Minding your own business

Paul Gosling introduces this two-page report on the pros and cons of running a small business

Thinking Of a good idea is one thing. Raising the finance to turn it into an effective business can be quite another.

Finding capital is seldom easy. The result is a basic flaw in the structure of British small businesses in comparison with their international competitors. Our small firms tend to be under-capitalised, tied instead into a succession of short-term lending arrangements, dependent on bankers' goodwill to maintain costly and inappropriate overdraft agreements which banks can pull the plug on at any time. A major challenge for small firms is to break out of this bank-dependency cycle, and establish more stable sources of finance.

The Alternative Investment Market was opened last year, under the umbrella of the Stock Exchange, to help overcome this problem, and raise equity capital for small and fast growing companies. Despite the publicity AIM attracted when it opened, most proprietors of small companies know little about it, and are reluctant to consider it as a serious option.

Proprietors of small firms are also reluctant to approach other venture capitalists, such as investment banks, as they see the process as time- consuming, costly, frustrating and unproductive, unless they already have a good track record. In any case, many entrepreneurs prefer to avoid sharing equity as they fear it will dilute the long-term returns for the founders.

One advantage of approaching venture capitalists is that their searching attitude is likely to improve the quality of the business plan, and can increase the likelihood of creating a successful enterprise.

Entrepreneurs might also consider the purchase of a franchise. Many franchisers have negotiated deals for loans with banks to enable them to include the raising of finance in an overall package that also takes care of quality control, staff training and marketing.

Most start-up businesses begin and end in their search for finance at the doors of banks, looking for loan and overdraft finance. It is essential, though, to compare a range of banks and their products, to establish which is the most appropriate, and which will work out cheapest in the longer term.

Under-capitalisation is one of the most persistent problems for small businesses, and leads to perpetual symptoms. One of these is the inability to buy in bulk, losing the potential for quantity discounts. The under- financed business is more likely to make bad business decisions, forced to accept unfavourable contract terms in order to keep revenue coming in.

A recent report from Bradford University's Credit Management Research Group concluded that it is often problems with external financing that leads to late payment, and that small and medium sized enterprises have a cultural deficiency of ineffective financial management. The Research Group argued that SMEs must put more effort not merely into sorting out their credit control systems, but also into ensuring that their overall capitalisation arrangements are adequate.

For many years one of the biggest challenges facing small businesses has been their deliberate exploitation by big corporations, including some multinationals, that have refused to pay invoices within the specified period. In practice, some major corporations have obtained working capital by delaying payment to smaller trading partners.

It is this practice which has added strength to the debate on whether there should be a statutory duty on businesses to pay on time, and a right for creditors to charge interest on late payers. This debate has gone off the boil recently, with the British Government set against legislation, although the European Commission is sympathetic to new EC-wide laws.

Instead, the Government has initiated a new British Standard, and companies must pay on time to comply with this. BS 7890 has been supported by the Confederation of British Industries as complementary to its Prompt Payment Code, which has been endorsed by 1,000 CBI members. The problem, of course, is with the other three million British businesses.

BS 7890 establishes guidelines for the behaviour of both buyer and seller, and should make communication clearer at the stages of ordering, goods despatch, invoicing and bill chasing. Where both parties quote the Standard when entering into a contract it becomes legally binding. Trading standards officers at local authorities will have the power to investigate non-compliance in such cases.

The Government has also expanded the jurisdiction of the Small Claims Court to consider debts of up to pounds 3,000, to ease the legal processes for obtaining unpaid bills.

This approach is supported by the Federation of Small Businesses. Spokesman Stephen Alambritis says: "The argument for a statutory right to interest is beginning to wane now. We want courts to be used to chase debts, and for them to publish black lists of late payers. A shame list is going around now, not on paper, but people are talking and it is beginning to get out into the open."

This is assisted, says Mr Alambritis, by the Government's request for names of major corporations that are paying late, causing difficulties for small firms. Ministers will then put pressure on companies that are repeated late paying offenders.

If Britain's small firms sector is to thrive then the biggest corporations are going to have to learn to play fair.