Use of Funds: Why “Growth” Is Not a Financing Strategy

A company seeking capital will eventually face a deceptively simple question: what exactly will the money be used for?

The answer is often surprisingly vague. “Growth”, “international expansion”, “working capital” or “general corporate purposes” may describe the broad objective, but they tell an investor or lender very little about what will actually happen once the capital reaches the company.

A credible financing request requires more than an amount. It requires a clear connection between capital, deployment and expected economic outcome.

If a company is asking for €10 million, the capital provider should be able to understand why €10 million is needed rather than €6 million or €15 million, when it will be deployed, what it will finance and what effect that expenditure is expected to have on the business.

The use of funds is therefore not a secondary section of the presentation. It is one of the foundations of the transaction.

From an amount to an investment plan

Consider a manufacturing company seeking €12 million “to expand production and support growth”.

The statement is plausible, but not particularly useful.

A more credible request might identify €6 million for a new production line, €2 million for additional inventory and receivables generated during the ramp-up period, €1.5 million for the opening of a new commercial market, €1 million for technology and automation, and €1.5 million as liquidity reserve during implementation.

The total amount has not changed. The quality of the financing proposition has.

The investor or lender can now analyse whether the production line is appropriately costed, whether the additional working capital is consistent with projected revenues, when the new capacity will become operational and whether the liquidity buffer is sufficient.

In other words, the funding request has become testable.

That is essential because professional capital providers are not simply deciding whether they like the company. They are deciding whether they are comfortable financing a particular deployment of capital.

The use of funds should explain the financing structure

Different uses of capital naturally support different financing instruments.

Long-term industrial capex that is expected to generate predictable cash flows over several years may be suitable for medium- or long-term debt. A temporary working-capital requirement may instead call for a revolving or short-term facility. An acquisition may require acquisition finance, equity or a combination of both. A high-risk expansion into an untested market may be difficult to finance entirely through senior debt.

This is why “we need €10 million” is only the beginning of the conversation.

The adviser should ask what each euro is expected to finance and then determine whether the proposed capital structure matches the economic life and risk of that expenditure.

A common mistake is to do the opposite: management first decides that it wants debt or equity and then attempts to fit every capital requirement into that instrument.

The financing structure should follow the use of funds, not dictate it.

Capital expenditure and operating losses are not the same thing

The distinction becomes particularly important when a company describes its funding requirement as “growth capital”.

Suppose two businesses each seek €8 million.

Company A needs the money to build a facility that will increase production capacity by 40%, with customer demand already substantially identified.

Company B expects to lose €8 million over the next eighteen months while attempting to reach sufficient scale to become profitable.

Both may legitimately describe the funding as capital for growth. Economically, however, the two propositions are completely different.

In the first case, the capital is being invested in an identifiable asset expected to generate incremental cash flow. In the second, the capital is funding a period during which the company's operating model remains cash-negative.

That distinction will materially affect the type of capital available, the risk assessment, the expected return and the conditions attached to the financing.

Precise use-of-funds analysis therefore prevents broad terminology from obscuring the real economics of the transaction.

A use of funds should connect to measurable results

The strongest financing cases do not stop at explaining where the money goes. They explain what the money is expected to produce.

If €5 million is being invested in additional production capacity, what capacity does it create? What incremental revenue can that capacity support? When does production begin? What margins are expected?

If €3 million is allocated to an acquisition, what EBITDA is being acquired and what integration costs are anticipated?

If capital is required for working capital, what growth in receivables or inventory explains the requirement, and when should that working capital convert back into cash?

This does not mean every investment must have an immediate or perfectly measurable return. Technology, brand development and geographic expansion may have longer or less predictable payback periods.

But the economic rationale should still be intelligible.

The use of funds should provide the bridge between the financing being requested today and the business the company expects to have tomorrow.

The amount requested should withstand scrutiny

Another recurring problem arises when the funding amount appears to have been selected before the underlying requirements were calculated.

Management may initially decide that it wants to raise €20 million because that amount provides comfort or because it represents what the market is believed to be able to provide.

Once the expenditure plan is examined, however, the business may only have a credible requirement for €13 million.

Raising more capital than necessary is not automatically positive. Debt creates interest and repayment obligations. Equity creates dilution. Undeployed capital sitting on the balance sheet may therefore impose a cost without producing a corresponding return.

The opposite problem is equally serious. Underestimating the capital requirement can force the company back into the market before the original investment has produced results, often from a weaker negotiating position.

Good advisory work should therefore challenge the amount requested rather than merely package it.

The relevant question is: how much capital does the business actually need to execute the plan with a reasonable margin of safety?

Timing matters as much as amount

A company may genuinely require €20 million over three years without needing €20 million on day one.

If €5 million is required immediately, another €7 million after twelve months and the remainder only once specific milestones have been achieved, a staged financing structure may be more efficient.

This can reduce financing costs and, in an equity transaction, potentially reduce dilution if later capital is raised at a higher valuation after milestones have been delivered.

It can also improve the risk profile for the capital provider by linking additional funding to execution.

The use-of-funds analysis should therefore consider when capital is required, not simply its aggregate amount.

This is especially important in project-based businesses, acquisition programmes, development situations and companies undertaking substantial capex.

What investors and lenders infer from the answer

The use-of-funds discussion also tells the capital provider something about management itself.

A team that can explain precisely why it needs €12 million, how the amount was calculated, when it will be spent and what results are expected demonstrates a degree of financial discipline.

A team that cannot explain why it needs €12 million rather than €10 million raises a different question: how carefully has the underlying business plan actually been prepared?

For that reason, the use of funds is not merely a financial schedule. It is also an indicator of management's understanding of its own capital requirements.

Professional investors and lenders will often challenge individual assumptions precisely to see whether the financing request has been built from the business upwards or simply from the desired amount downwards.

Capital should have a job

Every financing transaction begins with a need for money, but a serious financing proposition should end with something much more precise.

The capital should have a defined purpose, a deployment timetable and an identifiable economic rationale. The amount requested should reconcile with the business plan, and the financing instrument should be appropriate for what the money is intended to achieve.

“Growth” may explain why a company wants capital.

It does not explain why someone should provide it.

A credible use of funds does.

The most useful question for management is therefore not simply “How much capital do we want to raise?”

It is: “What specific job will that capital perform once it enters the business?”