With banks taking a more conservative approach to financing, it's wise to explore these other options.
Growing your small business is challenging, whether you're an ice cream company looking to significantly expand distribution, a software company establishing a new office to double your staff, or a parts manufacturer looking to create a new customized production line. One of the biggest hurdles is getting the capital you need to take the business to the next level. A lack of funding can stunt growth and force you to forgo profitable opportunities. At Avondale, we often get the following questions from business owners, so we thought we would take this opportunity to share our perspective with our readers.
Can I get a bank loan?
Getting credit today is still very challenging relative to the go-go era of loose credit and easy money. To qualify for a small business loan, you need to convince banks that you'll have a certain cash flow-oftentimes through personal guarantees.
Services-based businesses and companies with short-term contracts get extra scrutiny when seeking bank financing, further decreasing your chances of success. Businesses with limited assets will face further challenges, since banks look for hard assets that allow them to get their investment back if the business starts to flounder. If your company is a services business with short-duration contracts, then you really have an uphill battle.
What are my other options?
Entrepreneurs can pursue several alternatives to traditional bank financing, including:
Venture funding / private equity
Public / municipal development funds
Equipment financing / asset-based lending
Equity-based financing can be a smart way for entrepreneurial firms to grow. The right strategic investors will allow you to grow your business faster than you would be able to do on your own. While equity funding may require you to reduce your ownership stake, this is often still a value-creating proposition.
Consider two scenarios for a company worth $100. In Scenario A, the business doesn't take on equity partners and successfully grows to be worth $400 in three years. In Scenario B, the company takes on a 25% equity partner, who helps grow the business to $800 in three years. After three years, the owner in Scenario A has a company worth $400, while Scenario B has delivered $600, or 75% of a company worth $800.
In this example, the strategic partner has created $200 in incremental value under Scenario B for the company's owner, in addition to injecting capital in year zero.
How should a small business position itself to get financing in today's market?
When raising capital, the "who" is just as important as the "how much?" Always select an investor that brings more to the table than cash alone. The following steps are critical in developing a robust growth engine for your business over the long haul:
1. Find a partner you trust
All good relationships are based on trust, and finding a business partner is no different. Look for a partner who's willing to help you in advance of a formal agreement and someone who understands how to truly partner to grow businesses.
2. Find a partner who understands your business
An equity partner who understands your business has every incentive to truly partner with you to grow your business, which is very different than a general purpose bank lender. Banks are focused on getting repayment of their loan; strategic partners focus on growing your business. A strategic partner with industry experience can be helpful, but it's more important to have a strategic partner with a strong track record of driving profitable growth.
3. Get the right funding for your business
Each funding source will bring some new value to your business, but all capital comes at a cost. Depending on your business's growth ambitions and capability gaps, finding the right growth partner with the right amount of capital is critical to building a profitable and sustainable business.
Passing on active strategic equity partners can impair a good business's growth prospects by not aligning new stakeholders with the business and potentially starving your growth engine of much-needed capital.
Additionally, small businesses often underutilize trade financing and other specialty loans. Equipment suppliers, municipalities or strategic customers all might offer significantly more attractive terms than your average lender and add strategic contacts to grow your business.
The most important concept is to match the right type of funding and the right capital partner with the needs of your business. This simple process goes a long way in setting up the company for long-term growth.
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