Growth is a natural part of every business’s journey. However, even when business is booming, SMEs may lack the funds to cater to these growing demands. This is what growth capital is for. This guide covers everything business owners need to know about the practice, including the many forms it comes in, whether it's likely to suit your business needs, and some important things to consider before seeking it out. We conclude by looking at some growth financing solutions before answering some frequently asked questions.
In business, growth isn’t just aspirational; it’s essential. Not only does it motivate teams and strengthen a business’s position in the market, but it’s also crucial to its long-term survival. However, while business growth is ultimately a good thing, it can cost a company initially. This is because when demand for your product or service snowballs, more capital is often required to keep up with this growth.
If you lack the time and funds to grow organically, growth capital can be an excellent way to take your small-to-medium size enterprise (SME) to the next level. Financing for growth allows business owners to bolster their cash flow to keep up with growing sales. This can provide a real lifeline for businesses expanding faster than they can afford.
If you're curious about growth financing, this guide will explain the difference between debt and equity capital, run you through the multiple forms growth capital comes in, and help you to decide if it's the right course of action for your business. However, before we get into the details, here's a basic overview of the practice.
GROWTH CAPITAL: A SUMMARY
Simply put, growth capital is funding a company’s resources to support its growth. Also commonly referred to as growth financing or expansion capital, the practice is usually taken on by mature enterprises looking to fulfil their strategic growth plans. However, growth capital can also be used by small to mid-size businesses intent on scaling up their operations.
As opposed to working capital, which is used to cover the short-term trading operations, growth capital is exclusively used to finance longer-term growth. Business owners can use this cash for a variety of growth-related purposes. For instance, the funds can be used to cater to existing demands, launch in new markets, or invest in new assets or technology.
DEBT VS EQUITY FINANCING
This type of finance traditionally comes in two forms: debt and equity. Here we outline the difference between these two types of funding and discuss the benefits and drawbacks of each.
As the name suggests, debt financing is a way that businesses can secure capital through borrowing. After borrowing a lump sum from traditional banks or private lenders, business owners pay back the loan in regular instalments alongside additional interest. Through using this type of funding, businesses can use a portion of their future earnings to make investments in the present. This is an essential practice for most businesses at some point in their journey.
This form of financing allows business owners to fund their company’s growth without diluting their ownership. However, if businesses struggle to pay back their growth capital within the agreed-upon time frames, they risk defaulting on their loan and jeopardising their credit score.
On the contrary, equity financing (or growth equity) refers to businesses selling a stake in their company in return for financial investment. These shares can be sold privately, to friends and private equity firms or publicly, on the open market. Unlike debt financing, equity capital doesn't require you to pay the funds back over time. However, by selling a portion of the company's equity to investors, business owners will be forced to relinquish some of their profits and control over the company.
Since you aren't required to pay the investment back in the future, equity financing can be an extremely sensible decision for high-growth enterprises. However, despite its clear benefits, securing equity capital can be time-consuming, forcing business owners to dilute ownership of their company.
GROWTH CAPITAL OPTIONS
Now that we've had a look at the two main types of growth capital let's break down the options even further. If you're looking to pursue either debt or equity growth financing, these are solutions that you're likely to come across.
Invoice financing is a type of debt funding businesses use to access cash tied up in unpaid invoices. Since late and unpaid sales invoices are one of the biggest cash flow obstacles business owners face, invoice financing allows business owners to free up capital that can be used to invest in their company’s future growth.
This financial facility is especially suited for growing businesses because it can grow in line with your sales. However, some invoice finance providers take a substantial cut of the payment, so it's important only to borrow from respected lenders.
If your business is looking to expand its horizons, chances are you’ll require specialised equipment to help you take these next steps. Fortunately, for business owners who don’t currently have the cash to purchase these tools, asset finance allows them to pay for important machinery and technology over an extended period.
Not only does this remove cash flow barriers in the short term, but it helps businesses potentially generate more revenue. However, since asset finance is a form of debt financing, if businesses can't afford their repayment terms, the lender will recover their assets.
Merchant cash advances
A merchant cash advance is another debt financing measure that gives businesses access to flexible funding. Merchant cash advance providers give businesses large lump sums in exchange for an agreed-upon percentage of their future credit or debit card sales. Since the repayments are relative to the current earnings, it's a useful tool for vendors that deal with fluctuating demand. Unfortunately, if sellers don't generate a high volume of sales through merchant card processors, it will be difficult to secure a sizable loan.
