Entrepreneurs at growing companies often rush to raise venture funding. But they probably can find better sources of funding right under their noses.
We often get asked some version of the following question: "When should we seek venture capital funding?" It's a question that growing businesses grapple with, whether they are a successful startup or a fledgling adjacency business within a larger corporation. Growing businesses need funding, and most inevitably find themselves raising funds from some form of venture investor.
In our view, there is entirely too much emphasis on raising equity financing through traditional venture approaches, instead of taking the time to find the right type of capital to match the specific needs of the company. We've written in the past on alternative funding options such as venture debt, and we've talked about the cases where it makes sense to raise venture funding. But, giving up equity is extremely costly, and there are a number of reasons to avoid it if you can.
There are a number of other funding sources that you should explore before raising equity capital. Here are five, in order of most to least preferred.
Cash flow from operations: A basic principle of business strategy is to invest profits in areas that will create high returns on investment. First determine how you can maximize cash flow, then deploy that cash flow to fund high-value investments. Profits, not revenue, are the fuel for growth.
Founder's equity: Without putting yourself in a highly risky financial position, you should look to invest any outside capital you have in the business. This allows you to retain ownership and avoid dilution from other capital providers, but it also is an important signal to future equity contributors that you believe in the business.
Friends and family: Much like founder's equity, raising funds from friends and family shows that you and your trusted advisors believe in the business. You also avoid giving up control to third parties with potentially conflicting interests.
Bank loans and lines of credit: Bank loans, especially those supported by SBA lending programs, are often the best source of funding. These typically must be backed by inventory or accounts receivable, however, and often require a personal guarantee.
Venture debt or mezzanine debt: When traditional bank loans are not sufficient, alternative debt providers are an option, albeit at higher interest rates. Venture debt typically is backed by assets of the business, while mezzanine debt is often a high-interest rate debt that may be convertible to equity in some business scenarios.
If you've already exhausted these options, take another look at your business and ask yourself what your future look like if you funded growth only through the above means? Slowing down your growth may eliminate the need to raise capital from outside sources, while also providing some strategic advantages to your business. Before you commit yourself to raising venture capital, convince yourself that you really can't live without it.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark