Does the Buck Stop with Lending Institutions?


Gregory S. DuPont Jan. 30, 2020

Businesses that are planning to expand often wonder where they will get the cash to finance planned growth. For smaller companies, the bank is a common and important source of the capital required for growth. The lending level that a bank considers prudent is based, at least in part, on the amount of the business owner’s equity in the company. For this reason, many business owners must turn to outside investors for some equity financing.

First and foremost, business owners must decide whether they would be willing to accept outside equity. For many, the possible loss of independence to outsiders is the single most important barrier to accepting such investments. While this concern is realistic, it may be outweighed by the significant benefits to be gained from accepting outside equity participation.

One key benefit of outside equity is the potential to increase growth and enhance the value of the business, but this may not be the owner’s only consideration. Equally cogent objectives may include insuring a succession of ownership to family members, enhancing the reputation of the business and its products, and acknowledging concerns of employees. Successful equity participation, therefore, requires that both personal and business objectives be appropriately considered. In addition, successful equity participation also requires the business owner to balance his or her corporate and personal objectives with those of the investor, bearing in mind that an investor’s ultimate objectives are to achieve a high return and to minimize risks on the investment.

Once a decision to seek outside equity has been made, the business owner must devote a significant amount of time and effort to a variety of complex issues, which can often distract management from immediate business problems. Any or all of the following may be required:

1. Preparation of a business plan suitable for presentation to outside investors;

2. Discussion of price and terms;

3. Detailed valuation of management capabilities, marketing strategy, and existing—as well as future—products, which may require the assistance of an outside consultant;

4. Investigation of the company’s systems, management information, and financial controls;

5. Complex agreements and legal documents; and

6. Meeting conditions imposed by the investor.

While equity obtained from outside investors can enhance a company’s value and increase potential for growth, a full understanding of the investment process is essential. The keys to deciding whether to seek outside equity financing are identification of the owner’s personal objectives as they relate to the business and how outside equity participation may affect the overall picture for the business owner.