If your business has a strong credit score or can offer reasonable collateral, it may be worth exploring bank financing. Bank financing is any type of funding businesses can secure from traditional lenders. It includes solutions like business loans and overdrafts, and because it's perceived as a less risky form of finance, it can offer relatively low-interest rates. However, due to the strict eligibility criteria and lengthy application process, many businesses are excluded from this form of growth capital.
Unlike the options we've listed above, equity finance is a way to fund your business’s growth without incurring debts. As was explained earlier in the article, equity finance allows business owners to sell shares of their business in return for financial investments. It's an alternative form of finance that's best suited to companies with high-growth potential, and it's typically sourced through venture capitalists or angel investors.
IS GROWTH CAPITAL RIGHT FOR YOUR BUSINESS?
As you should be aware by now, there's no shortage of growth capital options to choose from. However, if you're still unsure if growth financing is the right fit for your business, here are three things to consider before reaching out to third parties.
1. Does your business have predictable revenue streams? Whether you're looking to secure finance from angel investors or alternative lenders, you stand less chance of being approved if your income isn't stable or predictable. Lenders want to keep risks to a minimum, so if your business can't guarantee future sales, they will be less willing to invest in its future.
2. Are you a high-growth business? With the clue being in the name, growth capital may be hard to pin down if growth isn't on the cards. Growth lenders want to be confident that their investment will pay off, especially if they'll be receiving equity in your business. Therefore, if your business doesn't have strong momentum, it may be better to look into more temporary solutions like working capital loans.
3. Does your business have a diverse customer base?
If you've already secured a varied customer profile, it's much more likely that you'll be financially secure in the long run. Therefore, no matter what product or service you sell, lenders and investors will be much more willing to move forward with your application if your business has a diverse customer base.
THINGS TO CONSIDER BEFORE SOURCING GROWTH CAPITAL
Growth financing can provide a lifeline to businesses with promising futures. However, before business owners seek capital externally, they need to have a clear strategy in place. Here are some questions you should ask yourself before landing on a solution.
- How much capital is my business after?
- When do I need it?
- How much interest can I afford?
- When will I be able to pay back loans?
- What type of financing will suit the needs of my business?
- Am I willing to give up stakes in my company?
FUEL YOUR SME’S GROWTH WITH KRIYA
For businesses struggling to maintain their expansion, financing can be an indispensable way to bring about sustainable growth. By reading our guide to growth capital, we hope you have gained a deeper understanding of the practice and have decided whether it's right for your business.
If you’re confident growth capital will be in your business's future, Kriya may be able to help. From invoice financing to flexible loans, we provide a range of flexible solutions that have been designed to turbocharge the growth of small businesses. If you’re interested in how these options could benefit your business, you can learn more about them here.
FREQUENTLY ASKED QUESTIONS (FAQS)
What is growth capital? Simply put, growth capital is funding a company’s resources to support its growth. Also commonly referred to as growth financing or expansion capital, the practice is usually taken on by mature enterprises looking to fulfil their strategic growth plans. However, growth capital can also be used by small to mid-size businesses intent on scaling up their operations.
What are the main types of growth capital? Growth capital can be roughly divided into growth equity and growth debt. Within these categories, growth capital can come in the form of many solutions, including invoice financing, asset financing, merchant cash advances, traditional bank financing and equity financing.
Which form of growth capital is right for my business? Before you decide which type of growth financing to move forwards with, you need to consider several factors. For instance, you should ask yourself how much capital you require, how much interest you're able to afford, when you need the funds, when you can pay it back, and if you're willing to give up shares in your business.
What is growth equity? Growth equity is when businesses sell a stake in their company in return for financial investment. These shares can be sold privately, to friends and private equity firms or publicly, on the open market. While equity capital doesn't require business owners to pay the funds back over time, it does force them to relinquish some of their profits and control to investors.
What is growth debt? Growth debt is a way that businesses can secure capital through borrowing. After borrowing a lump sum, business owners pay back the loan in regular instalments alongside additional interest. Through this type of funding, businesses can use a portion of their future earnings to invest in their growth. This is an essential practice for most businesses at some point in their journey.