All of us in business are concerned with cash.
We are under constant pressure to balance a limited supply of cash with the seemingly unlimited demand from cash-consuming sinkholes such as operating expenses, accounts receivable and inventory - and that’s just normal operations.
Things get really hard if we’re growing. Growth requires more and more cash to finance higher operating expenses, more receivables, more inventory, larger facilities, more machinery, more equipment and so on.
Growth almost always means we need to raise cash, and the most common way to do that is by borrowing. Many of us struggle with that because conventional wisdom tells us that debt is bad. It’s in our psyches.
"Used properly, debt is also one of the most powerful tools in business and has tremendous advantages over the alternatives."
Debt IS bad - if we use a credit card to buy a round of drinks for our buddies, or a bank loan to finance a Cadillac Escalade for the tax write-off. But, used properly, debt is also one of the most powerful tools in business and has tremendous advantages over the alternatives.
There are two alternatives to debt for increasing cash in our businesses. One is by self-funding a cash reserve through savings, and the other is by selling equity (ownership) in our companies.
The least risky way to finance our cash needs is to build a cash reserve from our business operations. The advantages of a self-funded reserve are that:
Those are compelling advantages, but self-funding has some drawbacks, too:
Selling equity means giving part ownership of the company to someone in exchange for cash. The advantages of selling equity are that:
Those also are attractive advantages, but they are offset by three unattractive considerations:
In order to know how much of the company to give up in exchange for a certain amount of cash, we have to know the value of the company as a whole. Valuing small companies is very subjective, and it is, more often than not, difficult to reach agreement with prospective investors.
An equity investment means that we bring on co-owners as “partners”. The moment we bring on partners, we have other people’s interests to consider in every decision we make. Perfect partners can be wonderful additions because they can bring good judgment, perspective, ideas and collaboration to the business, in addition to cash. Most partners, however, are not perfect.
When we sell part of a business, our share is reduced, or “diluted.” As co-owners, equity investors are entitled to their share of profits for the life of the business and to their share of the proceeds if the company sells. Dilution means that selling equity in a successful business is likely to be, by far, the most expensive form of financing.
Debt, of course, means we borrow the cash. There are three advantages to borrowing:
Those are good reasons to borrow money, but there are also reasons not to borrow money:
There are three ways to raise cash for growth: savings, equity and debt.
It is not possible in this article to say that one method is the best for every company. Some companies use hybrid combinations of all three to meet their cash needs.
"When we put borrowed money to work effectively we can see a remarkable boost in the return on our investment."
However, for companies that have effective growth opportunities and need cash to fund them, it is hard to beat debt as a means to raise it. Debt is faster than savings, better understood and cheaper than equity, and offers the huge potential of financial leverage.
Do you need to raise cash for growth? Do you have opportunities for growth? Do you have the cash to fund them? Which method looks most attractive to you?
