For many entrepreneurs, the availability of business finance plays an important role when coming up with new business ideas. Is your idea fundable? Will you be able to find a venture capital firm, business angel, bank or crowdfunding platform to support the business plan financially. This may not be the very first thing you think of, yet in the end it may be one of the telling factors when choosing to move forward with a specific business venture.
Before looking for business finance, you may want to consider the following. Using the latest in business plan software will help you to do manage a number of these processes automatically:
Do you need more capital or can you manage existing cash flow more effectively?
How do you define your need? Do you need money to expand or as a cushion against risk?
How urgent is your need? You can obtain the best terms when you anticipate your needs rather than looking for money under pressure.
How great are your risks? All businesses carry risks, and the degree of risk will affect cost and available financing alternatives.
In what state of development is the business? Needs are most critical during transitional stages.
For what purposes will the capital be used? Any lender will require that capital be requested for very specific needs.
What is the state of your industry? Depressed, stable, or growth conditions require different approaches to money needs and sources. Businesses that prosper while others are in decline will often receive better funding terms.
Is your business seasonal or cyclical? Seasonal needs for financing generally are short term. Loans advanced for cyclical industries such as construction are designed to support a business through depressed periods.
How strong is your management team? Management is the most important element assessed by money sources.
Perhaps most importantly, how does your need for financing mesh with your business plan? If you don’t have a business plan, make writing one your first priority. All capital sources will want to see your business plan for the start-up and growth of your business.
Not All Money Is the Same
There are two types of financing: equity and debt financing. When looking for money, you must consider your company’s debt-to-equity ratio – the relation between dollars you’ve borrowed and dollars you’ve invested in your business. The more money owners have invested in their business, the easier it is to attract financing.
If your firm has a high ratio of equity to debt, you should probably seek debt financing. However, if your company has a high proportion of debt to equity, experts advise that you should increase your ownership capital (equity investment) for additional funds. That way you won’t be over-leveraged to the point of jeopardizing your company’s survival.
Most small or growth-stage businesses use limited equity financing. As with debt financing, additional equity often comes from non-professional investors such as friends, relatives, employees, customers, or industry colleagues. However, the most common source of professional equity funding comes from business angels. These are institutional risk takers and may be groups of wealthy individuals, government-assisted sources, or major financial institutions. Most specialize in one or a few closely related industries. The high-tech industry of California’s Silicon Valley is a well-known example of capitalist investing.
Venture capitalists are often seen as deep-pocketed financial gurus looking for start-ups in which to invest their money, but they most often prefer three-to-five-year old companies with the potential to become major regional or national concerns and return higher-than-average profits to their shareholders. Venture capitalists may scrutinize thousands of potential investments annually, but only invest in a handful. The possibility of a public stock offering is critical to venture capitalists. Quality management, a competitive or innovative advantage, and industry growth are also major concerns.
Different venture capitalists have different approaches to management of the business in which they invest. They generally prefer to influence a business passively, but will react when a business does not perform as expected and may insist on changes in management or strategy. Relinquishing some of the decision-making and some of the potential for profits are the main disadvantages of equity financing.
There are many sources for debt financing: banks, savings and loans, commercial finance companies, and the Industrial Development Corporation (IDC) are the most common. National and local governments have developed many programs in recent years to encourage the growth of small businesses in recognition of their positive effects on the economy. Family members, friends, and former associates are all potential sources, especially when capital requirements are smaller.
Traditionally, banks have been the major source of small business funding. Their principal role has been as a short-term lender offering demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment. Banks generally have been reluctant to offer long-term loans to small firms. The IDC guaranteed lending program encourages banks and non-bank lenders to make long-term loans to small firms by reducing their risk and leveraging the funds they have available. The IDC’s programs have been an integral part of the success stories of thousands of firms nationally.
In addition to equity considerations, lenders commonly require the borrower’s personal guarantees in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business. For most borrowers this is a burden, but also a necessity.
Remember that once you have your business plan developed and you are looking for business finance that you need to choose carefully. Do your due diligence and ensure that you can work with the finance provider especially where the relationship may be a in the form of venture capital or angel funding and you will need to work closely with the person or firm in question.