In a non-capital-intensive business like FunctionEight cash is not usually a major barrier to growth. Indeed, the business was founded without any debt financing, rather sweat equity and several strategic partners with good connections were used to provide the basis for growth in the early days. However, any business that has no track record of borrowing or any debt financing in place will often find themselves struggling to secure that financing, either when opportunity knocks, or they find themselves in difficult moments.
In fact, in the early days when the business was valued on a regular basis for insurance purposes, we often received the advice that due to our high ROCE (return on capital employed), we should look to borrow more money and invest in the business. Whilst this might seem like good advice, all the shareholders understood that it wasn’t cash that was the roadblock to our growth, but rather finding the right people at the right time and adapting to changing technology quickly that was proving the greater challenge.
Having said that we were also very aware that we lacked any debt financing track record, so we took the decision to secure some debt for the purposes of developing better banking relationships. The difficulty was to use the proceeds in a productive fashion that could generate returns at in excess of our interest rates. In Singapore we took debt in the form of a mortgage to buy an office space, which enabled us to be free from landlords and rents. This decision proved very worthwhile as we have been able to use the equity for re-financing on later occasions when we had requirements for capital. In Hong Kong we had the option to purchase a small IT business for which we used the financing. This debt facility has been increased and extended over the years as other opportunities came along.
When considering your options for looking for capital there are 4 key things to remember;
- Debt financing is the cheapest, but riskiest form of money you can seek. Unlike equity investment, bank loans must be paid back, or you run the risk of being declared bankrupt and your business folding. (Unless you owe more money the bank can afford to lose – but that’s another story).
- You should look to secure some small debt financing when you don’t need it. It will allow you to shop around for better interest rates and develop a relationship with a lender who may then understand more about your business and may be a source of support for you in the future.
- If you don’t have a requirement for the money you borrow, look to invest it in secure assets that can be sold, refinanced and offer a return in excess of your interest if possible.
- Don’t take debt financing for highly speculative ventures. You must be confident of a good cash flow from the investment in order to repay the loan. More speculative borrowing should be directed to venture capital or cash equity partners who aren’t looking for a short term/rigid return for their cash.