Finance Fundamentals – Distributing Capital

Introduction

Closing our the Finance Fundamental series - We’ve raised capital, employed it effectively in our business, and managed it carefully.

Now, the question is: how do we distribute that capital effectively to maximize its value and create long-term success?

Capital distribution refers to the allocation of profits back into the business or among shareholders. If you’ve done a great job employing and managing your capital, your business should be in a position to generate profits, the true goal of any business venture.

These profits can then be distributed in various ways, including shareholder dividends, reinvestment in the business, or capital allocation for growth opportunities.

In this article, we’ll cover key strategies for distributing capital, including understanding dividends, reinvesting into growth, acquisitions, and new verticals. By the end, you’ll have a clearer view of how to manage capital distribution process effectively to drive your business’s next stage of growth.

Shareholder Distributions (Dividends)

When a company turns a profit, it’s common to distribute some of that profit back to the shareholders, especially if the business is in a mature stage.

In many cases, this is done through dividends.

A dividend is a portion of the company’s profits paid to shareholders, typically on a per-share basis. The amount distributed will depend on how many shares you hold and what percentage the company allocates for this distribution.

It’s important to note that dividends are post-tax profits, meaning they’re calculated after accounting for taxes such as corporate tax. However, any dividends received by shareholders are subject to personal tax and should be reported accordingly.

While rewarding shareholders is an important use of profits, it’s essential not to distribute everything.

If you take out too much capital through dividends, it could leave the business in a weakened financial position, particularly if unforeseen costs arise or you need more capital for growth.

Reinvesting Profits

One of the most strategic uses of profits is reinvesting back into the business. As your company grows, so do its needs for further investment, whether it’s upgrading infrastructure, scaling operations, or investing in new technology or talent.

In particular, investing profits into Research & Development (R&D) is crucial, especially for tech companies and SaaS businesses.

This reinvestment can be used to:

Improve existing products or services
Develop new offerings
Enhance customer satisfaction
Stay ahead of competitors
Move into new markets

For SaaS businesses, reinvesting in R&D might also involve improving software features and accelerate the roadmap, enhancing customer experience, or optimizing your tech stack to provide better scalability and security for your customers.

Reinvesting profits also ensures that the business continues to evolve and adapt to changing market conditions. Failing to reinvest could result in stagnation or the loss of your competitive edge.

Acquisitions and Mergers

Another strategic way to distribute capital is through acquisitions or mergers.

This strategy allows you to expand your market presence, add new products or services, or acquire valuable talent.

For SaaS companies, acquiring smaller competitors, tech startups, or businesses with complementary technology can help accelerate growth and solidify your market position.

When looking to acquire a business, you’ll want to ensure that the target company complements your current offerings and fills in any gaps in your business model.

For example:

Does the company have a strong customer base or intellectual property that can complement your product?
Are they a competitor that’s weakening in the market and could be acquired at a favorable valuation?
Does the company have valuable assets, like a strong sales team, that could help scale your business faster?

Using profits to acquire other businesses can allow you to enter new verticals, expand your customer base, or increase your market share quickly.

New Verticals or Market Entrances

As businesses mature and their existing models become increasingly optimized, the next step for growth might involve entering new verticals or markets. By re employing capital and using profits to diversify, companies can position themselves for long-term success, especially in rapidly changing industries like SaaS or tech.

For example, a SaaS business that focuses on project management software might choose to enter the collaboration tool space to broaden its market. Or, a tech company that initially served the healthcare industry might look to expand into education, fintech, or another vertical that is ripe for disruption.

New verticals could also include expanding into international markets, either by setting up local offices or through online channels. This kind of expansion requires careful planning, especially for SaaS businesses, which need to consider compliance, localization, and regional customer needs.

By distributing capital towards new ventures, you’re setting the foundation for future growth that’s aligned with your long-term goals.

Savings and Financial Flexibility

Another important consideration in capital distribution is maintaining cash reserves for savings and ensuring financial flexibility. It’s tempting for business owners to use all profits for reinvestment, but having adequate reserves is essential to handle potential downturns, unexpected expenses, or strategic opportunities that may arise.

A good practice for managing capital is to ensure that your business has enough working capital to cover day-to-day expenses, like operating costs, supplier payments, and salaries.

Beyond that, consider putting profits into high-yield savings accounts or short-term investments to earn interest while maintaining liquidity.

Savings and emergency funds give businesses the cushion they need to weather difficult periods or respond quickly to unforeseen opportunities, like launching a new product or service or entering a new market.

Conclusion

Distributing capital is one of the most important decisions business owners and investors make, and equally as important as raising capital in the first place. Whether you choose to reward shareholders through dividends, reinvest in R&D, acquire complementary businesses, or enter new markets, each decision should be made with long-term growth in mind.

SaaS businesses and tech companies, in particular, benefit from strategic capital distribution because of the fast-paced nature of the industry.

Reinvesting in R&D and using profits to expand into new verticals or markets can create substantial returns and ensure that your business remains competitive in an ever-evolving environment.

If you’re considering how best to distribute capital within your business, make sure to take a balanced approach. Consult with your team, financial advisors, and non-executive directors to ensure that capital is being allocated wisely, and that it aligns with your long-term business goals.

If you have any questions on how to distribute capital in your business, feel free to reach out.