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Capital continuum: a roadmap to business financing
Over the past several years, our dynamic economy has created a multitude of opportunities and challenges for business owners. Access to capital and debt is one area left blemished by those dynamics. As a community banker, I have had the opportunity to meet many business owners, from the start-up entrepreneur to the 40-year veteran.
Although the details and scale may vary, the need for capital or debt remains fairly consistent for a business owner. There are four stages in a business lifecycle, and there are five sources of capital and debt that provide financing options for each. The five sources of capital and debt make up a capital continuum. Understanding the relationship between the capital continuum and the business lifecycle can help business owners and strategic partners better employ funding options for the business.
The capital continuum chart illustrates how the funding phases typically relate to a company’s journey through the four stages of life: idea, startup, growth and maturity. The first phase is the three Fs: friends, family and founders. This phase is often matched with the idea stage of a business’s life, attempting to develop an idea into a marketable product or service.
Angel investment is the second phase of funding, usually available to companies in the startup stage. Angel investor groups have formed in Michigan providing capital to companies that have proven a market exists for their product/service and have generated at least modest sales. Typically, angel investors do not require interest on their investment, but instead require an ownership stake or warrants allowing the investor to convert the warrants into a minority ownership in the future.
The next phase is venture capital, which typically injects capital or subordinated debt into a company. These funds typically have attributes of both capital and debt. For example, subordinated debt instruments usually carry a higher rate of interest (4 to 6 percent above typical bank loan rates) and warrants that the lender can convert into a minority ownership position. Venture capital seeks companies nearing or entering the growth stage that have intent and potential for growth.
The fourth capital continuum phase can be government-guaranteed loans, representing a shift from capital to debt. Debt usually has more specific and shorter repayment terms than capital and does not take an ownership position in the company. Government-guaranteed loans are typically funded directly from commercial banks and are guaranteed by a government agency, such as the Small Business Administration, U.S. Department of Agriculture or the Michigan Economic Development Corp. Borrowers of this debt type may be in stage 2, 3 or 4, but a company in growth stage would be the most likely candidate.
Bank debt is the final phase in the capital continuum. These loans are funded directly from commercial banks and are typically used to acquire assets, refinance existing debt and finance working capital. Repayment terms are based on the expected life of the asset financed and traditionally are set up as monthly payments. Bank debt is primarily for companies in stage 3 or 4 of the business lifecycle that report consistent and positive cash flow. Assets typically funded by conventional bank debt include equipment, land, buildings, inventory and accounts receivable.
A company does not always progress through the various stages in a neat, straight line as depicted in the graphic, although a successful company will be familiar with each of the stages before reaching maturity. Companies often experience changes in the marketplace or internally, requiring movements back and forth on the capital continuum including new project development, lost profitability or shareholder buyouts. Whatever the stage of the company, various funding sources exist to complement its needs.
Michael Sytsma is senior vice president and business banking manager for The Bank of Holland.