A business can go a long way with a strong product or service, a well-thought-out strategy and disciplined execution. When it comes time to expand the business, that same level of analysis should go into identifying and selecting the best sources of capital. All capital is not alike, and business owners’ financing decisions can have profound effects on cash flow, business risk, valuation and options for future capital rounds, mergers or sales. Selecting the best capital source(s) from the array of traditional, and not so traditional financing options starts with understanding the options:
Conventional Loans - Loans and lines of credit from banks on standard terms. More than a fifth of businesses report that they will seek a bank loan for capital to fulfill their growth plans,1 and businesses often use lines of credit to support short term cash needs. Conventional loans are designed to accommodate larger loans with favorable terms for bankable businesses and are an important element in driving down the cost of capital. These loans often include credit terms with owner guarantees and routine financial reporting requirements.
Credit Cards or Line of Credit – Personally-secured business credit cards and lines of credit finances inventory and working capital. Business credit cards lines provide owners possessing good credit and assets access to additional capital and a means for electronic payment, even when a company is at an early, pre-bankable development stage. Business credit cards and lines are a relatively expensive source of capital, and terms vary across different types of lines and cards.
Leasing – Effectively renting capital equipment or vehicles without the capital requirements or ownership commitments of purchasing. Eighty percent of U.S. companies lease equipment2 to take advantage of lower payments and improved cash flow. The simplicity and reduced commitments of leasing come at a cost: leasing programs generally represent a higher cost of capital versus outright purchase using other funding sources.
Equity Investors – Selling part of the company in exchange for capital. Equity funding can originate from a variety of sources including current owner, business partners and professional private equity investment firms. Nearly 20 percent of businesses are pursuing private equity group financing.1 Private equity typically targets companies needing growth capital or those businesses undergoing company or industry restructuring. Governance and advice is provided by private equity group general partners. Owners can expect significant dilution and sharing of control and profits with private equity group investors.
Mergers & Acquisitions (M&A) – Merging or acquiring to take advantage of a target company's funding and potential synergies. Twenty-three percent of business executives have M&A in their plans over the next five years.1 Combined the resources of two entities can provide additional capital and management skills along with synergies to eliminate product, sales and distribution, operations and infrastructure overlap. Successful M&A requires lining up strategy, deal selection and merger execution and is often supported by industry and corporate finance specialist with deal expertise.
Small Business Administration (SBA) Loans - Loans from banks guaranteed by the government offering favorable terms and flexible underwriting criteria. SBA loans are designed for earlier-stage companies – although they can meet many more mature company needs as well - and offer the features that many growing companies need like flexible terms and the ability to meet a wide variety of financing needs. Their use can range from start-up financing to larger loans that provide growth capital or finance ownership changes. SBA loans require thorough documentation and need a motivated and experience banker to work through SBA requirements and schedules.
Personal/Alternative Sources – Financing the business from personal savings, loans from friends and family or crowd funding methods. Investment capital may come from a variety of sources including: owners’ savings, credit access or distributions; friends and family; angel groups; crowdsourcing, etc. While terms may be more favorable than from professional sources, contracting, closing and ongoing management from part-time investors can be challenging. Rules around crowdsourcing can constrain other fundraising and limit future rounds.
Vendor Credit - Leveraging supplier payment terms, financing and discounts. Vendor credit provides a source of inexpensive working capital, but its use is limited by the scale of supplier credit and the usual terms of the industry.
Receivables Factoring – Selling receivables to a commercial finance company at a discount. Factoring provides cash and reduces collections risk by transferring receivables to a commercial finance company. While arrangements can vary, the commercial finance company often takes direct control of the receivable and interacts with customers to collect payments. Factoring is a relatively expensive form of capital and is only available to businesses with creditworthy customers.
Government Programs/Grants – Lending programs offered at the federal or state level or public policy grant awards. Government programs offer flexible terms and wide variety of options. Grants do not generally have to be repaid. Availability of government programs varies by region, and grants are usually limited to specialized fields.