Small Business Finance – Finding the Right Mix of Debt and Equity
Financing a small business can be the most time-consuming activity for a business owner. It can be the most important part of growing a business, but one must be careful not to allow it to consume the business. Finance is the relationship between cash, risk, and value. Manage each well, and you will have a healthy finance mix for your business.
Develop a business plan and loan package with a well-developed strategic plan, which relates to realistic and believable financials. Before you can finance a business, project, expansion, or acquisition, you must precisely develop your financial needs.
Finance your business from a position of strength. As a business owner, you show your confidence in the business by investing up to ten percent of your finance needs from your own coffers. The remaining twenty to thirty percent of your cash needs can come from private investors or venture capital. Remember, sweat equity is expected, but it is not a replacement for cash.
Depending on the valuation of your business and the risk involved, the private equity component will want on average a thirty to forty percent equity stake in your company for three to five years. Giving up this equity position in your company, yet maintaining clear majority ownership, will give you leverage in the remaining sixty percent of your finance needs.
The remaining finance can come in long-term debt, short-term working capital, equipment finance, and inventory finance. By having a strong cash position in your company, various lenders will be available to you. It is advisable to hire an experienced commercial loan broker to do the finance “shopping” for you and present you with various options. It is important at this juncture that you obtain finance that fits your business needs and structures instead of trying to force your structure into a financial instrument not ideally suited for your operations.
Having a strong cash position in your company, the additional debt financing will not put an undue strain on your cash flow. Sixty percent of the debt is healthy. Debt finance can come in unsecured finance, such as short-term debt, a line of credit financing, and long-term debt. Unsecured debt is typically called cash flow finance and requires creditworthiness.
Debt finance can also come in the form of secured or asset-based finance, which can include accounts receivable, inventory, equipment, real estate, personal assets, letter of credit, and government-guaranteed finance. A customized mix of unsecured and secured debt, designed specifically around your company’s financial needs, is the advantage of having a strong cash position.
The cash flow statement is an important financial in tracking the effects of certain types of finance. Therefore, it is critical to have a firm handle on your monthly cash flow, along with the control and planning structure of a financial budget, to plan and monitor your company’s finance successfully.
Your financial plan is a result and part of your strategic planning process. It would help if you were careful in matching your cash needs with your cash goals. Using short-term capital for long-term growth and vice versa is a no-no. Violating the matching rule can bring about high-risk interest rates, refinance possibilities, and operational independence. Some deviation from this age-old rule is permissible.
For instance, if you have a long-term need for working capital, then a permanent capital need may be warranted. Another good finance strategy has contingency capital on hand for freeing up your working capital needs and providing maximum flexibility. For example, you can use a line of credit to get into an opportunity that quickly arises and then arrange for cheaper, better suited, long-term finance subsequently, planning all of this upfront with a lender.
Unfortunately, finance is not typically addressed until a company is in crisis—plan with an effective business plan and loan package. Equity finance does not stress cash flow as debt can and gives lenders the confidence to do business with your company. Good financial structuring reduces the costs of capital and the financial risks. Consider using a business consultant, finance professional, or loan broker to help you with your financial plan.