Business Lifecycle and Capital Structure
In the next two or three postings we will discuss the financing of your business depending on its life cycle stage. We will give indications of best methods of funding at different stages. We will also review the various methods used by Zimbabwean banking entrepreneurs to make this practical and relevant. Enjoy
An entrepreneurial venture needs to raise capital regularly to avoid undercapitalisation. This is mainly done through retained earnings if proper growth strategies are in place. However in a hyperinflationary environment marked by significant exchange rate fluctuations, capital is frequently eroded. Banks, being intermediaries in the economy, are required by law to maintain certain capitalisation thresholds. In a hyperinflationary environment these capitalisation requirements become a moving target. This section analyses the strategies used to raise capital at different stages of the venture’s lifecycle.
Start- Up Stage
The start up stage represents the highest level of business risk. The new product/service may not work effectively, or if it does, it may not be accepted by the market. If accepted by the market, the market size may not grow sufficiently enough, to absorb the development and launch costs incurred. Consequently, raising capital for an unproven concept is challenging. Investors are wary. Normally investors who seek high returns at low investment costs with a short investment period would be ideal in this stage. In developed countries this phase is normally funded by venture capitalists because these invest for capital gains and not necessarily for dividends, since in this phase the business normally has a negative cash flow.
The majority of the Zimbabwean banks could not access venture capital as this industry was in its infancy. Consequently some used private placement to institutional investors e.g. NMB used Old Mutual and Pension Funds. Kingdom, Trust and Renaissance used the bootstrapping strategy and started with the entrepreneurs’ funds within a framework that did not require heavy capital injection. They started as advisory services and when they had proven themselves and generated financial muscle and credibility, they converted into merchant banks. Others like Royal Bank used debt backed by owners’ collateral because at that time there were negative real interest rates. However this was a risky strategy as any significant movement of interest rates could have jeopardised the venture. The inverse correlation of business and financial risk indicates that start up ventures should be funded by equity with minimal or no debt.
The majority of these entrepreneurs sought to reduce their financial risks and hence
- · some used equity funding from either internal or external equity sources. No dividends were paid on the equity base.
- · most used the bootstrapping strategy that reduced risk by using minimal capital requirements initially.
- · one bank used debt financing, relying on the likely higher growth of the founders’ assets as compared to the negative real interest rates obtaining on the market. This unusual strategy worked.