to £25,000 each, with a maximum of 4 director applying, or £100,000 available per business. The loans are typically repayable over 4-6 years with an interest rate of 6% p.a.
The loan is unsecured (i.e. no security against assets or guarantors are required to support an application), however, should the business not succeed, the directors will still need to continue with the remaining payments.
In addition to finance, successful applicants receive 12 months of free mentoring and exclusive business offers to help them succeed.
Most start-ups less than 2 years old are eligible. We recommend applying either through Outset Finance or Virgin Start-Ups.
Funding Finder (Swoop)
The number of options for debt products available to SMEs has grown quite considerably recently. We’ve set up a webpage with our partner Swoop, that can match you with suitable debt products, and you can receive advice.
Swoop charges no costs to businesses as they are paid through arrangement fees with banks and lenders.
Revenue-Based Loans
This form of debt funding is designed for growing companies who need growth funding but do not want to give up their equity. These loan providers normally charge a flat fee on the amount you borrow, and get repaid through a revenue share agreement.
Uncapped, for example, provides loans of £10k-£10m to businesses that process payments online with monthly turnover >£25k (e.g. ecommerce, subscription models, D2C, apps, SaaS…)
One flat fee from 2% of the capital provided, no interest, no equity, no hidden charges and no personal guarantees. Check if you qualify.
Revenue-based funding options are also available through Swoop.
R&D Tax Credits
R&D Tax Credits are a popular scheme amongst innovative UK SMEs, with average company claiming £45k p.a. back on qualifying R&D spend. We can help you submit a claim, get in touch with us for more information.
Note, there are organisations that will advance R&D Tax Credit monies typically for an overall cost of 3-5% of the borrowed amount plus circa 1% pcm in interest.
HMRC has recently announced key changes to R&D tax reliefs which might mean a higher qualifying spend for tech companies that heavily invest in cloud computing and pure maths, but does limit claims to work carried out in the UK, effectively excluding overseas contractors from the qualifying costs.
R&D Tax Credits is one of Finerva’s areas of specialism. We can advise, prepare, and manage your claim with HMRC. Get in touch if you would like to speak with one of our R&D Specialists.
Innovate UK Grants
Long before COVID-19, innovative companies have been benefitting from Innovate UK grants to fund their research and development projects. During COVID-19, the Chancellor has announced plans to increase the level of Innovate UK grant funding available.
You can check Innovate UK’s website at any time to search for funding opportunities. Innovate UK recently published a series of short PDF guides to help companies navigate the application process.
Allowances
When cash is tight, making the most of Government allowances on certain types of business spend or investment is essential.
An example of this is the Employment Allowance, which allows SMEs to reduce their NI tax bill and was raised from £4,000 to £5,000 at the beginning of the tax year.
At Finerva, we are able to advise on a number of Capital Allowances, which might mean a tax relief if you’re investing in the construction, refurbishment or acquisition of a commercial property or other types of asset.
Download our OnePager to learn more.
Deferring Tax
Lastly, if you don’t have enough cash in your business to pay a tax bill, you can contact HMRC’s Payment Support Service to arrange payment in instalments, known as HMRC Time To Pay arrangement.
Investment
The state of the economy has direct and indirect effects on investor sentiment and expectations, which in turn affects companies’ likelihood to secure funding, as well as the terms at which investment is provided.
How are investors reacting to high inflation?
For two consecutive quarters now, funding rounds have been plummeting in number and value from a peak in late 2021.
A number of factors contributed to the downfall of capital investment in the first half of 2022, including a crypto-market crash, a bear-ish equity market, global instability and fears of a recession. Inflation, of course, also plays a starring role in the equation.
The most direct effect of inflation is that it devalues future cashflow at a higher rate, leading investors to demand higher returns, and decreasing their appetite for risk. Sequoia Capital warned founders earlier this year to move quickly to extend their runway, predicting an environment where VCs are not as keen to sign checks as they have been in the past.
However, it’s been noted that late-stage start-ups are seeing the most negative effects of the current climate, with large funds such as a16z, Softbank and Tiger Global pulling back from mega-deals.
This can be an opportunity for Seed or Series A-stage companies with high potential to attract some of the “dry powder” that VC funds have continued amassing.
Fundraising in the current environment
The key change for early-stage companies looking to fundraise in the current environment is that VCs are going to expect higher returns to offset inflation, with as-low-as-possible risk to balance the ever-so-uncertain economic outlook.
Start-ups with solid business models with sustainable plans of long-term growth will attract the attention of Venture Capitalists, who increasingly ask Founders to show evidence of their capital efficiency, with metrics such as burn multiples, or the so-called “SaaS magic number“.
Reviewing your financial model so that these metrics are under control, and showing investors that your path to profitability does not solely rely on repeated cash injections down the line will be essential in order to raise equity funding in the current climate.
Strategic Advice
Whether you are worried about your company’s runway, you’re trying to raise a crucial Funding Round in the next few months or you simply want to know how to survive and thrive in the current climate, the answers revolve around one main objective: make your business model more efficient.
Short-term solutions to contain your costs and keep selling prices competitive will start by dissecting and analysing your supply-chain and customer acquisition pipeline, identifying and eliminating all inefficiencies and leveraging technology to deliver more value for at scale.
Medium-term solutions to secure investment and scale up your business revolve around building a sustainable path to profit, investing in productivity-enhancing infrastructure, seizing “the full benefits investment in technology and capital items can deliver”, as suggested by RSM’s Thomas Pugh and Simon Hart.
Finally, long-term solutions that deliver value to all stakeholders, including founders, investors, customers and employee are ultimately focused on ensuring your financial model and business strategy so that your company is running at the highest possible capital efficiency.
Remember, we’re here to help
If you want to speak to a member of our team and be advised on how to best cope with the challenges from a financial point of view, please contact your account manager or Ben, Seema or Adam. If you are not a client yet, get in touch here.
The information available on this page is of general nature and is not intended to provide specific advice to any individuals or entities.
We work hard to ensure this information is accurate at the time of publishing, although there is no guarantee that such information is accurate at the time you read this.
We recommend taking professional advice before taking on additional financing. If you would like to speak to one of our advisors get in touch.
