Thank you for joining me in this course on financing strategies. In the first lesson, I'm setting the table to talk about financing from a strategic perspective. Now most businesses need capital to exist. The exceptions are few. In fact, unless you can convince your customers to pay you up front for your goods or services, before you build them, procure them or deliver them, then your business needs capital. Let's look at all the various potential uses of capital.

First of all, capital can be used to fund ongoing operations. I've never met an employee who doesn't like to get paid, and suppliers of similar ilk. Capital can be used to fund capital expenditures to build and maintain plant and equipment. Capital can also be required for mergers and acquisitions and m&a. Activity allows a company to purchase incremental or adjacent businesses to accelerate growth. Now these first three uses tend to be obvious bipolar a classroom full of participants.

Everyone seems to come up with these ideas, but the next four tend to be less obvious. Can you think of the other uses of capital. Now capital can also be used to fund working capital, everything from raw materials to assembling finished goods to selling goods to customers on credit. This might seem obvious, but in practice, I've come across countless business cases that have neglected to consider the required investment in working capital. Next we have capital that can be used to replace or refinance other capital. Next we have recapitalizing a business to facilitate a transfer of ownership.

For example, cash could be used to buyout previous owners, or the capital could be used to monetize a portion of the shareholders investment. And finally, capital can be used as a reserve for financial flexibility and to build financial strength. Companies will hold excess capital for strategic purposes, either as a preventative measure to protect the company from downturns, or as an opportunistic measure to allow it to act quickly to capitalize on opportunities as they present themselves. Now, you probably didn't think of all of those as potential uses of capital, few people do. Capital must also serve shareholder objectives and corporate objectives. These corporate and shareholder objectives don't always coincide.

Shareholders may want to monetize some of their investment by using up available debt capacity. At the same time, that the company's management may need capital to fund the growth plan. Here's another example of a potential conflict. The company may wish to pursue a growth plan or growth opportunity but lack access to funding because they have a shareholder base who's unwilling to suffer dilution caused by issuing new equity or the increased risk from issuing more debt. Now, financing strategy must be aligned to corporate strategy, and corporate strategy and business lifecycle are awfully strongly correlated. And we can overlay the financing lifecycle on top of these concepts.

Let's walk through this diagram because it's fundamental to your understanding of financing strategy. Now a company in the development stage is characterized as a startup, basically an idea that needs financing to get off the ground. The capital requirement is typically modest and is used to build a prototype or develop a proof of concept. Except, and unfortunately given the high rate of failure for new business this deters institutional investor interest. Thus the entrepreneur is left seeking what is sometimes referred to as FFF money. That is money from family, friends and fools.

Along with the personal savings access to capital is the key financing strategy early in the company's lifecycle. Now, as the company moves through these early stages, it reaches the commercialization point. And this is where it's moved beyond that proof of concept and is ready to launch the product or service to the market. The business still has little or no revenue, and is losing money as it funds startup costs to hire administrative and development and sales staff. However, if the business concept has significant potential, the company may be able to attract certain types of equity investors to provide capital to launch the commercial operations. Here we see venture capital Angel investors playing a larger role in sourcing this capital.

As a company moves into its growth stage it has a proven business model revenues are growing rapidly and profitability has been or soon will be achieved. debt financing is still challenging early in this phase as the company may be unlikely to generate sufficient cash flow to service debt or so additional tranches of equity financing may be required in greater amounts, venture capital, private equity or sometimes even public issuances into capital markets are all potential sources of equity in the growth phase. At some point in this phase of the lifecycle, however, debt will become available with the existence of positive working capital and a track record of growth and profitability as the company reaches the maturity stage and begins to experience less organic growth. But it's now generating strong cash flow. Financing strategy at this point begins to change from worrying about the availability of capital to worry more about this cost of capital idea, debt providers are favored over the equity providers who demand higher returns.

