- Personal Funds
- Friends/ Relatives
- Angels/Private Investors
- Venture Capitals
Arranging for your financing
Arranging for financing a new business is no easy task. New businesses do not have sales or a 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’ll 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.
NB: More than 80% of new business start-ups are financed through the entrepreneur’s own savings.
Sources of funds
The primary sources of funds for small business start-ups are personal funds, friends and relatives, angels 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 yourself. 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 saving account or other investments, tapping into a life insurance policy, selling some real estate or postponing some other expenditures.
Once you’ve assessed your own saving and found that there is still a shortfall, it may be time to look to raising money from friends and relatives. This is 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 if capital is that it can create a considerable strain on relationships if your business does not work out. It is therefore important that you treat their investment as the same as you would be 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 your business this type of financing may be sufficient to supplement your own funds.
Angel/ Private Investors
Private investors often known as “angels” are becoming more and more active in early stage of financing. Angels are normally high net worth individuals including successful entrepreneurs, senior executives, and professionals. They represent the single largest source of external start-up capitals for entrepreneurs. In addition to providing capital, private investors can also provide experience and managerial expertise, factors critical to the growth and success of young, fledging companies. They represent a critical component of the private equity capital markets.
Finding private investors is not a simple task. They are mainly private individuals who usually keep their investment activities confidential and prefer to learn about investment opportunities from respected sources. The investment process can be quite lengthy and can range anywhere from a few weeks to several months. Private investors can be found through professionals such as accountants, lawyers, and investment advisors since they typically have clients who may be active private investors.
Private investors can provide capital of anywhere between $10,000 to $500,000. The vast majority have preference to co-invest with other investors. This investment most often takes the form of equity in a business, mainly to compensate for the lack of securable assets and the high degree of risk involved. Due to the risk, investors who make direct investment in private companies normally seek returns higher than other more conventional investment. Hence business opportunities suitable for this type of investment are those which demonstrate high growth potential.
Before embarking on the search for “angel” financing, entrepreneurs must have a good understanding of the characteristics of this type of investor and be thoroughly prepared. Bad first impressions are often the last. To help entrepreneurs better understand the specific characteristics, investment preferences and expectations of private investors, this subject is addressed in greater detail at the end of this section.
Banks are one of the most widely used external sources for funding new business. The primary consideration for banks in assessing a loan application is their confidence in the person’s ability to pay back the loan. This confidence is a function of a number of factors: 1) the person’s previous track record an credit history, 2) adequate cash flow in the business to meet the payment schedule 3) sufficient equity or assets. Banks do not tale large risks. They have a responsibility to ensure the safety of their depositor’s money and obtain a reasonable return. Unfortunately 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”. Informed entrepreneurs go to the bank with all the information the banker may need at their fingertips including their financial history, business plan and resume.
If you qualify, the types of financing you can get from your bank include:
Short-term loan-Usually repaid within 30 to 180 days, short-term loans are used to purchase extraordinary inventory, finance cash flow shortage, and access supplier discount for early payment. Some form of personal guarantee, outside security or company asset is usually required to secure these loans.
Operating loans- Banks will usually lend about 65 to 80% of the value of approved receivables and maximum 50% in inventory in a short-term basis. Not all receivable qualify; it is usually targeted to those that are considered good credit risk and are no more than 90 days old while only raw materials an finished products (readily saleable) inventory are acceptable. It is usually based on a line of credit allowing you to access money up to a pre-established limit and repay the money with interest. It can be compared to a preauthorized loan. Small lines of credit are issued on an unsecured basis depending on the entrepreneur’s financial statements and track record.
Fixed asset loans- these are usually long term loans provided for a year or more to cover the costs of fixed assets such as machine/ equipment, vehicles, commercial buildings, and real estate. They are normally term loans linked to the lifespan of the asset. These loans usually cover about 60 to 80 percent of the cost of equipment and about 75% of the market value of property.