Growth Financing: Everything You Need to Know
January 16, 2023
Your business cannot stay stagnant. If you want to continue to be competitive and reach new levels, you have to find a way to scale your business. Of course, this is often easy to figure out on paper: you need X to achieve Y. In reality, there’s a factor that can be difficult to account for.
When preparing to scale their businesses, many business owners realize that the one thing they lack that they need to achieve those goals is money. Growth capital and growth financing allow you to reach new consumers, break into difficult markets, and fund new projects. These things not only generate more revenue, but to scale your business into the next phase.
Let’s take a deep dive into what you need to know about obtaining capital in order to grow and scale your business.
Read on to learn about the following:
- What is growth capital?
- Why is growth capital important?
- Types of growth capital
- Personal risk with growth capital
- Benefits of growth capital
- Drawbacks of growth capital
- Are you ready for growth capital financing?
- An alternative growth solution for eCommerce businesses
Growth capital is a financing solution that provides companies with the funding they need to grow. It differs from traditional bank loans and other types of funding because it is usually provided by firms and private investors who are looking to make a profit off of your debt.
Typically, an outside party, or parties, who see potential in your business provide capital up front. In exchange, they become a minority shareholder in your business and you must pay them a percentage or portion of your profits until their interest is met. Additionally, they may expect to play a role in decision-making and other aspects of your business functions.
Such investors usually focus on a specific type of business, and may bring their expertise and knowledge to the table, too. For some businesses, this can be a valuable asset, making growth capital an appealing form of financing. Other business owners, however, prefer not to give up any control in their business, so they should avoid equity agreements.
Obtaining growth capital requires some time and legwork. In order to find an investor, you need a well constructed business plan and an idea for growth. Then, you bring your ideas to relevant parties and explain what you have to offer. If the investor feels it’s a good fit, they’ll decide to provide you with capital in exchange for equity.
This is how the process works:
- You set up a business plan and decide how much money you need.
- An investor provides the capital and becomes a minority shareholder.
- You pay out a percentage of your revenue to the shareholder.
As a minority shareholder, the investor has partial say in how the money is spent – after all, they are not investing to lose money. Part of the agreement is they become a partner in your business. This could be for a limited amount of time or until they have reached a specific return on their investment. Either way, you are now responsible to both your own goals and the investor’s pocketbook.
It can take years to save up enough capital to finance your business on your own. So if you’re looking for a faster way to get the funding you need to take your business to the next level, you might need some help. When your business interests align and you are ready to take that next step, growth financing can be just the thing to help your business grow.
Growing your business takes a great deal of capital, so many business owners can’t necessarily do it alone. Running your business in the beginning stages forces you to wear all of the hats, but as your company grows, so does your staff; so does the need to meet customer demand; so does the need for more space. To accomplish these things you need the capital to front the cost.
If you are facing issues with funding day-to-day operations, you are unable to increase your inventory, or you need to pay outstanding debts, there is little-to-no room in your budget for growth. That is where growth financing gives you a leg up to scale your business.
- Here are a few of the key problems you can solve with growth capital:
- Reach and acquire new customers.
- Invest in training for your employees to increase their productivity and duties (i.e. managerial training, advancement opportunities).
- Expand your warehouse or increase locations to offer faster shipping and delivery.
- Update your office technology and software for a faster and more accurate system.
- Increase your inventory to better meet customer demand.
- Hire experts in areas such as marketing, advertising, and user experience.
- Update your website.
Individually, you may be able to cover some of these suggestions with your own funds. For example, if you use a website building software, you may be able to tinker around to customize your web store. But if you want a completely unique customer experience, a personalized site builder will cost money. Additionally, tackling multiple items at once would become very costly.
All of the targets outlined above will lead you to exponential growth, but you need the capital to make these goals tangible.
One-size-fits-all financing is a myth. Even with broad terms like “growth capital” or “growth financing” you have varying levels and programs to choose from. Understanding the key differences could be the difference between choosing a growth plan that skyrockets you into success or plummets you into debt. You need to choose a financing option that fits your business size, industry, and goals.
Private equity is one of the most common and well known types of growth financing. This type of funding comes from a private sector source or an individual. In other words, it is a non-federal or non-government source of financing. Private equity provides startup funds and capital for established companies looking to scale their business in exchange for a share in your company. In return, they provide you with both funding and their own expertise.
