Generating enough capital to continue to grow and expand is one challenge many companies face. In addition to reinvesting profits back into the business, companies may need to seek alternative sources of working capital and growth capital to accomplish their goals.
There are many financing options that provide the necessary working capital to grow successfully. We’ve outlined five options below. Some of these may be used alone or in combination, with the objective of providing the right debt and capital structure at an acceptable cost to the business, without overburdening the company. Determine your capital needs for working capital and growth first, and then identify the various sources of capital available.
- Traditional senior debt may meet all or most of your needs, but there may be limitations on how much is available based on your industry, company profile, and complexities as well as your assets and liabilities, profits, and cash flow. Some growing businesses have difficulty with traditional debt since there is a higher focus on growth versus profits.
- Asset Based Loans, or ABLs, are a form of secured lending that is based principally on the value, quality, and adequacy of the assets (collateral) pledged. The lender’s interest is secured by the borrower’s assets, which typically consist of inventory, accounts receivable, and other assets. The amount of credit the borrower can access is based on the value of the assets. Generally, the more liquid the assets, the more desirable the collateral becomes, and the higher the advance rate is available on the borrowing base. Advance rates depend on a variety of factors, but can range from 80% to 85% for accounts receivable and from 60% to 70% for inventory. ABLs benefit growing companies with high working capital needs by using strong tangible assets, accounts receivable, and inventory. As sales grow, tangible assets grow, thereby increasing a company’s borrowing base.
- Mezzanine debt is a layer of financing between the company’s senior debt and equity. It is subordinate to senior debt, but senior to common stock or equity. It usually has embedded equity instruments such as warrants, which can be converted into equity by the holders. Owners still maintain control of the company but may face some dilution of their ownership interest. Mezzanine debt can be structured with flexible payment terms but will incur interest expense over the term of the debt. It can be an attractive way to obtain capital to fund a growing company’s expansion or acquisition needs.
- Investors or friends and family may be an alternative for additional capital, often in conjunction with bank financing. However, the main disadvantage of bringing in additional investors is that it dilutes existing owners. Plus, the cost of raising equity can be higher than bank facilities and may take a significant amount of time from key stakeholders.
- Private equity funding can provide a significant amount of capital and active management expertise that a growing company may not have within its existing management team. The key downsides to this alternative are that owners usually lose control of the company, the existing owner’s stake in the business is diluted, and the private equity fund will look to exit the business in a five to seven year timeframe.
Consider the financing options that will put your company in the best position to succeed. When evaluating your options, weigh the risks, price, opportunity cost, flexibility of the structure, and ease of use. There should be a proper balance between price and structure that allows you to meet your growth objectives without being so restrictive that it disrupts the business.
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