Growth Phase Capital- The Need and Options
Startup businesses’ first priority is to get market acceptance of their ideas and get traction. At this stage, most startups’ funding is based on bootstrapping unless it involves prototype development or product testing when external funds are required.
The entrepreneurs, after their initial success, who wants to grow their businesses require external funding. The funds are required for working capital as well as long term capital for acquiring assets.
The issue of funding is one of the biggest pain points for startup businesses wanting to grow their businesses—and one that comes up on a daily basis.
There are many options available and choosing the right source at the right time is important for success.
What are the options to raise the capital?
"Growth is never by mere chance; it is the result of forces working together."-James Cash Penney, Founder of JCPenney
Startup capital refers to the money that is required to start a
new business, whether for office space, permits, licenses, inventory, product
development , manufacturing, marketing or any other expense.
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Unlike working capital which is used for bills and basic cyclical expenses, growth capital isn’t tied to any particular business cycle. Instead, growth capital is designed to provide long-term health for the business. It builds up over time and can ensure the business’s well-being. Once a business decides that it is going to make a major change, like an expansion, adding another location, or a merger with another company, growth capital will come into play and be used.
In fact, the following options are available for growth capital of a startup in the growth phase.
1. Additional funding from the owner(s) or bringing in additional partners
2. Plough back the profits – Retained earnings
3. Government Subsidy Schemes
3. Borrowed funds, typically from financial institutions or banks
5. Leasing of assets- convert fixed cost to variable cost
All business transactions should be done through reputed bank right from the beginning. This facilitates in building relationship with the bank manager. This can help in shortening the time to get approval for funds. This advice may appear to be common sense but in real life it is not uncommon to find business owners neglecting this activity.
The owners have to plan for growth funds right at the beginning. The product business with assets can attract funds from banks and financial institutions. However intellectual property based businesses may have to approach angel or venture capitalists.The temptation is to use all sources of funding to expand rapidly and achieve astronomical growth. This may appear sound on paper. What is the reality? Managing this high growth means adding additional human resources and the top management may not be able to pay sufficient attention to this crucial resource. Changes in external environment can make an existing business go bankrupt due to a slump in the market.The temptation to use working capital for long term growth by managing more credit from suppliers or advance payments from customers should be avoided. This a mouse trap and we know what happens to the mouse.
it is better to focus on a slower growth, so the fund stays strong and the company builds strength at a more sustainable rate.
Mr. Subramanian had a great academic credentials being a alumni of IIT- Madras and IIM-Ahmedabad. After a few years of corporate experience, he set up a financial services company. This business was doing well and Subramanian had comfortable cash reserves. The financial services meltdown in 1997/1998 made him look for an alternative business.
He, along with his team did an extensive research on Retail Industry and based on this, decided to enter retail business. He opened his first store in 1997 at Chennai. In the next three years the number of stores grew to 50, in different parts of Chennai.
The initial success spurred Subramanian to rapidly grow Pan India and by 2007 had reached 1000 stores. By FY 2008 end the number of stores touched 1600.The turnover touched INR 23 billion.
This steep growth caused severe strain on working capital as the company did not infuse fresh long term capital. The rapid expansion and induction of new employees without proper systems and procedures resulted in stock shortages and other issues which were pointed out by the company auditors.
Subramanian postponed going public to raise funds. The 2008 subprime crisis and global meltdown was an inappropriate time to raise funds. He diverted working capital to fund each store expansion
The suppliers started curtailing shipments as their overdue payment was mounting. Finally, in 2008 one by one the stores started closing. Finally, the litigation from ICICI bank resulted in the complete closure of Subiksha.
The moral of the story is lack of planning for infusion of long term funds for growth resulted in business closure. Further, too rapid an expansion without proper support systems and inadequate training of new human resources caused the downfall.
order to scale up and grow the business an entrepreneur has to plan for
sufficient working capital as well as long term capital to acquire assets.
The growth cannot skyrocket without the top team’s strategic thinking and assessment of the inherent risks.
The rapid growth can also lead to the entire business collapsing without proper organizational controls, systems and IT support.