Equity versus borrowing: how can I grow my business?
What’s the number one reason a business goes bust? It’s because it’s run out of money.
When a car runs out of petrol, the answer’s obvious – surely we just fill it up again? But what if it’s running out of petrol all the time? Then there’s something seriously wrong with the mechanics. And this is draining you of time and money.
The challenge for any business is having an adequate flow of working capital. But this isn’t something that can be suddenly fixed. It’s not like turning on a tap and having an instant stream of cash.
Instead cash flow comes through carefully planning and creating achievable goals for your business. The only way to survive and grow is to have a sound financial blueprint that identifies your working capital needs
We know how tough it is to survive in the current environment. According to the ABS, 50% of new sole traders in Australia fail within three years. It’s a daunting statistic but, luckily, clever strategies will always triumph.
What is working capital?
Working capital is the difference between the company’s Current liabilities and current assets. It’s the money you have coming in and going out.
It’s what funds your company’s day to day operations. Hence the word “working” – it means your business can keep functioning and pay your bills when they are due.
The liabilities usually are the debts your business incurs. These may be outstanding accounts from clients, wages or salaries payable or money due to your suppliers.
The assets are whatever money is in the bank as well any you have on hand. These assets may be stock or accounts receivable.
So when you deduct the short-term liabilities from the short-term available assets – that’s the amount of money you have on hand to work with.
Improving your cash flow options
Let’s consider some of the options available to help your business’s vital cash flow:
1) Borrowing – whereby you take a traditional loan out for your business, either from your family, a bank or a third party. The advantages are that you keep complete control of your business, but you’ll have a set time frame to pay back the money. Keep in mind that repayment of the loan can also potentially stifle the business by eating into your cash flow which reduces your working capital.
2) Equity – where you raise money through either yourself or a third party. The investors can be friends, family, banks or other businesses. You’re selling part of your ownership interest in the business. The investors get a slice of the profits. You’ll have to show that your business is likely to make a profit in order to get equity financing – investors will rarely contribute in blind faith. The advantages are that you’ll have more cash in hand and the investment doesn’t have to be paid back in the short term. You can set the terms of the investment and how the returns are paid out. If you’re putting your own money into the business make sure you have a good exit strategy – you don’t want to lose your home and your business.
3) ESS (Employee Share Scheme) – The ESS gives your employees a share in the business. This means they may forgo future salary or performance bonuses. In turn they get shares in the company. It also gives the employees a real incentive and stake in the company. It means you may be able to keep down the salary increases or wage rises over time.
Traditional equity via a third party
It’s not easy finding the right investor for your business. It can be a laborious task with much legwork and meetings. It’s a little like matchmaking as you and the investor work out what suits you both and where the common ground is.
For example, you may offer an investor 25% stake of the business. This entitles them to a share of the annual profits plus share of the gains when the business is sold. They will get a say in the business’s direction and expenditure and decisions.
There’s much to commend this strategy. It frees you up financially and you’re not under pressure to repay a loan instantly. Just make sure that your business is ready to have investors as this will involve a significant change in your operations and mindset.
For instance, you’ll have to meet reporting requirements for profit and loss and then you’ll have to put into place shareholders reports. Think about it: if you were an investor wouldn’t you want a monthly update or report?
Implementing an ESS scheme
An ESS gives your employees shares in the business. It also helps and protects your working capital.
It can be instrumental in creating a dynamic company culture as it turns your business into a collective where you’re all working for the common goal.
You won’t have to worry about having to pay performance bonuses or salary increases. Instead your employees will instead get shares in the company.
This gives them a terrific incentive to work hard and think smart to make sure the business flourishes. This helps create a dynamic, “we’re all in it together” culture.
Company culture is one of those intangible things that’s hard to attach a dollar figure to. Yet it clearly has a significant value. When you’re a fledgling business being buffeted by all the heady winds around you, having a really rock-solid team is a major asset.
It’s an ideal option for a new business or start up. It helps you hang on to those really talented and enthusiastic employees and also grow the business.
Pros and Cons of ESS
Pros:
1) Your employees are invested in the business and have a major incentive to help make it succeed.
2) Keeps your talented employees on board without having to entice them with higher salaries or other perks.
4) Creates a strong team culture which increases output and efficiency
4) You get taxation relief if you meet the right conditions.
Cons
1) It requires a lot of initial administration and paperwork. This is something ATB can help you with but, on your own, it requires a great deal of set up and understanding of highly complex taxation and corporate law issues.
Borrowing to expand your business
It’s been the traditional model of business expansion throughout the ages. This is where you take out a loan from a bank or financial lender. There’s a number of options to look at in terms of direct borrowing in order to expand your business. These can be anything from general unsecured loans to specific loans for a feature of your business such as:
– business vehicle loans
– equipment and tool loans
– business expansion loans (for instance, opening up a new office)
– business property loans (if planning to buy another commercial premises)
Borrowing can also be used to increase your working capital. Working capital can cover bills and short-term expenses or to grow your business. The amount of working capital you need depends on your type of business as well as when you need it. Timing is everything. Because incoming and outgoing money rarely meet as perfectly as we’d like them to do.
Example:
Carla is the manager of a trendy CBD bar. It attracts corporate types as well as inner city hipsters. She knows from experience that December will be the busiest time of year as large bookings are made for Christmas office parties. Plus the bar itself will be full of seasonal drinkers.
So what does this mean? That she’ll have to purchase a lot of stock in November to cope with the onslaught in December.
However the only problem is that she doesn’t have that cash – yet. This is where borrowing is a feasible option.
So what amount should you look for and what should you use it for? This is where you’ll need a proper financial blueprint. Working capital should be tied into a plan for growth and that’s where we can help.
Make sure you're ready to expand
Growth requires preparation.
How do football teams win grand finals? They win because each player is at their absolute peak. Everyone knows their role and is working for the common good of the team. This is where something like the EES scheme really creates a unified sense of purpose.
But how did they get there? To reach the grand final, that team has been training from the early days.
They’ve targeted the grand final as their goal and have been working as a cohesive unit ever since.
Sure there’s been mistakes. But they now know what their best positions are on the field and how to work together. They know how to cope with defeat and how to orchestrate success.
It’s the same with your business. All the cogs need to be functioning at their best. This includes your staff, your operations and your cash flow. This means preparing a solid financial blueprint and identifying the strengths, weaknesses and then implementing a strategy.
Say if you jump from being a small business with 10 – 15 staff to a larger enterprise of 30 – 40 people your old systems may strain to cope. You will have to suddenly deal with things like administration, payroll and human resource management. You can’t simply transplant what worked with a smaller group to a bigger enterprise.
How we can help
Moving up to the next level as a small business is a massive undertaking to do on your own and will seem overwhelming.
Our team is passionate about what we do. We have almost twenty years experience creating successful blueprints for businesses.
We can help. ATB has a five-step process:
1. Find out what’s important to you and your business
2. Prioritise your business goals so they’re achievable
3. Develop a strategy to achieve those goals
4. Implement the plan
5. Measure the results
Develop a realistic business plan so you can have clear goals and objectives:
– Advise on the nuts and bolts of your business’s operation so you can expand.
– Look at areas that are taking up too much of your time and working to alleviate those pain points.
Remember, the businesses without a carefully thought out plan to get to the next level, won’t make it. Let us help you achieve the growth you deserve.
“Growth is never by mere chance; it is the result of forces working together”. – James Cash Penney, founder of JC Penney
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