Seeking growth capital is a critically important function for a company or business owner, a function that requires considerable planning. Many times, however, business owners and managers, once they realize they need capital to continue growth, act hastily without planning, which often leads to mistakes if certain aspects are overlooked or overvalued.
“The capital acquisition process requires forethought,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “Importance should be placed on it well ahead of the time it’s needed.”
Companies and business owners seeking growth capital also have a tendency to focus narrowly on interest rate. Altman says negotiating small differences in the interest rate on growth capital to fund an initiative that is expected to bring, say, a 25 percent return, isn’t very meaningful.
“What is meaningful is working with the right partner to provide that growth capital,” he says.
Smart Business spoke with Altman about options and strategies when seeking growth capital.
What capital options are available to companies to fund growth?
There are a number of options for companies seeking capital. Companies can turn to banks for term loans and lines of credit as a source of senior capital. Additionally, some companies can get the junior/subordinated capital funding they need through angel investors and private equity firms. Terms are generally more flexible with those type of firms. Depending on what the business owner is looking for, an equity investment from these firms would require giving up a percentage of ownership, which may not be plausible to a company given where it’s at in its growth phase and how current ownership feels about relinquishing some control to an unknown new partner.
How do companies determine which form of capital is best to support their growth?
It’s important to have a multiyear financial projection model as the basis for decisions such as funding growth. From that projection model, a company can work with an accountant or a banker to determine the appropriate levels of capital needed and what form of capital might be best for the long term.
Capital need and the form of capital will migrate as a company’s leverage profile and leverage position change over time. Typically, the larger the company becomes — as its revenue, cash flow and asset base increase — the more capital options it has.
Capital providers will start by determining what level of capital the overall asset base of the company supports. As companies grow, that decision can shift to the level of capital supported by cash flow or its level of enterprise value.
What questions should companies with growth capital needs ask lenders?
When companies are exploring their options for growth capital, the focus should be on determining the advantages, disadvantages and characteristics of each form of capital. Equally if not more important than the terms and the cost of capital is who is providing the capital and what kind of partner that represents to a company. Certain sources of capital might want more control over a business, which might mean bringing on a partner who has the authority to make decisions on behalf of the company.
Talking with bankers, in particular, is a good opportunity to ask how the bank has helped other companies that are similarly situated. Find out how those companies found success, what made them stumble and what mistakes other business owners have made that caused setbacks at this stage in their company’s growth.
Finding the right solution is the most important decision a business owner can make. Start planning early and involve trusted, experienced advisers. It’s limiting to think of growth capital based solely on the rate, structure and terms. The partner is important, which is why companies should establish the relationships needed to acquire that capital well before it’s needed.
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