Challenges With Financing Growth

“What’s The Best Way To Finance Growth For The Greatest Economic Return?”

The best approach to business financing growth is a short term vs long term type answer.

That is, do you focus on short term profitability or long term profitability or both?

If you have unlimited access to a cheap source of capital, then an optimal profit focus in the short term and the long term is going to be preferred with an emphasis on accurately managing margins to gain market share as fast as possible without eroding profits.

But most small to medium sized businesses in a growth period do not have an unlimited supply of cheap money, so there is a couple of different ways to look at the best approach to financing growth.

On the one hand, you could argue that its better to grow at the speed at which you’re low cost supply of money will allow you, even if this is not as fast as you could penetrate the market.

On the other hand, you could also argue that the cost of capital you’re prepared to pay should be dictated by the margin you generate in the market and that as long as you’re covering your cost and believe you can gain and keep share in the mid to longer term, that the speed more capital provides you is desirable as long as you can afford it.

This is where many SME’s struggle with using asset based lending compared to bank margining during a period of growth.

Bank financing is going to be cheaper on the surface, but may not be as cheap or as flexible as you may think.

For instance, if you’re talking about a margining facility in the millions of dollars, you’re going to have to provide audited financial statements on an annual basis and some pretty detailed monthly reporting and potentially third party measurement services as well. The incremental cost of these requirements can push up the effective rate considerably.

But the cost is the cost, and is bank margining is cheaper, then it should be used, provided that its also readily available and flexible enough to deal with your growth curve.

This is where bank or institutional margining in the short term can be very inefficient and costly to growth, even at a lower cost of borrowing plus the incremental administrative costs.

While many banks can be very cautious with extending credit limits, and sometimes even putting the brakes on their financing position, regardless of what their initial commitment may have indicated, asset based lender tend to follow more of a linear path and as long as you fall within their lending ratios and maintain the quality of assets, capital availability can growth at the right speed.

Once again, the key measuring stick is the collective profitability over both the short and long term.

The source of capital you use at any given point in your growth cycle should provide you with the capital required to growth the market as fast as you can manage at the least amount of cost, provided that you can cover the cost with the cash flow being generated.

This can also mean changing from one source of capital to another over time.

For instance, a business may start out with a bank or institutional working capital facility, move through one or more traditional asset based lenders as capital demands increase and then make a final transition to bank or institutional asset based lender that can provide the best rates versus leverage, but only tend to become interested when your monthly sales levels are at $5,000,000 or higher.

There can be tremendous challenges in figuring this out, but figure it out and stay ahead of the growth curve you must, otherwise you may loose momentum or be overtaken by someone else in the market that has figured out how to finance their growth.

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About the Author Brent Finlay