YOUR SOURCES OF BUSINESS FINANCE
Sources of business finance
The main sources of finance for your business include the traditional loans and equity. Equity is own funds . Loan is borrowed finance.to be repaid. Other sources include venture capital, angel investors, joint ventures, and microfinance. These mainly cater for those who cannot get financing from conventional banks.
The choice also depends on the business legal form, business goals and objectives, and the business expected performance or profitability.
The main sources of business finance include equity and loan. Equity refers to own funds invested in the business. Loan is borrowed funds. Other sources include venture capital, angel investors, joint ventures, and microfinance. The options cater for businesses unable to obtain financing through the usual bank loans.
The different sources suit different types and stages of the business. While some are suited for start-ups, others support business growth and expansion. Some remain in the business for a long time, participate in management, and share in profits; others are repayable, charge interest, and require collateral or security.
A major challenge is raising funds for start-ups.
Your chosen source depends on, among other factors:
- The purpose for which the funds are required.
- The stage of business growth.
- The period over which the funds are required.
- The extent to which you are willing to share decision-making and profits.
- The level of risk you are prepared to carry.
- The availability of assets to provide as security for borrowing.
The choice also depends on the legal form of the business, its goals and objectives, and its expected performance or profitability.
(i) Equity
- Equity is the owners’ funds invested in the business, as share capital. The owners aim for profit.
- It is long-term, held for the life of the business and is suited for long-term costs.
- Equity investors aim to share dividends when the business makes a profit. They equally carry the risk of loss if the business does not do well or fails.
- Normally require to participate in management.
- Equity funds are required particularly for start-ups or at the early stage of a business. Part may finance permanent working capital.
- Equity is normally financed from savings or injection by other investors.
(ii) Loans
- Loan is borrowed funds to be repaid.. It includes short-term loans, repayable in less than three years; medium-term, generally repayable in three to five years; and long-term loans, repayable in over five years. It also includes secured and unsecured loans.
- Loan financiers do not participate in management,
- Charge interest, and take collateral security to cover themselves should the business fail.
- Loan is growth finance. It is recommended when a business is generating sufficient cash flow to enable meet loan repayments. The principle is that each loan justifies itself, in that the loan should enable generate more revenue than it takes to repay it.
- In matching costs and finance, long and medium-term loans are to be used for long-term costs, and short-term loans for short-term, operating, or working capital costs.
Mezzanine Finance
- Mezanine finance is a loan with an option to convert to equity. If there is default or the business is unable to pay, the amount is converted to equity for the lender. Mezzanine finance helps reduce cash outflow and may involve less security. The conversion to equity, however, dilutes or reduces the ownership interest and control of the primary owners and needs to be carefully considered.
(iii) Angel Investors
- Wealthy individuals, normally retired from their successful businesses
- Looking for an area to invest for more than financial return.
- May include supporting an area of interest.
- Focus on innovative high-potential small business startups or at growth stage but cannot access bank credit.
- Invest individual funds normally in equity or convertible debt, for part ownership.
- Provdes mentorship, business advice, and access to valuable networks
- May receive a dividend, and participate in management
- No time limit. Hope to gain as the business grows increasing in value or is sold.
(iv) Venture Capital
- Institutional investors.
- Invests money held for other people.
- Looking for a high return
- Focus on innovative, high-risk, high-return businesses, usually start-ups or businesses at the point of rapid growth.
- Normally invested in in equity, takes dividends, and may participate in management.
- Fir a specified period normally 5-10 years., after which the investors may sell their shareholding to the owner of the business or to other parties.
(iv) Joint Venture
Funds contributed by two or more parties for a joint defined task.
The funds may be in loan or equity, and may be in cash or kind.
A partner contribution may be in skills or expertise..
Governed by JV agreement.
- The venture has a specific period.
- Partners share costs and profits.
- Both parties may participate in management.
- Ends with the project.
Joint ventures are common between local and foreign investors. Gain capital and skills, cheap labour and market access.
(iv) Microfinance
- Micro-finance Institutions (MFIs) provide support to businesses that cannot access bank credit.
- This includes mainly micro and small enterprises (MSEs) — businesses at the early or growth stage, mainly owned by individuals, women, or community groups and often informal.
- The institutions may be in Cooperative Societies and SACCOs, government programs, Microfinance Banks, community organisations and mobile money platforms.,
- They provide loans in small amounts, with innovative minimal collateral, including group lending and joint guarantee and simple procedures and repayment terms. They also provide capacity building or training for borrowers.
- Initially, services included only micro-credit. Microfinance now offers credit, savings, insurance, and money transfer services.
- The loans are normally short-term and not suited for financing long-term assets.