Most small firms will never be able to raise all the finance of their total funding demand from banks and other traditional lending institutions.
By: Phoenix Lee/
In this sense there will always be a deficiency in the funding of the sector equal to the difference between the total funding demand and that part of this demand which qualifies for funding support. Small businesses may especially have a larger total funding demand, and be particularly vulnerable to a credit crunch.
This is because small companies do not have access to the capital markets. Thus, their sources of external financing are much more limited than large corporations. If these sources shrink, small businesses pool for total funding demand may be adversely affected.
Not surprisingly, the largest source of external finance for total funding demand of small businesses is commercial banks. However, small business finance is more complicated than this for two reasons. First, there are many different types of financing—even different types of bank financing. These are sometimes referred to as lending technologies. Second, there are other sources of financing in addition to banks.
Banks are not the sole source of small-business financing. On average, small businesses obtain about half of their total funding demand met internally and about half externally.
The amount you will need to finance your startup should never be an estimate. This means you should determine the loan amount by drawing up detailed projected financial statements.
Most banks do not provide all the funds required for start-up finance, but you should carefully consider the various other sources of your total funding demand, as some are better than others due to the interest rates, risk and potential problems you may run into.
You should approach your search for financing in this order:
- Own cash/funding – always best, and the and most readily available.
- Loan from a bank – will require a business plan, and possibly a personal cash contribution.
- Business partner – might require you to relinquish shareholding.
- Venture capitalists – expect to pay a higher interest rate or sacrifice a high percentage of shareholding.
- Loan from 3rd party (individual, family). Your last resort and one not to be taken lightly as this could sour relationships forever.
Some non-bank financial institutions provide funding solutions to businesses of all types and sizes regardless of credit rating. They believe in working with their clients directly to offer tailored financing to help them reach their goals quickly and efficiently. Whether you need extra working capital, financing for large-scale growth and construction, equipment, or anything in between, they can sometimes structure a customized funding strategy without the red tape and prohibitive requirements associated with traditional lending channels.
Licensed moneylenders for example, offer a wide range of different kinds of financing so you can always choose one that suits your exact needs. Plus, can also work alongside you to help you understand which option is best.
Regardless of the capital you seek, you must start by building a foundation for your business. As a general rule, you need to separate your personal and business activities as much as possible.
The most important lesson you can get is that all money is not created equal. As you look at sources of capital for your business you need to consider the following:
- Debt vs. equity. Any capital that you receive is either going to be debt or equity. Equity requires the surrendering of ownership. You need to be clear on what type of money you are obtaining. For the most part, banks and businesses deal with debt, and investors deal with equity. Equity gives the investor a percentage of future profits. So while it may feel like free money, this is the most expensive capital you can get for your business (if you are successful!).
- Control. Does the money reduce your control? Bringing on investors or partners will lessen your control. A lender may request financial oversight or independent audits. You need to be aware of what you are giving up.
- Security. How is the lender or investor securing the money? Are you personally guaranteeing it? Is there a blanket lien on your assets? If you default, who will they go after for repayment?
- Transferability. Can you transfer the capital to the next business owner? In other words, is the capital for you or is it for the business? It won’t do you much good to sell a business if all the working capital is still tied to you.
- Ease of attainment. How easy is it to get? And how much time will you need to invest in order to secure the capital that you need? Team. Are you adding players to your team that are invested in your success? Sometimes bringing on investors and surrendering control is exactly what you need to do.
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