- Boustead Securities
Two Types of Growth Capital
My recent article on growth capital triggered a great deal of interest.
Companies responded to the message that they can rapidly raise capital on attractive terms to expand sales, marketing and production capacity, in other words, to “step on the gas”.
We decided that the topic of growth capital merits a couple more articles.
In this article, I’ll describe two types of growth capital, growth equity and growth debt.
Growth equity investors buy equity, maybe a preferred stock.
These growth equity investors take risk side by side with growth company entrepreneurs.
The growth equity investor’s return depends on future value appreciation to generate a healthy return.
Given that growth companies often experience some variability in performance, deviating from their projections, having a growth equity investor riding in the co-pilot seat through performance turbulence can be helpful.
As a side note, I’ve worked with many growth companies and can’t recall an instance when there wasn’t deviation from the projections.
Growth companies are simply in a dynamic period of change.
Growth equity investors know this and expect it.
Also, on the issue of investor control, in the growth capital sector, investor control varies with circumstances and is not a given, especially in cases of growth debt.
There’s a second type of growth capital, growth debt, which is sometimes called venture debt.
This is not the type of debt that banks offer (based on assets). This is more like equity but on a company’s balance sheet as debt.
Growth debt investors get their return in two forms, (i) a periodic cash interest payment and (ii) equity which has some future value.
A growth company may be permitted to defer interest payments initially until it becomes cash flow positive and, in any case, the interest rate is typically low.
For its equity return, a growth debt investor often gets warrants to buy equity in the growth company in the future. With this form of equity, a growth debt investor isn’t a shareholder until the warrants are exercised, likely at the time the debt is repaid.
Which reminds me to tell you that growth debt eventually must be repaid, perhaps three to five years in the future.
With strong projected growth, a growth company will likely have ample opportunity to repay or refinance its growth debt well before its maturity.
Recent Growth Debt Deal
Recently, my colleagues and I arranged a growth debt deal for a client. This client had some customer traction but was not yet profitable.
Under its growth debt arrangement, our client drew capital as needed based on contracts signed.
After a deferral period, our client was required to make periodic cash interest payments. The interest rate was low.
Our client’s equity give-up on this deal was very small. The value of the equity, presuming the company’s future success, plus the periodic cash return from the interest payments will give the growth debt investor a healthy return.
We believe that growth capital, whether debt or equity, is an attractive source of capital.
Please contact us to discuss growth capital or any capital market projects.