So lenders are willing to loan on the basis of this track record of cash generation and the existence of adequate security debt can be introduced into the capital structure in greater proportions at a lower cost, thereby reducing the overall cost of capital. Now a company in the early stages of decline is characterized by one that has falling revenues and diminishing competitive advantages. However, many businesses in this early stage of decline still continue to generate strong cash flows as the business is milked by the owners, allowing them to monetize a portion of their equity. As the revenues declined further though, refinancing debt will once again become more challenging, more expensive and depend on the availability of security. So once again, the key strategic objective will be maintaining access and flexibility of our debt financing arrangements. So with an understanding of the life cycle in the back of our mind, let's work through the layers of capital that a business may deploy.

So, think of financing as the credit side of your balance sheet as we work through each of these layers. Now, the company's goal is to match capital with the lowest cost sources of capital. Now, fundamental to this matching idea is the concept that short term assets should be financed with short term financing while long term assets should be financed by sources of long term financing. So short term Non permanent sources of financing are typically used or matched against working capital requirements. Here we will typically use supplier credit and an operating line of credit with our bank to fund these short term cash requirements. semi permanent sources of financing are often secured by hard assets, such as equipment, and real estate.

And these are in part or in full finance using things like term loans, leases and mortgages. Now, more aggressive forms of semi permanent financing would include loans that are either unsecured or carry a second charge, or maybe even a hybrid instrument with characteristics of both debt and equity. Now, I'm going to refer to these sorts of arrangements as mezzanine financing in this course. Permanent sources of financing include common shares and preferred shares permanent in the sense that there is typically no repayment obligation associated with these instruments. As we work through the various sources of financing, let's keep in mind what I'm going to refer to as the dimensions of capital. The availability of capital refers to the degree to which capital is standing by as accessible by the company to fulfill operational and strategic objectives.

The amount of capital is going to vary based on all sorts of factors ranging from the nature of the business and the types of security to the ability to meet financial covenants. Now, EBITDA earnings before interest, taxes, depreciation and amortization is a convenient metric that gets used all the time to determine the amount of financing available from different sources. And speaking of sources, sources of capital can also vary widely from your personal savings as we discussed, to banks to pension funds to private equity funds, and perhaps even capital markets. Now, the term for each of these sources of finance speaks to how long the financing instrument remains outstanding, which can vary from a few days to having to never repay. And the cost is another important dimension of capital, some capital is available for free. Other sources are very expensive.

And finally, what are the conditions relating to each source of financing. Some of these sources don't have very many conditions say your common shares, which really makes it harder for you to get into trouble. Other sources of capital come with stringent conditions which if not met, could cost you your company. Other factors impacting the availability of capital aside from the company's position in that business life cycle include both macro economic and micro economic factors. The micro economic factors are firm specific, and they include business attributes such as the size of the business the level of profitability, the consistent Have historical results, the experience of the management team and the company's position in the market, the more favorable each of these sorts of attributes are the more financing alternatives that a company is going to have available. The macroeconomic factors on the other hand may seem less important on the surface.

However, this is a mistake that many practitioners ignore. different industries have different risk profiles, and some industries are very cyclical, such as commodity industries, which causes profitability to widely fluctuate. other industries such as consumer products or utilities are more stable factors such as these impact the amount and sustainability of the available sources of financing. So regardless of the business in the industry, the reality is that capital markets to have their own degree of cyclicality IPOs may be hot one year, but not the next. Banks may be willing to lend to a specific sector one year, but a different one the next and not at all the year following that, these may be beyond the control of management, but must be factored into your financing strategy because sometimes you raise capital when you can, even if you don't need it. So let's summarize this module.

First, recognize that there are probably more needs for capital than you may have first realized and that sometimes different stakeholders have different ideas on what the financing strategy should be at any given time. Second, realize that financing strategy is not an isolated plan. It's integral to your overall corporate strategic plan. And finally, when you go to evaluate the different sources of financing, you need to weigh in all the dimensions of capital. And these dimensions provide you with room to negotiate and make trade offs as we learn through The remaining lessons in this course. So until the next lesson, we'll see you then