Acme External Financing Alternatives

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ACME: External Financing Options

Acme needs $500m to finance the cost of expanding your business. Companies look to three possible sources of funds: internal, conventional external and risk capital; however this presentation's focus is exclusively on the external-financing alternatives.

1. Internal Sources
Begin by looking inside your own company. Can you make funds available by increasing your company's efficiency? For example, can you negotiate better terms with your suppliers, or lower your accounts receivable and inventory to free up working capital?

2. Conventional External Sources
Next, look for funding from conventional sources, such as your bank. Lines of credit, long-term and short-term loans, and mortgages are examples of conventional financing.

3. Risk Capital
Finally, once you've explored both internal and conventional sources, then consider risk capital financing. At this point, too, you'll need to look at your overall capital structure.

How One Company Used All Three Sources
New Tech Distributors Corp. (New Tech) is our case example company. It needs $1,575,000 to cover the costs of expansion. The owners are going to use a mixture of sources to get the capital they need: $775,000 from internal sources, $200,000 from conventional sources and $600,000 in risk capital (in the form of equity).

In other words, you have two basic external funding sources: conventional capital and risk capital. Each option bears a different cost. And risk is the key to determining what the cost will be to finance your growing business.

Conventional sources lend at lower rates but impose restrictions to lower the lender's risk. So, for example, when you seek capital from banks and other conventional sources, you may find constraints placed on your borrowing. Maybe the size of your operating line of credit will be restricted, or the amount of your term debt will be limited.

Risk capital sources will fund businesses that conventional sources will not finance. But they will only do so for a price. They will expect a higher rate of return to compensate for the higher risk.

Risk and Rate

Simply put, risk and rate (that is, rate of return for the investor) go hand in hand. As risk goes up, so does the rate. Why? To compensate for the investor's additional risk. And a higher rate of return means a higher cost to you, to finance your investment needs.

Using the types of external financing, see how risk and returns are related below:

Risk and Returns: Types of external financing alternatives

See below how the different types of external financing to see how risk and return are related.
- Base Case
- Conventional Capital
- Conventional and Risk Capital

The two EXTERNAL sources of funding (conventional and risk) can be further broken down into short-term and long-term financing. A growing or expanding company looking for financial help can consider four categories: short-term and long-term financing, from both conventional and risk lenders. And within each of these categories there are even more options.
In your previous business experience, you've almost certainly tapped into one or more specific types of financing that fall into these four categories. Have you ever used a line of credit from your bank, for example? Then you've used conventional short-term financing. If you've leased a car, then you've used conventional long-term financing.

Risk Capital Long-term Financing
- Equity
- Subordinated Debt

Risk capital investors invest in equity shares and equity-related debt in relatively small or untried ...