The Value of Growth Capital for Businesses

Posted on: December 17th, 2020

growth capital

Often businesses, caught up in the daily grind, fail to reflect on the strategic importance of necessities such as capital. While most conceptually know the importance of capital access, companies frequently operate in a manner that suggests they are oblivious to the bigger picture of the value of growth capital.

This is often caused by a single minded, doggedness on the part of the owner to be capital efficient. This admirable trait is partly the reason the company has been successful but can also be the same reason why the business has difficulty scaling. Growth capital is usually thought of by companies as what is left over at the end of the year, after bonuses and distributions are taken. It is cash retained in the business to be used for operations or growth in the upcoming year. It is a sort of means tested variable for the majority of middle market businesses.

Unfortunately, this amount is often insufficient for the business to take meaningful growth steps. The business settles into a sub-par long term growth trend dictated more by internal capital than market growth opportunity. Growth Capital offers businesses the ability to address this constraint and build capital liquidity in anticipation of fast growth. Strategic growth paths require careful bottoms-up capital planning, as if the business is a startup. Both the development and launch of new products is a painstakingly long-term process, that is measured in years rather than in months. Internally generated cash can only cover a fraction of the capital costs for strategic growth.

Growth capital can bridge this funding gap and ensure the business can invest commensurate with the market growth opportunity. As opposed to investing up to your available cash, with growth capital you can invest up to the magnitude of the strategic growth opportunity. If your business needs $5 million to double in size, and you have only $2 million in the bank, raising $3 million of growth capital is the appropriate step to take. With the right amount of growth capital at your side, you can credibly chart a growth path resulting in a significant scale up. It can be capacity expansion, product line expansion, regional growth, or an acquisition. Growth capital allows for transitional periods of hyper-growth followed by years of growth stability.

As new acquisition financing credit funds pivot to non-private equity sponsored deals, many lack experience with the asset class. Non-sponsored deals such as direct loans to companies or loans to independent sponsors making acquisitions are quite different from private equity backed deals and require a different thought process and engagement style from the lender.

During their underwriting processes, acquisition financing providers analyze probable performance projections for their proposed borrowers. The underwriter often toggles between a few scenarios to sensitize the growth variables leading to slower revenue and margin growth over time. The lender’s underwriting view is usually an extension of its credit intelligence and historical experience.

Mezzanine debt loans occupy the risky echelon beneath the bank but ahead of the equity in a capital structure. They are naturally subordinated to the bank loan via an intercreditor agreement wherein the senior lender retains the power to block their interest or force them to standstill.