What is Capital? [& What Type of Capital is Best for You]
We all experience the relationship process as we sojourn through our lives. We start out as babies, evolve into childhood, and into adolescents. Through all these stages, we have amazing moments of growth opportunities as well as moments of struggle and hardship. At some point in this journey, we look for a partner, someone who we mesh well with and who will provide us with love and support throughout our life. We hope to have a reciprocal relationship and provide this partner with the same love and support they show us.
As I thought about this, it really made me consider the relationships we have in business; those short-term and sometimes long-term relationships that help us build up our respective dreams. In turn, we help those that invest in our growth and progress. As business owners in those early stages of adulthood, we are trying to make it on our own and fund our own organic growth. But at some point, we realize we can’t take it to that next stage without a partner.
Types of Capital
There are two types of capital that your business can attract, and each has its benefits and drawbacks. This decision is critical for the future progression and goals of your business and should be analyzed with a very sophisticated approach.
Just as we date our potential spouse in our relationship journey, we can similarly create a relationship with a banking partner. This is an arrangement that is normally short-term in nature and does not grant any long-term equity position. The debt may be very short such as a line of credit or a term loan. Or there can be a longer-term commitment such as a commercial mortgage or an SBA loan. It is important to note that debt financing typically has more stringent requirements on repayment with conditions and covenants. The banks want to ensure that you are a safe bet (just like in the dating world) and will often require a personal guarantee and/or a first position on the assets of your company. Even though the banks provide a few more requirements on their required provisions, they are a cheaper alternative to capital than an equity option.
In relationship terms, equity = marriage. When you are seeking to have an outside party come in and take partial ownership of your business, it is key that you are actively searching for partners that will help you succeed. Ideally, they will be a strategic source for that growth. Whether it’s “friends and family”, an angel investor, or a VC, the search for the ideal fit will be either a blessing or a major headache for the future of your business. Just as you as a business owner are looking to attract the right kind of investor, the investor is looking at you and your business’ risk profile. “Is this a business that will grow quickly and give me strong returns?”. “What sort of risk am I taking with this potential investment, and should I mitigate my risk by taking a larger part of the company and taking an active role in the operations?” These are important questions as a business owner you will need to consider. How much control do you want to give up? How strategic is your potential investor and can they help you with more than just capital? Should I consider debt vs equity, or can I grow the business from earnings?
Let Us Help You
Throughout the process of deciding on your capital structure, it is critical to have the guidance of a trained professional. Relying on a CFO that has been through this process before and knows what to look out for will save you from entering a less-than-satisfactory relationship. Guidance on the amount of debt and/or equity to take on, how to attain it, and who to speak with is the kind of help you need. We recommend that your financial partner has the following skills to facilitate the preparation, introductions, and relational expertise to deal with lenders and equity holders post-close.
- Understanding of the broader market and potential risks of your business
- Financial modeling skills to help project your business’s future goals
- The ability to communicate effectively with investors and management
- Honest and hard-working
- Strategically minded and able to navigate a continually shifting environment
Here at Amplēo, we are a group of entrepreneurial, strategic thinkers who love to work through the issues that help our clients succeed and grow. Raising capital is so important and having a trusted advisor to help navigate and coordinate that process relieves a lot of stress from the businesses we’ve helped. This is the final key to the 5 Elements to Financial Success, and quite possibly, the most important.