Raising capital for your business can be a difficult task and a roadblock to its eventual start-up and implementation. When looking for funding, you must first determine how much money you require to start or expand your business. Then you should understand the different types of Financing there are and their benefits and constraints.
Different Types of Finance
Debt finance refers to borrowing money from someone (a bank, the government, a family member, or a friend) that you must repay at a later date. A loan is the most prevalent sort of debt financing.
If the loan is for a shorter than a year, it is considered a short-term loan. It is generally referred to as a long-term loan if it is for more than a year.
You or your company becomes a debtor when you borrow money. Creditors are the people who have given you money. In exchange for this money, the borrower will be charged interest during the course of the loan, which will be due every month.
The Advantage of Debt Financing
- It can be used to fund businesses of practically any size and type.
- Another significant benefit of debt financing is that you will not be relinquishing ownership of your company, and you may be able to negotiate fixed interest rates and flexible repayment alternatives.
- Interest, fees, and charges on a business loan are tax-deductible, unlike private loans. This is a powerful argument in favor of debt financing.
- You are not required to share your company’s profits.
Disadvantages of Debt Financing
- Accessibility — when it comes to lending money, banks are cautious. Debt financing may be difficult to come by for new enterprises.
- Repayments – You must ensure that your company can earn enough revenue to pay off the debt (i.e. repayments plus interest). Even if your firm collapses, you must still pay your bills. Your cash flow may be insufficient to repay debt funding on a regular basis if your company is still in its early stages.
- Failure to make timely payments will harm your credit rating, which may limit your ability to obtain future loans or credit conditions from your suppliers.
- Cash flow – Making regular repayments can have an impact on your cash flow. Cash flow difficulties are common in start-up businesses, making regular payments problematic.
- Personal liability — if your company fails, you may be held personally liable for the loan.
When someone donates money to a firm in exchange for ownership, such as selling a share of your company for cash, this is known as equity finance.
The percentage of the firm sold is determined by the quantity of money invested and the company’s valuation.
Equity finance is an investment in your business from the standpoint of the funders, and they will demand a return on their investment even though they control a portion of it.
Be confident that you want to give up a specific amount of ownership in your company before contemplating equity financing.
Advantages of equity financing
- Unlike debt funding, you don’t have to make repayments on investments. Having no debt can be a tremendous benefit, especially for a tiny start-up company.
- Term of investment – equity investors, such as business angels, may be willing to wait for a longer amount of time before seeing a return on their investment.
- Repayments – rather than a set sum, funds are reimbursed through an investment exit strategy.
- Investors frequently provide essential expertise, the management or technical skills, contacts or networks, and reputation to the firm in addition to capital.
- Follow-up finance – when the business develops and flourishes, investors are typically eager to contribute extra funding.
Disadvantages of equity financing
- Shared ownership — you will have to give up some control of your company in exchange for investment capital. Investors not only profit from the company, but they also have a say in how it is run. While there are benefits to this, you should consider how much control you are willing to give up. When negotiating agreements, this can lead to disadvantageous terms.
- Accepting investment capital from family or friends might have a negative impact on personal connections if your firm fails.
- It takes time and money to approach investors and become investment-ready. It requires both time and money. If you have to spend a lot of time on investment techniques, your business may suffer.
- Availability — in Australia, certain sorts of investors, such as business angels, might be difficult to locate and attract.
- Obligations — Your company will be responsible for additional reporting and disclosure.
Returns – the demand to find business prospects that can yield a certain return on investment each year may increase as a result of equity investment.
Types of equity investors
1. Angel Investors: Angel investors are typically “high net worth individuals” who invest their own money in a firm in which they expect a high return.
2. Venture capitalists: These individuals invest in high-risk, early-stage firms. They choose to invest in high-growth companies that can provide them with substantial returns. Normally, they invest in technology companies, but they are currently aiming to diversify into other high-growth industries.
Giving up a piece of your company in return for cash is what equity financing entails. This is a major decision that must be thoroughly studied. If you’re unsure, seek professional help.
Other types of finance
Islamic finance: refers to the types of investments that are authorized under Islamic law, for example, charging interest is prohibited. If you are a practicing Muslim, you must be aware of this in order to obtain financing from the relevant institutions.
Crowdfunding: This is the process of raising finances for a project or company idea by soliciting monetary contributions from a large number of people, usually through the Internet. People don’t expect a return on their donations, but normal practice, such as Kiva and Kickstarter, is to keep them informed about progress.
Advantages of crowdfunding
- Your backers do not own a portion of your project or business (unlike other funding investments).
- You can test your concepts directly with your clients in low-risk, risk-free conditions.
- Before your product hits the market, you can collect feedback and build a consumer base.
- You may communicate with your audience and impact your campaign using social media technologies.
Disadvantages of crowdfunding
- Take the time to organize, compose pitches, and differentiate your campaign in order to attract possible backers.
- There are no assurances that you will achieve your financial objective within the time frame you have chosen.
- You must plan meticulously in order to deliver on your project’s commitments.
Grants: This is money that you don’t have to repay because it was provided to you by the government or a non-profit organization. There are very specific guidelines for how you can spend the money, and you will be held accountable for your actions. It’s a good idea to look into what kinds of grants are available for small businesses in the country where you live.
Micro-finance: Small loans are provided by microfinance organizations, which would be considered too small by traditional banks. Microfinance has the disadvantage of having extremely high-interest rates on these loans.
Government: A number of governments have established financial agencies to assist micro, small, and medium-sized businesses. To find out what assistance is available in your nation, use the Government Funding Agencies tool in the resource area.
Government Funding Sources For African Countries
Agency: SMEDAN – Small and Medium Enterprises Development Agency of Nigeria (www.smedan.gov.ng)
what they do
Stimulating, monitoring, and coordinating the development of the MSMEs sub-sector; Initiating and articulating policy ideas for small and medium enterprises’ growth and development; Promoting and facilitating development programs, instruments, and support services to accelerate the development and modernization of MSME operations.
Funding: 220 Billion Naira MSME development fund, was announced in 2014
Agency: DTI, NEF, SEFA, IDC. www.thedti.gov.za, www.nefcorp.co.za, www.sefa.org.za, www.IDC.co.za.
Government funding agency, which provides finance to qualifying businesses in South Africa. they have Annual budgets set for funds.
Agency: SME Bank www.smebank.com. na
Bank started the founded by the government of Namibia in 2012 with NAD 630 million (USD 58.7 million) in non-reimbursable funding
aims to fuel growth among small and medium-sized enterprises.
Agency: PEP – Private Enterprise Programme, Zambia
March 23, 2015 – Small and growing business funder GroFin in Zambia signed an agreement with the Private Enterprise Programme- Zambia (PEPZ) looks set to provide much-needed funding to help small-scale entrepreneurs to grow their businesses and tap into the local supply chain.
GroFin considers funding SMEs that are locally owned and managed and have less than a 150 employees. Their annual turnover must not exceed US$15 million or gross assets must not exceed US$6 million. The SME’s funding needs must be between US$100,000.00 and US$1,500,000.00 and must meet a set of ethical standards.
Agency: SME Fund
Source: www.oxfordbusiness group.com/news/ghana-boosts-financial-support-sme-development
SME fund is linked to established institutions such as local credit guarantor EximGuaranty and the Venture Capital Trust Fund, in addition to rural banks and microfinance firms. $20m, was made available from the government’s SME fund, which received financial backing from the Export Development and Agricultural Investment Fund, in addition to loans and grants from development partners.