Businesses that get growth capital lenders excited
5 min read
27 April 2017
Growth capital loans are an alternative source of funding for fast-growing small and medium-sized businesses. It is capital that can help companies grow but which does not require to give up control of the company or dilute its equity.
Melissa Yvonnou, principal at BOOST&Co, has detailed what types of businesses are best suited to raise growth capital loans.
Businesses with certain characteristics are likely to find that growth capital lenders are more enthusiastic about lending money to them. None of the qualities listed below are hard criteria, but they will give you a flavour of the appetite that lenders might have for your company.
Growth Capital lenders like to invest in companies when they have strong momentum and can demonstrate trading is on the up. Lenders will rely on your company’s future growth rather than past performance to service the debt, so strong momentum gives them confidence that your company is on track to achieve this.
Generally, growth capital lenders actively seek scalable businesses because they offer a risk profile that is very well matched to growth debt. A scalable opportunity is one where the business is fully proven and successful but needs additional resources to expand. For example, it needs to take on sales staff, invest in production, or to replicate a service in new locations.
From a lender’s perspective, this is an opportunity for clear growth and controlled risk, as the company is simply doing more of what it is already very good at – there is nothing new!
A hot market means the company is more likely to be successful. It will find it easier to scale and it will have a stronger chance of achieving a high value exit, because such markets will attract equity financing and M&A.
Companies active in hot markets can easily reach annual growth rates of 50 per cent to 100 per cent. Examples might include:
- Businesses building a leading position in an emerging market
- Businesses offering a disruptive service in an established market
High gross margin
High gross margin businesses are well suited to growth debt because they service fixed repayments of the debt more easily. A high gross margin is often an indicator that your company delivers high value-added services to its customers.
That is evidence of the longevity of the business model and also provides headroom to lower margins if competition increases.
In addition, lenders like the fact that in a downside scenario, it is easier to support or save such companies because it is easier to act on overheads than on variable costs.
Recurring and predictable revenue streams
Lenders love business models with recurring revenues because a company scales faster when it only has to win customers once. Also, recurring revenue streams are often predictable; this attribute gives the lender visibility on the company’s future cash flows and its ability to service debt.
Businesses in this category include:
- Software-as-a-service enterprises
- Businesses with long term contracts – the backdrop is often long sales cycles so you will need to demonstrate a strong pipeline to support growth forecasts
- Low churn and good organic growth with existing customers
Cash is king for lenders. A business plan showing clear cash headroom will ensure the lender is comfortable about your ability to service the debt.
Asset-heavy business model
Downside protection is very important. It is easier to lend to companies with tangible assets – property, stock, or account receivables, for example – that the lender will rate as high-value collateral.
Specific situations that growth lenders like include:
- Funding equipment or hardware that is needed to accelerate growth.
- Funding stock that is needed to increase sales.
- Funding working capital where revenues are recognised ahead of receiving payments.
A business with good customer diversification will be considered a well-proven model and less risky. For companies with long sales cycles, the expectations in terms of customer concentration tend to be lower.
Management team who deliver their business plans
Lenders will challenge you to show that you have achieved what you said you would. This could prove vital for businesses that reach out to a growth lender six to 12 months ahead of being in a position to start the fundraising process.
There is a large upside to delivering on your plans – or in exceeding them. Doing so is rare and lenders will give you credit for your ability to make accurate forecasts. They will feel more confident about your growth plans.