My Name is Andrew Gere and this is a small booklet I have
put together to help young entrepreneurs looking to start up their own small
business.
Often the
hardest part of starting a business is raising the money to get going. The
entrepreneur might have a great idea and clear idea of how to turn it into a
successful business. However, if
sufficient finance can’t be raised, it is unlikely that the business will get
off the ground.
Raising
finance for start-up requires careful planning.
The entrepreneur 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?
Definition
A finance
source, or financing method, helps an organization meet short-term operating
needs, such as paying for costs of materials, salaries and other administrative
expenses.
Financing is
a significant business practice in modern economies. A firm with no access to
financial markets or unable to raise funds privately may have difficulties
operating. Senior leaders may be unable to set long-term goals without funding.
There are two
major types of sources of finance they are Equity and debt financing products.
Small
businesses can get money through "equity financing" or "debt
financing." Equity financing means that you sell stock in your company to
a buyer, who then has an ownership interest in your company. Debt financing
means a loan -- you owe the person who holds the debt (usually a promissory
note) the amount borrowed.
Equity
products include shares of common stock and preferred stock. Debt products
include bonds, private loans and overdraft agreements.
Equity Financing
Equity
financing also known as “share capital” is the act of raising money for company
activities by selling common or preferred stock to individual or institutional
investors. In return for the money paid, shareholders receive ownership
interests in the corporation.
Equity
financing helps top leadership raise funds by selling shares of equity, or
stocks, on securities exchanges. A shareholder, also called stockholder,
receives regular dividend payments and makes profits when share prices rise.
Debt financing
When a firm
raises money for working capital or capital expenditures by selling bonds,
bills, or notes to individual and/or institutional investors. In return for
lending the money, the individuals or institutions become creditors and receive
a promise that the principal and interest on the debt will be repaid.
Internal
sources of finance are funds found inside the business. For example, profits
can be kept back to finance expansion. Alternatively the business can sell
assets (items it owns) that are no longer really needed to free up cash.
This approach to financing
business activities is only possible when the business's principals have
sufficient funds at their disposal to allocate some for their company's use.
Traditionally,
the major sources of finance for a limited company were internal sources:
·
Personal
savings
·
Retained
profit
·
Working
capital
·
Sale
of fixed assets
Personal
savings
Quite simply, personal savings are amounts
of money that a business person, partner or shareholder has at their disposal
to do with as they wish. If that person uses their savings to invest in their
own or another business, then the source of finance comes under the heading of
personal savings.
Although we would generally discuss
personal savings as a source of finance for small businesses, there are many
examples where business people have used substantial sums of their own money to
help to finance their businesses. A good and very public example here is Jamie
Oliver, the television chef. Jamie financed his new restaurant, 'Fifteen',
using fifteen raw recruits to the catering trade and a large amount (£500,000)
of his own cash.
Retained
profit
Simply put this is money re-invested
back into the business, usually to improve or expand it
When a business makes a profit and it
does not spend it, it keeps it - and accountants call profits that are kept and
not spent retained profits.
The retained profit is then available
to use within the business to help with buying new machinery, vehicles, and
computers and so on or developing the business in any other way. Retained
profits are also kept if the owners think that they may have difficulties in
the future so they save them for a rainy day!
Working
Capital
Working Capital
This is the short-term capital or
finance that a business keeps. Working capital is the money used to pay for the
everyday trading activities carried out by the business - stationery needs,
staff salaries and wages, rent, energy bills, payments for supplies and so on.
Working capital is defined as:
Working
capital = current assets - current liabilities
Where:
Current assets are short term sources
of finance such as stocks, debtors and cash - the amount of cash and cash
equivalents - the business has at any one time. Cash is cash in hand and
deposits payable on demand (e.g. current accounts). Cash equivalents are short
term and highly liquid investments which are easily and immediately convertible
into cash.
Current liabilities are short term
requirements for cash including trade creditors, expense creditors, tax owing,
dividends owing - the amount of money the business owes to other
people/groups/businesses at any one time that needs to be repaid within the
next month or so.
Sale
of fixed assets
This is selling of what is no longer
required (turn the asset back into cash).
A fixed asset is anything that is not
used up in the production of the good or service concerned - land, buildings,
fixtures and fittings, machinery, vehicles and so on. At times, one or more of
these fixed assets may be surplus to requirements and can be sold.
Alternatively, a business may
desperately need to find some cash so it decides to stop offering certain
products or services and because of that can sell some of its fixed assets.
Hence, by selling fixed assets, business can use them as a source of finance.
Selling its fixed assets, therefore, has an effect on the potential capacity of
the business - the amount it can produce.
You
contributing your own money to your business is the easiest way to finance it.
Some of the
pros of internal sources of finance include;
·
Decision-Making Freedom
When you
finance your business activities internally, you are not accountable to any
outside entity. You don't need to explain your business decisions to anyone
outside your company or seek their approval before making changes or expanding.
This decision-making freedom enables you to weigh personal as well as financial
considerations when choosing the right course of action for your business.