Venture capital and angel investors
While on the surface, venture capital firms and angel investors have a similar structure and goal in mind (to make money from their investments), they vary in pretty significant ways. Venture capitalists are firms and corporations that create a fund to invest money into smaller businesses. Angel investors are individuals with personal wealth who are looking to invest that wealth through providing capital to businesses. Both of these types of capital investment carries both a risk and reward for the investor.
In order to understand these arrangements, let’s talk about a scene from an incredibly popular American TV sitcom: The Office (spoilers ahead, but it’s been off the air for several years). When Michael Scott walks out of Dunder Mifflin and decides to start his own paper supply company, he knows he needs capital in order to finance his startup. So Michael creates a presentation and delivers it to none other than his grandmother’s investment group.
This group of women (who inevitably pass on Micheal’s offer) were interested in finding a business or startup that would in turn provide them with a return on the money they put into the company. This is a hilarious but factually accurate example of angel investment.
Venture capital firms, on the other hand, are firms that tend to offer funding as well as mentorship to early-stage businesses in exchange for a minority stake in that company. They often specialize in a specific type of business, which allows them to offer expertise, management assistance, and advice to the businesses in which they choose to invest.
Both angel investors and venture capitalists provide seed money (startup capital) or investments to move your business through progress to upscale your company and generate higher revenue.
Notice that we haven’t used the word “lender” when talking about growth capital and growth financing. That is because these are not loans in the typical sense. If you have ever played around with the stock market or currency trading, you know there are wins and losses. The same goes for venture capital and angel investors. These people or companies are now your minority partners who either benefit from your revenue or suffer your losses.
If we are putting terms into boxes, equity crowdfunding would fall halfway into the ‘crowdfunding’ box and halfway in the ‘growth financing’ box. Equity crowdfunding is the process of attracting several investors to provide capital in exchange for equity in your company.
Similar to venture capital and angel investors, your funded capital is repaid through partial ownership in the company. Many businesses choose to dip their toe into equity crowdfunding because they can receive a higher quantity of investors leading to a higher volume of capital. On the plus side, you have the potential to bag enough capital to sustain and scale your business. On the downside, you now answer and pay out dividends to multiple investors instead of just one.
An important factor to consider is that equity is divided up based on how much each person or entity invests. You still have to answer to the investor that holds 1% of your equity as you do someone with 15% of equity, but the balance has to be appropriate. Additionally, does the person who invests smaller amounts have the same say as the person who invests higher amounts? There is a lot of juggling when it comes to equity crowdfunding and you have to be able to manage it all at the same time.
Using equity crowdfunding means you have partial-owners that want to be heard and have the potential to pull their investment or sell their share if they are not receiving dividends or the financial wellbeing of the company is in jeopardy. This puts you back at square one.
Refinancing for growth capital
Refinancing for growth capital is an opportunity to use the equity of your existing assets to finance your business. Assets such as land, property, and real estate carry up to hundreds of thousands of dollars in value.
What you do with that equity is up to you, but some businesses will choose to refinance their assets to take out the equity to fund their business. This allows you access to capital through an existing loan. Once you refinance, your loan is reconstructed to accommodate the new balance and new term agreements.
Think about when you buy a house: you take out a 30-year mortgage and make a fixed monthly payment until the mortgage is repaid. Now, 15 years into paying off your mortgage, you decide to refinance to extract some or all of the equity of the value of your home. When you do this, you acquire capital to scale your business,maintain your personal or business assets, and you might even get a lower interest rate in the process.
Refinancing for growth capital is not without its own risk. By refinancing you are digging yourself a deeper debt hole. It’s wise to closely evaluate your ability to make the repayments, potentially at a higher monthly rate for the length of the loan. If you are unable to make these payments, your property is taken as collateral. If your property loses value by the time it’s repossessed, your other personal assets will be used as additional collateral. However, if used wisely with proper financial planning, you can unlock needed capital to grow your company.
Ultimately, obtaining growth capital or growth financing is relatively less risky than other forms of raising funds. However, the major risk you have with growth financing is dilution of your ownership. The trade off is that you are not digging yourself into debt in order to acquire that capital. With traditional loans, and even with many eCommerce specific loans, you owe the lender their initial investment back plus interest or costs and fees. If you are unable to make these payments, you could lose your credit or personal collateral and plummet into further debt with the accumulation of fees, interest, or even court costs should you face civil suits.
