Business growth rarely appears magically without a business owner planning for and securing funds to make it happen. Some businesses “bootstrap” their growth using cash flow. Many come to realize that squeezing cash will not yield the funds for the investments needed to grow at the pace wanted, and that means exploring additional financing. Whether growth requires a complete IT system overhaul, a new die-cut machine to speed up production, a new delivery van or even hiring and training new staff, a variety of options exist for a business owner to fund expansion.
Primary types of credit
If you are looking to find expansion funds, start with a basic understanding of your financing options. That means funding that fits your business need and that has a term that matches the anticipated life of the item being purchased. The most common types of credit and their use for your business growth plans include:
Line of Credit
A line of credit supports immediate short-term cash needs. A business can borrow against the line, repay the debt, and then re-borrow the funds as business and cash needs change. It is not uncommon for a business to borrow and repay the line amount two to three times during the course of a year. A line of credit is an excellent tool to cover payroll, pay bills, rent or even purchase inventory.
Fixed length loans commonly used for fixed asset acquisition, a term loan provides permanent working capital for expansion items such as hiring and training new staff, purchasing equipment or business acquisition. Term loans are secured with some sort of collateral from your business, such as equipment, and have predictable monthly payments, making budgeting easier. When using a term loan to purchase equipment outright, it becomes a depreciable asset on your balance sheet, and may be eligible for tax benefits.
Leases are typically used for equipment necessary to your business. The advantage of leasing versus purchasing equipment outright is that a lease strengthens your financial position by keeping the debt off your balance sheet. Leasing also protects against obsolescence with equipment that might be useful for only a few years.
Real Estate Mortgage Loan
The real estate mortgage loan has become one of the most popular financial products in today's environment. Issued based on use of the property - owner occupied or investor property - mortgage loans have terms up to 25 years and can be used to purchase, refinance or improve existing buildings. Mortgaging property (whether new or improving for expansion) can free up enormous amounts of working capital and help improve your business' cash flow.
Letters of Credit
Letters of Credit are becoming more common as tools to finance business necessities. Letters of Credit are proof of a buyer's credit quality and repayment abilities. Banks issue Letters of Credit guaranteeing repayment of the debt. A Standby Letter of Credit is based on contract performance, guaranteeing the buyer makes payments by dates specified. For instance, a landlord may ask a tenant to put a standby letter of credit to guarantee repayment of their rental stream. A Commercial Letter, on the other hand, is more generally used for the acquisition of merchandise or fixed assets. The Letter guarantees that the seller will receive payment on time and for the correct amount. Letters of Credit are effective tools for your business when dealing with new vendors, or vendors that are located far away. They act as a good faith instrument for vendors that are not familiar with your company, reassuring them of debt repayment.
Other financing options
Many other financing options exist, all with their own risks and rewards. Depending upon the stage of your business, you may opt to self-fund your expansion from personal savings or investments. This may make sense if you have stockpiled a large rainy day fund, but your business will then be limited to whatever personal assets and savings you have collected, and there is potential risk to your retirement and savings.
Loans from friends and family may also be available to your business. While this type of financing most likely offers favorable terms and helps if your business is not ready for bank initiated loans, the drawbacks can be a risk to personal relationships as well as control and management of your business, not to mention your finances may become an issue.
Vendor credit is an inexpensive credit option that leverages supplier payment terms, financing and discounts. Your vendors can be a good source of working capital, however you will be limited by your business scale and how much the supplier will actually be able to provide you in credit.
Do not be afraid of debt capital
Financing used intelligently can bolster your cash flow while funding the items necessary to keep your business operational and growing for years to come. Smart businesses do not let their working capital needs stand in the way of their short- and long-term growth plans. Using any one of the flexible financing options discussed above will help conserve cash to fund capital spending. Talk to your banker to determine which of these options fits with your business balance sheet and expansion plans.
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.