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By Steve King
Finding the right type of financing is one of the most challenging obstacles for business owners in the retail food industry. Most often, business owners will approach a bank lender or pursue other traditional means to raise capital, but they may not be the best or most viable solutions.
The need for financing may vary, but commonly includes raising capital for: a partial exit, generational transfer, recapitalization, management buyout, or perhaps most importantly, for growth.
While available financing options will vary based on the specific needs, overall profitability and creditworthiness of a company, it’s important that business owners and senior managers consider not just traditional, but alternative sources of capital. Often times, they believe that undergoing an IPO or approaching a private equity firm are the only options, but there are others to consider such as “non-control equity.”
Most Common Financing Options
Traditionally, there have been two financing options available to business owners: debt and equity. Each has a unique set of advantages and disadvantages.
With debt, a business borrows funds from a lender, who generally will not have a say in how the business is run nor will it be entitled to future profits. However, with debt come fixed repayment obligations, which can be a burden during business declines, especially for new or expanding businesses. These repayments also require a business to divert capital away from being re-invested into the business during positive cycles.
With equity, a business sells ownership interest to new investors. Sources of equity financing include friends/family, angel investors, private equity or an initial public offering (IPO). While equity financing eliminates several of the disadvantages of debt, it means the business owner will dilute his/her control and open investors to a share of business profits and key management decisions.
In certain circumstances, such as an IPO, equity financing may also require a business to comply with federal and state securities regulations. In cases where a business wants to remain private and angel investors or family/friends do not have the necessary funds, private equity is an option. However, private equity funds typically have minimum investments sizes and require the business to relinquish majority control, including decisions related to the business culture and operations. Often times, private equity funds also have an exit strategy in mind, with a five to seven year timeline.
Alternative Financing Sources
For many business owners, the traditional sources mentioned above may not be available or attractive. For example, a company may not meet requirements to secure a bank loan and, if they do, cannot afford to wait the months (and sometimes years) for the financing. Alternatively, a company may not be able to find the right investors to invest in the business and does not want to go public.
So, what’s a business owner to do?
Many alternative debt and equity financing sources have emerged, such as non-bank loans, crowdfunding, peer-to-peer lending and invoice factoring, but a unique financing method that is beginning to gain traction is non-control equity, as previously mentioned. It is an uncommon term in the U.S., but a viable option for retail food companies that require instant or ongoing capital injections. Non-control equity is similar to private equity in that it invests in private businesses, but only takes minority interest in the form of preferred equity.
Thus, unlike traditional private equity, the business owner and management retain majority voting control, common equity ownership, and remain the primary factions in charge of day-to-day operations. Furthermore, non-control equity interest does not participate in all the growth that a company generates going forward; it can be capped at a certain percentage.
In addition, non-control equity does not have an investment timeline and does not need an exit at any point. A company that provides this form of financing only looks to exit along with the business owner if he/she decides to sell out at some point in the future. Unlike traditional equity holders, non-control equity interest does not give the investor any right to exit in a normal course of operations.
Understanding If a Business is the Right Fit
Certain businesses may be best suited for non-control equity financing, including those in the retail food industry. Each business typically has the following elements:
- Long track records of sustainable free cash flow
- Low levels of debt and low unfunded capital expenditure requirements
- Experienced management teams with an existing management succession plan
- Low cyclicality and low risks of obsolescence
- Diversification among industry, customers or geographic location
While the above checklist provides qualifications for the invest-ability of a business, other items on a company’s balance sheet, such as EBITDA, are important qualifiers. In general, if a company has a business plan that is worthy of being funded, there are many sources of equity capital to choose from, regardless of size. The right advisor will be able to match up a successful company with appropriate investors.
At a time when the business-lending environment in the U.S. is still somewhat tight and traditional sources of equity capital are not necessarily suitable, business owners in the retail food industry must not overlook alternative financing sources. By weighing both traditional and alternative options, a business owner and his/her management team can be assured they are making the appropriate moves for their company, employees and customers.
Steve King is president and CEO of Alaris Royalty Corp., a Canadian-based company that provides alternative financing for a diversified group of private businesses in North America.