2. FINANCING A START-UP
Every start-up needs capital
Start-up finance is the initial infusion of money needed to turn the idea into something
tangible
Financial needs of a business vary according to the type and size of the business, for example:
A processing business will usually be capital intensive and requires large capital. A Retail
business on the other hand usually requires less capital.
So, raising finance for a start-up requires careful planning. The entrepreneur needs to decide:
i. How much finance is required ?
ii. When and how long the finance is needed for?
iii. What security can be provided ?
iv. Whether he or she is ready to give up some control (ownership) of the start-up in return
for investment.
3. When starting out, you are not t the point yet where a traditional lender or investor would be
interested in you, so it leaves you with very little option for sources of finance.
Some sources are short term and must be paid within a year, other sources are of finance are
long term and can be paid back over many years.
One way of categorizing the sources of finance for a start-up is to divide them into 2, internal
sources which from within the business and external factors which are from outside providers.
These internal and external sources are then further more categorized into 2 sectors which are
Debt Financing and Equity Financing.
Debt financing involves a payback of the funds plus a fee which is the interest of using the
money and Equity financing involves the sale or exchange of the ownership interest in the
venture in return for an investment in the firm
4. INTERNAL SOURCES OF FINANCING A
START-UP
1. Personal Sources – these are the most important sources of finance for a start-up. They
can be personal savings or other cash balances that have been accumulated. It can be
personal debt facilities or retirement funds. This is a cheap form of finance and it is readily
available. Investing in personal savings maximizes the control the entrepreneur keeps over
the business. It has no interest rate charged or a fixed payback period but the money
saved is usually limited and it might encourage more drawings for the entrepreneur.
5. 2. Personal credit lines or Credit cards – the use of credit card is the most
common source of finance amongst small businesses. Each month the
entrepreneur pays for various business-related expenses on a credit card. The
balance is paid by the business within the credit-free period and the effect of this, is
that the business gets access to a free credit period of around 30-45 days. The
drawback that comes with this source of finance is that interests are related to delay
in repayments and if business isn’t profitable or making enough to payback it could be
difficult to recover.
3. Share capital (invested by the founder) – founding entrepreneur may
decide to invest in the share capital of a company, founded for the purpose of
financing a start-up. The founder provides all the share capital of the company,
retaining 100% control over the business. The entrepreneur may be using a variety
of personal sources to invest in the shares and once investment is made, it is the
company that owns the money provided.
6. EXTERNAL SOURCES OF FINANCING A
START-UP
1. An overdraft facility – Bank Overdraft. This is whereby a bank allows the entrepreneur
to take out more money than he or she has in their bank account. This has an advantage
of low interest rates and cash can be obtained quickly although it has a short payback
period and increases liabilities.
2. Trade credits or Vendor Financing – this is whereby suppliers deliver goods now and
are willing to wait for a number of days before payment.
3. Loan capital – can be either a bank loan or a micro-loan. A micro-loan is a small loan
that can be up to $10,000 and have a low interest rate and is a short-term source of
finance. A bank loan on the other hand provides a longer-term of finance for a start up,
and the bank usually requires some security provided by the entrepreneur .
7. 4. Business angels – these are professional investors who typically invest in businesses with
high growth prospects. In additional to that angels often make their own skills, experience
and contacts available to the company but the entrepreneur has to be ready to accept the loss
of control over the business.
5. Borrowing from family and friends – family and friends who are supportive of the
business idea provide money either directly to the entrepreneur or into the business. This
can be cheaper and quicker to arrange (compared with a standard bank loan) and interest and
repayment terms may be more flexible than a bank loan.
6. Grants – these can be from the government or charities to help the business get
started.
8. 7. Hire purchase – this is where monthly payments are made for use of equipment
such as a car. Hired equipment is owned by the firm after final equipment
8. Lease – this is a method of obtaining the use of assets for the business without
using debt or equity financing. It is a legal agreement between 2 parties that specific
terms and conditions for rental use of a tangible resource such as a building and
equipment. Unlike like hire purchasing, lease equipment is rented and not owned
by the firm.
9. Once you get over the initial hump of starting up a business, it is possible to seek out
funding sources available to more advanced companies and here are some of them.
10. SOURCES OF FINANCE FOR AN EXISTING
BUSINESS (INTERNAL AND EXTERNAL)
1. Debt Factoring – this is when the business sells it debts to a debt factor. It helps
to cover debts within a short period of time and also minimizes bad debts for
the business. It gives access to instant cash although the business’s debts are
always sold at a discount, hence the full amount may not be recovered and the
debt balance will not b adequate to cover up the required amount of finance.
2. Venture capital – this is financing that comes from companies or individuals in
the business of investing in young businesses for an exchange for ownership
share of the business.
11. 3. Debentures – this is a loan certificate issued by a company with a fixed rate of
interest and is secured against assets. It has a long pay back period and issuer of
debenture has no interference in decision making.
4. Mortgage – this is a loan obtained through the conveyance of property as security.
It is usually acquired for when the entrepreneur is looking at buying property.
5. Retained Profits - this is the portion of net income of a business that is plowed back
and not paid out as dividends but reinvested in the business it has no interest
rates to it but at times it could not be readily available to use due to credit sales.