Growth is a necessity in business. It enables entrepreneurs to realize new opportunities, expand their products and services, attract new customers, increase sales, and add staff. In fact, growth is essential to any business’s long-term survival, enabling companies to respond to the demands of the market. It may also give an enterprise added credibility and enable it to stave off the competition. But in order to grow successfully, businesses need capital.
Whether your company is a small SaaS startup, a large healthcare company, or something in between, growth is always the goal. In order to make that a reality, businesses look for growth financing, capital specifically directed to aid them in achieving their targets for expansion and reaching the next level of their activity.
However, finding growth financing can be a challenge, especially for small and medium-sized enterprises (SMEs).
Larger traditional banks often fail to provide this type of funding for entrepreneurs seeking growth. After the 2008-2009 financial crisis, traditional lenders faced increasing regulatory restrictions, which they have responded to by preferring large, established companies with significant cash flow and a strong debt-to-income ratio.
There are, however, viable growth financing opportunities available to SMEs. Alternative lenders, including business development companies (BDCs) such as Saratoga Investment Corp., meet the needs of these businesses while providing significant benefits throughout the process. BDCs offer not only access to growth financing but also flexibility, an easy application process, and a quick turnaround time.
Technology financing is particularly appealing to alternative lenders, especially for companies providing Software as a Service (SaaS). That’s because they feature predictable cash flow courtesy of subscription-based, recurring-revenue models, as compared to the physical assets typical of the larger companies favored by traditional lenders.
What Is Growth Financing?
It’s pretty simple — growth financing is financing specifically directed toward company expansion. Growth financing can be a necessity to take advantage of opportunities that require a business to scale up production, make a large advance order, or otherwise invest significantly in growth. As a company grows, so too does its need for growth financing.
In order to improve the business, increase sales, or expand market penetration, a significant investment is often necessary. Businesses may need financial resources to obtain inventory to fulfill a large order or get new equipment to improve or expand their services. Growth financing is designed to help businesses get to the next level and achieve greater profitability.
How Is It Typically Structured?
Growth financing can take many forms, from lines of credit extended by a traditional bank to SBA loans from the federal government’s Small Business Administration. Businesses may seek out venture capital or angel investors, or they may consider going public with an IPO of stock. All of these can bring in substantial funds, but some of them are challenging to access while others require significant size, time, and documentation to begin.
Companies may also use vendor and seller financing, payment plans provided by certain suppliers. In the first of those, companies may offer discounts in exchange for a commitment to purchase a product over the long term.
Vendor and seller financing is often widely available, although it can be more expensive than other methods of obtaining financing for inventory expansion or equipment improvement. In essence, the buyer continues to pay off the seller of a business over time, enabling a transaction to close and the seller to receive ongoing payments.
Other options, like debt financing and mezzanine financing are important mechanisms for small and mid-market businesses to access growth financing. These options often bring together aspects of equity and debt financing. Business development companies and other alternative lenders offer high approval rates for these financing options, many of them structured to meet the financial concerns of small and mid-sized businesses.
Here are some of the most common growth financing options.
Non-Bank Cash Flow Lending
Non-bank cash flow lending is also known as enterprise value lending. While many traditional lenders like banks rely on tangible assets like equipment or real estate to evaluate a business for potential financing, business development companies offer cash flow lending.
This means of debt financing examines the potential growth of a business to underwrite a loan. This type of debt financing offered by alternative lenders is particularly well-suited to growth financing, as it is based on the evaluation of growth potential. Business development companies also offer flexible payment options alongside professional guidance to help recipients achieve their goals.
Recurring Revenue Lending
Recurring revenue lending is another area of debt financing well-suited to small and medium-sized businesses, especially those with SaaS or other subscription-based, recurring-billing models. These SMEs and startups may not have physical assets to leverage for a loan, but they do have predictable and growing revenue streams. In this form of financing, lenders evaluate a company’s annual recurring revenue (ARR) or monthly recurring revenue (MRR) before giving the green light.
Home Equity Loans/Lines of Credit
These are common options for small businesses, although they differ from other types of debt financing because they require tapping into the business owner’s own assets and credit, rather than that of the business. If you have owned a home for some time and can borrow against its equity, these types of bank loans may offer low interest rates. However, they come with a major downside: A business owner could potentially lose his or her house in the event of default.
Debenture
A debenture is a type of debt instrument, like a bond. However, it is not backed by collateral and physical assets, but instead by intangible assets, the company’s reputation, and its performance. Cash flow, credit ratings, and other aspects may be taken into account when creating a debenture.
Mezzanine Financing
Mezzanine financing is a form of hybrid debt that is subordinate (ranks lower in repayment upon default) to other debt from the same lender. It bridges the gap between equity financing and debt financing.
Because it is subordinate to pure equity but senior to pure debt, it is a higher-risk form of debt financing. It can be considered more like a stock than debt because the options built into mezzanine financing make it attractive for lenders to convert their debt into some form of equity. Taking its name from architecture, where the mezzanine is an intermediate floor between two levels, mezzanine debt bridges the gap when a company only can offer so much equity and a lender may only contribute so much debt to conclude a deal.
This form of financing dates back to the 1980s, when insurance companies and savings and loan associations dominated the mezzanine financing market. More recently, pension funds, hedge funds, and leveraged public funds have joined insurance companies in this space.
Situations Where Growth Financing Can Help
Companies want to expand to realize new opportunities, bring in staff and inventory, expand their product lines and attract new customers, all in an effort to enhance profitability and improve the bottom line. Growth financing helps achieve these goals.
Consider a recent example like WireWheel, an Arlington, VA-based software startup founded in 2016 that secured $20 million in growth financing to expand its reach to SMEs that want to provide greater transparency to customers. Their product provides solutions that help customers see what data is collected on them and how it is used.
The health tech company Carevive also recently sought $19 million in growth financing. Carevive, based in South Florida, has developed a platform that helps clinicians personalize treatment plans for cancer patients.
Another up-and-coming cloud-based service, Webscale, an e-commerce platform, raised $26 million to accompany its 108% growth in 2020. As companies pivoted to online sales during the pandemic, e-commerce companies grew with that transformation.
Should You Consider Growth Financing for Your Business?
For companies wanting to take their achievements to the next level, growth financing can provide the resources necessary to make it happen. Alternative lenders offer speed, flexibility, and simple application processes well suited to small and mid-market businesses.
When seeking out growth financing, it is important to look for a proven track record of success. At Saratoga Investment Corp., we pride ourselves on our reputation for speed and flexibility that meets the needs of small and medium-sized businesses.
Businesses looking to expand with growth financing may review Saratoga’s investment profile to determine whether their company is a good fit.