Every week I deal with businesses that are growing quickly, but just can’t find enough cash to finance their growth. Certain businesses are much more capital intensive than others. In general, physical product based businesses are far more capital intensive to start and grow than a software business or a service based business. It can take millions of dollars to produce, sell and distribute a physical product on a national level. If you are facing this struggle, I don’t need to explain why it is so difficult to finance a capital intensive business, rather I hope to provide some advice to help you find success in this type of business.
1. Find an Investor, Be Willing to Give Up Equity – There was recently a great example on Shark Tank. A business owner had developed an interesting product, 100% recyclable shoes, but needed some cash to take it to the next level. The business owner asked for $50,000 in order to create the mold of the product and build up some inventory, but the sharks weren’t biting. Why? Mark Cuban said something to the effect of, “if you are successful you will drive yourself into bankruptcy.” Here is why. If the company got a large order from a big box retailer like Target, it would probably take the entire $50,000 just to fulfill that order. Then Target would pay him in 90 days. What if the shoes were selling great, and Wal-Mart placed an order, and then Kohl’s placed an order? He would still be waiting to get paid from the initial $50k order, so he would have to borrow even more money to fulfill the 2 new orders. The product’s success could actually bankrupt the company because they would reach a point where they could not borrow any more money, which means they wouldn’t be able to fulfill new sales.
So here is what happened. One of the sharks made him an offer. He offered to fund his entire business for 80% of the company. So he gave up 80% of his company, but in return he can have the freedom to go out and generate sales. On his own he never would have made it in the capital intensive business of shoe manufacturing, but because he was able to find an investor, and was willing to give up significant equity, his 20% stake in this business will probably turn him into a millionaire very soon.
2. Develop a Strategic Partnership – I have worked with one client who was able to find a private company that was willing to fund his business in exchange for a cut of the profits. This is truly the best possible solution. Here is why. This particular business dealt with purchasing expensive used medical equipment, repairing it, and reselling the equipment. The bottleneck in the business is the fact that the used equipment cost $10,000 to $15,000 per unit. He could easily find 10 units to repair and resell in a moment, but he did not have the $125,000 it would take to purchase those units, so he purchased 1 or 2 units a time.
When he partnered with this strategic partner, he was given a large line of credit to purchase and resell as much equipment as he wanted. The deal was contingent on giving half the profit made on the sale back to the partner. This was a great solution for this particular startup because he was able to grow his business by 650% in a year without giving up any equity in the business. Now he has generated enough sales that he can approach a traditional bank and secure a traditional line of credit which will be far cheaper than giving up 50% of his profits. This strategic partnership was a great deal for both parties involved.
So in order to succeed in a capital intensive startup business you can’t rely on a 1 time loan. It is not a sustainable solution, in fact your success may drive you right into the ground. Instead, I encourage you to find investors or strategic partners who are willing to put unlimited cash in your hands for as long as you can provide a return on that investment.
About the Author: Adam Hoeksema is the Co-Founder of ProjectionHub. ProjectionHub is a web application that helps small business owners create a set of financial projections without the need to have a PhD in spreadsheet modeling.