Each stage of an entrepreneurial firm’s lifecycle presents unique funding challenges. Here’s a look at the capital requirements and demands of each stage.
At the seed stage, your business is just a thought or idea. You’ll spend this time matching business opportunities to your skills, experience, and passions. You’ll also be exploring potential sources of cash, typically owners, friends, and family, as well as suppliers, customers, government grants and financial institutions. Your overall business plan should also include determining ownership structure and seeking professional advisors. Creating and enacting a comprehensive business plan is often the biggest success predictor for an emerging company.
To bring the company into existence, you’ll need money to finance business feasibility studies, prototype development, evaluation of market potential, protection of intellectual property, and research into other aspects of the business. Once you decide to go ahead, you should have enough working capital to run the business, cover losses, and set aside contingency funds for emergencies.
The business will continue to rely on cash from owners, friends, and family. Other sources of capital may include suppliers, customers, or grants and bank loans. Since young firms are frequently financed by debt, you may be able to obtain a loan using your personal savings or assets as collateral. Or you may apply for bridge financing to cover the period between expenditures and returns. Friends, family, or angel investors may also purchase parts of the business, providing crucial seed money.
In the survival stage, your business idea has proven workable. A major focus now will be on generating enough cash-flow to stay in business and finance growth, with the emphasis on maintaining working capital to finance increased inventories and receivables. As the owner, you will continue to shoulder the financial burden. However, you may seek creditor financing if your company has established credibility with suppliers. Bank overdrafts and short-term loans are other common sources of capital at this stage.
Small businesses rarely grow past the survival stage, since owners may be satisfied with marginal returns on their investment, or they may be unable (or unwilling) to delegate responsibility. Many companies also fail at this stage due to an inability to cover the cost of creating or offering new products or hiring staff to expand services.
At the success stage, your business will need significant funds for growth. Options can include seeking venture capital to grow the business, raising capital through equity financing, and offering shares to the public. The main concerns are avoiding a cash drain and shoring up the company’s ability to endure tough times. All cash will be reinvested into the business to finance increased working capital demands. In some cases, the owner may sell the business at a substantial capital gain.
A firm that grows too rapidly can overextend limited resources. Liquidity could become a problem as cash is reinvested into product development and/or marketing. The firm could end up folding, even if its products or services had been successfully in the marketplace.
At takeoff, the focus is on financing rapid growth. There’s a danger of running out of cash during this period; business owners must be willing to tolerate a high debt-to-equity ratio. The challenge will be to ensure that cash-flow isn’t eroded by inadequate expense controls or bad investments. The company will still be dominated by the owner’s presence and controlling ownership. Sources of funds may include profits, joint ventures, loans or grants, licensing, and new partners and investors. From this pivotal stage, the company can go on to become a big business or it may be sold, usually at a profit.
At resource maturity, your company’s biggest concern will be to consolidate and control the financial gains brought on by rapid growth. The company will have the financial resources to engage in detailed operational and strategic planning. The owner and the business will now be separate, both financially and operationally.
If the firm has no new projects, the financial needs will be low and internal funding will be high – so high, in fact, that it may not be possible to put all of it to productive use. The company may choose to finance operations by issuing bonds and equity.
With the advantages of size, financial resources, and managerial talent, the company can be a formidable force in the market if its entrepreneurial spirit can be preserved. If not, the business may enter a period of ossification, characterized by a lack of innovation. Large corporations often fall victim to this. Their considerable market share, buying power, and financial resources enable them to remain viable until they’re caught off-guard by one or more major market changes that competitors are swifter to respond to.
In the decline phase, sales stagnate or shrink, often due to the availability of superior offerings from competitors. Falling sales and profits will result in negative cash flow, and cost-cutting becomes vital. The business now needs its highest level of capital. Suppliers, customers, owners, banks, investors, and government can be major sources of finance. At this point, you’ll have to decide whether to expand or exit the business.
Exit can be your opportunity to cash in and make the most of the years of effort you’ve put into your business. Or it may mean shutting down the business. Don’t fall into the trap of overestimating the value of your company; find a business partner who will provide a realistic valuation. The real value of any firm is the cheque that an entrepreneur or other business is willing to put on the table to acquire the company. Consult with your accountant and financial advisors for the best tax strategy to sell or close the business.
Nithya Caleb | Contributing Writer