This is the first of a three-part series designed to educate business owners on sources of capital for fast-growth businesses.
Growing businesses are notorious for burning through cash. Oftentimes, the faster the growth, the quicker the burn.
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Early-stage companies, especially those in the tech field, must fund product development work ahead of revenue. To develop, market and sell, companies must hire teams of people, invest in infrastructure (office, leasehold improvements and equipment) and support working capital requirements (accounts receivable, inventory).
“Bootstrapping” your business – funding only through operating cash flow – is a practical and appropriate philosophy, so long as the business is not losing market opportunity by growing at a modest rate. Otherwise, you run the risk that better-funded competitors take market share at your expense.
As you start the process of considering your financing options, you will want to start with the least expensive and easiest to access capital resources. Your least expensive form of capital may be bank debt.
This form of financing may provide you with working capital credit lines (backed by your inventory, accounts receivable and possibly a personal guarantee). Term debt may be available to you if your cash flow (positive) and asset base (equipment, building) allow. Many small companies, however, may not be sufficiently developed to attract bank financing.
If you find you are too early for bank financings, you will want to explore other options: friends and family; federal and state grants; and equity investors (wealthy individuals or angels, venture capital). Each has its tradeoffs.
Most company owners approach friends and family first. This source tends to be easy to access, offering less rigor (no application process) and relatively easy terms (valuation/pricing, payback, interest). On the other side, tapping FF capital can take a toll on the relationship if things don’t go well.
Federal programs – such as the Small Business Innovation Research (SBIR) program – offer significant (six-figure) taxpayer-funded grants to facilitate technology development in a range of sectors (health care, defense/aerospace, IT, etc.). The government typically expects royalty-free use of the invention/development, leaving you with commercial rights to your development. Finally, SBIR grants don’t require repayment. To access them, however, requires a well-developed technical business plan outlining how you plan to do your work and a credible management team. SBIR grants also involve lengthy application and review processes (in contrast to other funding sources), as well as greater reporting requirements.
Some regions have providers offering near-equity, or royalty-based obligations. Typically, capital providers expect their return on investment to come from a percentage (5 to 10 percent) of your company’s sales. An attraction to this form of capital is avoidance of ownership dilution (in contrast to equity). Payback level correlates to selling success. And like a relationship with a bank or creditor, there is typically limited involvement at the board level (unlike equity). Negatives, however, can include the requirement of payment whether or not your company is cash-generative. And generally, near-equity providers, like their lending brethren, provide limited value beyond capital.
Equity is the most expensive form of capital, requiring the greatest engagement with the capital provider. The positives of an equity partner relationship can be meaningful: long-term capital with limited or no near-term cash-flow implications; if the company fails, there is no obligation to repay; finally, equity investors can bring industry, financial and/or operating backgrounds to bear, helping companies “beyond the money.” On the negative side, capital is, relative to grants and debt, more expensive than other forms of capital – investors often require you to give up a significant ownership position (typically between 10 and 40 percent) as well as a role on the board of directors. Equity investment also requires more of a business partnership than a strictly financial relationship, as well as more complex investment documentation, terms and conditions than other forms of capital.
The differing sources of capital are not mutually exclusive – indeed, they tend to reflect the full spectrum of capital you may tap while building your business from small to bigger. But remember that each comes with its baggage and benefits. You must find the capital that best meets your needs. •
Michael Gurau is managing general partner of Clear Venture Partners, a venture capital fund targeting Rhode Island growth companies across a range of sectors and states. He can be reached by e-mail at mg@clearvcs.com.
