Positioning businesses for growth is mostly “business as usual” for professional services firms. But what happens when they start considering their own growth?
Professional services firms are very good at telling others how to navigate tricky situations. Whether they guide their clients through building their teams, growing their brands, developing their strategies, or financing for growth, outside professional advisors tend to be great at helping others see the forest for the trees. However, when it comes to financing their own expansion, many professional services firms commonly find themselves at a loss. Being a food and beverage company that is trying to raise capital is very different from an accounting, law, or marketing firm on that same path. Why? It is more difficult to ascribe value to products and deliverables when they are so intrinsically human-based. Yet, there are different types of capital available for professional services firms.
The greatest challenge is just choosing the right option.
Different roads lead to different capital
It is important for professional services firms to understand the different avenues to financing growth. Professional services firms tend not to be the types of businesses that can or will lead to equity investment opportunities. As a result, each of the more typical sources of capital represents commitment to some type of debt, so the first essential step is to be clear on the growth goals.
Is the investment needed for buying real estate for a new office?
Or perhaps to expand the current physical footprint?
Does the company need to hire competitive talent?
Or is it looking to acquire another firm?
Being clear about the reasons for growth helps to decide on the best financing option to reach that purpose.
Choosing the path to growth
There are typically three main areas to look for capital when expanding a professional services firm. They serve different strategies, and their end results also depend on the company’s profile.
1) Letter or line of credit
This is the most typical way services firms can go out to the market and raise money. Letters of credit or lines of credit are especially good for risk-averse companies because they do not necessarily require that money be drawn. Firms may obtain access to capital from an “in case of need” perspective.
Companies should consider this option if:
- They want to avoid becoming overburdened and prefer to control the entire life cycle of potential debt;
- They have regular revenue streams that banks or individual investors can rely on when considering eligibility for a loan;
- They already have a solid operation and need a safety net for small-scale growth initiatives, such as hiring new people.
2) Bridge financing
But what if the company is still new or too small to qualify for a line of credit? Or what if there are big plans ahead that require shorter term financing and access to immediate cash? Bridge financing is an option for those types of cases.
This is one of those terms that a lot of people do not understand. Bridge financing has nothing to do with infrastructure, but refers to the ability of a business to bridge its growth from one stage to the next. It is a type of investment that involves a transformational process, which sometimes comes with growing pains. Most businesses consider bridge financing in that in between stage – no longer a caterpillar, not quite yet a butterfly. It also typically requires a lender, whether that is a venture bank or an individual or group of individuals who are in the business of making these types of capital investments, who understands the firm, its goals and the path it seeks to follow. Of the three types of financing discussed here, this is the type that looks the most like what you read about or see on TV – this is typically make-it-or-break-it financing that will help get a company over the hump and into a new realm.
Bridge financing is effective for getting a firm from one stage to the next. However, it represents more expensive debt. It is important to consider these features before taking it on:
- It usually sets higher interest rates and penalties;
- It involves partnering with venture banks or syndicated investors;
- It may require a warrant, an equity linked security, or even a personal guarantee by the principals of the firm to assuage lenders that the company’s debt obligations will be met;
- It demands highly defined parameters for growth since the investment cycle is much shorter.
3) Term loan
This is the financing option for firms that need a lot of capital over a long period of time – whether that time is for actual growth or for repaying the debt. It is usually designed for the type of situation when a firm is acquiring another firm, or when a company decides to drastically scale the number of its employees. However, a term loan is one of the most expensive ways to raise capital. It is what we often call a debt of last resort, and if not negotiated very carefully, it may overburden professional services firms and render them unable to function – so it is important to consider the following:
- Banks require concrete collateral for a term loan, which might be a challenge for a services company;
- Computers and furniture can be viewed as assets, but eventually the business itself (its name, client list and anything else that the lender deems of value) will likely be collateralized;
- The value in professional services firms is mostly associated with the reputation of its partners, so it is ultimately each owner’s name at stake when it comes to pledging the business as collateral for debt.
Custom solutions for unique businesses
The bottom line of financing growth for professional services firms is that there is no one-size-fits-all solution. We have summarized above a few of the key options available from the 30,000 foot perspective. The key for all kinds of financing, however, is fully understanding the company’s profile and goals before committing to an expansion plan.
Ideally, growth needs to fit into a long-term strategy in which the company plans the end goal before starting off. While plans can change, the failure to plan is often said to be a plan to fail. Proper goal setting will assist in reducing the risk of the scaling transaction and will also allow for contracting smarter and more appropriate debt.
Another key aspect for business growth is that relationships are just as important as capital. When looking for financing, ideally you should try to identify a lender that has experience with the type of company you are trying to develop. If you find someone who understands your business, your pressure points and has ideas of your potential paths to success, you might end up getting an advisor along with an investment. At Indigo Advisors, we are a collective of experts in a variety of areas with extensive experience growing professional services firms. Our custom methods are built to align with the framework set by each founder and leader. Every company is unique, yet one piece of advice goes for all: enter into strategic financing with your eyes open and your purpose in mind.