What financing options are available to companies planning their next stage of growth? We provide an overview of the pros and cons that may help you select the right type of growth financing.
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Companies looking to embark on a big growth strategy are usually not able to do so with their own finances. Let’s take the example of a Swiss food manufacturer specializing in organic and sustainable products. This SME wants to launch a new product line with vegan snacks. To do so, it will require machines and raw materials, and it must invest in marketing to make these vegan snacks the talk of the town. This all costs money. To successfully implement its growth plans, the company will need financial capital. This is also referred to as growth (or expansion) financing.
When it comes to growth, companies have to invest in advance: for instance, they must advance costs for product development, marketing, sales and staff before the additional income they have planned can be generated. Successful growth usually only shows up in a company’s bank account weeks or months later. If the company wants to avoid a liquidity shortfall in this period, it will require new liquid assets. But how much capital is needed right now and in future to secure liquidity for each stage of growth? It is important to answer this question carefully and early on. In the growth phase itself, a liquidity plan gives an accurate overview of availability liquid assets.
Growth isn’t always about launching a new product on the market. The Ansoff Matrix can be used to identify and develop corporate growth strategies. This showcases four potential growth strategies: market penetration, market development, product development and diversification. We’ll take a closer look at these. Financial requirements also hinge on the choice of growth strategy. Growth through market penetration, for instance, should generally be less capital intensive than growth through diversification.
The company wants to grow in an existing market by increasing the sales or market share of its products. It works the market by selling existing customers more products (e.g. via a bulk discount), acquiring new customers (including ones who have previously bought from the competition) or employing a combination of these methods. To achieve this, it might consider the following measures:
The food manufacturing company mentioned at the outset uses bulk discounts to motivate existing customers in Switzerland to buy in bigger volumes. Additionally, it runs special promotions and loyalty schemes on a regular basis to boost customer retention.
Market development is when a company looks to sell its existing products or services on new markets, whether on a regional, national or international level. As expanding into an unknown market often comes with greater risks than market penetration, this strategy requires careful planning and analysis. Important tasks include clarifying what the legal provisions are in the destination country (e.g. is the product actually permitted in the target country?) and checking customs formalities and logistics regulations.
The Swiss food manufacturing company specializing in organic and sustainable products plans to launch its premium organic products on the German market.
The product development strategy involves companies attempting to satisfy the needs of their existing market with new products (innovation) or by developing additional product variants. This strategy also entails significantly greater risks than market penetration, as it is harder to predict how quickly an innovation will become a hit, if at all.
A well-known Swiss label for leisure fashion is developing a new line of outdoor coats using recycled and biodegradable materials. Built-in solar panels allow charging functionality for small devices, such as smartphones or GPS devices. For every coat bought, the company plants a tree in Switzerland. It aims to continue growing in Switzerland thanks to this product innovation.
Product diversification not only requires the development of a new product or service, but also tapping into new markets. This is the riskiest of the four growth strategies.
The Swiss company specializing in organic and sustainable products plans to launch a new range of organic skincare products, including soaps, shampoos and lotions. This product diversification strategy is about harnessing existing expertise in the field of sustainability and organic food to tap into new market segments.
Optimizing billing processes helps save on costs that can be put towards financing growth strategies.
Regardless of which growth strategy a company chooses: healthy growth requires carefully considered growth financing. But what financing options does a company looking to grow actually have? The image shows different options – divided into external financing (financing with third-party debt capital) and internal financing (funding from within the company).
Loans from banks and other providers are especially suitable for companies offering collateral such as real estate, receivables, stock, machinery, patents and sureties, and which are able to produce solid financial figures that assure the creditor the loan will be repaid. The benefit of this kind of financing is that liquidity is made available immediately.
This tends to be funding provided by family and friends, usually with favourable terms and flexible conditions.
Crowdlending is a form of financing where several private individuals or institutional investors issue loans to startups and SMEs via online platforms. Unlike traditional loans, which are provided by banks or other financial institutions, crowdlending takes place between the investors and the borrowers directly. Crowdlending involves startups or others receiving money in return for interest.
Private equity (also known as off-exchange or private equity capital) comprises capital participation in unlisted companies. The opposite is public equity, i.e. exchange-traded equity capital. Specialized affiliates (private equity firms) invest in established companies and elsewhere with the aim of accelerating their growth. In return for their investment, they expect profit when the company is sold or floated on the stock market.
Backers invest in a company, in exchange for either a share in the company or a share in profits. Unlike conventional equity financing, small amounts can also be invested, depending on the platform.
