David Wilner started his company with a combination of personal savings and credit-card loans and grew it to seven employees and annual sales of $1.4 million. Now he'd like to take Rhino Imaging LLC to the next level, and he's pondering how to pay for it. After settling $40,000 in start-up credit-card debt, he's not anxious to borrow again. "I just like knowing I don't owe anybody," explains the 31-year-old founder of New York City document management company.
Entrepreneurs considering expansion have three basic financing choices: internal funds, borrowing or selling equity. But the key question is timing. When should you seek financing? And the short answer is: Now. "The first rule for getting any money is to have set yourself up for new capital before you need it," according to Ralph Alterowitz, a Potomac, Md., new venture consultant and co-author of Financing Your Business Made Easy (Entrepreneur Press, 2006). Approaching a bank about a line of credit or a relative about investing helps you learn and tells financing sources you are serious about cash management, Alterowitz adds.
Assuming you have your financing set up, when do you pull the trigger? You may need to consider expanding when you can't meet demand, says Andrew Zacharakis, entrepreneurship professor at Babson College. "One of the biggest indicators is that you're getting a lot of customer inquiries and you can't fulfill them in a timely manner," he says.
You may also need growth financing when an expanded workforce and mounting materials orders make it hard to cover payroll or supplier bills, Alterowitz says. To anticipate problems, measure yourself against industry benchmarks in sources such as Robert Morris' Annual Statement Studies. And track your financials closely so you can project cash-flow shortages. "That's one of the greatest failings of small business," warns Alterowitz. "They don't track their money."
Many companies finance growth internally. After borrowing to get underway, Wilner has since used retained earnings to pay for new equipment, new facilities and new hires. Entrepreneurs can also use personal savings or credit by, for instance, taking out a home equity loan. Consider asking employees to help finance the company's expansion. Co-founders or early hires already have a stake in the business, Zacharakis notes. "If they're as excited as you are, you should tap into their personal finances just as you have." Other stakeholders who can help include landlords, who may give free rent and improvements when you move to larger quarters, and customers, who may make advance payments on orders, allowing you to use upfront cash to expand.
The business can grow with debt financing by borrowing with lines of credit or term loans from banks, family and friends, suppliers, angel investors and, less commonly, venture capitalists. Banks want borrowers with consistent sales and profits plus assets such as accounts receivables to secure loans, Zacharakis says. Friends and family are less demanding, but even loans from close relatives should be documented, laying out the same terms a bank would require, Alterowitz stresses. Another source of debt financing is suppliers, who are often eager to grant credit to good customers. You may, however, free up nearly as much money for growth without having to pay it back by renegotiating supplier contracts to get lower prices in exchange for higher volume, Alterowitz notes.
Equity investments can come from friends and family, angel investors and venture capitalists. The same requirements go for equity when it comes to friends and family: Make a fair agreement and put it in writing. Angel investors are harder to find than accommodating relations but may have more to invest. Many wealthy investors belong to networks, making them easier to locate, but Alterowitz says unaffiliated individuals may be more willing to take risks and demand lower returns.
Venture capitalists are the most expensive and demanding of financiers, commonly obtaining majority control in exchange for financing. VCs are only interested in high-growth, high-potential companies with strong barriers to competition, Alterowitz says. Initial public offerings of stock are too costly, due to the complex legal and regulatory requirements, for all but the most promising small growth companies to consider, he adds.
Sometimes the best way to finance growth is to avoid it. "It may make sense to slow down and let your company catch up rather than go outside for financing," Zacharakis says. That's Wilner's approach so far, although he plans to arrange a line of credit -- just in case. "I have a very conservative approach to money," he explains. "I work very hard and I don't like to ever lose what I work for."
Mark Henricks is a freelance writer based in Austin, Texas.