Sources of Finance for financing growth

WHAT CHOICES DO YOU HAVE TO RAISE FUNDS?

1.  DEBT FINANCING involves a loan that will accumulate future interest.
2.  EQUITY FINANCING involves accepting a lump sum in exchange for selling the future benefits and profits of your business to investors.

WHAT MIX OF DEBT/EQUITY IS USED IN A BUSINESS LIFE CYCLE?

1.  SEED STAGE
WHAT IS IT?  When your business is just a thought or an idea
FINANCIAL SOURCES:

• Family and friends
• Private savings
• Credit cards:  usually much quicker than waiting for a loan approval.

2.  START-UP STAGE
WHAT IS IT?  When the company has officially launched.
FINANCIAL SOURCES:

• Banking, typically the first option of small business owners.
• Small, community banks.
• Leasing:  paying a monthly payment for renting assets like equipment or office space.
• Factoring:  paying an advance rate to a third party (factor) in exchange for cash.
• Trade credit:  when a supplier allows the buyer to delay payment.

3.  GROWTH-STAGE
WHAT IS IT?  When a business has successfully traded for a period.
FINANCIAL SOURCES:

• Angel investor: a wealthy individual who hands over capital in return for ownership equity.
• Venture capital funds: large institutions seeking to invest considerable amounts of capital into growing businesses through a series of investment vehicles.
• Initial public offering (IPO):  the sale of equity in a company, generally in the form of shares of common stock, through an investment banking firm.

4.  MATURE STAGE
WHAT IS IT?  When its business has an established place in the market.
FINANCIAL SOURCES:

• Capital market securities such as common stock, dividends, voting rights.
• Bonds - loans that take the form of a debt security where the borrower (known as the issuer) owes the holder (the lender) a debt and is obliged to repay the principal and interest (the coupon).
• Commercial paper -  a money market security issued by large banks and corporations for short-term investments (maximum nine months) such as purchases of inventory

Key terms

Angel investor:  a wealthy individual, often a retired business owner or executive, who hands over capital to a new business in return for ownership equity.

Venture capitalists:  commonly large institutions seeking to invest considerable amounts of capital into growing businesses through a series of invesmtent vehicles that include state and private pension funds, university endowments, and insurance companies.

Commercial paper:  a money market secuirty issued by large banks and corporations for short term investments (maximum nine months) such as purchases of inventory.  These unsecured IOUs are consideed safe, but returns are small.

Factoring:  describes a loan by a third party (factor) given in the form of cash (often within 24 hours) for accounts receivable.  The borrower pays a percentage of the invoice.

External Form of Growth: Could your business benefit from these?

Business can grow by:

• Internal growth:  By paying attention to the internal affairs of the company, and diversifying into new products and new markets. 
• Go-it-alone option: 
• External growth:  Through mergers and acquisitions.

EXTERNAL FORMS OF GROWTH

Could your business benefit from an acquisition or a merger?

Again, you need to take a good look at the business to understand just where it is at the present time. 

• What are the strengths that you can build on? 
• What do you have that would make your company attractive to other companies? 
• Are there areas of weakness in the business? 
• Could these be strengthened by acquiring another company or merging your business with another?

SOME OF THE QUESTIONS TO ASK ARE:

1. Should we obtain more quality staff with different skils?
2. What do we know about our sector of the industry or service?  Could we improve our business intelligence to our advantage?
3. Is our business underperforming and, if so, in which area(s)?
4. Can we access funds for further development without endangering the normal business cash flow?
5. Could we access a wider customer base and increase our market share without outside help?  How much would it cost in extra resources?
6. Could we diversify into other products or service areas?  What would be the long-term effects?
7. Can we reduce our cost and overhead structure without damaging our product, service, or customer base? Would there be an adverse effect on performance and quality?
8. What would be the effect if we could reduce the competition?
9. Would "organic growth" take too long?

The answers to the above questions will be a good guide to future planning of the business.  But a lot depends on how the management team sees the future of the company.


FACTORS TO CONSIDER

So what would be the reasons for considering growth either through a merger or by an acquisition?

1. Bigger is better?
2. Image enhancement?
3. Market expansion?
4. Product range expansion?
5. Diversification? 

Among the forms of external growth are:

1. Mergers
2. Acquisitions
3. Joint ventures
4. Partnerships
5. Collaborations

External growth - Acquisition

What is an acquisition?

