Financing Business Growth

by Dave Kahle

Chances are, if your business is at all successful, you are going to confront that question. At some point, you’ll need to fund your business growth: a larger space, more computers, more sophisticated software, and more equipment.  You’ll have to buy raw materials, build your inventory and hire additional people.  You’ll need to invest in continual training and developing your people.

         All of this requires an upfront investment of money, invested with the hope of it bringing a return and growing your business’s size, profitability and impact. And, of course, that investment is made with the risk that it may never work out the way you’re planning.

         So, you’ve prayed about it.  You’ve run the numbers, considered all the alternatives, and you’ve come up to a set of conclusions:

1. You should grow your business.
2. This is the time and opportunity to take the next step.
3. It requires more money than you have.

         Now, you are faced with the decision.  How do you fund it?  Where does the money come from?

         There is an answer out there in the compendium of worldly wisdom.  Depending on the size of your business, the conventional wisdom says that you go to the bank and borrow the money.

Does that knee-jerk reaction, and off-the-cuff advice hold true for a Christian business?

Nuances

In our 21st Century business world, we should recognize some nuances when it comes to business debt… Not all debt is the same and some debt is less onerous than others.  For our purposes, debt can be characterized and classified in several important ways. When considering taking on debt, we should keep these issues in mind.

The relative amount.

It’s one thing to owe $1,000 and it’s another to owe $1 million. If you are a sole proprietor, the $1 million debt might be staggering. However, if you’re a Fortune 500 company, it may not be even noticeable.

         For a business, the real issue is the amount of debt payment relative to the cash flow.  The greater the ratio of cash flow to payment, the more acceptable the debt is. For example, if you are bringing in $100,000 per month, $1,000 a month debt is 1/100th of your cash flow.  That same $1,000 is 20% of your cash flow if you are averaging $5,000 a month.  Clearly, the smaller the percentage of your cash flow the debt requires, the less dangerous that debt is.

         Another way to look at the relative amount of debt is the asset to debt ratio.  This looks at your business assets and then compares the total amount of debt to the total assets in the business. If, for example, your total debt exceeds your assets, you are in jeopardy of going bankrupt.  So, the lower the debt to asset ratio, the more tolerable is the loan.

The purpose of the debt.

Again, it’s one thing to borrow money to acquire a new piece of production equipment, and it’s another to do it so that you can re-decorate the corner office.  A long-term lease on a production facility is one form of debt, a credit card bill for entertainment expenses quite another.

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The means and type of commitment for repayment.

For example, you may create a royalty payment for a lender, where he is repaid by a certain dollar amount or percentage of every sale of a product or service.  In that case, the lender assumes the risk of bad sales and little repayment.  If the product doesn’t sell, he doesn’t get paid back.  If it does, he makes an excellent return.  On the other hand, you may decide to personally borrow $100,000 and put your house up for collateral.

The quality and type of lender.

It’s one thing to borrow the money from your family and friends, and quite another to get it from the bank across town.  It’s one thing to have a vendor finance your purchase of a piece of equipment, and quite another to acquire the funds from the loan-shark downtown.

The cost of the debt.

Typically, the interest rate that you will pay to the lender for using his/her money can take lots of different forms, from the points you pay at the beginning of a mortgage, to the penalties you pay for missing a payment. It’s common sense to understand that lower-cost debt is preferable to higher-cost borrowing.

         For a business, not all debt is the same.  We can use these five criteria to assess the quality of the debt we are considering, and to alter the terms in our favor when possible.

One other thought…

Before we go any further, let’s put the issue of debt into a larger framework.  Borrowing, in all its forms, is a way of bringing other people’s money into the business. For whatever reason, you have a need for money, but your business doesn’t have enough of its own. So, you need other people’s money to fund some aspect of your business.  Borrowing is one choice, but it isn’t the only choice.

Options

You can access other people’s money by selling equity. You can, for example, sell a portion of the business and have a minority stockholder.  Or, you can create a limited partnership for a specific purpose and sell partnership shares in it.  Or you can sell an interest in a specific product line, production line or branch office, for example.

When you need other people’s money, borrowing, and creating debt, is only one of the choices. If you must acquire other people’s money, think carefully about the structure of the debt, and use the most favorable structure.

Let me illustrate this example.  Let’s say that you own a... CLICK HERE TO READ THE FULL ARTICLE

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