Pro’s & Con’s of Funding Sources for Business Growth
You have a good and profitable business with strong opportunities for business growth (BTW, if you don’t you should not even be thinking about expansion!) and you want to replicate or multiply what is working now by expanding into new markets.
“New markets” can mean same-products-more-territory or same-territory-more-products. Either way, what you are going to need is funding.
The sources of that funding are limited in number and may be limited in volume (of cash).
Funding Sources for Business Growth
Founder Capital
Your present savings, or borrowings against assets you may have inherited or purchased with past savings or profits.
Upside: You don’t have to answer to anyone for their use, and you don’t sell a part of the farm.
Downside: Funds are usually limited and when they are fully exhausted and you need more and go looking for other sources you become dependent upon the judgement and decisions of others, and you are likely to have little leeway in which to negotiate terms.
New Shareholder Capital
Sell “Blue Sky” (the idea of future success based on past success, or of perceived strategic opportunity) and a share in the business to people with money, for cash – or, in some cases, “kind” such as premises, strategic relationships, stock, services or labour.
For example, you may trade a celebrity part of your business in exchange for their endorsement and marketing power, using credit of some form to bridge the short-term costs of expansion in the hopes of a rapid recoupment from strong, profitable sales generated by their pulling power.
Or, ultimately, you could look at an IPO, but beware of the leap into the Public Company space of compliance and accountability.
Upside: You’ve shared the load and, in the case of a wealthy investor, you may have gained access to future further funds or in the case of a popular celebrity partner, on-going brand power. In the case of an “ideal investor”, as well as their money, they may make their expertise, experience, contacts and other resources available free or under favorable terms.
Downside: You are now answerable to others and may have to negotiate or explain decisions on matters you’ve previously settled without consultation or accountability. You may also be entangled with their fate such that a catastrophic event within your investor’s world, over which you have no control – and probably no oversight – may now impact even more catastrophically on yours. In the case of an IPO, your now a mere part of a Board and subject to group decision making, regulatory oversight, etc.
Profits
The ultimate no-hangover source of expansion capital is consistent, high volume profits from every site that you operate. If you set and achieve goals to be sufficiently profitable as to self-fund a controlled, 20-Mile March[1] approach to expansion then strategy, people and execution – not cash – will be the limiters on your expansion.
BTW, if you succeed in this strategy you are likely to find that all of the other sources of funding push money, credit and other resources upon you!
Upside: You are beholden to no one and can follow your own star. If the market slows and profits dip, it is an automatic warning that you should perhaps either slow expansion or, if you have enough socked away, continue while better managing conditions that are presently disadvantaging your competition.
Self-funding is likely to have you permanently focused on profits and cash at bank and that is never anything but a good thing!
Downside: You will be controlled by your ability to generate profits; by your ability to attract, induct, develop and empower good people; and by your ability to develop and improve systems that facilitate growth.
Suppliers
You may enjoy credit terms from your suppliers and these are basically short-term loans under which you are provided with products in advance of payment. If your turn cycle is shorter than the terms you can negotiate with suppliers, then your suppliers will not only fund your cost of sales (CoS) but the profits you generate from reselling that stock may be sufficient to cover your overheads as well and – in the best of possible worlds – yield free cash with which to expand.
The three operative factors in this strategy will be:
- The terms (all-up price plus length of credit) on which you purchase;
- The speed with which you can sell stock; and
- Your gross and net margins.
Negotiating consignment terms with suppliers may be one solution to the first two factors for under such an arrangement you don’t pay for stock until it is sold.
Upside: This is effectively “an interest free loan” (though you have to ask what terms you might enjoy if you paid COD). Besides, your suppliers are invested in your success – the more successful you are, the more of their products you move. They may also be prepared to assist in other ways via introductions, references, strategic alliances, delivery options. In short, there may be a wealth of mutual opportunity to be explored.
Downside: If you misuse this form of “free credit” and become dependent upon it, its withdrawal or curtailment at the discretion of a concerned supplier could bring you down when you are at your most vulnerable.
Customers
The ultimate form of Customer funded expansion is crowdfunding under which prospective new customers pay (usually, but not necessarily, a small sum) in advance of supply. In some cases, in advance of creation!