In the case of factoring, companies sell receivables they have from customers to a factoring company. In return, the company is paid the invoice total, minus interest and fees. The financing price depends on factors such as the company’s creditworthiness, the receivables, the revenue and the number of invoices. Factoring is an attractive source of financing for companies going through growth phases in particular. After all, as revenue increases, so do the receivables that can be sold.
A lease is when machines, vehicles, real estate, etc. are hired out for a limited period of time at fixed rates. In return for using the property, the company (as lessee) pays lease rates that, in addition to interest and administrative costs, also include an amortization amount. Depending on how the contract is drafted, the property can be returned to the lessor once the term has expired, or the lessee/third party can purchase it. Given the flexibility involved and the fact that the costs, and therefore outgoing payments, can be calculated in advance, leases are a sensible source of financing for small companies undergoing growth. This financing option is especially worth looking into in times of rising interest and rapid technological change.
Crowdsupporting is when backers are often given a gift in return for their capital contribution − or, in the case of product developments, they are given the product before it’s released on the market. Even though the majority of projects financed through crowdsupporting have so far been in the field of sports and culture, crowdsupporting can also be a viable alternative for commercial projects.
Mezzanine financing is somewhere between financing through equity and debit capital, with a number of instruments used. It is frequently used to boost the equity in companies or to finance growth. This financing can be adapted to the company’s individual needs through various instruments. Typical mezzanine instruments are profit-participation rights, convertible and warrant bonds, and silent participation. Silent participation offers a good illustration of the principle of mezzanine financing. Silent participation is when an external investor provides a company with growth capital without being actively involved in the company’s management. In return, investors receive interest on their capital and potentially a share in company profits. A silent investment often serves to increase a company’s equity without the need to sell company shares. From an economic perspective, mezzanine capital is viewed as equity capital; legally speaking, it is treated as debt capital (the debt interest is tax deductible).
Under certain conditions, the four surety bond cooperatives in Switzerland help productive SMEs with startups, investments and succession planning. As partners, they can facilitate access to secure financing by acting as guarantor for bank loans of up to 1 million francs. By doing so, they help the SMEs obtain the necessary loans.
Equity is increased either from the outside (injection of new funds via investments made by owners as part of a capital increase) or from the inside (accumulation and retention of profits, i.e. profit waiver and reinvestment). Injection of funds from the inside is regarded as conventional self-financing in the strictest sense of the word if a company is healthy. The retained profit is either allocated to reserves or carried forward.
The prime objective when selecting a financing source is the long-term success of the company.
It’s worth considering the following factors when deciding exactly which option to select:
As with any type of financing, companies should keep track of the capital costs in relation to the expected ROI (as far as this can be planned), and this applies to growth financing, too.
A checklist of possible pros and cons associated with selected financing options (external financing) may help companies choose the right kind of external financing for their growth project.
| Financing options | Pros | Cons |
|---|---|---|
| Financing options Bank loan |
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Cons
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| Financing options Third-party loans (family, friends, etc.) |
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Cons
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| Financing options Crowdlending |
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Cons
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| Financing options Equity financing |
Pros
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Cons
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| Financing options Mezzanine capital |
Pros
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Cons
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| Financing options Factoring |
Pros
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Cons
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| Financing options Leases |
Pros
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Cons
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A plan is indispensable: if a company wants to grow, it must update its business plan or create a new one that is geared towards its growth phase.
Specifically:
When adapting the business plan or compiling the growth plan, careful research must go into backing up financial predictions, and assumptions must be credibly substantiated. This shows prospective investors that your company has performed a realistic assessment of the feasibility of your growth project (see also next question).
If a company wants to convince investors it’s worth investing in its growth project, they must be able to realistically substantiate it with facts, figures and data. After all, while investors may give startups benefit of the doubt early on, they will require clarity over expected profit, opportunities and risks later down the line. In other words, well-established companies should focus more on key figures. The relevant key figures vary by industry. This could, for instance, be KPIs such as conversion rates, customer acquisition costs, customer retention costs or customer lifetime value. Current market position and the general developments in the industry are also important indicators. Additionally, a solid credit standing may also prove vital. This consists of a positive business history, demonstrable income and steady growth potential. Last but not least, investors also pay attention to management proficiency and a company’s ability to manage risk.
The break-even point is a crucial factor in growth financing. It establishes the point at which a company is able to cover its costs with income and turn a profit. Reaching the break-even point shows investors and lenders that the company is economically viable and a worthwhile investment.
There are many reasons why a company might need additional debt capital to see through a growth project. For instance:
In addition to the debt capital needed for growth, additional working capital is also needed, as this can run low when capital is used for other purposes.
