The improving economy has caused many business owners to consider expanding their business. Typically, business
expansion requires additional facilities, equipment, and working capital, all of which can be financed with bank debt.
Done properly, bank debt can be the best and cheapest form of capital for financing an expansion.
But too much or the wrong type of debt—along with other miscalculations—can cause trauma for a business owner.
The good news, is many of these mistakes can be avoided if a business owner is aware and takes steps to plan for them.
In no particular order here are 10 mistakes a business owner can make in financing an expansion:
• Failure to generate a robust projection model based upon reasonable assumptions derived from market studies and conversations with your customers to estimate revenue. Also, lack of realistic forward-looking estimates on input and operating costs. The model should demonstrate that cash flows from pro forma new operations (the historical operation combined with the expansion) are adequate to repay total debt with a comfortable margin. Remember to be conservative, as the model will be the basis for the repayment arrangement and financial covenants required by your lender.
• Failure to generate a comprehensive budget for the expansion that includes hard bids from suppliers and a contingency for cost overruns.
• If the expansion involves a construction project, failure to make sure the contractor is bonded and utilizes good sub-contractors.
• Determining the right balance of debt and equity that the expansion will require. Can you utilize the equity in your existing operation to satisfy the equity requirement or do you need to inject additional cash equity into the operation? If it is cash equity, will you have to dilute your ownership percentage, and is the project worth the potential complication of dealing with a new partner? On a pro forma basis, how will your new leverage level compare with your competition’s? You do not want to be more levered then your competition.
• Insufficient analysis of the competition’s reaction to
your expansion. Could your competitor react by lowering prices, jeopardizing the accuracy of your projections? Or could your competitor design an improved product that your customers might prefer, decreasing demand for your product?
• Not gaining commitment of your suppliers to support your expansion. Will they increase your credit limits by enough to cover your increased purchases? Do your suppliers have the production capacity to accom-modate your increased volume and avoid production bottlenecks?
• Failure to plan for the possibility that the expansion might be unsuccessful. Have you completed a “stress case” projection model that demonstrates you have the liquidity to survive an unsuccessful expansion? And have you thought through a safe way to disinvest should it not succeed (in other words, do you have a Plan B)?
• Have you planned for the increased working capital needs that will result from your expansion and verified that you
have a source for financing the growth (working capital line of credit)?
• Do you have the right people in place to support a larger operation? If not, where are you going to find them? And do your existing managers/employees need training to deal with an expanded operation?
• If you are a manufacturer, have you thought through the impact of higher input prices on your manufacturing margins? Similarly, have you thought through the impact of rising interest rates on your borrowing costs? Should you hedge some of your input costs or should you fix some or all of the interest rates on your debt?
Business expansion done the right way is what creates new jobs and drives the U.S. economy and that is a wonderful thing. Hopefully, this list will help you think through the potential mistakes that can be made and avoid them with your expansion.