What You Need to Know About Financing Your Business - Financing 101: An Introduction
At some point in the life of every business they need money to operate or grow their business. You only need to watch shows like ‘Dragons Den” or ‘Shark Tank’ to see what happens when a business is unprepared or hasn’t properly thought through what they need or even if equity is the best option for them. Your funding needs to be tailored to the type and nature of your business as well as your personal goals and objectives. Cost and availability of funds are other factors that will have an impact on your decision regarding the amount and type of financing you will pursue.
This is the first in a series of blogs “Financing 101” discussing the various forms of finance, the pros and cons of each, what different funders look for, and how to access them. This blog will look at some basic truths about financing that apply to all of the various forms.
The first truth is that it is always more difficult to find funding for a start-up than for an established business. This arises from the fact that all funders expect to get their money back, hopefully with a return on their investment. Their chances of doing this are greatly enhanced if the business has cashflow. Existing businesses have this while start-ups don’t. When looking for funding, the earlier in the life of your business, the more expensive it will probably be.
The second truth is that all funders would prefer that you have some “skin” in the game. After all, if you don’t believe in your business why should they. The amount of the investment you will require (the skin) depends upon how much you are looking for and the type of funding agency you are approaching. We will discuss this further in the upcoming blogs. If you are short of personal investment you can always use “love money” i.e. money from family and friends. However, if you do raise “love money” see if you can get it as a ‘gift’ rather than a loan. The rationale behind this is that if it is a gift, then it increases the equity you are contributing, however, if it shows as a loan then, when the funder is calculating how much to lend you they will treat this as an amount that has to be repaid rather than equity and deduct it from the amount that they are willing to consider lending you. This is not as critical if you are looking for investment, but we will discuss this too in a later blog. A cautionary note: while funding agencies appreciate the hours you put into your business when getting it up and running none of them will monetise this effort when considering your investment in the business.
The next truth is that you need to be prepared, preferably with a well thought out business plan containing financial projections showing what you need the money for and when it will be used. Your financial requirements should be split into your asset requirements and your operating requirements. If you are a start up, you need to build into your projections six months operating expenses. This is required as it normally takes at least that long to build sufficient clientele to meet your needs. Remember that the funding agency will test your financial forecasts for credibility; so, they should be realistic. There are a number of tests that you can use to prove these but that is a topic for another blog. Also remember that your forecasts should show your ability to repay the funding where this is required. Failure to demonstrate this will result in a quick no by the funder. Also, if you are forecasting fast growth for your company, you also need to indicate when and how much financing you will need in the future. The rationale for this is to make sure that you are being realistic about how much money will be required to support this growth. Oh, and one more point, when you are asked “how much money will you need”, never ever say “how much will you give me”. This is the most irritating response funders hear and almost invariably the answer is nothing.
Yet another truth is that funding agencies do not exist to altruistically assist you in making money. They are very successful businesses and entrepreneurs who let you use their money for a fee which will be based on the risk that they perceive they are taking. They may, like banks, take security to secure their loans or they may seek a higher rate of return to compensate them for the risk that they are taking. You have to weigh the amount you are being asked to pay against the benefit you will accrue from using their money.
Thinking about costs, it is amazing how often you see businesses haggling over interest rates even when the haggling may be over a half a percent and they will walk away because of the interest rate. Newsflash, unless you are borrowing many millions of dollars these small differences in interest rates even when they may be 1 or 2% make relatively little difference to most small and medium sized businesses. A more important question to be asking is how will the various funding models impact your cashflow. For instance, investment requires no repayment and as such does not negatively impact your cashflow. A bank loan that requires a significant down payment and a short repayment term may have a major impact on your cashflow. Since it is cashflow that will keep you in business this is what your major consideration should be, not interest rates. That’s not to say that interest rates are not important just that they should not be the only factor that you use when making your decision as to the financing source to use.
A major fallacy that arises in financing is that bringing in outside investment is low cost. In fact, it is the most expensive financing there is. The minute you bring in outside investment you are giving up a piece of the future of your business. How much you give up will depend upon the stage your business is at. The earlier the stage, the more you will have to give up. The more developed your business is, the less you will give up. The point you need to keep in mind is that, most small and medium sized businesses make the bulk of their money, not from the operations but from when the business is sold. When you bring in outside investors you could be giving up a significant portion of this money.
Some final thoughts:
Always allocate your funding to the operating costs particularly if you are a start up. As these items can not be taken as security they are very, very difficult to finance unless you are seeking investment monies. Always approach the funding agencies for the physical assets that you require. There are many more options for this type of financing since the assets can be given as security.
Also, if you are seeking funding, do your homework and choose the best source for your particular needs that offers you the best shot of getting the yes you want the first time. The danger of you applying to too many sources at once is that each source you apply to will probably request a credit check on you. If there are multiple credit checks on you requested in a short space of time the credit agency will label you as a credit seeker and this usually results in the funding agency saying no because credit seekers are considered to be high risk. If you do get a no, always ask what you could do to get to yes. Take that learning and apply it to the next presentation you make to a funding agency.
In the next blog in this series we will look at Chartered Banks, their pros and cons and how to approach them. In the meantime, if you have any questions you can contact us at firstname.lastname@example.org