Growth Strategies: Does Your Business Need More Capital?
"Does your business have enough capital to continue growing?" For many privately held small to-mid-size businesses right now, the answer is no. Funding top-line growth was identified as a major challenge by mid-market CEOs in a recent Conference Board research report. And applications for SBA-backed loans are pouring in at a record pace – up 21 percent for the first three quarters of fiscal 2005 compared to a year earlier. For many owners, that challenge in funding growth is as much identifying how much capital is needed as determining how to fund it.
How much is enough?
While each business is unique, there are some guidelines that an owner
can use to determine how much capital is needed. Asking the following
questions can give a business a head start in working with a financial
professional to identify capital requirements:
- How fast is the business growing? An early-stage, fast growing business will have greater capital needs than a more mature organization.
- How seasonal is the business? A toy retailer or landscaping company will need greater capital to bridge slow seasons or fund pre-season inventory accumulation than a business that operates on a more even keel all year.
- How cyclical is the business? Beyond annual seasonality, many businesses must manage in the context of longer selling cycles. Technology firms, construction companies and some manufacturers may need to anticipate long lead times from concept to final sale or boom-and-bust sales cycles driven by economic trends.
- Is the company's value based on hard or soft assets? If the company is a manufacturing operation, its assets are physical – equipment and inventory. These may require greater initial capital outlay, but they also provide a more tangible basis for determining assets that can be considered when seeking financing. In contrast, a professional services firm's assets are knowledge and people – less capital intensive but also more difficult to account for on a balance sheet.
Once an owner understands what level of capital requirements the business has, the next question is how much debt the business can carry.
When evaluating a business, banks and other financing sources typically look at two key criteria: balance sheet leverage and cash flow leverage. In other words, they examine the borrowing power based on the net worth of the company, using an assets-to-liabilities ratio, and they examine the company's ability to repay a loan based on current sales and income levels. What constitutes a healthy balance sheet varies from business to business; some types of business can have a debt-to-assets ratio of as high as 20 to 1 if the cash flow analysis shows that the business can comfortably repay the loan.
Where is funding available?
While there are many stories of business ventures that started out
being financed on the owner's personal credit card, most businesses
need more sophisticated funding strategies.
Yet few private business owners fully understand the variety of funding sources and strategies that are available. For example, short term financing can often by arranged simply by negotiating extended payment terms with suppliers. This is often an appropriate solution for seasonal businesses. Other strategies:
The owner's personal equity is often tapped for financing a start-up business. A less risky alternative is to use the personal equity as leverage for a business loan.
Bringing in strategic partners can provide additional capital in return for a percentage of the business. An added benefit is that the partners often bring additional expertise or contacts. The downside is that as the business grows, the partners' share increases proportionately.
Traditional bank lending can be an appropriate alternative, especially if you find a banker who is experienced in your industry and will offer his or her business judgment. Many banks offer SBA-backed loans and some have departments that specialize in working with small businesses. A good banker can become a trusted part of your advisory team.
If the business has assets, they can be used as collateral for a loan. Asset-backed loans may carry more attractive interest rates than unsecured debt.
For a company with high growth potential, equity or venture capital may be a smart option. Venture capitalists are private investors who seek out companies that can generate significant returns with an infusion of capital. Some venture firms take a passive interest in the business, while others prefer to become active managers of the businesses in which they invest.
Where do I start?
When looking for additional capital, it is wise to start with the relationships
that are already in place – bankers, suppliers, advisors or
board members, attorneys or business associates may be able to provide
funds or recommend funding strategies.
Other resources include state and federal agencies such as local small business development bureaus or the Small Business Administration, as well as industry groups or small business advocacy organizations.
