9 FINANCING TOOLS YOU CAN USE TO GROW YOUR BUSINESS WITHOUT SACRIFICING INDEPENDENCE
Start a company. Grow. Find Investors. Raise money. Grow Faster. Repeat. Exit.
This is the startup way.
But increasingly, people are realizing this way is broken.
The day you bring in outside investors is the day you give up control – not just of your company or your workday, but often, your life.
Conventional investors want two things: an outsized financial return and liquidity.
What does that mean for you, the business owner, who is accepting their money?
It means that you are agreeing, implicitly or explicitly, to two things:
You and your team will work voraciously and continuously to increase the company’s profits, at the expense of everything else.
Eventually, you will sell your company or otherwise buy out your investors for a financial return (ideally a high return within 3 - 7 years from taking their money).
Let’s consider all of the situations when the conventional approach may not be optimal for you, the founder/owner/CEO:
You want to focus on other things within your business besides growth (sometimes even at the expense of growth)
You want to purposefully reduce your profitability by running your company in a more humane way (i.e. by providing exceptional pay and benefits)
You want to grow slowly because that is less stressful
You don’t want to spend time or psychic energy worrying about investors
You’re not sure that you ever want to sell the company, or if you’d be able to find the right buyer (or if they even exist)
You are afraid of being forced to sell the company to the wrong buyer, or at the wrong time
You don’t want to have to report to anyone besides yourself
You want a lifestyle business that gives you the freedom to work 20 hours per week or to travel when you want
You want the flexibility to shut down the company when the time is right
Etc.
So what are you, the business owner, supposed to do if you aren’t crazy about the idea of raising conventional equity?
Below is a rundown of 9 financing tools you can use to grow your business without sacrificing independence. The purpose of this list is to get you thinking about alternatives. It is to remind you that selling big chunks of your company to profit-motivated investors is one way, but not the only way.
9 Financing Tools for Independent Businesses
1. Institutional Debt
Institutional debt from banks or other financing institutions is the most common and obvious alternative to conventional equity. The problem is, it may be inaccessible or create unworkable demands on cash flow for companies in the startup or growth phase. And for businesses of all sizes, institutional debt may be too much of a hindrance to cash flow or flexibility, or it may simply be anathema to the founders, or the company may already be over-leveraged.
Nonetheless, if you can access traditional senior (secured) or subordinated (unsecured) debt at a workable price, this is often the fastest and most efficient way to access capital.
In addition to traditional senior or subordinated debt, other forms of institutional debt include:
a. Cash Flow Loans
Cash flow-based loans allow companies to borrow money based on the projected future cash flows of a company. These loans may be good options for companies with a history of consistent positive cash flow and low/no amounts of existing debt. These loans do not require physical collateral like property or inventory, and so they are well suited to companies that don’t have much collateral (i.e. a service-based business). Instead, the loan is typically secured by part or all of the future cash flows of the business.
b. Inventory Financing
Businesses that buy and sell inventory may be eligible for inventory financing. This is when a business borrows money to buy the inventory and then pays it back as they sell the inventory. The loan is collateralized by the inventory itself. Inventory financing is often used by smaller privately-owned businesses that don't have access to other options.
c. Equipment Financing
If you are a business that relies on equipment - a grocery store for example - you may be eligible for equipment financing to help you build out your store. The lender loans you money to buy your equipment, which is then used as collateral against the loan until it is paid off.
2. Mission Aligned Common Stock Investments:
Selling common stock to investors is one of the most common ways that companies raise money. But as noted in our introduction, it comes with downsides for the independent-minded business – namely that common stock comes with voting rights (ie., control).
One way to mitigate this downside is to raise common stock from the “right people” AKA those who are not (and will never be) interested in control. Two examples:
a. Friends and Family (AKA friendly capital)
Friends and family want to see you succeed, and oftentimes may be willing to provide capital for your business. The upside of this is that you can take advantage of your close relationship to design company-friendly terms and to be clear upfront about questions like control, return expectations, timeline, etc. The downside, depending on your personality, is that you may feel indebted to your friends and family, which is stressful. If you accept friendly capital, all parties should understand that your friends and family may never get it back. If that would make it difficult for either of you to sleep at night, then it’s probably best to avoid this route.
b. Mission-Aligned Silent Partner
In 2006, Jeff Bezos bought a minority, no-control stake of the company Basecamp from the two founders who were the sole owners up until that point.
The purpose of the deal was to provide some liquidity to the founders so that they would not be tempted to sell and sacrifice independence. Bezos was given a one-time provision to sell his stake back to the company after seven years, but that was it. There was no other plan for an exit, the deal was simply that he was entitled to his pro-rata share of company profits, just like the two founding owners.
Fourteen years later, Bezos is still a silent partner, with no end in sight (and indeed, no way for him to force an exit or exert any governance control). As of 2017, he had already made over 5X on his initial investment. You can read more about that deal here.
3. Non-Voting/Limited-Voting Preferred Stock
Non-voting preferred stock is one of the most compelling alternatives to conventional stock. It provides investors with many of the same economic rights that they would get in a conventional stock sale, but without the voting power. Disconnecting the company governance from economic ownership is a key tenet of steward ownership.