Meaning "to gain possession of," the acquisition of all parts of another business is an alternative method to develop or expand your own business.

1.  An acquisition is the most apposite option where you need specialist skills and knowledge or facilities for your own future development.

2.  This is a way of filling "holes" in a company's current or future straegy; it can be very successful as long as there is a good understanding of what the knowledge gaps are and how they cna be filled effectively.

3.  As is the case with mergers, the relevant questions should be asked and answered, and the correct business fit must be achieved.

Most acquisition involve businesses of unequal size with, usually, the larger or more powerful company purchasing or acquiring the smaller.  In recent times, this has not always been the case, and examples can be found of relatively small companies buying out much larger ones, either to obtain resources or to gain additional assets to supplement those currently owned.

Such deals are usually financed quite heavily with loasn and other deals and are often followed by a very vigorous pruning of parts of the acquisition to repay the financing involved.  This is known as asset stripping and is rarely intended to achieve growth of an established business, but rather functions as a financial dealing that will generate cash for further enlargement.

HOSTILE ACQUISITIONS OR TAKEOVERS

Many acquisitions are known as "hostile takeovers" where the management of the company being purchased actively resists the unwanted overtures of the predator company.

When talking about mergers, such phrases as: "teamwork," "sharing," and "mutual benefit" are appropriate; some expressions used when considering hostile takeovers might be:

• "We have bought you."
• "Do as you are told."
• "Our way is best."

One of the keys to success is not to keep the newly purchased company at "arm's length" but to actively create value from the new relationship.   The underlying idea of growth through acquisition is to utilize the resources you targeted at the investigation stage as quickly as possible to enable your own business to grow and flourish. 

Before any acquisition (or merger) it is essential to establish that what you think you are acquiring is real and worthwhile and to use a process such as due diligence.  This includes complete studies of the business you seek to acquire, which should be carried out by specialist, univolved, third parties, who look at every part of the business and report on its viability to meet the requirements you have set before you take irrevocable action.

Using the due diligence procedure to arrive at incisive answers to the many questions needed, to making the decision to acquire, represents the exemplary use of due diligence.

VALUING THE ACQUISITION

There are several valuation methods that can be used, and it is always best to seek professional expert advice before making the final decision.  You will need to consider many relevant factors to obtain an overview of how healthy the business might be, these include:

• The history of the business
• The current performance
• The financial situation
• The condition of the premises
• Intangible assets
• Employees

Once you have considered all of these factors, you can then decide

• how much you think the business is worth, and
• how much you are prepared to offer, if you decide to proceed.

THE FINANCIAL STRUCTURE OF AN ACQUISITION IS:

Company "C" shares ----> ----> ----> Company "A" shares ---->> Larger company "A" shares

External growth - Merger

What is a merger?

The dictionary definition of a merger in the business or commercial context is "the combination of two or more companies, either by the creation of a new organization or by absorption by one of the others." 

The underlying logic of mergers is that the resulting enterprise will be stronger than the combined resources of the individual companies.  This is described as synergy, and it offers more business possibilities.  It also has the advantage that there will be less competition as a result of the merger, although this depend on the guidelines of a monopoly commission.

WHAT ARE THE MAJOR ATTRIBUTES OF A TRUE MERGER?

1.  TEAMWORK
2.  SHARING
3.  NONDOMINATION
4.  MUTUAL BENEFIT


THE FINANCIAL STRUCTURE FOR A MERGER IS:

Company "A" Shares ----->  COMPANY "C" SHARES

Company "B" Shares ----->  COMPANY "C" SHARES


IS THE TIME RIGHT FOR A MERGER?

Ascertaining whether the time is right for a merger depends on the state of your business relative to the market and to the competition.

The practicalities of growth in your business

There are many resources that need to be considered when deciding to grow the business.  Among these are:

FINANCE
It is unlikely that the business will have generated large reserves of cash that will enable expansion to be paid for from internal sources.

STAFF
Do you have sufficient staff to undertake the extra work, or will you need to employ more people?

PREMISES
Do you have sufficient rooms for the new production facilities and increased stock levels of both materials and finished parts?

MARKETING
Can your current marketing arrangements cope with increased sales and the new product or service?


Having posed some questions regarding the availability of finance, staff, and premises, it is necessary to know where to look for sources of supply of these.

