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It takes money to make money.
Whether you’re looking to build a multimillion-dollar business or to follow your calling to invent the future, apart from a tenacious spirit, you’d also be needing the necessary capital infusion to help materialize that aspiration. And it is not just new businesses that seek financing, even a company with a balance sheet as intriguing as that of Apple, needs access to capital through business financing to meet their obligations.
In any economic system, Business financing plays a pivotal role as it allows companies to purchase products out of their immediate reach. It works on the principle of – let the dollar work for you, allowing individuals with surplus of money to meet the demands of capital seekers with the hope of generating returns.
Before we enumerate the 7 Sources of Finance For Your Business in 2020, it is important for you to ingratiate yourself with two very common types of financing available for business: Debt and Equity. Basically, debt is a loan that must be paid back often with interest, but it is typically cheaper than raising capital because of tax deduction considerations on the other hand equity does not need to be paid back, but it relinquishes ownership stakes to the shareholder.
Now that we have a common understanding about the two basic sources of business finance, let’s delve deeper into the list of 7 Sources of Business Financing.
Have you ever noticed a piece of leather at the back of your boot that helps you to put the boot on, that is what actually a bootstrap is. The very famous phrase on self-reliance is also derived from it, “Pull yourself up by your bootstraps” which means to succeed or elevate yourself without any outside help. In terms of business finance, it follows the same ideology, using your own money to get your business off the ground. Bootstrapping is a type of internal funding which relies on one’s ability to utilize their company’s resources to free additional capital to launch a venture, meet operational needs or expand the business. There are many e entrepreneurs who bootstrapped their way to success by doing one or more of the following:
- Owner Financing: The use of personal income and savings.
- Personal Debt: Usually incurring personal credit card debt.
- Sweat Equity: A party’s contribution to the company in the form of effort.
- Operating Costs: Keep costs as low as possible.
- Inventory Minimization: Requires a fast turnaround of inventory.
- Subsidy Finance: Government cash payments or tax reductions.
- Selling: Cash to run the business comes from sales.
Governments and other institution often have ﬁnancial assistance in the form of grants and/or tax credits for start-up or expanding businesses. Usually you don’t have to pay back a grant but an institution does not provide you a grant unless your business is in a specific industry or serves a targeted cause. Also some grants have waiting period known as lock-up or vesting periods, before the grantee can take full ownership of the financial reward. Although effectively it is a gift, it is not simply bestowed upon a business.
A business has to apply for a grant by crafting a convincing proposal which can be an excruciatingly competitive process. There is a huge amount of initial and ongoing documentation required with a grant application, including reporting on your progress. Small Business Administration is an example of an autonomous US government agency that promote small businesses. There are many Small Business Innovation Research grants which let you bank on your intellect.
As the name suggest, the “crowd” finances the funding need of a company. A campaign where a large number of people come forward to finance a business. This approach leverage on the vast network of people and crowdfunding websites to bring investors and entrepreneurs together. It can be further broken down into four sub types:
- Debt Based: Any crowd funding campaign in which individuals lend money to businesses or other individuals with the expectation of being repaid together with interest added. It encompasses mini-bonds, peer-to-peer lending (P2P lending), invoice financing and other crowd based lending. Eg: FundedHere, CROWDO.
- Equity Based: An equity-based crowdfunding allows contributors to become part-owners of your company by trading capital for equity shares. As equity owners, your contributors receive a financial return on their investment and ultimately receive a share of the profits in the form of a dividend or distribution. Eg: SEEDRS, CAPBRIDGE, AngelList
- Reward Based: Any crowd funding campaign in which individuals contributing to your business get a “reward,” typically a form of the product or service your company offers. Kickstarter is one of the famous platform that offers tangible rewards or experiences to its backers in exchange for their pledges. Eg: Kickstarter, Indiegogo, Ulule.
- Donation Based: Any crowd funding campaign in which there is no financial return to the investors or contributors as donation-based crowd funding. These types funding forms the sources of finance for disaster relief, charities, nonprofits, and medical bills. Eg: Friendfund, YOUCARING, patreon.
It could be difficult to get expensive fixed assets financed for an unproven business. In such cases, entrepreneurs often resort to smart leasing which involves leasing assets like machineries and other equipment that allow companies to spread payments over a longer period of time instead of having to fulfill the full payment of an investment upon the moment they decide to purchase an asset. Most equipment leases are structured so that the finance company buys the equipment and rents it to you for a monthly payment. The cost of a lease may be slightly higher than bank financing but the cost of the down payment you did not have to make is likely to be less painful than the dilution you suffer from giving away equity.
5. Venture Capital
Venture capital (VC) is a type of private equity which focuses specifically on risky investments in terms of early stage companies and are not publicly listed. Unlike Private Equity, Venture capital invest in growth capital of young companies.
This source of finance is suitable for companies that have already passed the “seed stage” and are looking for series A or series B funding. Venture capitalists do not normally fund startups from the onset. It is therefore meant to help companies grow faster than when they would grow organically, for instance if a firm wants to internationalize.
The mavens at Accel Partners investing in Flipkart, Sequoia’s stake in Pine Labs, Lightspeed Venture Partners’ stake in Oyo are some of the famous examples of VC investment. But a word of caution: Consider venture financing only if you have an innovative concept with high margins that can scale quickly. Getting this type of funding is notoriously difficult. As a matter of fact, many entrepreneurs spend weeks or months creating presentations and pitching to venture capitalists and end up with nothing to show for their efforts.
6. Angel Investors
High net worth individuals acting as sources of finance for small startups or entrepreneurs, typically in exchange for ownership equity in the company are called Angel Investor or Private Investor. As they generally provide initial funding to an innovative idea, they are also called Seed Investors. Angels typically offer an additional benefit known as smart capita.
Apart from financing a project they also provide network and knowledge within the specific sector of that project. Therefore having an angel that fits with your company in terms of experience and sector knowledge, imparts additional benefit to your business. There are several prominent projects proliferating in the market owing to the wits and wherewithal of their respective angels. Ola cabs, Fab hotels, Fab Alley, Zoomcar, Zimmber etc.
Factoring is a method to finance the working capital by lowering the size of accounts receivable.
Example: Most small businesses encounter financial problems because their commercial clients ask for payment terms. As a small business, you have to give them 30 to 60 days to pay an invoice. Otherwise, you could lose the client. The problem is that most small businesses cannot afford to wait up to eight weeks to get paid. If an invoice is sent to a customer, but it takes him/her 60 days to pay, then you can decide to ‘sell’ this invoice to a factoring company (against a certain payment of course). The company factoring will pay for the invoice immediately (or provides you with a loan) so that you do not have to wait 60 days before the invoice is paid. Such a company can also take over the risk that a customer does not pay.
It provides you immediate working capital which you can use to operate the business and get new clients. This is a great option for small scale businesses with a huge base of clients. And it goes without saying if you do not have any paying customers, factoring is not a source of working capital for you.
Hope these 7 sources or options for business financing provided an overview to you!
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