I had the good fortune to begin my career at what is now Accenture. When I joined in 1982, it was the Management Information Consulting Division of Arthur Andersen & Co. The company evolved, rebranding itself first to Andersen Consulting, and then eventually Accenture. The firm changed more than just their name over the years, they evolved their business from information consulting roots, to adding business process management, outsourcing, strategic services, etc. Today Accenture is a $40+ billion dollar worldwide organization, with almost half a million professionals.

A consistent piece of advice we gave clients was to evolve their businesses from positions of strength – a CEO shouldn’t wait until a downturn occurs in their business to make changes that he or she knew were necessary and strategic for the long term. Requiring discipline and foresight, it was almost always good advice for those clients and it was also a prescription used by Accenture for their own success – even during recessions.

In fact, in some ways an economic downturn can be a good time to effect such change. Weaker competitors fail. Markets demand more differentiated products and services. Opportunities emerge.

One Founder’s Foresight
Such was the case in 2011 when our firm, Cypress Growth Capital, provided $2 million in non-dilutive growth capital to Riveron Consulting. Riveron’s Founder and CEO, Landon Smith, possessed the foresight to see opportunity in what was still a somewhat fragile economy, especially as it affected the professional services marketplace. He used our capital to expand the company’s geographic footprint, to add functional capability, and to hire some of the best and brightest people in his industry.

Landon liked our form of capital because it allowed him to retain control over the direction of the business, preserved his equity, and was highly flexible and adaptive to both up and down economic scenarios. Landon’s foresight paid off: today Riveron is a premier, nationwide consulting firm with over 550 employees, operating in 13 major markets, and serving a diverse group of over 750 clients annually across the corporate, private equity and lender communities.

It takes significant growth capital to fuel most change initiatives. For an emerging business, expanding a sales and marketing footprint or developing that next iteration of software requires not only time, patience and foresight, but outside investment.

Choppy Financial Waters
CEOs and CFOs today are navigating through uncharted and choppy financial waters (to say the least!). COVD-19 driven government programs such as the Payroll Protection Program, the Economic Injury Disaster Loan program and the Main Street Lending Program are intended to provide access to working capital that help companies affected by the pandemic stay solvent and retain their employees. Given that time has been of the essence, their associated rules and details are still evolving, and will catch up, relative to loan returns, forgiveness and repayment.

At the same time this unique form of liquidity is flooding the market, normal financing options are reacting as they normally do during a significant market downturn. Traditional debt options through banks seem to be tightening. And, at the other end of the scale, selling equity is still an option, but the cost of that capital is rising as valuations fall. While all of this is happening, many companies are extending their financial runways by tapping their bank lines of credit to add cash buffers to their balance sheets.

We have talked to several executives recently that are still considering growth-related initiatives. Like Riveron, they see real opportunities to better position their companies for the future – either despite today’s environment, or because of it. These executives are all asking us the same basic question: given the dynamics of capital markets right now, and the different options available, how should they best fund their growth initiatives. Here is what we’re telling them:

Working Capital vs Growth Capital
First, don’t deploy working capital sources for growth-related initiatives. The cost of working capital obtained through a bank line of credit or term loan is typically cheaper than what you will find through growth capital providers – but it also usually comes with strings attached, which could include restrictive financial covenants, personal guarantees, rigid repayment terms, securitization, and a limitation on taking additional debt.

The financial covenants tend to be the sticking points. Can you remain in compliance as your growth investments immediately impact your balance sheet, where the associated financial returns may be out a year or more? Typically, the answer is ‘no’, or at least ‘maybe not’.

And, will you potentially need that working capital to smooth out the financial edges should you encounter loss of customers or, at least, ‘lumpier’ cash collections?

Second, be sure to understand your growth capital options as well. Equity can provide the amount of capital and the patience needed to fuel long-term growth. But how much management control will you have to cede – whether it be board of director presence and decision-making, a real commitment to move to an exit, and/or the approval and blocking rights the investor will maintain around such an exit. Will you still be able to transition your company as intended?

Third, know the potential cost of that equity. If the growth initiative is successful, and the company doubles or triples in size, and then exits at a healthy multiple, the cost of that equity may be far greater than realized – especially if today’s environment dictates depressed valuations, and/or more aggressive deal terms that could include participating preferred provisions or other accelerators.

It may be that a hybrid growth capital source such as royalty financing makes sense. Covenants are light, the cost of the capital sits between debt and equity, but is non-dilutive and capped, there is no loss of management control, and repayment terms are flexible. It co-exists easily with bank debt, so your working capital sources are preserved. And, it doesn’t preclude a company from using the investment as a bridge to an equity round down the line, if they choose to do so, as markets stabilize.

For those entrepreneurs facing these choices, we welcome the opportunity to discuss your situation and options in more detail. Regardless, though, we wish you all good health and an optimistic future.

Bart Goodwin