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Why growth and transition capital is a smart alternative solution


You may have heard it called "mezzanine financing", "junior debt", "structured equity" or "quasi-equity financing." But the myriad of names all share a common principal—growth and business transition capital is basically a hybrid of debt and equity financing.

It shares some of the characteristics of debt financing because the borrower has the obligation to repay. On the other hand, growth and business transition capital also mimics equity financing because repayment is based on cash flow rather than depreciating company assets.

So what's the key advantage of this type of financing for a small or medium-sized business? It provides the capital necessary for a business to fuel its growth or secure its continuity. Repayment is not based on diminishing asset value but more on cash flow potential.

Expected cost

Entrepreneurs can expect part of the cost to be in the form of fixed interest, which is a deductible expense. The remaining cost comes in the form of a variable component such as a royalty, bonus payments or options to purchase shares in the company at a discount.

However, it’s not a formula-driven solution and can be customized to specific needs, depending on factors such as business seasonality, working capital requirements and repayment structure.

The first step is to sit down with your lender, bring in your transaction and explain exactly what you're looking for. After that, a customized deal can be worked out.

Typical investment scenarios

So what are the most typical scenarios when lenders consider growth and transition capital as an option?

Management buy-outs/buy-ins

With an aging population, many 50+ business owners are looking for ways to exit their companies. Growth and business transition financing can provide the necessary funds for an existing management team to invest in the company.

Case study

Company X is an insurance adjuster in business since 1986, one of the largest in Canada, showing $22 million in sales and very profitable.

Fourteen senior managers in the company want to buyout owners who are 60+ and are looking to retire. The lender structured a deal that involved an equity injection by the new owners, a loan provided by the exiting owner and growth and business transition capital to round out the financing.

Mergers and Acquisitions

Mergers and acquisitions naturally involve both fixed assets and more difficult-to-finance and intangible assets such as "goodwill." Growth and business transition capital can help companies purchase the goodwill while preserving their cash flow during a period where some uncertainty may exist.

Case study

An online research company has been in business since 1973 but has postponed its IPO due to market conditions. The company has expanded into the U.S. and acquired businesses that will drive 25% growth over the next two years. The company has proven profitability, a strong management team and is a market leader with consistently retained earnings. The deal involves growth and business transition capital with payment at maturity, allowing the business to preserve cash flow.

Working capital for growth

Growth and business transition capital is often used to finance working capital for growth, which enables companies to increase revenues and profits. Entrepreneurs looking to invest money in marketing, improve product R&D or finance additional headcount can take advantage of this form of financing without compromising their regular cash flow used for daily operations.

Case study

A hardware company in business since 1981 has recently completed development of a proprietary technology. Financing was needed to help the company market this technology to existing clients and a broader market. This business needed to react to the market on a timely basis and to pre-build a one-month inventory of its products. The growth and business transition deal enabled this company to do just that.