When a business is new, its owners may not know where to turn for help raising capital. Is funding from a bank a better option, or is private equity a better fit? And how do you decide?
Your banking partner can help you evaluate your needs and options, then steer you in the right direction, even if the bank isn’t the best solution, says Michael Field, executive vice president, technology banking division, Bridge Bank.
“Your banker can look at all the factors and determine whether it can put together funding to meet your needs,” says Field. “But even if the bank isn’t comfortable, your banker may be able to provide a solution to enhance the debt side of things or the equity.”
Smart Business spoke with Field about what to consider when looking for funding and common mistakes to avoid when doing so.
What should start-ups consider when looking for access to growth capital?
The first thing is debt versus equity. If you have no product, just an idea and a business plan, debt is probably not the right solution. That’s more of an equity play with investors who support and finance research and development.
The bank then steps in to finance growth, after you’ve developed a product, or raised sufficient capital so there is an ability to execute the plan. But it can help you at any stage. For example, if are looking for equity, the bank can help introduce you to the right players.
What are the factors to consider when determining whether bank funding or private equity is a better fit?
First, look at cost. Equity is much costlier than debt, and you have to give up a percentage of your company. With debt, you may not have to give up any of your company.
Also consider flexibility. Debt has more restrictions, whereas with equity, the money can be used with more freedom.
What do banks look for when judging a young company’s ability to repay a loan?
Banks look for sources of repayment. They look at cash burn — how long will the cash you have currently and the bank’s cash last you? They look at cash flow and measure balance sheet strength and how liquid you are, what kind of investor support you have and whether future rounds of funding are expected, and whether you have a lead investor who is supporting the company or if you are bootstrapping with friends and family.
What common mistakes do start-up firms make when seeking capital?
Companies don’t realize they can leverage their balance sheet using debt versus raising equity. Why would someone use debt versus equity? Often, it’s to get to the next stage and increase the value of the company before going for equity. In addition, they’re not giving up as much of the company. Leveraging debt to get to the next stage really allows you to get a better deal from investors.
Also, sometimes people get greedy. They may have a really good investment on the table from an investor, but they don’t take it and then the opportunity goes away. They get greedy because they think they can obtain a better deal by continuing to shop. Sometimes there is a good deal on the table, and you should just take it, whether it’s from the bank or from equity.
Business owners also make the mistake of viewing funding as a transaction rather than a partnership. Is the person you’re working with on the same page as your management team and investors? Are your goals aligned? Is everyone working in the same direction? If the relationship is purely transactional, that can get a company into trouble.
In addition, companies sometimes fail to balance sources of capital. All equity or all debt may not be the best solution. Sometimes spacing it out by taking some equity and some debt can help you on price, as well as diversify your sources of capital.
How can a banker help you identify the best solutions for your needs and provide opportunities for growth?
The banker will ask about your business, your investors and your plans for capital. He or she will look at financial projections, as well as history, to assess where you are and where you are going. As far as banks go, products are products. It’s how your banker applies them to your individual situation that makes a difference. That’s where that expertise comes into play, whether it’s with debt, or with equity solutions, even though the bank is not providing the equity itself.
People often don’t realize the benefits of associating with a bank that knows the market. The bank can provide introductions to service professionals and equity investors. It can assist your company as it grows, providing widespread solutions.
The bank can also help as you look to expand internationally. In the early stages, a company may not have the management team to understand the international side of things. Relying on the expertise of a bank with international experience can help you get to the next stage.
When should a business begin to establish a banking relationship?
Starting that relationship early, even if it’s just with a checking account, makes the bank aware of you, and as you grow, it can help guide you through the process and into the next stages.
Think not just about the transaction but about your relationships with different providers. There are providers who will become partners, and there are others that are just transactional. Finding those partners is key to your success.
Michael Field is executive vice president, technology banking division, at Bridge Bank. Reach him at [email protected] or (408) 556-6501.
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