While mismanagement is most often cited as the reason companies fail, inadequate or untimely funding is nonetheless one of the main reasons.
Whether you are starting a business or expanding one, having sufficient capital is essential. But it is not enough to have sufficient funding, it takes knowledge and planning to manage it well. These qualities ensure that entrepreneurs avoid common mistakes like securing the wrong type of financing, miscalculating the required amount, or underestimating the cost of borrowing money.
Before asking about financing, ask yourself the following:
Do you need more capital or can you better manage your existing cash flow?- 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 get the best terms when you anticipate your needs rather than looking for money under pressure.
- How big are your risks? All businesses carry risk, and the degree of risk will affect the cost and the financing alternatives available.
- In what stage of development is the business? Needs are most critical during the transition stages.
- For what purposes will the capital be used? Any lender will require capital to be requested for very specific needs.
- What is the state of your industry? Depressed, stable or growing conditions require different approaches to money needs and sources. Businesses that prosper while others are in decline will often receive better financing terms.
- Is your business seasonal or cyclical? Seasonal financing needs are generally short-term. Advanced loans for cyclical industries like construction are designed to support a business during depressed periods.
- How strong is your management team? Management is the most important element evaluated by money sources.
- Perhaps most importantly, how does your need for financing fit in with your business plan? If you don’t have a business plan, make writing one your first priority. All sources of capital will want to see your plan for starting and growing your business.
No All money is the same
There are two types of financing: financing through Actions and financing through debt. When looking for money, you need to consider the debt-to-equity ratio of your business – the ratio of the dollars you’ve borrowed to the dollars you’ve invested in your business. The more money the owners have invested in their business, the easier it is to attract financing.
If your business has a high equity-to-debt ratio, you should probably seek debt financing. However, if your business has a high debt-to-equity ratio, experts advise that you should increase your equity (equity investment) for additional funds. That way you won’t be overrated to the point of jeopardizing the survival of your business.
Equity financing and venture capital
Most small or growing businesses use limited equity financing. As with debt financing, the additional capital often comes from non-professional investors such as friends, relatives, employees, clients, or industry colleagues. However, the most common source of professional equity financing comes from venture capitalists. These are institutional risk takers and can be wealthy individuals, government-assisted sources, or major financial institutions.
Most specialize in one or a few closely related industries. California’s Silicon Valley high-tech industry is a well-known example of capitalist investment.
Venture capitalists are often viewed as large-cap financial gurus looking for startups to invest their money in, but in most cases prefer three- to five-year-old companies with the potential to become large regional or national companies. and return above-average profits to its shareholders. Venture capitalists may examine thousands of potential investments annually, but they only invest in a handful. The possibility of a public offering of shares is critical for venture capitalists. Quality management, a competitive or innovative advantage, and industry growth are also important concerns.
Different venture capitalists have different approaches to running the business in which they invest. They generally prefer to passively influence a business, but will react when it does not perform as expected and may insist on management or strategy changes. Giving up part of the decision making and profit potential are the main drawbacks of equity financing.
You can contact these investors directly, although they typically make their investments through referrals. The Small Business Administration (SBA) also licenses Small Business Investment Companies (SBICs) and Small Business Investment Companies (MSBIs), which offer equity financing. Apple Computer, Federal Express and Nike Shoes received financing from SBICs in critical stages of their growth.
Debt financing
There are many sources of debt financing: banks, savings and loans, commercial finance companies, and the SBA they are the most common. State 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 lower.
Traditionally, banks have been the main source of financing for small businesses. Its primary role has been as a short-term lender offering on-demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment. In general, banks have been reluctant to offer long-term loans to small businesses. The SBA’s guaranteed loan program encourages banks and non-bank lenders to make long-term loans to small businesses by reducing their risk and leveraging the funds available to them. SBA programs have been an integral part of the success stories of thousands of businesses nationwide.
In addition to equity considerations, lenders generally require the borrower’s personal guarantees in the event of default. This ensures that the borrower has a sufficient vested interest at stake to pay full attention to the business. For most borrowers this is a burden, but also a necessity.
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