The State of Capital Markets for Expanding and Emerging Businesses

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The economic turn-around is bringing more than competitive disruptions to independent start-ups and existing businesses that are looking to expand and grow. Funding options are expanding to include venture capital, angel investing, private equity markets as well as traditional bank lending. Each funding option comes with its own set of requirements, costs and performance characteristics. This year’s Pepperdine Private Capital Markets Report (PPCMR) specifically examines the behavior of senior lenders, asset-based lenders, mezzanine funds, private equity groups, venture capital firms, angel investors, privately-held businesses, investment bankers, business brokers, limited partners, and business appraisers.

The Pepperdine Private Cost of Capital (PCOC) survey is conducted each year by Pepperdine University Libraries  and investigates each private capital market segment, the important benchmarks that must be met in order to qualify for each particular capital type, how much capital is typically accessible, what the required returns are for extending capital in today’s economic environment, and outlooks on demand for various capital types, interest rates, and the economy in general. Originally launched in 2007, the report was the first comprehensive and simultaneous investigation of the major private capital market segments.

The report findings indicate that the cost of business capital varies depending on the size of the funding, the type and the level of risk. “The data reveal that bank loans have the lowest average rates while capital obtained from angels has the highest average rates”. Other sources reveal that 2018 turned out to be a boom year for non-bank business lending as a reported 80 percent of small bank business loans were rejected.

The accepted thought among a majority of business soothsayers is that 2019 will be a good year for optimistic entrepreneurs to engage plans to open or expand their business. However, 39 percent of the responders to the PCOC survey believe that general business conditions will worsen over the next 24 months and that nearly 44 percent of predicted loan demands would increase. A third of the lenders responding to the survey thought domestic economic uncertainty was a leading issue for independent businesses that sought to expand in the coming year. Labor availability and access to capital were also seen as complicating issues.

Refinancing, expansion and acquisition was the most commonly described financing motivation and concern for debt-service coverage ratio remains the most important factor when deciding whether or not to invest. Loans between $1 million to $10 million require the greater amount of personal guarantee and collateral. The survey reports that 31% of cash flow applications were declined; 34% of applications were declined due to poor quality of earnings and/or cash flow and 19% were declined due to insufficient collateral.

Despite all the preponderance of predictions, funding an independent business comes with significant risk both for the borrower and lender. Regardless of the source, spending investment dollars wisely remains an important factor for success. While most organizations are applying their investment dollars responsibly, it is important to be reminded that there is no such thing as “free” money. Gaining the best information on the available sources and the cost and requirements associated with each is critical to the success of any start-up or expansion plan.