Examples of companies that have successfully financed themselves by selling non-voting preferred equity include Organic Valley, Equal Exchange, Namaste Solar, and Organically Grown Company. For more detail, we recommend this post about how OGC structured their non-voting preferred stock.
You can also design a hybrid stock with limited voting power that provides investors with governance rights in certain situations, but generally limits the potential for profit-motivated influence and control.
When designing preferred stock with limited control rights, it is important to describe in detail how investors will receive a return, since they have less ability to influence that later when compared to common stock. Some creative methods of designing return include:
a. Revenue or Profit Based Financing AKA Demand Dividends
Some lenders or investors will be amenable to revenue or profit-based financing. For example, an agreement that says 2.5% of the company’s gross revenues or profits or “free cash flow” will be used to pay back the investors each year. Further, depending on how this is structured, the total return may be capped as a multiple of the original investment (typically somewhere between 1X and 3X). This can be a helpful tool for a company with high variability or an uncertain future, because they pay more when times are good, and less when business is slow. An example of a fund that does sort of investing is Lighter Capital.
b. Structured Exits
Imagine designing your company’s stock so that the return profile and the exit timeline are agreed upon in advance, rather than being reliant on some TBD acquisition, IPO, or another liquidity event. That is a “structured exit.”
The details of a structured exit can vary widely, and may actually utilize many of the tools on this list (i.e. revenue-based financing, capped returns, or a demand dividend) but the gist is this:
The company and the investors agree in advance how the company will buy out the investor (i.e. share buybacks every year for the next 10 years and/or an investor put option at year 7);
What the return profile will look like (i.e. a variable return based on company performance, but capped at 3X);
Other provisions that are specific to the company and situation (i.e. perhaps there is a holiday period for payment for the first 24 months following investment and anytime profitability dips below X).
Traditional exits are not suitable for many independent-minded, purpose-driven companies. Structured exits provide an alternative that still offers liquidity for equity investors without forcing an unwanted sale of the company.
4. Tenant Improvement Allowances
If you are a brick and mortar business that is leasing commercial or industrial space, you may want to try and obtain a tenant improvement allowance from your landlord. Essentially, a landlord will agree to finance part or all of your improvements (by giving you $X per SF), often in exchange for higher rent over the lifetime of the lease. It’s best to agree on this upfront when you are negotiating your lease.
5. Invoice Factoring
Invoice factoring is when you sell your unpaid invoices (your accounts receivable) to a third party, typically a factoring company, at a discount (say 90% of the amount owed). Invoice factoring is often expensive and disruptive to customer relationships, so it’s not a great solution unless you are in a major cash flow crunch.
6. Grants
Depending on your industry, and your company’s purpose, you may be eligible for certain grants, typically government- or foundation-backed, which, if you can get them, are often a really great deal - non-dilutive, non-interest-bearing “free” money. Grant requirements vary, but very often are targeted toward small businesses, minority-owned businesses, rural businesses, The SBA Grant website is a good place to get started.
7. Crowdfunding for rewards or pre-sales
Depending on your business, you may consider using a platform like Kickstarter to crowdfund your business. Instead of offering debt or equity, you can offer rewards and/or pre-sell goods or services. Brick and mortar or CPG businesses, for example, are good potential candidates for a crowdfunding campaign. This provides non-dilutive financing without covenants or the other restrictions that come with traditional debt, plus it is often easier on cash flow. It can be a great financing option when you’re first getting started and building your minimum viable product or business.
8. Crowdfunding for debt or equity
Thanks to the Obama-era JOBS Act, it became a lot easier for companies to raise money from non-accredited investors starting in 2015. The relevant regulations are Regulation A and Regulation Crowdfunding, and depending on which route you choose, you can raise up to $50M from non-accredited investors across all 50 states.
Non-professional investors (AKA regular people) who want to support your business are often willing to agree to much more limited governance rights and other alternative terms. Or they may even be interested in low-interest debt if they know it is going to support a company they love.
More and more platforms like WeFunder, SeedInvest and Republic are popping up to make it easy for companies to raise money directly from the crowd.
9. Slowing Down and Reinvesting Profits
Finally, the last “tool” is not really a tool at all, but a strategy - in fact, it’s the oldest strategy in the book. You can reinvest your profits as you go, growing as fast or as slow as that allows. Of course, the feasibility of this strategy depends largely on the type of business you hope to build and your industry.
Final Thoughts
Selling conventional stock in your company is not always a bad idea. Depending on your goals, it very well may be the best and most-efficient way to finance your company. Or it may be the only option that is realistically available to you.
But before you automatically go down the route of raising money from conventional outside investors, pause and consider the alternatives.
Remember - many alternatives are not mutually exclusive. So even if you still need to raise conventional equity now or in the future, perhaps you can make that number smaller by also leaning on other financing tools that are less likely to require you to sacrifice independence.
So, what’s the next step?
If you’re serious about this, we recommend that you sit down and check-in with yourself by using the following questions as prompts:
Why does my business exist? What is its purpose?
What are my short- and long-term business goals?
What are my short- and long-term lifestyle goals?
Given my answers to 1 - 3, what course of action feels right for me and my company right now? [brainstorm - no right answer at this point]
We recommend actually sitting down with a pen and paper and journaling on these prompts. You might be surprised by what you write.