How to finance business growth in a slowing economy

By Odhiambo Ocholla

You have grown your business one customer at a time to get to where you are today. Going forward, a company will require additional capital sufficient to execute its growth strategy.

Should a company raise debt or equity or some combination of the two? A company that is growing rapidly will often need to make many changes as it moves from one stage of its lifecycle to the next. Capital structure is no exception.

The mix of debt and equity that fit your company’s needs will depend on your capital structure, risk tolerance, preferences of the owners, consistency of the business’ cash flow and maturity of the product markets, among other things.

It is critical to determine how much cash your company requires to successfully execute your growth strategy, as well as what mix of debt and equity best meet your needs.

Eventually, most growing businesses will face severe liquidity and cash flow problems. Fortunately, our capital markets allow for opportunities to finance corporate growth through readily available providers of debt and equity.

Invoice discounting

One of the most common types of a lending instrument is "asset-based lending facilities." These facilities usually allow lending based on an agreed-upon percentage of the underlying security, which can be your accounts receivable or inventory. This is a good tool for growth as you only borrow as much as you require and given the current interest rates, it represents an inexpensive financing vehicle.

Another banking option available for companies is "factoring." This is where a company in essence sells its accounts receivable to a finance company.

Factoring tends to be more expensive than an asset-based lending facility, but often, they are more readily available and quicker to implement, especially for companies that do not have a tremendous sales volume, or do not want to be tied down by what can be a cumbersome loan document.

Invoice discounting is a source of steady and predictable cash flow, which is crucial to the success and profitability of every business.

All too often, a business will find the majority of their working capital tied up in accounts receivable. Invoice discounting is the business of financing accounts receivables. A third option is through "purchase order financing".

This vehicle allows a company to borrow against a purchase order that it may have received from a major customer. The proceeds received are usually provided directly to an inventory supplier to ensure the inventory is delivered to fulfill the purchase order.

This type of facility is not common in our market and can become very expensive. Another option is bank debt, which comes with interest expense and conscious CEO’s may want to avoid these costs. Bank debt may also burden the company’s balance sheet.

Private equity instruments

Growing companies may also want to consider private equity instruments as another financing tool.

The downside to this strategy is that equity transactions tend to be more complicated, take longer and essentially involve bringing in a new partner.

Should you select this option, be aware that there are numerous forms of equity arrangements for you to evaluate, including common stock, preferred stock and redeemable or convertible stock. Each of these equity instruments contain different types of rights and privileges.

As a business owner, you will need to receive reliable business advice and carefully analyse the agreement and its implications before entering into any type of equity transaction.

The equity deals are permanent, as opposed to a loan, which you can always pay off.

Another option is Asset finance, which allows your business access to vital assets without paying for them at once.

All forms of leasing are basically rental agreements, giving you the right to use an asset owned by the finance company for a specific period of time in return for regular payments. The benefits of asset finance is that it allows the lessee to use assets directly, thus saving on start-up capital costs thus improving cash flow.

—The writer ([email protected]) is an Investment Banker.