The "go-it-alone" option for growth

One option for growth that falls between internal and external growth is the go-it-alone option.

1. The major benefit of this option is that the business retains full control with all profits (or losses) retained in-house, as are all designs, manufacturing and marketing knowledge.
2. It presupposes the business is in good financial and operational "health": and that it can supply all of the necessary resources to launch and supply into the market.
3. Although the title of the option suggests that all the work is carried out in-house, this will depend on the manufacturing strategy that is operating within the company.
4. Even though most businesses would like to keep control of all the processes involved in manufacturing their products or the services they offer, economics and common sense decree that some processes are best performed by outside contractors.  This is referred to as a "make or buy policy" and will determine where work is performed.
5. The work of the contractors is controlled to advantage through agreements and contracts.

Internal Growth through Diversification into other related products or services

Many small businesses can grow by diversifying into other related products or services.  For example, an office stationery supplier might decide to add a range of computer consumables to its portfolio.  This could result in existing customers now buying these items as well.

Diversification can occur in different forms, such as:

1. Selling similar or related new products to exisitng customers.
2. Selling existing products into new markets, even overseas.
3. Selling new products to new markets.

Before deciding on diversification, take the following actions:

1. Thoroughly research both markets and customers for the new product or service.
2. Decide on a clear development strategy.
3. Do a trial run with a limited output of prototypes to test the market before committing to the new product or service.
4. Ensure that the internal departments and outside suppliers can maintain a steady throughput to provide continuity.

It would be damaging if the customer orders are plentiful but the supply of the product or service is intermittent. 

In early stages, diversification will rate highly in your risk assessment program, and in order to mitigate some of the risk, it is advisable to try to secure customer orders or commitments in advance of stepping up production.

Business strategy for growth

Business strategy is ... "....the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out these goals."

This necessitates a thorough evaluation of a business to get a clear picture of its strengths, weaknesses, opportunities and threats (SWOT).  This will provide important insights into the type of growth strategy that best suits the business for the immediate and long-term future.


INTERNAL GROWTH

1. Are there ways in which you can improve the efficiency of the business? 
2. The use of a system of statistical process control will show if your processes are working correctly.
3. Could the quality of the product or service be improved?
4. Adopting a system of Total Quality Management (TQM) may effect a change to your end product.
5. Are costs as competitive as they can be?
6. If these checks are carried out successfully, then it is reasonable to expect that the business will grow by its organic growth.  This will make the business more competitive.

The first thing to establish is whether you can increase your share of the market.  To do this, you would have to take customers from your competitors or attract new customers.  You have to understand your customer base and that of your competitors.


CUSTOMERS

Who are your existing customers?
Are there any that you ahve not yet targeted?
Are there any that no longer do business with you?   Why?
Do any of them buy from your competitors?  Why?
Do they have instant, alternative choices?


COMPETITORS

What are their strengths?  Can you match them?
Have you lost customers to them?
What do they do better than you do?


OURSELVES

What is our sustainable competitive advantage?
What do we do that is better than our competitors?
What is our unique selling point?
How will growth affect our pricing, marketing and service levels?


Before increasing output by increasing the capacity of your processes, you need to ensure that there will be a market for your proposed additional producsts.  Many companies have increased output in the anticipation that the market will follow, only to find that there is a downturn or that a competitor has already improved performance.

Assess your options for growth in business

After you have completed a full assessment of your business in its current state and you feel confident that you have all departments and areas working efficiently and under control, it is time to look to the future.

1. What is your vision for the future?
2. Does your business plan offer a realistic guide as to your future direction?
3. Do you just want to consolidate your current position or do you want to find ways to make the business grow?

Starting a business can involve lots of hard work, courageous decisions, and not a few risks, and it may seem a good idea to just sit back, relax, and enjoy the benefits of all your efforts.

1. Can you afford to do nothing?
2. While you do nothing, your competitors will be growing and taking your market share - this will seriously damage your business's future.
3. To ensure that your business remains a success, it is time to identify your options for growth.

Growth options can be divided into two categories, internal and external.

1.  Internal growth or growth that can be achieved within your own business will involve

• increasing market share or
• diversification.

2.  External growth will involve joining forces with another business, either

• by merging with or acquiring another company or
• by forming a partnership or joint venture with another business.