Need Money for Your Business: 5 Things to Think About Before You Decide on Who You Should Approach
You will often hear this adage: Don’t use your own money, use other peoples. Is this good or bad advice? We have been trained by the media and TV shows, like Dragons Den, to think that venture capital is the way to go. However, even on Dragons Den, the Dragons will often offer to loan the people the money rather than invest in the company. Ever stopped to think why they do this? The answer is it depends, but on what? Let’s look at 5 things you should consider when borrowing money before deciding on what source you should use.
1. What do you want to borrow the money for?
The question here is, do you want to borrow money for working capital or assets? If your goal is to borrow money for working capital, then this is money that will be used for every day activities, such as covering inventory purchases, advertising, payroll, etc. You do not want to be paying this back over a long period of time long after the money has been spent. Remember this need may arise because you clients are paying you in 30 plus days or you have to buy inventory in advance of sales. Common ways of providing money for these types of purposes are investing your own money and/or chartered banks through lines of credit. If your business is less than 2 years old, the banks may not be willing to consider a loan, as there is no track record to show your ability to pay back the loan. You may have to think about factoring your receivables; factoring is when you sell your receivables at a discount to a factoring company. You may not realise it, but credit cards are a form of factoring.
If you are looking at asset financing then you want to match the term of your asset financing to the life of the asset you are buying. You do not want to be paying for the asset once it is obsolete. Providers of this type of financing are chartered banks through term loans, leasing companies, financing from the manufacturers, etc.
2. How will the type of financing you choose affect your cashflow?
One of the key things that you should always look at is how the type of financing you choose will affect your cashflow. For me, this is one of the most important questions to ask as cashflow is the lifeblood of the business. For instance, if you borrow from a bank to purchase an asset it is quite likely that this will be cheapest option but not necessarily the best option. Since you usually have to pay for the asset over say 3 to 5 years in most instances, it may have an adverse effect on your cashflow compared to say leasing, which may still be for 3 to 5 years but has lower payments due to having a residual payment due at the end of the lease. This is more expensive overall but is kinder to my cashflow.
3. How much personal risk do you want to take?
Each type of financing comes with an element of personal risk. For instance, chartered banks invariably ask for personal guarantees from smaller businesses thus exposing your personal assets to seizure if your business gets into trouble. With leases, your risk is that the asset will be seized in the event of non-payment, and while leasing companies do occasionally ask for personal guarantees it is uncommon. Thus, the chartered banks represent a greater personal risk than the leasing companies. All of the different types of financing come with different personal risks. This will be addressed further in a future blog.
4. Are you a control freak?
If you are one of those people who like to be the one in charge, then you need to think about the type of financing you are taking on. Different types of financing involve giving up different levels of control. For instance, if you use venture capital to fund your business, then you will give up varying degrees of control depending on the venture capitalist. Often while the risk is high during the start up phase, the amount of control you must give up could be considerable, and you will end up being just one of many making decisions for the business. On the other hand, chartered banks rarely get involved in making decisions for your business thus enabling you to keep more control.
5. What type of business do you operate?
Sometimes, the type of business you operate may limit the type of financing you can access. For instance, if you operate a software development company, then obtaining finance can be very difficult because you have very little security within the company, and this is unattractive to chartered banks. They may help you if you have personal security to borrow against. This is why software companies often turn to angel investors or venture capitalists for their money. Before you try them, look into what grant programmes the federal and provincial governments as well as other organisations are offering.
Now that we know what their decision depends on, we can go back to why Dragons will sometimes offer a business a loan instead of investing in them and this is because they like the idea but are not 100% sure they will be successful. Offering a loan instead of an investment reduces the risk, as a loan is short term and has repayment terms thus reducing, but not eliminating, the risk.
It is important that business owners ask themselves the above questions when looking to raise money for their business. The answers to these questions mean that you will understand what you have signed up for thus, hopefully, eliminating future surprises and risks to the health of your business.
If you found this blog useful and/or have any questions regarding securing financing or different types of financing, please don’t hesitate to contact us either on LinkedIn or send us an email at firstname.lastname@example.org
Keep a look out for our next blog and in the meantime visit www.joycegrp.com to read the other blogs on a variety of business topics.