Growth Strategies

Growing Their Own Way

Facing limited sources of external capital, midsize companies make financing expansion an inside job.
Josh HyattFebruary 7, 2013

Shunned by banks and other traditional sources of financing, midsize companies have finally found investors they’re sure they can rely on: themselves.

Even as the economy has begun its cautious climb upward, credit remains tight at lending institutions. Forced to look elsewhere for their fastest and cheapest source of growth capital, midsize companies have turned inward, dipping into their accumulated profits to fund expansion.

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In an electronic survey conducted by CFO Research, in collaboration with American Express, retained earnings outstripped other major forms of growth capital by a wide margin. The study garnered 323 responses from senior finance executives at U.S. companies with annual revenue ranging from $10 million to $500 million. Asked about their sources of growth capital over the past three years, 56% of respondents reported that they relied on retained earnings from ongoing operations (see Figure 1).

By contrast, just 24% of survey-takers chose secured debt financing, which was the second-highest-ranked capital source. Both equity financing and unsecured debt financing lagged well behind, with the former attracting 8% of respondents and the latter preferred by just 3% of finance executives. For the foreseeable future, anyway, midsize companies would rather fund themselves. “We’ve gone to a number of different seminars and met with banks and other funding sources,” says Robert Pruger, CFO of The Rudolph/Libbe Cos., a holding company for 10 businesses, most of them related to construction. “Traditional bank financing appears to be way more difficult than it should be from an economic point of view.”

Neither companies nor their bankers emerged from the downturn un-scarred. With the Great Recession having battered many a balance sheet, fewer companies are considered prized borrowers in the eyes of bankers. And in a tightened credit environment, any funding deal that wins approval may burden its borrower with both highly restrictive covenants and overly onerous interest rates.

But companies that have weathered the economic downturn have likely also developed the wherewithal to manage their working capital more shrewdly. The result: even if demand has only begun to show renewed signs of life, finance executives have mastered the skills to surgically squeeze more dollars out of every transaction. By improving efficiency, they’ve liberated loose cash that might have previously been locked up in receivables, payables, or inventory. They’ve fattened their profit margins by paring down expenses, persuading vendors to grant them extended credit terms, and working to ensure that their customers pay on time, whether by adding late fees or offering discounts for early payment. To whatever extent they could, they’ve also nudged prices up ever so slightly.

Learning to Prize Cash
Cretex Cos., a diversified manufacturer with multiple lines of business, based in Elk River, Minnesota, “came out of the downturn in pretty good shape,” according to CFO Steve Ragaller.

How has the company, with $400 million in revenues, done it? Management, answers Ragaller, has “engaged our whole organization” in collecting receivables, setting targets as part of its incentive compensation program and reinforcing the priority at monthly meetings. “A lot of times, people think that it’s just something for the finance organization to handle, but that’s not true,” says Ragaller. “It’s everybody’s job to complete the transaction, and the transaction with the customer is not complete until we collect the cash.”

Similarly, Eclipse, a maker of industrial and process heating equipment based in Rockford, Illinois, revved up cash generation by forming a team to focus on reducing its days inventory outstanding. The group developed an inventory analysis tool that enabled the company to simultaneously reduce inventory levels and cut stock-out situations. Managing inventory more efficiently freed up about $6 million a year, according to CFO Gregory Bubp. In addition, pent-up demand pushed revenues up nearly 30% in the company’s 2012 fiscal year. “We’ve more than recovered from what we experienced during the downturn,” says Bubp.

Why Banks Still Rate
Midsize companies have high hopes for how far their retained earnings can take them. In fact, survey respondents who agree that cash from ongoing operations will be their company’s primary source of growth capital over the next two years outnumber those who disagree by more than five to one (see Figure 2). “Saying that ‘we’re just going to grow with internally generated cash’ is the safest answer” given uncertain economic conditions, says Robert Alessandrini, CFO of The Judge Group, a $300 million staffing and IT consulting firm. He refers to the current state of bank borrowing as “a one-way street.”

Nonetheless, banks continue to serve as a critical source of capital for midsize companies. Fifty-eight percent of survey respondents say they occasionally or frequently use commercial bank financing to improve their cash positions. In interviews, finance executives cite revolving lines of credit as playing a key role in funding such day-to-day operations as making payroll and buying raw materials.

But when it comes to providing funds for riskier investments — beyond, say, operating loans — “banks can still be pretty strict,” says Alessandrini. As the economy begins to gain speed, companies that can’t invest in growth fear being left behind by their rivals. Adding to its presence in Shanghai, The Judge Group last year invested in opening a Toronto office. Eclipse has made inroads into China and moved its India operations into a new, leased facility.

Companies relying on their own retained earnings still can’t do everything they might want; they have to move slowly, using the time to accumulate capital. “There are constraints,” says Bubp. But let the banks rebuff them. They are free to expand mostly as far as their cash can carry them.

To download the full report, “Funding Opportunity,” go to