"Common Sources
of Financing for Small Business"
By Jeff
Schein
The choice of financing is
an important determinant of whether a product reaches the
market, or whether an existing business can survive. The
choice of financing is an important part of being an
entrepreneur and business owner, and the ability to raise
cash when you have no or limited history takes skill and
creativity. There are a number of sources of financing. The
suitability of the alternatives depends on what stage you
are at, and will change as the company matures from stage to
stage. The following outlines the most typical forms
available.
Yourself, Family and
Friends
The most obvious and common
start is for people to self finance. That means they either
draw down on their savings or they use personal debt such as
credit cards, credit lines or equity mortgages to finance
their business. Family and friends are often used as a
source of financing. Although they are not always in a
position to properly evaluate the business venture, family
and friends have long-time relationships and experience with
the entrepreneur and are knowledgeable about his/her
reliability and ability.
Strategic Partner
Strategic partners can not
only provide a source of financing, but often they can
provide an area of expertise that the entrepreneur does not
bring to the table, such as operational or marketing skills.
Naturally, the pitfall of a partner is that you do not
maintain full control over the company and that sometimes
there is a falling out between the partners. So it is
important that you do your homework and choose your partner
carefully.
Angel Financing
Angles tend to be freelance
financers interested in loaning smaller amounts of money,
say between $50,000 -$500,000. They can often provide the
seed capital required to develop an idea to get to the point
where a firm can obtain formal financing. Angel investors
will also invest in growing companies that may have a strong
revenue base, but are not yet established enough to get bank
or other financing. Another benefit of Angels is that they
can bring a lot of experience and industry contacts to the
table.
Venture Capital
When firms approach venture
capitalists, they are generally developed to the point where
a venture capitalist can add value. The venture capitalists
will generally sit on the board of directors, provide
expertise and provide funding based on the attainment of
milestones. They are generally interested in firms that can
generate rapid growth – and returns - over a few short
years; your time horizon is generally 3-8 years.
Trade Credit
One of the largest sources
of short-tem financing, trade credit occurs whenever you
purchase from a supplier but do not need to pay for the
merchandise for 30 days (or whatever the terms are). Trade
credit can be expensive if you are foregoing discounts, but
a new firm may not have much of a choice.
Factoring
Factoring is also a popular
source of financing for growing firms. When you generate a
receivable you may sell it to a factor who will then collect
the receivable for you. Typically, you will get between
75%-90% upfront for the receivable and the remainder when
the factor collects, less a fee.
Asset Based Lending
Asset based lenders will
lend to businesses that lack sufficient cash flow to support
unsecured financing, but have sufficient assets that can
serve as collateral. Typically, the assets are accounts
receivable and inventory, but can be equipment or other
similar assets. The lender relies on the assets to repay the
loan, not the cash flow of the firm. Fast growing firms who
cannot get sufficient financing from a financial institution
will be a typical client of an asset based lender.
Mezzanine Financing
Mezzanine financing is
subordinated debt, a type of hybrid between senior debt and
equity. As Mezzanine financing is typically high risk, it
can be expensive. A typical target company generally has
been in business for a number of years and has an
established revenue base and positive cash flow stream.
Often, a company may have reached its maximum level of
financing from a lending institution and will obtain
mezzanine financing to bridge the gap and finance their
growth. The Mezzanine financer will subordinate its debt to
the main lender.
Banks
By the time a firm can
approach a bank they usually have been in business for a
couple of years, have developed solid revenue, are earning
profits and have a reasonable balance sheet. The bank will
provide daily operational financing as well as long-term
financing. Generally the cheapest form of financing, it can
also be the hardest to get.
About The Author
Jeff Schein is a CGA and offers advisory services in the
areas of business planning, business modeling, strategic
planning, business analysis and financial management for new
ventures and growing small businesses. Visit
www.companyworkshop.com or
mailto:jeff@companyworkshop.com.
