How to finance your growth strategy.

As you look to expand your family-owned business, one of the most critical components of success is finding he appropriate growth capital. But the search for financing can be a frustrating experience, particularly if you're not familiar with the ever-changing financial services landscape.

Most family-owned businesses are initially capitalized by equity investments from "friends and family." This type of funding, while often the easiest to obtain at the outset, has its limitations if you are actively trying to grow your business. Fortunately, there are a number of different ways to access capital and prevent your ownership stake from becoming too diluted.

A well articulated business plan or executive summary, which includes the financing and operations of your business, including market research and strategy, analysis of the competition, cost breakdowns, management policies and how capital will be raised and spent is important Just ask Barry Karlin, CEO of CRC Health Corporation, a network of drug and alcohol rehabilitation clinics headquartered in San Jose. Just as a resume gets a potential employee's foot in the door, a business plan is the first impression that a lender or investor has of a company. This is your first -- and possibly last -- impression, so make it your best one.

Lenders and investors will look favorably upon business leaders who can clearly and concisely communicate the company's vision, demonstrate a solid understanding of the company's competitive positioning and deliver a simple plan for future action. Lenders will also look favorably upon companies that understand their risk factors and have articulated how capital will be raised and spent within the context of the overall business plan.

The other thing you can do to give your family-owned business an advantage is to familiarize yourself with the inner workings of the financial services industry. Ask questions, listen and adjust your approach accordingly. Depending on your growth strategy, you may want to consider using a combination of senior bank debt, subordinated debt (mezzanine capital) and/or new equity investment.

The rationale for such an approach is based on the risk/return requirements of different financial institutions. In other words, financial institutions (or even divisions within financial institutions) have varying degrees of risk tolerance based on their credit culture and opportunity for return. Understanding their requirements and your family company's "risk" factors are crucial components of successful capital raising.

Equity investors, including friends and family and venture capital firms, have the highest tolerance for risk. Equity investors anticipate a 35 to 50 percent annual return on their investment, which means they can accept some investments that are total losses and still meet their return targets. Depending on the size of your business and the industry sector, corporate (strategic) investors may also be a logical consideration given their understanding of certain risk factors associated with a particular industry.

Mezzanine lenders receive their return in the form of high yield interest rates (1 0%+) combined with some level of equity appreciation (usually in the form of warrants). They clearly take a risk with their invested capital and so will expect a 15 to 30 percent annual return. From a business owner's perspective, mezzanine financing is generally preferable to pure equity investment because it does not dilute your ownership stake as much.

The two primary sources of senior debt, defined as debt that is paid off first in the event of liquidation, are commercial finance (or asset-based) lenders and senior lenders. Senior lenders, such as banks, will borrow money from a variety of sources and re-lend it to their customer for a spread higher than their cost of money.

These financial institutions are the most risk averse, because they simply cannot afford to lose principal on their loans. As an example, if a bank takes a $1,000,000 write-off for a bad loan on a portfolio that is averaging a two percent spread, the bank would need to find, book. and service $50,000,000 in new performing loans to make up for that loss.

Bottom line: even the most expensive senior debt is much less expensive than mezzanine or new equity, but underwriting guidelines are stricter and will require both a primary and secondary source of repayment.

Once you understand investors' and lenders' tolerance for risk, you need to understand your own company's risk factors. If you are planning an acquisition, for example, it raises the level of risk and the corresponding cost of capital. As a result, a senior lender may not be willing to be the sole financier of your project; you may need to seek funding from a combination of capital sources.

In assessing your own company's risk, you should first evaluate profitability over the past three years as well as a lender's primary and secondary source of repayment. Beyond that, consider risk factors such as entering new geographical markets, introducing new products, a change in management, acquisitions and mergers. Any modification to your existing course of business may be viewed as a credit risk for a lender or investor.

If you've borrowed a lot of money in the past two years, you will also be considered a higher risk.

In the long run, the most successful family businesses demonstrate a clear understanding of their company's strengths and weaknesses, have a well articulated business plan, and are willing to listen, learn and adjust financing strategies appropriately.

Most importantly, they're not afraid to take some risks. Because sometimes the riskiest behavior is doing nothing at all.

Bita Ardalan is Senior Vice President and Division Manager for Union Bank of California, providing Commercial Marketing and Lending expertise to the Greater Los Angeles area. Bita joined the Bank in 1986. For more information about Union Bank's products and services, call [phone].