Financing Growth in Uncertain Times
How to determine whether the time is right to plan for strategic growth, funded by debt or equity.
Corporate leaders today sit at a crossroads. Continued economic prosperity has led to favorable business conditions, which have many companies poised for growth. On the other hand, speculation that the business cycle may have hit its peak—coupled with talk of an economic downturn on the horizon and political uncertainty over the course of this election year—has even the most optimistic CEOs and CFOs carefully weighing any expansion plans.
The number-one question many business leaders are facing: Is now the time to take on debt to finance growth? My answer: Given the cost of capital and the still-strong U.S. economy, there has rarely been a better time to implement a well-thought-out strategic growth plan.
In today’s market environment, interest rates and the cost of debt are near all-time lows for companies looking to borrow to fund operational expansion or to make a strategic acquisition. The market is awash in cash and looking for places where it can be invested. Corporate valuations are still at record levels for organizations looking to sell or divest part of the business. Despite slowing global growth and trade uncertainty, overall economic activity remains strong, except in some parts of the manufacturing sector.
The bottom line is that there’s a window of opportunity, over the next 6 to 12 months, for businesses to lock in an attractive long-term capital structure while rates are still low and both credit and the broader capital markets are accessible to most organizations.
When planning for the future, company leaders should assess their strategic growth plans and ask some tough questions:
- Where do we, as a company, want to be in 5 or 10 years?
- How can we get from here to there in terms of future revenue growth? Should we focus on organic growth, inorganic growth, or some combination of both?
- What are the competitive threats to the business?
- What are the implications of this plan on gross margins?
- Do we need to upgrade equipment and technology? Increase research and development (R&D) spending and staffing?
- And the biggest question: How will we finance this growth strategy?
For corporate leaders who are currently developing new strategic growth plans funded by debt and/or equity, here are three suggestions for how to make a well-informed decision.
1. Review your current cash flow realistically and thoughtfully.
Cash flow is the first factor that commercial and investment bankers, private equity firms, and other financiers will look at when assessing the growth potential of a company moving forward. Among other things, potential financial partners will be examining the predictability of cash flow over time, the ups and downs, and whether strategic growth is both realistic and sustainable. The cash flow review should go back at least through the last downturn to demonstrate the company’s resiliency.
2. In evaluating cash flow, differentiate between maintenance expenses and future growth expenses.
Maintenance expenses deal with how much the company is currently spending just to maintain the status quo. Growth expenses are all about how new capital spending will specifically lead to revenue growth (or margin expansion) via new equipment purchases, technology upgrades, R&D growth, and possible staffing and real-estate investments. Corporate leaders need to clearly identify these cash flows, which will most likely be scrutinized by potential financial partners.
Planning for future growth becomes trickier when the expansion is reliant on merger and acquisition (M&A) strategies. For instance, in assessing the pluses and minuses of an acquisition, one needs to differentiate between expense (or cost) synergies and revenue synergies.
Expense synergies reflect the opportunity, as a result of an acquisition, to reduce costs tied to the new operational structure of the combined company—whether it is overlapping equipment, staffing, real estate holdings, or other costs that can be cut to achieve efficiencies while not undermining growth. Companies need to be very careful not to overestimate the potential expense-synergy savings; that’s a common mistake when mapping out an M&A growth strategy.
Revenue synergies are the opportunity for a combined company to generate more revenue through non-overlapping operations and product lines, leading to higher overall revenue than if the two companies had remained separate.
3. Recognize the strengths—and weaknesses—inherent in your industry.
The more predictable a company’s cash flow is, the more attractive that business becomes to potential financial partners, who will want to know the true peaks and valleys that a firm might endure during a downturn. In this regard, industries are not all created equal. Some sectors can sail through downturns with relative ease, while others tend to face strong headwinds and choppy waters whenever the global economy slows.
For companies whose industries fit in this latter category, diversifying revenue streams can help stabilize cash flows during a downturn. One of the best ways to diversify revenue streams is through mergers and acquisitions. Look for a target that will serve as an effective hedge if your market is disrupted.
It is also important for executives to think like disruptors. As markets change, the organization might face competition that comes from unusual places. It is important to think about how new technologies, for example, could be changing the game.
The Question Remains
So, is now the time to take on debt to finance growth?
An organization can really address that question only after going through a careful review of its own cash flows and those of its industry. After doing that analysis or enlisting an investment banker to advise them, decision-makers may find that the business is in an excellent position to pursue a new strategic growth plan.
Moreover, given the current economic climate and the relatively low cost of debt capital, there may be no better time than the present to put your plan into action.