Your guide to growth financing: Funding options to scale smarter

Businesses need to grow for long-term sustainability and to keep up with competition. This may require additional investment to expand operations to meet growing demand, developing new product lines, or entering new markets. These expenses are categorized as business expansion financing, or growth financing.¹

A recent report from the U.S. Department of the Treasury notes that "Over the last decade, large banks have tightened credit standards and originated fewer loans."² Businesses must be agile to find opportunities to secure business growth financing in an often-challenging environment.

This post will explore some of the terms and concepts associated with growth capital financing, as well as some of the options businesses consider when pursuing growth financing options.

Understanding growth financing

Growth financing is a type of business capital that helps businesses grow. Companies usually seek this type of funding once they have established some stability, revenue, and customer base but need more capital to reach the next level. The funds might cover market expansion, acquisitions, or a new product roll-out.

Growth funding is differentiated from other sorts of financing such as seed funding, which helps a business with startup costs,³ or bridge funding, which covers short-term costs while a company seeks longer-term financial support.⁴

Timing: When to seek growth capital

Typical signs that a business is ready for growth financing include consistent revenue growth⁵, a proven business model, and more demand for their products or services than their current capacity can handle. These indicators include capacity constraints or an overflowing sales pipeline. Companies may also seek to fund growth if they are under competitive pressure.

Potential investors will typically look at key traction metrics such as user or customer growth, Annual Recurring Revenue (ARR)6, and margins. These metrics paint a picture of the company's financial health, prospects, and profitability.

Main types of growth financing

There are three main types of growth financing:

• Equity financing: This type of financing is gained by selling shares in the company. This can be achieved through venture capital, private equity, and angel investors. 
• Debt financing: Achieved by taking out lines of credit or bank and government loans
• Hybrid and alternative instruments: Hybrid financing blends features of debt and equity. Examples include convertible notes, mezzanine financing, and revenue-based financing (RBF). Alternative financing options include self-financing, crowdfunding, government grants

Pros and cons by financing type

Each type of financing has pros and cons. Equity financing, for example, offers businesses strategic support and doesn’t require repayment, but it dilutes ownership of the company. Businesses that opt for debt financing retain control but take on repayment obligations, with interest. A hybrid option, such as RBF⁷, can offer more flexible payment options than conventional loans but incur higher effective costs.

Eligibility and investor criteria

A business seeking investors should expect to be scrutinized. Investors assessing a company's financial health look at the following metrics:

• Revenue scale: This is the level or size of a company’s revenue, essentially how much money the business generates at different stages of growth. Revenue is "scaling" when it increases without a significant increase in resources⁸
• Unit economics: The revenues and costs of a business calculated on a per-unit basis⁹
• Burn rate: The rate at which a company spends its cash reserves to cover operating expenses before generating positive cash flow¹⁰

Potential investors will also seek to understand a company's market opportunity by evaluating these metrics:

• Total Addressable Market (TAM): The maximum revenue opportunity if the company captures 100% market share (all possible customers)¹¹
• Serviceable Addressable Market (SAM): The portion of TAM that the company can target based on its resources and focus¹¹
• Share of Market (SOM): The portion of the SAM that the company actually controls¹¹

Investors will also hope to find a competitive moat: a completely unique quality in your business that direct competitors cannot offer.¹²

Leadership is also important. Investors attach significance to team credentials and a company's governance practices.

Preparing to raise

When preparing to raise growth financing, businesses must craft a compelling pitch deck that clearly shows the growth projections that have inspired the desire for expansion. They need to build a robust data room with financials, Key Performance Indicators (KPIs), existing contract obligations, and any intellectual property assets. Also, businesses must stress-test their valuations and run several capitalization table scenarios to fully understand ownership and equity distribution implications.

The due diligence process

A serious investor has to conduct due diligence. This includes performing a financial audit, a full legal review, and an assessment of any IP assets. The due diligence process can take a few weeks or many months, depending on the complexity of the business. Companies must retain momentum with investors during this period by maintaining transparency throughout the process.¹³

Negotiating deal terms

Negotiating terms of a funding deal can be challenging for businesses, especially ones new to the process. Different types of funding generate different concerns.

For example, equity financing deals tend to pivot on issues of company valuation, liquidation preferences (circumstances under which an investor can cash out), and control provisions, given that the investor is taking an equity stake in the business. Debt financing deals tend to be more concerned with things like interest rates, which effectively govern the cost of the loan, collateral, and covenants.

All deals are potentially subject to "founder-unfriendly" clauses that favor investors over company founders and challenge founders to negotiate for better terms.

Grow your career in business with the KU online MBA

The online MBA from the University of Kansas School of Business is designed to equip you with the tools, knowledge, and experience to make smart growth financing decisions. Review our course descriptions or admissions requirements online, or contact us directly for more program information. When you're ready to elevate your business career with an advanced degree, schedule an appointment with one of our admissions outreach advisors to discuss your next steps.