Growth and expansion to multiple locations are one of the most effective ways to substantially add to the value of your business entity. An expansion with multiple locations increase the value proposition to referral partners, improves your ability to increase discount with key vendors. When you grow to reach an appropriate size, it makes your business more visible and attractive to potential investors, in the industry.
In order to a systematic creation of a business with the generational wealth that can pass to your next generations, it is very important to analyze the different option of funding such expansion. It is important to know how growth is financed while analyzing the price of finance and the terms of transactions. Price knowledge of such sensitive issues, allows both seller and purchase to negotiate a mutually beneficial deal.
A clear understanding of the options to finance growth and expansion minimizes the risk of failure. It is the primary role of any corporate finance professional to be aware of different types of financing option with the aim to managing the overall capital structure of the business, some of the ways are listed here as under.
- Vendor Finance
In this method, the finance is provided by the vendor companies as prior orders, or pre-discounts or credits in exchange for a commitment to purchase a specific quantity of product during the tenure of the agreement. It is a good option for companies who are just on the growth track as this type of finance is easily accessible and causes fewer restrictions. However, vendor financing offers an expansive form of capital relative to other sources as it is tax inefficient.
- Seller Financing
In many acquisitions or seller purchaser agreements seller provide substantial financing by deferring the payment to close the acquisition. Very often the buyer is unwilling or unable to make full payment to the seller while closing the deal. The seller agrees to accept the part payment of the purchase price at the time of the initial deal and the reaming part is given to the buyer as a loan which was to be paid along with the interest by the acquiring person over the time. This process creates an alignment between the buyer and the seller as both parties have vested interest in the successful completion of the deal.
- Bank Financing
Bank finance in the growing economy is also a viable source for financing growth of any company. However, banks tend to be more conservative in financing such acquisition or expansion trades. They require substantial information in the form of financial disclosures and often ask for personal guarantees and other collateral securities. The banks personal may not have the expert knowledge on a specific business or industry. Therefore they may be reluctant to lend or may ask higher interest rates to compensate for the risk involved.
- Equity financing
In equity financing, the company sells shares to raise capital, whereas in debt financing the company borrows the money to pay it back in future. In equity financing funds are raised from friends and families and the public in exchange for a part of ownership proportional to their investment. The benefit of equity financing compared to debt financing is that equity financing does not carry interest or require future repayment. The equity selling dilutes the ownership and passes it to the new entities, thus diverting the cash flows to new owners.
While there is no cash cost reflected on profit & loss statement associated with equity financing, equity financing is much more expensive than debt financing.
Private equity groups are investors who invest in privately held businesses. The benefit of taking private equity partner is that these provide additional capital for a company to grow.
Though private equity finance apparently seems more lucrative, you may have to compromise over the decision making capacities. It may be just like a transition from the owner of an enterprise to a CEO who has to report to the board of Directors.
- Other means of financing
There is also some other additional financing option available using private placements, mezzanine debt, asset-based debt, and preferred debt. These forms of financing are based on blending different components of equity and debt financing with each other. This type of instrument often attracts a higher rate of interest. Some of these are mentioned as. a) Equity warrants – It is the option to purchase equity at a predetermined price, often at discount.
b) Payment in kind (P/K) – Here the interest is deferred and added back to the principal loan amount.
c) Convertible debt – Here the principal debt is converted into equity ownership.
The above other options are used when traditional financing options are exhausted. They are used and negotiated on the deal to deal or lender to lender basis. The rates and terms are negotiating and can be an attractive option to attract capital to the company.
Growth of business in a successful manner is important than increasing the sales volume and expanding locations. Managing the right source and right use of debt and equity financing certainly ensure that the business grows in a sustainable and efficient manner.