Funding Your Business
Every business needs funding—money other than what it gets from customers. This money may be used to start the business, expand the business, or to smooth out temporary shortfalls. Funding comes from two sources: loans or investments. These two types of funding are known as debt and equity.
Debt or Equity: The Fundamental Consideration
Should you borrow money for your business or seek investors? And what should you consider before seeking funds from anyone? In general—whether you seek investors or lenders—you need to determine whether the money is needed for a temporary problem or a fundamental problem. Often, temporary problems can be resolved with a simple funding solution such as a merchant card account. But a fundamental problem—for example, lack of sales, too high cost of sales, too high administrative costs, too much inventory, too much accounts receivable—usually will not be cured by borrowing money. In that case you need to address the fundamental problem and it's not a wise idea to borrow until you have done that.
Your first consideration for funding is whether you want to seek a loan or an investment. The advantage of a loan (debt) is that you are not giving up any ownership in your enterprise, and the lender has no management say or direct entitlement to profits in your business. Your only obligation to the lender is to repay the loan on time and you can deduct the interest payments at tax time. The disadvantage of a loan is the debt—the looming monthly payments and the potential for personal liability (if you guaranteed the loan), loss of property (if you secured the loan), or a lawsuit if you default on the loan payments.
The advantage of an investment (equity) is that you will not have to repay investors if your business goes under, and your personal property is unlikely to be at risk. The disadvantage is that you get a smaller piece of the pie because you are giving up a share of the business. And if an investor seeks to control your business, it may be more of a nuisance than a help.
Sometimes, your funding choices are made for you. For example, if you don't qualify or have enough resources to get a loan, then you need to find investors. The most common sequence for finding investment? (1) Look to your own resources, (2) look to family, and (3) look to friends. After exhausting those, look to an interested outsider.
- Personal investment
Ideally you should be the first investor in your business either with your own cash or with collateral on your assets if you have any assets. This is an important sign of your commitment to the venture for any other future investors or bankers.
- Patient Capital-Look to Family and Friends
Often referred to as ‘love money’ because it is money loaned by a spouse, parents, family or friends. Some key considerations you should be aware of when borrowing ‘love money’ include:
- Family and friends are likely to have limited capital
- Family and friends may want to have equity in your business
- Business relationships with family or friends come with various challenges and complexities
- Angel Investors
Although not yet very visible in Zimbabwe, angel investors are made up of high net worth y individuals or retired company executives who invest directly in small firms owned by others. More often they are leaders in their own field. Thus they can bring their experience and network of contacts and also their technical and/or management knowledge to the Enterprise.
- Venture Capital
Venture Capital is a growing source of capital for Enterprises but is not suitable for all Enterprises. It could better work for technology-driven businesses and companies with high-growth potential in sectors with distinct blue spaces. In return for capital investment, venture capitalists acquire equity in the business. In Zimbabwe’s context this could be in mining and information technology related sectors.
- Government Grants-Leads
The Government of Zimbabwe has a stated commitment to the promotion of Enterprises. Hence, there are potential leads for funding from government related entities such as the recently formed Women’s Empowerment and Youth Bank Initiatives. Some opportunities may also emerge from multilateral initiatives which the government engages in with institutions such as the World Bank.
- Bank Loan
Banks are a commonly used source of funding for Enterprises. One has to shop around and consider the various banks and their products in order to find the bank that meets your specific needs.
Increased access to technology and the internet in particular has opened up opportunities for Enterprises to use crowd funding to raise capital. This involves using specialist crowd funding platforms to raise capital from external sources. Key considerations when crowd-funding include the need to set realistic funding goals which make your project appear attainable and realistic. Demonstrate that you know your business, and be transparent about your budget. Note that most platforms will also take a cut of the funds you raise and you can crowd-fund for a specific component of your venture.
Maximising Your Chances Of Getting A Bank Loan
What Bankers Want to Know?
Don't be misled by the conventional wisdom that you always need to provide a business plan to get a loan. When evaluating loans, usually bankers want the answers to five questions: (1) How much money do you want? (2) What is the money being used for? (3) How will you collateralize the loan? (4) When are you going to pay me back? And (5) how are you going to pay me back? Most borrowers will be able to tell you the answers to these questions in a conversation and if they can't … that's a red flag.
The other key element in getting a bank loan is understanding collateral. Collateral refers to the assets that you pledge for the repayment of a loan. These assets can be your business's accounts receivable, inventory, or business equipment and they are used to secure the loan (versus an “unsecured” loan which has no collateral). In the event you default on the loan, the lender can acquire and sell the collateral. If a business does not have any assets worth securing, a lender will look to personal assets—for example, stocks or bonds—or some other form of personal guarantee. A personal guarantee means that the borrower guarantees repayment from personal assets, rather than from business assets.
Avoid having your spouse sign a guarantee unless he or she is active in the business.
Getting ready to seek a loan? Consider the following issues before handing in your application:
- Be prepared to provide collateral or a personal guarantee. Expect a request for either or both, especially if you're a first-time borrower. If you sign a guarantee, try and limit it to a one year guarantee that can be renewed if necessary. Avoid having your spouse sign a guarantee unless he or she is active in the business. If you have friends or relatives who are willing to guarantee your business loan but they're not willing to guarantee the whole loan, it could be because the guarantee requires them to be ‘jointly and severally' liable, meaning they must pay the entire loan if there is a default. To avoid this result and to encourage multiple guarantors, a guarantor can simply provide collateral for the portion of the loan they are guaranteeing. So if there are three guarantors, each may guarantee only one-third of the loan.
- Ask for enough.
One of the most common errors people make when borrowing is that they underestimate the situation and they borrow less money than they should. Once upon a time, there was a company who was making wooden furniture and doing a great job. They borrowed money from a bank and unfortunately they borrowed less money than necessary. When they went back to borrow more money, they found it was now more difficult because the bank was suspicious. Why hadn't they anticipated the right amount in the first place? And that made borrowing more difficult. By borrowing less than you need you haven't really solved the problem.
- Establish your company's creditworthiness. Here's one tip for building your company's creditworthiness: Don't use a personal credit card for business purposes. That's the single rule that's violated most often. Most people have personal credit and they figure, well, we've got this card so why not use that to buy for the company. The problem is that it doesn't do a thing to help your business credit.
- Know your credit history. Do you have a checkered personal credit history? How long has your business operated? (Businesses under two years old tend to be viewed critically.). Do you know your credit score? You can't fix it if you don't know what it is.
- Make sure your financials match up. Don't provide financial reports that were printed at 3 a.m. the night before your meeting. Proof and review any financial documents used for a loan application with an accountant or financial advisor.