Show me the money: Create Your Funding Strategy for Expanding Your Business Abroad
This is part 6 of a 17-part series on global expansion. You can find the full list below this article.
Every time you set up a business in a new jurisdiction, the expansion is going to require funding. And even if your business is profitable, the cash you have on hand might not be enough to fund your growth even though you know you could turn a bigger profit down the line, or it may not be prudent to be cash poor when you enter a new market.
There are four kinds of traditional funding options you’d have for expanding your business: (1) cash from your business, (2) loan from a bank or third party, (3) investment by new equity partners, (4) government grants, or a combination of these so as to manage risk.
The difference between each of these options comes in the form of (A) how much money you can receive from the source, (B) the terms for how to pay the money back (when you borrow money, it’s called “debt funding”), and (C) how the funding will affect the ownership of your business.
How your execution model affects your funding strategy
Most jurisdictions will not allow you to set up a presence (e.g. entity or branch office) and then obtain a loan within the local jurisdiction, immediately. What that means is that regardless of whether or not you will have a rep office, EOR, branch office or entity, you’ll likely need to obtain your capital from your headquarters to fund the expansion at the outset.
While the process of sourcing capital for international expansion is similar to sourcing capital for a domestic business, one caveat is that some local banks have policies in which you cannot use the money to grow a business in another jurisdiction. The reason for this policy is that banks need to know how they are going to get money back even if you are unable to pay the loan off, and they cannot access any assets you may have outside of the country for collateral.
Also, if you were to obtain a loan, the terms of the loan will depend on the local jurisdiction. A country like Japan might give you a large sum of money to fund a business with a low 1-2% interest rate, whereas other countries might provide you with less capital for a higher 10-15% interest rate.
What kind of funding do you want to pursue?
Most business owners who need capital ask themselves, “How can I get funding?”
As mentioned above, one form of funding is debt and when considering debt the important questions to ask are, “What kind of debt do I want to have?” and “How will I pay this debt off?”
There are different kinds of debt: Bank loans are generally categorized as “senior debt” and are collateralized by assets or future cash flows. There are other organizations that also offer debt instruments that can be collateralized, like a line of credit based on the work in progress which has its own calculations.
Loans that come from non-financial institutions (investors) are called “mezzanine” and “junior” debt and these tend to have higher interest rates. These terms are all based on who gets paid first if you were to go bankrupt; senior debt gets paid first since they took a lower interest rate, generally than those that offer mezzanine or junior debt. Mezzanine or junior debt gets paid later because they are typically earning a higher interest rate and because they take on more risk so their guarantee of a payout is lesser compared to senior debt.
Debt can also be agreed to convert to equity (meaning you lose ownership) depending on the circumstances.
When you have a typical loan, you still own 100% of your business even though you are receiving funds. If someone loans you 1 million dollars, you still have 100% ownership over your company.
On the other hand, giving up equity is related to selling shares of your company. If you were to receive 1 million dollars in exchange for 50% of the shares in the business, you will no longer own 100% of the company since the people who purchase the shares will own 50% of your business. Equity is the most expensive form of financing, as investors will expect a higher rate of return. Usually, equity holders (typically the founders of a startup for example) are not selling the shares they own personally but instead issuing additional shares from the business to be purchased by outside investors so as not to create a taxable event for the current equity holders. Also, the only way to remove equity investors is to buy them out and if your company continues to grow then the value of that buy-out or repurchase of shares will be materially higher than what they were when originally purchased. Having said that, equity investment could come from a parent company which at least keeps money within the organization.
Even though a bank loan might sound like a safer option, some companies choose to have investors because it is too difficult for them to qualify for a loan, especially to expand internationally and bringing on strategic investors is smart in many ways because not only do they bring additional funds but also their networks, know-how, and experience in growing other companies in the past. This is often the case with startups; when the company is just starting out, they cannot just waltz into the bank and obtain a big loan in the way they could receive a large sum of funding from private investors.
Another important thing to consider before you choose your funding is to understand how you will be able to pay it off based on the regulations each jurisdiction has regarding how much money you can remit overseas and how long that process can take. Come check out our article Landlocked: How Your Transaction Flows can Impact Your Access to Funds.
How Does Funding Through Equity Partners and Investors Work?
Startup funding happens at different stages (known as Series A, B, C, etc.), starting with pre-seed or seed financing which is generally a company’s first round of funding, with money generally coming from the founders’ own pockets or from family and friends. For further detail on the stages from seed to IPO funding, learn more here.
What is your funding strategy?
Here are a couple of examples of companies that went through the funding process (a.k.a “raising capital”).
A tour company located in Japan was looking for funding to expand its operations. They had a few offers from investors, but if they took the money from these investors the tour company owners would have been subject to strict terms, revenue goals and ultimately lose considerable control over the strategy of their business. When they went to a local bank, they discovered they could receive a higher loan amount with a low-interest rate while still being able to retain ownership over their business. In their case, the importance of control over the execution of their company’s strategy was most important so they went with the loan, or debt financing option.
Another example is an Asian media company that was struggling to obtain financing. A private equity firm offered them 17 million dollars in the form of a convertible loan (i.e. debt that converts to equity upon certain events/non-events) under the condition that they do an initial public offer (“IPO”) within 12 months of taking the money. At the time, they needed the cash, so they accepted the offer but they soon realized a successful IPO needed more than 12 months of preparation. The time pressure forced them into doing commercially questionable net-zero deals with customers to try and increase their pre-IPO revenues and valuation which actually left them with a net loss due to taxes on cross-border transactions. They were unable to accomplish their goal of an IPO in such a short time and ultimately this loan converted into equity and they lost control and had to sell their business. This is an example of how companies dig holes for themselves when the proper short and medium-term financial planning is not done correctly.
There is more than meets the eye when understanding what kind of funding is best for a particular business at a particular stage of growth. We’re happy to help walk you through your options based on your unique business. Don’t do it alone – feel free to reach out to us here!
Special thanks to Sam Barrett from EY’s APAC Operating Model Effectiveness team for his inputs and insights in putting together this series of articles.
International Business Expansion Series
This article is part 6 of a 17-part series about International Business Expansion. Here’s a list of the full series to give you a well-rounded understanding of what to consider when expanding your business abroad, from strategy to execution to management:
- The #1 Thing that Companies Need for a Successful Expansion Abroad
- The 3 Components of a Market Analysis to Know if Your Product is Viable Abroad
- How to James Bond Your Profit Margin with Location Analysis
- How to WIN in a New Market with These 6 Models of Execution
- Lost in Translation: How Culture Can Impact Your Business Expansion
- Show me the money: How to Fund Your Business Expansion Abroad
- Risky Business: The 2 Key Layers of your Operating Model to Align with Your Growth Strategy
- Avoid Being Taxed: How Tweaking the Structure of Your Organization Can Protect Your Bottom Line
- Trash Talk: Why You Need to Analyze Your Processes Before Expanding Globally
- 5 Reasons Why You Should Customize Your Technology for Your International Expansion
- Setting Up a Business Abroad: The 4 Kinds of Structures & Legal Implications
- Landlocked: How your Transaction Flows can Impact Your Access to Funds
- 5 Industry-Specific Legal and Regulatory Obligations that can Impact Your Business Expansion Abroad
- “Health Checks”: Your Ticket to Building a Sustainable International Business
- How Much Is Your Business Worth? 4 Drivers that Increase the Value of Your International Business
- Plug and Play: How to Efficiently Scale Your Business When Expanding Abroad
- Beach, or Boardroom? Plan Your Exit Strategy Before You Expand Globally