Arranging for financing for a new business is no easy task. New businesses do not have sales or track record. Hence they are considered much higher risk than financing an established business. New business entrepreneurs also find it difficult to estimate the amount of money they will need to get a business up and running. More often than not entrepreneurs significantly underestimate the amount of funds they require. They leave no room for unexpected obstacles or opportunities.
Sources of business Finance
The primary sources of funds for small business start-ups are personal funds, friends and relatives, NGOs or private investors, banks, government agencies and programs, and venture capital.
The most accessible and unconditional source of funds for your new venture is often in your own pocket. It is also the first source you should tap because most people will not invest in your business unless you can demonstrate some financial commitment your self. After all, why should someone else invest in your business if you are not prepared to put your own finances on the line? This may mean looking in your savings accounts or other investments, tapping into a life insurance policy, selling some real estate or postponing some other expenditure.
Once you have assessed your own savings and found that there is still a shortfall, it may be time to look to raising money from friends and relatives. This often known as “love money” and is used by many entrepreneurs for at least part of their start-up financing. The biggest risk with this source of capital is that it can create a considerable strain on these relationships if your business does not work out.
It is therefore important that you treat their investment the same as you would a bank or other external source of capital. Develop a formal agreement, lay out the terms and conditions including a repayment schedule plan, and keep them abreast of developments in your business. Depending on the nature of the business this type of financing may be sufficient to supplement your own funds.
Non-Governmental Organizations (NGOs)
There are several NGOs nowadays that are providing credit to small businesses. However, each NGO has its own conditions and requirements that must be fulfilled before providing loans.
Banks are one of the most widely used external sources for funding new businesses. The primary consideration for banks in assessing a loan applicant is their confidence in the person’s ability to pay back the loan.
This confidence is a function of a number of factors:
◘ The person’s previous track record and credit history,
◘ Adequate cash flow in the business to meet the payment schedule,
◘ Sufficient equity or assets.
Banks do not take large risks. They have a responsibility to ensure the safety of their depositors’ money and obtain a reasonable return. Unfortunately many entrepreneurs do not understand this. Hence it is common for an unprepared entrepreneur to walk into a bank, ask for a loan, and if they are refused, blame the bank for not caring for the “little guy” (Mlalahoi). Informed entrepreneurs go into the bank with all the information the banker may need at their fingertips including their financial history, current financial circumstances, business plan and résumés.
Types of financing that can be obtained from a bank are:
◘ Short term loan
– Usually repaid within 30 to 180 days and they are normally used to purchase extraordinary inventory, finance cash flow shortages, and access to suppliers’ discounts for early payment.
◘ Operating loans
– these are usually loans given for 90 days, based on a line of credit allowing entrepreneur to access money up to a pre-established limit (50% of raw materials or finished products) and must be repaid with interest. They are unsecured loans but less risky and they are given depending on the entrepreneur’s financial statements and track record.
◘ Fixed assets loans
– These are usually long term loans provided for a year or more to cover the costs of fixed assets such as machinery/equipment, vehicles, commercial buildings, and real estate. These loans normally cover about 60 to 80 percent of the cost of equipment and about 75% of the market value of property.
Governments at all levels have developed a number of financial assistance programmes for small business.
Venture capitalists provide equity investments for start-up or expanding businesses.
Other sources of financing
Employees share payment
Leasing vs. buying
Advance payments from customers
Forms of Financing
Capital is normally invested in a business in two ways or forms: Debt financing form or Equity financing form.
This is an investment in the business either as the owner, a partner or a buyer of shares in the corporation.
Key considerations in equity financing include:
- Requiring more commitment from investors.
- Less stress on the cash flow.
- Long term (fixed assets)
Types of equity financing are:
- Cash on capital contributions
- Personal equity
- Partnership equity or capital injection
- Love money (This is a common phenomenon in US and Canada)
- Investor (preferred or common shares)