Reading: Financing and Firm Life Cycle

Internal Financing

As revenues pick up, many firms start seeing positive operating cash flows and they reach the crucial financial milestone of break even. However, due to the large capital needs to scale up the business, these cash flows are often dwarfed by the firm's investment activities, so that high-growth firms still exhibit negative free cash flows and therefore require external financing.

Market success, along with a growing track record and declining business risk, will also allow many firms to put their financing activities on more solid grounds. During the early phases of the life cycle, most firms do not have a clearly defined financing strategy, as they lack access to many traditional sources of financing and therefore have to cut their coat according to their cloth.

Equity Instruments

Private Equity

On the equity side, firms could attract private equity funds. These financial sponsors can assume a similar role as venture capitalists; the main differences are that they tend to invest at a later stage and that they generally have larger minimum investment requirements.

Private equity funds, together with private placements to individual shareholders, can also be an important element in the consolidation of the shareholder base and the firm's ownership structure. During these phases of the corporate life cycle, many early investors, especially venture capitalists, want to exit their investment to free funds for new ventures. Private equity can fill the gap and orchestrate such liquidity events.

Public Equity

A few firms will also make it to public corporations and list their shares on a stock exchange in an Initial Public Offering (IPO).  The module Initial Public Offering (IPO) deals extensively with this topic.

Debt Instruments

Positive operating cash flows, declining business risk, and a generally stronger asset base could open up traditional debt financing instruments with a medium to long-term horizon. Such instruments can be valuable in the consolidation of early stage debt financing (in particular trade credit and factoring), which, as we have seen, tends to have a short horizon and can be rather costly.

Depending on the firm's asset structure, debt can also be a powerful source of growth financing, often in combination with private equity investments. For example, an airline company will generally find it easier to finance these stages of its life cycle with debt, as the planes serve as collateral and can be easily redeployed to other carriers in the case of financial distress.