It’s a systemic problem; successful companies committed to expansion seemingly frozen in place and unable to grow. Equally amazing is that many of these companies are well managed and profitable.
What’s the problem? Access to capital or, more specifically, access to ‘appropriate’ capital.
It’s no surprise life is tough for thousands of our country’s leading privately-held businesses. Unless you’re looking at the next tech darling, equity doesn’t flow easily or nearly often enough. Borrowing money can help, but conservative lending practices can put a crimp on the cash flows of the most promising companies. Even profit-driven growth is under fire as our country’s highest corporate tax rates kick in just as a growing organization is hitting its stride. What’s a company to do?
While there are no easy solutions, there are some simple practices that will help you fund growth more successfully. Consider the following:
Shore Up Profits and Fund Growth and Replacement Reserves
It’s an old adage, but profit and cash are king. Manage both zealously. Regularly and systematically review your operations for profit improvement opportunities. Plan, also, for growth and replacement reserves by segregating and protecting cash generated by non-cash expenses like depreciation and amortization. If you do nothing more, having internal equity at the ready goes a long way when negotiating terms with lending partners.
Negotiate Borrowings with an Emphasis on Term
Low interest rates make borrowing appealing, but be careful that aggressive repayment schedules or restrictive borrowing covenants don’t compromise your growth plans. Consider a $10MM company with 10% operating profits and $5MM in operating assets. The company currently owes $2.5MM to creditors with an average term of 5 years. On its face, $1MM in annual profits seems pretty good until you remove $380k for taxes and $500k for debt service. With just $120k left over, this company is essentially stalled without meaningful growth potential for several years. Manage the profits north to 12.5% and renegotiate credit facilities to an average of 7 years and things begin to change for the better. Growth potential returns, albeit modestly, to 8% to 15% per year, the latter based upon a lender’s desire to participate at historic financing ratios.
Compartmentalize Business Elements and Think Like a Portfolio Manager
If your business allows, manage it as a series of pieces, i.e., product lines, regions or unique business units. Thinking like a portfolio manager allows you to manage the overall success of the company through its individual elements. Should you identify units that are underperforming or reaching maximum potential, consider selling or liquidating and redeploying equity into other more promising areas of the company. Look, also, for opportunities to recapitalize individual business units. Bringing in fresh equity provides a great opportunity to restructure debt and fund growth.
Begin with an Equity Strategy in Mind
Equity is the first partner to the table for every new venture, and it’s also one of the most challenging to manage once you are on the way. If your business is focused on growth, there should be no expectation for cash returns to equity participants as all profits are needed for reinvestment in the business. This can be a problem for early investors, so having a plan to replace and/or supplement their positions is an essential element to achieving sustained growth. There are two basic approaches to this challenge. In the first, you continually add new investors using a managed valuation formula, segregating a portion of new proceeds for the retirement of initial equity. In the second, you periodically restructure your equity, replacing initial investors with new investors more aligned with the next round of growth.
Cultivate Relationships with Larger, More Well Capitalized Partners
Even following these practices, private-held companies simply cannot compete with their larger, more capital fluid counterparts in exploiting substantial growth opportunities. If your venture needs to grow aggressively and/or for an extended period of time, consider partnering with or selling to a company or investment group that can more easily support the funding requirements of growth. Sharing the opportunity is a small price to pay when compared to the risks of running out of capital part way through your expansion effort.
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About the Author. John Sherwood is the founder and Managing Director of CExOGroup, a professional services firm supporting the leaders and capital partners of privately-held companies in the mid-Atlantic region with assessment, advisory, management and recruiting services.