How to Finance Business Growth and Expansion

Is my business ready to expand?

While you might be excited to develop and grow your business, you first need to consider whether expanding is the right choice for your business. 

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Before scaling and expanding your business, it's essential to assess market demand to ensure the current and future markets can facilitate sustained growth. Analyse your financial position to confirm stability and determine necessary funding. Evaluate whether your operations, technology, and supply chain are scalable and ensure your staffing, leadership, and company culture can support growth. Maintaining customer satisfaction and adapting your brand and marketing strategies to new markets is essential. Consider the timing of your expansion, ensuring both the market and your business are ready. 

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When business owners wear their rose-coloured glasses, they sometimes forget to plan for any downsides. Identifying potential risks, establishing contingency plans, and ensuring compliance with legal and regulatory requirements is important. A long-term strategy should be in place that includes an exit plan and the flexibility to adapt to changing circumstances.

Economies of scale vs diseconomies of scale

Economies of scale refer to the cost advantages a business experiences when it increases its production level. As the scale of production grows, the average cost per unit of output typically decreases. This happens because fixed costs, such as administration, rent, and machinery, are spread over a larger number of goods or services. Larger production volumes can lead to more efficient use of resources, better deals with suppliers thanks to bulk purchasing, and improved operational efficiencies. 

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However, it’s important to understand factors that may lead to diseconomies of scale. This happens when a business grows too large and begins to experience an increase in average costs per unit of output. Diseconomies of scale can arise from several factors, typically linked to the complexity and inefficiencies that come with increased size, for example, management challenges, resource constraints, limited area, and higher human resource costs, etc.

Finance options for business expansion: debt vs equity funding

Debt and equity funding are two primary ways businesses can raise capital to finance operations, growth, or expansion. Each has its advantages, disadvantages, and implications for the business.

Debt funding

Debt funding involves borrowing money that must be repaid over time, typically with interest. This can be done through various types of business finance, such as a loan, line of credit, mortgage, asset finance, invoice finance, and much more.  

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Advantages of debt funding:

• Ownership retention. The business owner retains full ownership and control of the business, as debt does not involve giving up equity.
• Tax benefits. Interest payments on debt are usually tax-deductible, which can reduce the overall tax liability.
• Predictable payments. Debt typically comes with a fixed repayment schedule, making cash flow management easier.
• No profit sharing. Lenders are entitled only to the repayment of the principal and interest, not a share of the company’s profits.

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Disadvantages of debt funding:

• Repayment obligation: Regardless of the company’s financial situation, you must repay the debt according to the agreed-upon terms, which can strain cash flow in some situations.
• Interest costs. Borrowing costs can be significant, especially if the business has a poor credit rating or if interest rates are high.
• Security requirements. Many loans require collateral or security, which could put the business’s assets at risk if it defaults on the loan. If the business owner provides a personal guarantee, it could also put their personal assets at risk if the loan is not repaid.

Equity funding

Equity funding involves raising capital by selling shares of the company to investors, which could include venture capitalists, angel investors, or the public in an IPO (initial public offering) on the stock market.

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Advantages of equity funding:

• No repayment obligation. Unlike debt, equity does not require repayment, which eases cash flow pressures.
• Risk sharing. Investors share the financial risk with the business owners; if the company fails, there is no obligation to repay investors.
• Access to expertise. Equity investors, particularly venture capitalists or angel investors, may bring valuable expertise, connections, and advice to the business.
• No interest costs. Equity funding does not involve interest payments, potentially making it a cheaper form of capital in the long run.

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Disadvantages of equity funding:

• Loss of control. Selling equity means giving up a portion of ownership, which can lead to reduced control over business decisions, especially if investors hold significant stakes.
• Profit sharing. Investors are entitled to a share of the company’s profits through dividends or capital gains, which could be costly if the business becomes highly profitable.
• Dilution. As more shares are issued, existing shareholders’ ownership percentage is diluted, which can reduce their influence and returns.
• Complexity and cost. Raising equity can be complex and costly, involving legal fees, regulatory compliance, and ongoing obligations to shareholders.

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The choice between debt and equity funding depends on various factors, including the business’s financial health, growth stage, industry, and the preferences of the business owners. It’s essential to think about risk tolerance and the cost of capital when deciding on the best form of funding for your business expansion. It’s a good idea to speak to a professional when deciding how to fund your business growth — we’re always happy to help if you have any questions!

Types of business finance for funding growth

Bank loans

Businesses can secure loans from banks to finance expansion. These loans can be short-term or long-term, depending on the needs. Bank loans come with predictable repayment schedules, and potentially lower interest rates than alternate lenders. However, they require a strong credit history, and security may be needed.

Asset-based lending

This involves borrowing money against the value of your business’s assets, such as equipment, real estate, or inventory. For capital raise purposes, you will need to have sufficient equity in your asset; the finance then releases this equity to you, and you repay the loan as per the agreement. 

Line of credit

Similar to a credit card, you are approved for a credit limit, and you’re able to draw down funds up to this limit whenever required. As repayments are made, you repay the facility, leaving you free to draw funds as you need the cash flow. Unlike a business loan, you do not pay interest on the entire amount (or the limit), you simply pay interest on the amount in use, for example, if you have a $100,000 credit limit, and you draw down $20,000, you pay interest on the $20,000 while it’s in use, and not the entire $100,000.

These are just a few of the common methods of business financing — there are many different types of finance available on the market depending on your specific needs. 

We’re here to help

If you’re thinking about expanding your business and would like to understand whether it’s the right time for your business, we’d love to chat with you. We can help with all aspects of business growth planning, including structuring, tax planning, financing, cash flow forecasting, payroll compliance, and more. Please feel free to get in touch with us if you’d like some support with your business. 

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