Question: What are my options for financing the growth
of my business?
Answer: Before you seek financing, you need to know
what you need the money for. For instance, will it be to fund
ongoing operations, to introduce a new product or service, or
to grow through acquisition?
You need to match the form of financing with the type of
risk. Many business owners try to raise debt financing when
they really should be raising equity. Or they sell equity in
their company because it’s “free,” i.e., it carries no
requirement to pay a current return.
The liabilities shown on a company’s balance sheet list
capital in the order of preference in case of foreclosure,
liquidation or bankruptcy. Listed first, senior debt carries
the lowest cost and is backed by collateral and the company
owner’s personal guarantee. It may include a revolving loan on
the company’s accounts receivable and possibly a term loan for
hard assets. Banks are not risk-takers — they lend money and
want it paid back.
Preferred stock or sub-debt, often lumped together as
mezzanine financing, are subordinate in priority of payment to
senior debt, but is ahead of common stock. This is an option
for strong middle market companies with robust cash flow
seeking to expand. Small companies can’t often tap the
mezzanine market because they don’t meet the qualifications of
the institutions that provide this level of financing.
Equity financing is the capital appropriate for the highest
risk investments, such as starting up a company, developing
and introducing a new product line or entering a new market.
In exchange for taking this higher risk, the equity investor
will expect a much higher return than a bank or mezzanine
provider, making this the most expensive financing option.
Typical sources for equity financing are the owner of the
company, key executives/partners in the firm, friends and
family. Companies need to post revenues of $20 million or more
to even begin thinking about equity from an institutional
source.
Know what you will spend the money on. Understand the risk
you are asking the capital provider to make. Then go to the
source that fits your needs … and good luck.
Written by David B. Duval, Claiborne Advisors, sponsor
of the Chairmen’s RoundTable, a nonprofit volunteer
organization comprised of current and former chief executive
officers who provide free business advice and mentorship to
small-business owners. To learn more about the San Diego-based
group, visit http://www.chairmensroundtable.com/.
