Anyone who has been in ownership or management of a growing business understands the dilemmas the business faces as it reaches various milestones. It may be that you need a bigger facility; or you need bigger and faster equipment; or you need to hire a VERY talented person; or a customer wants to give you that big purchase order, but they hesitate for fear you cannot pull it off. The common denominator to each of those scenarios is cash – or more specifically, lack of cash.
Typically, a business owner’s list of how to get more cash into the business starts with personal savings, followed by friends and family. After those resources are tapped, you start to look at an array of bank, private equity and venture capital type sources. This is often unfamiliar territory and you may not be sure what the difference is and what place each of them has in the marketplace.
Pepperdine University’s Graziadio Graduate School of Business and Management recently released their ‘Capital Markets Report – 2014’ providing detail on a variety of market issues presented by each type of Lender / Investor listed in the chart below, broken down for various sizes of business.
One way to answer the question: “what source of capital makes the most sense for my business?” is to look at the expectations of those sources and match them to your willingness to pay their cost. The Pepperdine study showed the Return on Investment (ROI) each source of funding expects, as follows:
Lender / Investor
Range of ROI Required
4.3 % to 5.5%
|Asset Based Lender||
6.9 % to 8.3%
14.2% to 21.0%
|Private Equity Group||
24.4% to 28.3%
22.5% to 27.5%
25.0% to 30.0%
As you can see, there is quite a range in expected returns for the use of their money, dictated by the amount of perceived risk to the lender. So the three basic questions to answer are:
- How much money do I need to take advantage of the market opportunity in front of my business?
- How fast do I need the cash, and can I get the cash in installments as I need it?
- How can I reduce the risk to the lender / Investor to stay near the top of this list, at lower rates?
Most small companies try to stay within the bank lending system as long as they can for obvious reasons. The top three reasons bank and asset based loan applications get denied are:
- Low quality of earnings and cash flow (29%)
- Insufficient collateral (23%)
- Existing debt load (13%)
The fastest way to improve your chances of getting that bank loan is to improve your earnings and / or cash flow. The fastest way to accomplish that is to develop a plan that drives all your activities to those that generate positive cash flow and away from those activities that suck the living day light out of your cash and energy.
In The Pumpkin Plan, Mike Michalowicz describes several ways to attack these issues. You must understand your unique “AOI” – Area of Innovation. You must “Assess the Vine” – jettison those customers that cost more than they add to the organization. You must do more of what your best customers like and pay for. When you take steps like these you will find that your earnings and cash flow can improve quickly and dramatically.
When earnings and cash flow are stable or improving you make your company an easier company to lend to or invest in. This reduces the cost of that next chunk of cash needed to grow the business – which allows you to further improve earnings and cash flow – which makes you easier to lend to the next time you grow the business again. And so it goes.
The circle of life for your business revolves around your ability to fund the needs of the business as they present themselves. Having a plan to maximize earnings and cash flow is critical to keeping your business in the best position as it grows.