Unlike working capital, which is used for bills and basic, cyclical expenses, growth capital isn’t tied to any particular business cycle. Instead, growth capital is designed to provide long-term health for the business.
It builds up over time and can ensure the business’s well-being. Once a business decides that it is going to make a major change, like an expansion, adding another location, or a merger with another company, growth capital will come into play and be used.
What Is Growth Capital?
Growth capital doesn’t relate to the cycle of the business, where money comes in from customers and goes out to pay creditors. That cycle happens fairly quickly, and growth capital is more about the long-term health and well-being of the business. When your business plans to change in a major way, like expanding or adding a new location, growth capital will come into play. It can also be useful when a company merges with or acquires another business. All of these things cost a lot of money, but they’re not constant, cyclical expenses that would be paid with working capital. To cover these large, uncommon costs, your company should build up growth capital over time.
As a company gains more working capital, it can invest that money into the company on a long-term basis. That investment becomes growth capital, and accumulates until the company needs to use it for something. Often, growth capital is used to purchase new and better equipment, or to remodel the building. It can also be used to move to a better location or open a second one. No matter what your growth capital is used for, it should always remain separate from the working capital that is used for day-to-day and cyclical expenses.
Capital is so important to growing a business. If you don’t have what you need for your business’s development, all you’re doing is paying your bills and just getting by. Having enough working capital to pay those bills on time every month is important, but to take your business further, it’s growth capital you should be paying close attention to.
To do that, you have to understand how growth capital works, what it does, and how it helps your company develop from a small business to something much larger and stronger.
It can take time to scale a business. But with the right amount of growth capital development is certainly possible. Too many business owners fail to understand the difference between working capital and growth capital, which can cause problems when expanding your business.
For example, when a growth opportunity arises you often need to make a significant investment to accomplish your goals. If you don’t have a clear distinction between your growth capital and working capital, you’ll likely underinvest or compromise daily operations. This can have devastating effects on a company that would otherwise be very successful, and it’s something every company should avoid.
Why Is Growth Capital Important?
Without a growth capital fund to pull from, however, a business can’t really accomplish anything beyond its day to day operations. There will not be any expansion when there isn’t any growth capital to use. This generally comes about from poor financial planning, and can be profoundly damaging to a small business.
When your competitors continue to expand and develop, and your business can’t do the same, you can quickly end up without enough customers to keep your doors open. A lack of growth capital can translate into a lack of working capital because the business is not able to keep up with the kinds of things it should be doing in order to compete in its market.
Investing In Your Company’s Growth
As a company continues to gain a higher level of working capital, it should take that money and invest it back into the company. This is done on a long-term basis, so the investment becomes growth capital and is stored (earning interest) until the company decides that the capital needs to be used for a specific thing. If there isn’t enough money available, the company can wait until it has more, but sound investment strategies shorten that wait considerably.
Remodeling the company’s building, adding new equipment, and other large expenses are a big part of a business’s development, and growth capital is the heart of that development. Keeping it separate from working capital is also important, to ensure that it isn’t used for business cycle expenses that could deplete its reserves.
How Does Growth Capital Help Your Business?
When people begin to operate a business, they may not be clear on the major differences between working capital and growth capital. If they don’t begin planning for both types of capital right from the beginning, they may not get what they really need from their business. They also have to be careful that they don’t try to expand too fast, because that can deplete all of their growth capital at once.
If it is used up and then more is needed, it can leave a company in a precarious position and stop them from continuing their expansion. If that happens in the middle of growth, it can be highly detrimental and could even spell the end of the business.
Getting into a cash-poor position should always be avoided because it’s difficult to recover from. It makes sense that companies want to grow as fast as possible, but those companies must be very careful that they avoid the pitfalls of burning up their entire growth capital fund. Instead, it is better to focus on slower growth, so the fund stays strong and the company builds strength at a more sustainable rate.