Borrowing from friends and relatives, and advance payments from customers are other possible sources. Not all of these finance sources might be appropriate or available in all cases. For example, venture funding might be available only for innovative businesses that can achieve market leadership with their offerings, and command premium prices and profits. And new small businesses might find financing a difficult proposal unless they have some solid collateral security to offer.
Small Business Funding Problems
Startup funding and loans is usually difficult to find because new businesses do not have a track record of past successful operations that can provide confidence among prospective investors and lenders. The main sources of finance for small business will typically be owner’s capital and the money that the owner can raise from friends and relatives.
Large businesses are obliged by law to publish a lot of financial information, audited by independent auditors, and investors and lenders will feel greater confidence in these cases. While small businesses are freed of the bother of such disclosure requirements, the non-disclosure itself stands in the way of easier funding.
Banks consider small and medium enterprises a greater risk not only on the above grounds. Unlike large companies with substantial budgets, SMEs cannot usually afford to hire highly paid talent in such key result areas as marketing.
Only those small businesses that can offer collateral security such as owner’s residence or business premises will usually be able to raise bank loans with comparative ease. If their business plan is approved, government small business support agencies might also provide loan guarantees or even outright loans.
Raising Small Business Capital
Small businesses have to be ready with convincing details such as:
- A complete business plan that describes how they will handle the different aspects such as marketing, technology, staffing and profitability
- Resumes of their directors and managers showing that these key persons have relevant experience and records of success
- List of tangible assets that shows the firm will have the facilities needed to run the business and also offer some kind of security for the loans
- Other information such as the unique prospects of the business owing to an innovative product or business model
The very exercise of providing realistic and detailed information is likely to create a good impression in the minds of prospective investors and lenders. The qualification “realistic” is the key issue here. Unless the assumptions, computations and projections appear convincing to the audience, they are unlikely to accept it. And conviction can be generated best if the planner has done the homework to gather relevant facts on the ground and can answer any questions about the realistic nature of the plans.
Financing a Business
A brief look at the different sources of funding businesses can help the entrepreneur generate ideas for financing his or her small business.
- Own Savings: Any money that the entrepreneur might have accumulated is the primary source of funding business projects
- Borrowing from Relatives and Friends: Relatives and friends who wish the person well and also have confidence in the person’s ability to run a business might be willing to help
- Partnerships: The entrepreneur can associate a partner who might be able to invest funds or bring in expertise that makes obtaining finance from other sources easier
- Leasing and Hire Purchase: Where the business needs a lot of tangible facilities such as premises, equipment or vehicles, the option of obtaining these on lease or hire purchase can be considered
- Trade Credit: Raw materials and other supplies can be bought on credit, and it might even be possible to convert them into cash (or discountable invoices) by the time payment is due to suppliers
- Factoring and Invoice Discounting: There are specialist financiers who buy or discount invoices drawn on creditworthy customers of the business
- Angel Investors: Angel investors are rich individuals who might be interested in funding new entrepreneurs to earn a higher return on their money and/or because they feel good helping new entrepreneurs
- Venture Capital Companies: These are similar to angel investors except in that they are more professional and business like, and are not likely to be motivated by sentiments like helping newcomers
- Bank Loans: Bank loans can be fixed amount loans lent for the short or long term, or an overdraft facility under which the borrower can draw funds as needed and also deposit funds coming in to reduce outstanding (and interest bearing) borrowings
- Government Loans and Grants: Governments might seek to encourage development of backward regions or disaster-struck areas by extending business loans or grants to businesses coming to these regions and areas
- Internal Generation of Funds: Successful businesses will typically be generating profits and if these are not fully paid out as dividends, will be available for operating and expansion needs
- Equity Issue: Once a business has grown to a certain size, it might be practicable to go to the securities market and issue equity shares (or even interest-bearing bonds that do not dilute ownership)
- Sale of Surplus Assets: Where a business has idle or insufficiently productive assets, it can consider selling these to raise funds for expansion or promising new projects
Business funding sources are varied, ranging from owner’s savings through private business investors and banks to trade credit and invoice factoring. Entrepreneurs who take the trouble to prepare a detailed and realistic business proposal can usually find needed business finance.