·
Flexibility
Internal
financing allows you considerably more flexibility to pay back than outside
sources of capital. If you finance your business internally and you experience
a slow period that makes it difficult for you to repay a loan according to the
schedule you have outlined, you can simply make an extra payment the next
month. With internal financing it is usually easy to adjust payment terms in
accordance with your current business cash flow and other unanticipated
circumstances.
·
Credit Score Consequences
If you
finance your business internally and have difficulty making your payments, this
will not affect your credit score because you will not report yourself to the
major credit agency if things do not go as planned.
As easy as it seems to fund your small business through sources
of internal finance it has some important drawbacks
Capital Needs
The chief
concern with internal financing is that when you take money from your operating
budget or capital, it leaves you with less money to manage daily expenses. In
this way, using internal sources of financing for company endeavours can
compete with budgets already in place. For this reason, internal investment is
usually used to finance small projects and investments, where the costs are
small, the payback quick, and the estimated returns significant.
Discipline
Moreover,
internal financing is so easy that it leads to a lack of discipline. The
company risks becoming inefficient or even complacent unless it strictly
monitors the project's investment, budget and any increase in earnings that
stems from the project. These actions would normally be required if the company
took on debt, such as a loan, or used external financing like issuing stock.
Loss of assets
If you throw
all your personal savings into a business venture, you could lose it all. Some
assets, such as retirement accounts, are safe from creditors and bankruptcy
courts; placing such assets at risk may not be good for you, especially if
you're approaching retirement age and are running out of time to rebuild
depleted accounts.
Start-ups and
small firms are considered very high risk and find it difficult to raise
external finance.
External
sources of finance are found outside the business, e.g. from creditors or
banks.
Short-term sources of external finance
Sources of
external finance to cover the short term include:
An overdraft
facility, where a bank allows a firm to take out more money than it has in its
bank account.
Trade
credits, where suppliers deliver goods now and are willing to wait for a number
of days before payment.
Factoring,
where firms sell their invoices to a factor such as a bank. They do this for
some cash right away, rather than waiting 28 days to be paid the full amount.
Long-term sources of external finance
Sources of
external finance to cover the long term include:
Owners who
invest money in the business. For sole traders and partners this can be their
savings. For companies, the funding invested by shareholders is called share
capital.
Loans from a
bank or from family and friends.
Debentures
are loans made to a company.
A mortgage,
which is a special type of loan for buying property where monthly payments are
spread over a number of years.
Hire purchase
or leasing, where monthly payments are made for use of equipment such as a car.
Leased equipment is rented and not owned by the firm. Hired equipment is owned
by the firm after the final payment.
Grants from
charities or the government to help businesses get started, especially in areas
of high unemployment.
External
sources of finance have a number of big advantages over the internal financing
options.
Faster Growth
A business
needs investments to grow. Even the most profitable companies cannot rely
solely on reinvested profits to finance their expansion. Accordingly, a
business needs to secure bank credit, partner with venture capital firms or in
any other way tap external sources of finance. External finance provides the
room for faster growth, allowing the company to operate on a far bigger scale,
capturing new markets and providing products and services to an ever greater
number of customers.
Greater Economies of Scale
Large
businesses are generally more efficient than small ones. They have a greater
bargaining power with suppliers and they can spread their fixed costs, such as
administrative expenses, over larger sales. This results in lower costs per
unit of production, which, in turn, gives the company a competitive edge in the
marketplace. External sources of finance help a company grow faster, achieving
the economies of scale necessary to compete with the rival firms on regional,
national, or even international level.
Preserving Your Resources
One of the
advantages of external funding is it allows you to use internal financial
resources for other purposes. If you can find an investment that has a higher
interest rate than the bank loan your company just secured, it makes sense to
preserve your own resources and put your money into that investment, using the
external financing for business operations. You can also set aside your internal
financial resources for cash payments to vendors, which can help improve your
company's credit rating.
Working
capital is important, but a business should carefully consider the
disadvantages of external financing before it is undertaken.
Profit share
If the
business is making profits, a percentage of its profit has to be distributed to
shareholders and other firms where it has gotten finance from.
Loss of ownership
Some sources
of external financing, such as investors and shareholders, require you to give
up a portion of the ownership in your company in exchange for the funding. You
may get that large influx of cash you need to launch your new product, but part
of the financing agreement is the investor is allowed to vote on company
decisions. This can compromise the vision you originally had for your company
when you founded it.
Interest
The cost of
external financing is a major factor.
External
funding sources require a return on their investment. Banks will add interest
to a business loan, and investors will ask for a rate of return in the
investment agreement. Interest adds to the overall cost of the investment and
can make your external funding more of a financial burden than you had
originally planned.
Whether
you're starting a new business from scratch or operating a successful business
already, securing financing first requires you to think about the best method
to go about it.
The choice of
a source of finance depends on the following factors
·
Funding
availability: The first thing to do when choosing a method of financing your
business is to determine what your ranges of options are.
·
Personal
savings: When drawing on
personal savings for investment in a business, decide how much you can risk without
adversely affecting your personal circumstances.
·
Banks:
The factor to consider here is
whether you are willing to do the necessary work before you go ask for a loan.
·
Cash
needs: before thinking of getting loans you should have a good knowledge of how
much you need
I hope you find this booklet useful!
