BDC: Managing Growth
Tips for financing growth
One rule of thumb: When financing a long-term asset, seek an amortization period that is the same as the asset’s expected lifespan.
2. Look at loan terms—Look at more than the interest rate when seeking a loan. Also explore terms, such as flexible repayment and collateral requirements. Those can give you breathing room at the start of your growth project or later if you run into difficulties.
3. Diversify financing sources—Consider diversifying your financing sources. This can give you more options for planning growth projects. It may also be useful in the event of a slowdown, when lenders could get more risk averse.
Financing a quickly growing company can be tricky, especially in times of tight credit. Here’s how two entrepreneurs navigated the challenges.
The seeds of John Pavanel’s success were planted during one of the most difficult periods his business has ever experienced. It was the middle of the last economic downturn, and Pavanel had just been forced to lay off half of the workforce at his Guelph, Ont.-based auto parts company Hematite Manufacturing, which makes recycled sound insulators and air/water barriers for vehicles.
Despite the tough times, Pavanel also saw opportunity. He wanted to offer new high-tech vehicle parts that improved fuel economy and acoustics. The products were doubly attractive because they would be made from recycled auto trim scrap. That meant they would reduce the industry’s environmental footprint.
“Recycling is very much who we are, and we’re proud of that,” Pavanel says.
The problem was financing. Canadian financial institutions had significantly curtailed financing to the sector. “There was a lot of concern and caution,” Pavanel says. “Some people were questioning whether the industry would survive.”
Drawing on his working capital wasn’t an option either. He didn’t have enough cash on hand to make the large needed investments in facilities, hiring and equipment to launch the new product line. His solution was to seek financing from the Business Development Bank of Canada, which maintained active support for the automotive sector amid the downturn.
BDC agreed to finance Hematite’s purchase and renovation of a bigger new facility to accommodate new production facilities. BDC’s involvement also helped convince Pavanel’s other banking partner to kick in additional needed financing.
The project proved to be a success. In the last five years, Hematite has doubled both its revenues and workforce; it now employs 250 people. “It can be challenging to grow,” Pavanel says. “The revenue only comes at the tail end of the process. You need banking partners to believe in you.”
Pavanel’s challenges have been common in the auto parts sector since the downturn. Tighter liquidity has prevented many businesses from being able to jump on emerging business opportunities and grow as quickly as they would like.
Today, even as credit conditions have eased, the question of how to finance growth is still a critical concern. Many businesses pay for growth projects out of everyday cash instead of seeking financing. That can lead to a cash squeeze if the company experiences unexpected costs or sales declines.
Rapidly growing companies can be especially vulnerable because the greater expected cash inflows often significantly lag behind the outlays needed for new machines, employees and raw material.
“Even if a business is flush with cash, it shouldn’t finance long-term investments with working capital,” says Mary Ann Wenzler-Wiebe, BDC’s Vice President, Financing & Consulting for Southwest Ontario.
“That’s when we often see companies getting into hot water,” she says.
And when they do seek financing, businesses should look at not only interest rates, but also the loan terms, such as repayment flexibility and collateral requirements, says Wenzler-Wiebe, who is BDC’s executive sponsor for the automotive sector. “Dig in and read the fine print of the loan agreement,” she says.
For example, a lender may offer a principal repayment holiday during the first six or 12 months of the loan. That can let the company keep more cash on hand during the critical initial phase of an expansion or acquisition—a time often fraught with surprise delays and expenses.
The bank may also allow a longer amortization period or a temporary repayment holiday in the event of a cash shortage later on. Lower collateral requirements can be handy, too; they let the business retain more working capital to see the growth project through to success. It’s also useful to ask the lending institution how flexible it is about renegotiating loan terms if a company’s situation changes.
“If repayment terms are very tight and inflexible, that can impact working capital at a time when you need breathing room,” Wenzler-Wiebe says.
She advises businesses to diversify their financing sources and maintain good communication with bankers. “Doing that can help you not only take advantage of growth opportunities, but also be well positioned for any changes in business conditions,” she says.
Mohamed Gharib put many of these lessons into practice at his auto parts machinery and tooling company Upland Technologies, based in Cambridge, Ont. Like Hematite’s John Pavanel, Gharib had to lay off staff in the last downturn, shedding seven of 16 employees.
But it wasn’t long before Gharib also saw growth opportunities for his business, which makes machinery and tooling for the production of mufflers and exhaust systems. He wanted to expand production and acquire his own building for the company. However, credit remained tight. “We needed more financing than the banks would give,” he says.
Gharib turned to BDC to finance the building acquisition. The terms allowed him to make a lower down payment than other lenders sought. Gharib also obtained capital equipment financing from BDC, which loaned 125% of the assets’ purchase value. In addition, BDC offered an unsecured loan to finance work in progress and other financing for technology purchases.
The custom-tailored mix of loans fuelled rapid growth. Since 2009, Upland’s sales have shot up, while its labour force has ballooned fourfold to 38 employees. “Our business exploded,” Gharib says. “It was a very attractive financing arrangement that allowed us to continue to grow.”
What’s more, Gharib likes the fact that the financing helped him maintain stable cash flow despite the pressures of rapid growth. “When you’re growing quickly, you have to be very, very careful with your working capital,” he says.
“You can’t do it with internal financing alone. If we had relied only on our working capital, we would be a small fraction of where we are today.”
Another bonus: Gharib now feels better prepared for any coming slowdown. “We make sure to keep revenue in the business and remain financially stable so that when the next downturn comes, we are able to react and take advantage of opportunities,” he says.
Pavanel agrees. “The automotive sector is very cyclical,” he says. “Having the right financing and partners is key to being ready and having the ability to grow.”