Other forms of advance payment by customers may include:
- Bulk buys – pay favourable prices in advance for a year’s supply and draw on it monthly;
- Premium deals – pay a very high price for a collectible or prestige limited-edition version of a future larger volume product (manufacturers will sometimes do this with one-off versions of fashion items – or cars, perhaps the ultimate fashion item?)
- Early-bird deals – presell attendance for a rock concert or entertainment event (eg, the Olympic Games); pay a lower price in advance for a cruise or other journey; buy real estate in future developments off-the-plan at current rates in the belief that prices will be higher in the future.
- Memberships – once the province of the gyms (pay for a year’s membership in advance) but now largely illegal, if there is a legitimate way for your customers to pay you in advance, you have cash now that can fund expansion.
Upside: Cash now for product later. There may be little protection for the customer and little downside for you if you don’t deliver.
Downside: Cash now for product later. There may be protection for the customer and a lot of downside for you if you don’t deliver! Besides, you are taking on a liability to supply a product and (probably) a service – and carry the overheads of doing so – and will have to fund those from new cash, since you’ve already received and spent the revenue due on those when you were expanding.
This is the (cash) desert crossing that claims so many optimistic entrepreneurs who figured it would never stop growing and all go to plan.
Banks
Much maligned but probably the “cleanest” source of cash for your expansion. They don’t want to tell you how to run your business. They just want to charge you interest – usually a competitive rate of interest – and be repaid.
The challenge, however, will always lie in the gap between the characteristic that makes each great at their chosen profession: The entrepreneur’s optimism and the banker’s pessimism.
Banks make their money not by lending, but by being repaid with interest. Generally, they will want to limit their risk by understanding your cashflow history, and by staking a claim over assets. However, those assets may be lying idle on your Balance Sheet right now in the form of premises, equipment, stock, work in progress, debtor accounts, and order book.
Upside: Banks can provide a useful balance by providing tough, objective scrutiny of your plans and a discount on your optimism. If they do lend you money it usually comes with few strings attached, at market rates of interest, and may be provided as a revolving line of credit that you can draw on.
If you are blessed with the best of bankers (the ones who are willing to partner in your success), they may also provide you with a sounding board, review panel, advice, connections and more.
Downside: Banks are tough judges of business propositions. They don’t have stars in their eyes (if they did they’d be out there competing with you). They just look at the numbers, run them through decision-making software and tell you the answer. If there is a lot of blue sky in your expansion plans then the banks are unlikely to want to buy into them.
Banks are also megaliths and the person with whom you might do the deal is unlikely to be a shareholder, a high-level decision maker or a director of the bank; they are likely to be a cog in the machine and, like all good cogs, they’ll do as they are told from above. What that can mean to you is that your bank’s board can decide at any moment that they are “over exposed in your sector” and terminate your credit, not because of anything that you’ve done or not done, but purely because you no longer fit their current risk modelling algorithm.
Government
Never overlook the possibility of there being government funding available for business growth within enterprises committed to expansion. Governments count jobs because they generate taxes and keep voters happy. Governments will periodically seek to “stimulate jobs” by providing a range of funding designed to facilitate business growth. Federal, State and some Local Governments may be a worthwhile source of growth funding.
Upside: Cynically – the responsible department has a quota of businesses to assist and funds to disburse in the hope of meeting a target for new jobs created, and you look like a suitable candidate to contribute towards that quota. If you produce results, there could be more money over a term, as well as other forms of support (introductions, accreditation, infrastructure, and more). Explore what is on offer with one of the more motivated and clued-in officers and you may be surprised at the result.
Downside: Governments run on paperwork and you’ll be filling in forms, providing reports, answering questions. Sometimes it’s not worth it – other times it is. Policy can change overnight and blow a hole in your cashflow projections – and maybe in the bottom of your boat.
Bikies
Loan sharks by whatever name are seldom – very seldom – a worthwhile source of funds. The interest is high. The terms are punitive and usually designed to see you repay the loan many times over. They lack a sense of humour – and sometimes, a sense of decency.
Upside: We don’t know of any success stories to share.
Downside: Watch a couple of episodes of The Sopranos and you should have enough information to make your own judgements on this one.
