You can't grow unless you have money to invest in growth. That may seem strange at first. After all, growth is supposed to generate additional sales and profits, right? That's true, but before you can increase sales, you usually have to increase your current assets, such as inventory and fixed assets such as a plant and equipment. Rapid growth means hiring more people, furnishing more offices and perhaps renting new quarters. Since there's usually a time lag between the moment you need to invest in growth and the moment you receive the resulting sales and profits, you need money before you can grow.
Financing expansion can take many forms. You can use your own money, borrow from friends and family, use internally generated funds, approach equity investors or tap banks and other lenders. The sources for funding growth are generally the same sources you may have used to start your business. In many cases, you'll go back to the same sources to pay for expanding your company. The good news is that it's easier to fund growth in an existing business than it is to fund a startup.
Types of Expansion Financing
As you learned when you were looking for startup capital, there are many places to go when seeking money for business. As you probably also learned, only a few of those places are right for any given business. Selecting the right type of expansion financing is largely a matter of matching your needs to the restrictions of the source. Each type of financing has its own strengths and limitations.
Self-financing in the form of personal and family savings is the No. 1 form of financing used by most small-business owners. It's low-cost and has other advantages. For instance, when you approach other financing sources, such as bankers and venture capitalists, they'll want to know exactly how much of your own money you are putting into the venture. After all, if you don't have enough faith in your business to risk your own money, why should anyone else risk theirs?
Here are some of the sources of personal and family financing you should consider for growing your business:
- Personal line of credit, including credit cards: Although credit card financing is expensive, it can work for emergencies and small amounts.
- Home equity loan secured by your personal residence: Interest rates are low, but you may lose your home if you can't repay.
- Cash-value life insurance: Interest rates are reasonable on loans against cash-value policies, and you don't have to make payments because the loan will be repaid from proceeds of your insurance in the event of your death.
- Individual retirement account (IRA) funds: Laws governing IRAs let you withdraw money from an IRA as long as you replace it within 60 days. It's not a loan, so there's no interest, but if you pay it back late, you'll have to pay a 10 percent penalty plus taxes.
"Friends and Family" Financing
Friends, relatives and business associates are popular sources for financing the growth of small businesses. There are two main advantages to friends and family financing.The all-important issue of the character of the borrower is moot--these people already know you. Depending on who you're borrowing from, repayment terms may be extremely flexible, and you may not even have to pay interest.
The downside is that, if worst comes to worst and you can't repay the loan, the people who will be hurt will be friends, family and business associates. Make sure you explain the risks involved in investing in a growth business before accepting financing from friends and family. Otherwise, their wish to help you out may lead them to do something that could damage your personal relationship as well as your mutual finances.
Internally Generated Funds
One of the most advantageous ways to finance growth is through earnings your business is creating and that you retain. The only cost to using retained earnings is the interest you would receive if you kept the earnings in a bank account. Since this amount is likely to be much less than you will earn by successfully investing the funds in growing your business, plowing retained earnings back into your business is usually a smart move.
One risk to financing with internally generated funds is that you will divert too much of your current profits into expanding the business. This can starve your business and create more trouble than if you financed with a more costly source or never tried to grow at all. Make sure you aren't robbing Peter to pay Paul when you finance with retained earnings, and that your investments in inventories, marketing efforts, production staff and other outlays required for the existing business are maintained.