Ravi Chandran
Most start-up funds come from an entrepreneur’s personal resources, such as savings or personal loans from banks. But there are other common sources of funding.
By: Phoenix Lee
One of the unique talents of entrepreneurs is finding the resources to launch a business and in looking for start-up funds.
Table of Contents
This requires understanding the differences between:
- short-term needs, those associated with activities not part of normal operations; and
- long-term capital needs, relating to preparation for future growth.
Most entrepreneurs get their businesses started by bootstrapping or by relying on funds from personal loans for start-up funds. Operating a business through bootstrapping or personal finance requires the business operation to be as frugal as possible and cutting all unnecessary expenses, accomplished by borrowing, leasing, and partnering to acquire resources. Bootstrapping involves hiring as few employees as possible, leasing anything you can and being creative.
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Bootstrapping entrepreneurs can also ask suppliers to allow for longer payments terms, ask customers to pay in advance, or sell their accounts receivable to a factor. Such entrepreneurs have to factor in an agent who handles an entrepreneur’s accounts receivable for a fee.
The main sources for start-up funds for entrepreneurs include friends, family and others who believe in the entrepreneur.
These resources come in several forms, such as savings, credit cards, personal loans, and investments. Some sources of financing for growing your business include banks, finance companies, investment companies and government grants.
Entrepreneurs may also seek sources of equity financing for start-up funds. To obtain equity capital as a source of funding for a business, the owner must give equity to obtain the financing. Equity is an ownership in a business and equity funding is sometimes called risk capital. Equity financing required risk capital to be raised. This refers to a situation where money invested in companies where there is financial risk.
Sources of equity funding includes an angel. An angel often invests because of his or her belief in a business concept and the founding team. An Angel is often a private, nonprofessional investor, such as a friend, a relative, or a business associate, who funds start-up companies.
An existing business can use venture capital financing to raise large amounts of money to achieve its goals. Venture capital is a source of equity financing for small businesses with exceptional growth potential and experienced senior management. Venture capitalists often provide managerial and technical expertise to small businesses. Venture capitalists are individual investors or investment firms that invest venture capital professionally.
Sources of debt capital are far more numerous than sources of equity capital, but the entrepreneur must be certain the business can generate enough cash flow to repay the loan. Debt capital is money raised by taking out loans, which must be repaid with interest.
Banks were once the primary source of operating capital, but today they are much more conservative in their lending practices. Operating capital refers to money a business uses to support its operations in the short term. An established business can usually get a line of credit from a bank, which it can borrow against. A line of credit refers to an arrangement whereby a lender agrees to lend up to a specific amount of money at a certain interest rate for a specific period of time.
Some businesses may seek trade credit from other companies in their industry as a form of debt financing.
Trade credit refers to credit one business grants to another business for the purchase of goods or services; a source of short-term.
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Financial planning involves finding the right kind of financial resources at the right time in the right amount.
Financial planning involves:
- Identifying the stages of growth in your business;
- Identifying milestones that require resources;
- Identifying business advisers; and
- Hiring an excellent management team.
To obtain financing, you must create pro forma financial statements to include in your business plan. Pro forma refers to proposed or estimated financial statements based on predictions of how the actual operations of the business will turn out.
Venture capitalists rarely invest in start-up companies, but when they do, they expect:
- A tenfold return on their investment in five to seven years (for start-up companies);
- A five- to seven-times return on their investment (for businesses in the growth stage); and
- A business with large market potential, growing at least 20% each year.
Private investors, or angels,on the other hand expect:
- businesses they understand;
- investing with like-minded investors;
- ten times their investment at the end of five years; and
- a strong management team.
Commercial lenders like banks who lend to businesses, rely on the five Cs to determine the acceptability of a business loan applicant. The 5-Cs being Capital, Capacity, Collateral, Character and Conditions.
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