21.10.2009 21:35:08

Investors Network Team

When recently sitting on a panel discussion on business finance for small business we were discussing the types of businesses and the sources of finance available to them?

There were a number of business angles on the panel as well as numerous venture capital firms represented. The discussion was initially about the types of businesses commonly found in the South African economy. Most small businesses are life-style firms.  They may be operated part-time or full-time, but will not, as a rule, exceed R1 million per year in sales. These businesses are entered into by entrepreneurs who are seeking to make a living or control their own destiny by operating a small company with a modest business plan.  Many of these firms are limited in their ability to grow by the market their products and services seek to satisfy.  A number of these life-style business owners often grow their firms to a certain size and choose not to expand any further, regardless of the potential.

Life-style businesses obtain financing from the founding owners.  Banks, government loan programs, and non-bank commercial finance institutions are potential sources of financing for these small businesses.  However, lifestyle firms will not usually seek or be capable of raising funds from equity sources such as private investors, venture capital firms, or the public markets.  Most life-style small businesses cannot produce the rates of return necessary to attract equity financing.  The possibility of investors owning a portion of the company often runs contrary to the very reason a life-style entrepreneur started the enterprise in the first place.

The second type of small business is a foundation firm.  Foundation firms will generally have sales ranging from R1 million to as high as R20 million and employment levels of 50 to 500 people.  Their basic limitation is the ultimate market potential.  Manufacturing, technology, and small businesses that can expand their business model geographically are examples of foundation firms.

Foundation firms also have access to debt lenders (i.e., banks, government loans, and non-bank commercial finance firms), tapping the variety of possibilities these institutions have developed to serve their needs.  Some foundation firms may also raise money from equity markets, particularly individual investors.  Individual investors that may invest in foundation firms include other entrepreneurs, wealthy individuals, suppliers, prospective additions to the management team, and other professional contacts.  However, foundation firms will not usually be capable of raising funds from venture capital firms, or Wall Street through a public offering.  In short, some foundation firms have the potential to pay an investor the necessary rate of return to attract their capital.

Finally, the fastest growing small businesses are called high-growth firms.  They have the management team, the potential market, and the willingness to grow a firm from 25% to 50% per year.  High growth firms can draw on the financial instruments of debt lenders.  However, the growth rate that indicates their potential may also prevent banks and other lenders from providing all of the funding this type of company will need.  The management team of the high potential firm may not only be able to seek financing from investors, venture capital firms, and initial public offerings, it will probably be absolutely essential.

These categories are not always static.  A foundation firm may come up with a new product that will allow it to become a high potential firm.  Many lifestyle firms may have substantially greater sales and profits if their owners are willing to expand beyond the initial comfort zone.  High growth companies sometimes go up in flames by growing to fast.  In any case, knowing the type of small business you want to operate will indicate the funding sources that can be approached during the existence of the enterprise.

The idea here is that the type of business finance you will both qualify for or would want to access will depend on the type of business you have in mind for your idea, your entrepreneurial skills and ability and the vision you may have for your business. Business finance is an issue crucial to many types of business and nine more so than high growth firms. The key is to have both eh necessary business finance and skills needed for the business t start and grow at the pace you may foresee.

business funding | business financing | business finance