With growth capital, you are taking most of the financial risk off of your shoulders and saddling it onto the investor. The investor agrees to earn their initial investment back in dividends over time but will share the profits and losses with you along the way. This is why it may be hard for small or early-stage businesses to attract investors. They hold more risk than the financially stable, late-stage companies.
There are many benefits of using growth capital for your business. These include:
- No monthly payments or interest: Don’t stress every month with term loans or fixed monthly payments (unless you have chosen a refinancing equity option). Your investors are paid back based on a percentage of their share of the company, and there are no minimum payment requirements. You can breathe a bit easier knowing your budget includes improved cash flow and increased flexibility without also increasing your debt. Additionally, interest is essentially non-existent with investment based growth capital. Instead, when you produce revenue, you dish out dividends. If your scaling ventures don’t pan out, however, your investors do not collect return on their investments.
- Ability to utilize connections: Your investors are focused on earning their dividends. With their wealth and business experience comes connections to highly skilled people. If the investors want high yields returned to them, their contacts become your contacts. You can have access to financial planners, business experts, and technical assistance to draw from.
- Benefit from investors’ expertise: When you choose an angel investor or venture capitalist for growth financing, they bring their expertise and knowledge with them. This can be a great help for younger businesses who haven’ yet gained much experience in the field. The mentorship from such experts can be an additional resource to help your business grow.
- No personal collateral needed: Excluding the refinance equity model, there is no need to include personal assets in your quest to obtain capital for your business. While assets have their value and can certainly be a means to an end, growth capital financing does not require you to prove you can back up an investment. Since your investors are taking on their informed decision to provide capital without expectation of receiving fixed payment through profit losses, they are assuming the risk. Your personal assets remain untouched.
- Receive large amounts of capital up front: Whether you have a single angel investor, your campaign for equity crowdfunding meets its goal, or your venture capitalist investor agrees to the terms, you will receive a check for your capital upfront so you can begin tackling your financial to-do list. Having access to capital right away puts you back in the control seat and allows you to jump on opportunities faster and get the ball rolling.
Like any form of financing, growth capital comes with its own set of downsides:
- Dilution of ownership: Taking on investors not only means sharing your profits, but making choices that both improve the value and health of the company. You now have the additional task of keeping your investors happy by paying out dividends. They may also wish to play a role in decision-making and other management aspects of your business. While each investor may control a minority part of your company, too many investors could result in you holding a minority percentage of shares – meaning less money in your pocket and fewer decisions that you have control over.
- Attracting investors can be a full time job: We aren’t saying other financing options are easy to obtain, but there is extensive planning, research, and preparation that is involved with finding and convincing an investor to provide growth capital. This can often lead to business owners becoming distracted from their day-to-day operations. Small businesses may not have the staff to ensure the business continues to run smoothly while you do the financial leg work. It’s a vicious cycle: you need staff so you can find funding, but you need funding to hire staff.
- Rapid growth expectations: If your investor agrees to accept your offer, you may start to feel the pressure to perform and produce higher revenue in a shorter amount of time than initially planned. This rush could lead to cutting corners on quality, service, or rapid decision making that is not sustainable in the long run.
Now that you know all about growth financing, it’s time to consider if it’s the right choice for your business. Not only should you decide if growth financing fits your business model, but also ask yourself: Are you ready to scale your business?
In order for your scaling and growing dreams to come to fruition, you need a plan in place to present to potential investors with a timeline indicating when they will start to see returns. Your plan should include what you plan to spend the money on, how much you need up front, your current revenue and investments, a clear demand for your product or service, and forecasts of future demand. Don’t forget that this is a trade agreement and you need to provide an attractive enough offer to your potential investors without giving up majority control of your business.
Growth capital is an advantageous alternative to traditional loans that can bring your business to new heights.
Are you ready to grow your business but don’t want to give up equity? If that’s the case, growth financing might not be the right choice for you. Fortunately, there are other options out there.
8fig is a growth partner for eCommerce sellers that does not take any equity in your business. Instead, we provide flexible, continuous funding that is optimized for your cash flow. We offer you the tools you need to plan out your supply chain expenses, and then provide you with capital infusions when you need it most. Best of all, your funding and remittances are adjustable in real time, so you can keep up with the natural fluctuations of eCommerce.
Want to learn more about how 8fig can help you grow your business? Sign up for an 8fig Growth Plan today!
Rebecca is an eCommerce writer at 8fig. She strives to provide sellers with the information and support they need to succeed in the ever changing eCommerce space.