Sources of Capital to Grow Your Business
If you are looking to grow and expand your business, several sources of capital are available — some more appropriate than others depending on the life cycle stage, size and financial characteristics of your company. External capital (as opposed to internal capital resources such as cash flow) comes in three basic forms:
1. Equity, or selling shares in your company
2. Debt, which can include bank loans, corporate bonds and leases
3. Subordinated debt commonly referred to as mezzanine financing
Types of Equity Financing
When you raise capital for your business by issuing stock to new investors, you broaden your company’s
ownership. In exchange, you receive the funds you need to grow. These funds, however, come at a price. Paying dividends — which aren’t tax deductible for business purposes — can be one cost. But if your business is young and growing rapidly, you probably won’t be expected to pay shareholders’ dividends right away. All companies receiving equity financing, however, experience some dilution of existing shareholders’ ownership and often give up partial control over major business decisions.
When is it appropriate to seek equity financing? You may want to consider acquiring shareholders, such as angel investors, if your business is new and lenders view it as too great a lending risk. As your company grows, financing from a venture capital fund is a possibility.
Venture capitalists generally fund innovative ideas with high growth potential, and typically require a majority ownership and board positions. They particularly favor companies that are likely to go public. But before you seek venture capital financing, understand that these investors will probably want to be consulted regarding business decisions — even if your company has a proven management team and past successes.
But progressive and promising businesses that do not urgently need capital may successfully raise venture funds without relinquishing control, especially if competing interest is created among venture capital firms.
Another equity financing option is to take your company public with an initial public offering (IPO). The net proceeds from a public stock offering can provide your company with significant capital. IPOs, however, can be expensive and time-consuming, and you must be prepared to face an entirely new set of regulatory requirements by the Securities and Exchange Commission.
Debt has several advantages: It does not dilute the equity of your existing shareholders, and interest payments, unlike dividends, are tax deductible. Debt financing comes in many forms with varying borrowing periods, interest rates, repayment terms and collateral requirements.
How do you know if you’re a good loan candidate? Lenders look at the three Cs — credit quality, cash flow and collateral. If you can satisfy their requirements in these areas, you may qualify for debt
The most common type of loan is long term, or senior debt, obtained through a bank, government-sponsored program or small business investment firm. These loans are usually obtained to pay for major purchases such as plant facilities, major equipment and real estate. The principal and interest are paid in installments, often matched to the expected life of the funded asset. Lenders typically require significant collateral for long-term loans — including physical assets, inventory and company stock.
Banks also provide short-term revolving loans with terms of up to a year. Collateral requirements are usually less stringent, typically inventory or accounts receivable.
Leasing is another common form of debt useful for buying equipment and even facilities. While leases are more expensive than bank revolvers, or credit lines — which typically cover operating expenses rather than equipment — they can be a useful supplement to bank debt.
If your company carries large inventories but doesn’t qualify for senior debt, asset-based lending may
be available from some banks and specialized lenders. The creditworthiness of an asset-based borrower depends largely on its cash flow and the value of its inventory. Asset-based lenders closely monitor both metrics and may terminate these loans if borrowers appear overextended.
Subordinated Debt Alternatives
You might also consider a subordinated debt, commonly referred to as mezzanine financing, which boasts both debt and equity features, and has secondary claims on assets when a company enters bankruptcy. One type of mezzanine financing, convertible debt, is a loan that converts to common or preferred stock according to a repayment schedule and within certain performance measures agreed upon by the borrower and lender. Because lender risk is higher, borrowers generally pay higher interest rates on subordinated debt than on senior debt.
Process of Deploying Capital
Raising and deploying capital — whether equity or debt — is not just a transaction, but a process. It doesn’t end when you get the funding you need. New shareholders are likely to want to influence company strategy and, at some point, may seek dividends or dividend increases. And lenders require evidence that you are adhering to loan covenants and that your company is financially healthy enough to repay its debt.
Because you will need to provide investors and lenders with regular financial reports, you should have some understanding of basic financial ratios and accounting concepts. This knowledge will help you to work more effectively with your financial advisors and better identify future capital requirements.
Rely on the M&A advisors at Doeren Mayhew Capital Advisors to help you obtain the right source of financing to meet your capital needs. Contact us today!