source of financing a business, aims at solving the basic problems most entrepreneurs face in the initial stage of funding their business
HERE’S WHAT YOU’LL LEARN:
- How to analyse and prep yourself for a start up
- Techniques to implement in order to raise capital
- Different diversifications on financing a business
Often the hardest part of starting a business is raising the money to get going. The entrepreneur or business man might have a great and clear idea of how to turn it into a successful business; however, if sufficient finance cannot be raised, it is unlikely that the business will get off the ground. Raising finance for start-up requires careful planning. The entrepreneur or business man needs to decide:
- How much finance is required?
- When and how long the finance is needed for?
- What security (if any) can be provided?
- Whether the entrepreneur is prepared to give up some control (ownership) of the start-up in return for investment?
The finance needs of a start-up should take account of these key areas:
- Set-up costs( the costs that are incurred before the business starts to trade)
- Starting investment in capacity (the fixed assets that the business needs before it can begin to trade)
- Working capital (the stocks needed by the business – e.g. raw materials plus allowance for amounts that will be owned by customers once sales begin)
- Growth and development (extra investment in capacity)
One way of categorizing the sources of finance for a start-up is to divide them into sources which are from within the business (internal) and from outside providers (external).
The main internal sources of finance for a start-up are
Most start-ups make use of the personal financial arrangements of the entrepreneur. This can be personal savings or other cash balances that have been accumulated. It can be personal debt facilities which are made available to the business.
Savings and other ‘’’nest eggs’’:
An entrepreneur will often invest personal cash balances into a start-up. This is a cheap form of finance and it is readily available. Often the decision to start a business is prompted by a change in the personal circumstances of the entrepreneur.
Re-mortgaging is the most popular way of raising loan-related capital for a start- up. The way this works is simple. The entrepreneur takes out a second or a larger mortgage on a private property and then invests some or all of this money into the business. The use of mortgaging like this provides access to relatively low-cost finance, although the risk is that, if the business fails, then the property will be lost too. This is a common source to financing a business
Borrowing from friends and family:
This is another source to financing a business and is also common. Friends and family, who are supportive of the business idea, either provide money directly to the entrepreneur or into the business. This can be quicker and cheaper to arrange (certainly compared with a standard bank loan) and the interest and repayment terms may be more flexible than a bank loan. However, borrowing in this way can add to the stress faced by an entrepreneur, particularly if the business gets into difficulties.
Another important source of financing a business either large or small. This is the cash that is generated by the business when it trades profitably –note that retained profits can generate cash the moment trade begun. Like say, a start-up sells the first batch of stock for $1000 which it had bought for $500. That means that retained profits is $500 which can be used to finance further expansion or to pay for other trading costs and expenses.
The use of credit cards is the most common source of finance amongst small businesses. Each month, the entrepreneur pays for various business-related expenses on a credit card. Fifteen days later the credit card statement is sent in the post and the balance is paid by the business within the credit-free period. The effect is that the business gets access to a free credit period of around 30-45 days.
This can take several forms, but the most common are bank loan or bank overdraft.
Bank loan serves as a source of financing a business because it provides a longer-term kind of finance for a start-up, with the bank stating the fixed period over which the loan is provided (like 5 years) the rate of interest and the timing and amount of repayments. The bank will usually require that the start-up provide some security or the loan, although this security normally comes in the form of personal guarantees provided by the entrepreneur. Bank loans are good for financing investment in fixed assets and are generally at a lower rate of interest than a bank overdraft. However, they do not provide much flexibility.
This is a more short-term kind of finance which is also widely used by start-ups and small businesses. An overdraft is really a loan facility- the bank lets the business ‘’owe it money’’ when the bank balance goes below zero, in return for charging a high rate of interest, in the sense that it is only used when needed,. Bank overdrafts are excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short-term cash flow problems like when a major customer fails to pay on time.
Share capital – outside investors:
For start-up, the main sources of outside (external) investor in the share capital of the company are friends and family of the entrepreneur. Opinions differ on whether friends and family should be encouraged to invest in a start-up company. They may be prepared to invest substantial amounts for a longer period of time; they may not want to get involved in the day-to-day operation of the business. Both of these are positives for the entrepreneur. However, there are pitfalls. Almost inevitably, tension develops with family and friends as fellow shareholders.
These are the main kind of external investor in a start-up company. Business angles are professional investors who typically invest any amount. They prefer to invest in businesses with high growth prospects. Angles tend to have made their money by setting up and selling their own business- in other words they have proven entrepreneurial expertise. In addition to their money, angles often make their own skills, experience and contacts available to the company. Getting the backing of an angel can be a significant advantage to a start-up, although the entrepreneur needs to accept a loss of control over the business but its a source of financing a business.
SOURCE OF FINANCING A BUSINESS:
There you have it on the source of financing a business, I hope you found this post helpful and in case you didn’t get it all at once, here is a second chance at a better understanding.
- Retained profit means using the profits gained from the initial start up to expand. The idea here is to start up with whatever resources at your disposal so as to grow.
- Convincing people (friends and family) to believe and invest in your idea goes a long way in the source financing a business.
- Seek out investors as soon as the business commences.
I hope you were able to comprehend the above points on the source of financing a business. Feel free to share your thoughts.