Financing growth in small and mid-sized companies - How should a business finance its continued growth?


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SELECTING THE MOST SUITABLE FINANCING OPTION FOR YOUR BUSINESS
Many small and mid-size businesses are undercapitalised. This lack of long term financing is often the restricting factor in an entrepreneur's ability to continue to grow and expand a business.

Before examining the various financing options open to you as an entrepreneur or owner-manager it is useful to summarise a three-step process to establish the most suitable financing option for your business:

  1. Consider the nature of your requirements and match them to an appropriate source of finance.
    This exercise will identify those sources of finance that are potentially suitable for you. Finance for growth tends to be long term, typically provided by term loan or a third party equity investment.
  2. Carry out capacity tests.
    Does your business have the ability to attract the finance? For example, in the case of debt finance, does your business have the ability to borrow, secure and service the repayments? In the case of equity investment will your business development plans provide a sufficient rate of return to attract an outside investor? These tests will identify those sources that are effectively available to your business.
  3. Carry out a cost comparison of the various alternatives.
    Can your business carry these costs? In the case of debt, can you service the interest repayments? On the equity side of the equation, are you prepared to give up an element of control over your business?

With this process in mind, we can now examine the various funding options available to finance your expansion plans.


TERM LOANS AND COMMERCIAL MORTGAGES
These are secured loans provided by a bank (or other financial institution) for fixed periods, granted for a specified purpose such as funding the purchase of property, fixed assets, or perhaps another business. The debt will typically be secured by the property or the assets of the business purchased. Term loans and commercial mortgages are repayable by agreed amounts within a fixed timeframe. In the case of term loans this period will usually be between 2 and 7 years. For commercial mortgages this could extend to 15 or more years. The advantages of using debt finance include retaining equity, fixed interest payments and flexible payback terms.


FINANCE LEASING AND HIRE PURCHASE
These two financing products, though fundamentally different in their legal form, have common traits. They involve the bank (or other financial institution) providing funds for the purchase of an asset - generally plant and equipment, machinery, computers or motor vehicles. The financial institution is then paid periodic instalments, generally over 3 to 5 years. At the end of the finance period, the asset can be purchased outright by the borrower, often for a nominal amount. Alternatively, secondary rentals are entered into which will be for nominal amounts, e.g. $1 per annum. It is an ideal form of finance for assets that tend to depreciate over 3 to 5 years as it effectively matches the repayment period for the finance with the period that the business benefits from the use of the asset.


BUSINESS ANGELS
Business angels are generally high net worth individuals who are former entrepreneurs or executives who invest in entrepreneurial companies. In most cases they will wish to have an input into the running of the company and will generally provide wide-ranging advice to the existing owner-manager.


VENTURE CAPITAL
Venture capitalists operate by seeking investment opportunities that offer a higher rate of return based on the growth of the business during the investment period. They target companies that can achieve rapid growth in turnover, profitability and value. They invest by taking equity holdings in companies and consequently if the business fails the investment will most likely be lost. As they do not hold security on their investment they will generally be seeking to significantly increase the value of their investment in a three to five year period. Research internationally indicates the fastest growing companies in respect of profitability and employment have a venture capital shareholder.

Venture capitalists provide funding for a variety of uses, the most important of which are as follows:

  • To facilitate an increase in the rate of growth in a company
  • Expansion through acquisition
  • Management buy-outs and management buy-ins
  • In some cases by providing replacement capital when original shareholders wish to "cash-in" the value of their investment
THE NEXT STEP
Every company needs capital to conduct business or expand operations, but understanding how to finance your business effectively can be extremely advantageous - different sources may be appropriate depending on your company's existing position or its ambitions. Choosing the right time and the best way to go about obtaining your capital, whether through debt or equity funding, can save you a lot of headaches.