What is financing?
Financing refers to an avenue of credit or funds that are delivered to an individual or business owner to help fulfill various expenditures, loan obligations, or to pay for products and services needed to distribute a specific business model.
Many entrepreneurs, who are attempting to start a small business, will struggle with obtaining the capital needed to start a new business. Financing is the foundation for the small business; without the obtainment of capital, the business would fail in acquiring the funding necessary to implement its respective business model. That being said, there are numerous sources of finance that can be obtained to get a small business off the ground.
Financing is a type of loan; with all types of loans the applicant must meet the qualifications supplied by the underlying lending institution. As a result of this, the applicant must possess a good credit score, an ability to prove that the small business will earn a profit and a full list of all expenditures that the loan or credit line will be used towards.
What are the Sources of Finance?
Personal Savings: Although this is not a source of finance in theory, all experts will agree that the most efficient and best form of capital comes from an individual’s personal savings. Personal savings is highly liquid, does not require the fulfillment of a loan obligation, nor does it require the transfer of equity or ownership. Additionally, personal savings will demonstrate to prospective investors that the individual is willing to risk his own funds, does not possess exorbitant liabilities or a large exposure to credit, making his or her company stable even in tough economic times.
Borrowing money from friends and family: The second easiest source of finance comes from those closest to the entrepreneur. Borrowing money from friends or family will not require the delivery of paperwork (loan application) that a bank or lending institution mandates, nor will the loan be attached with predatory interest rates (for the most part). Additionally, the lenders will typically not require a decision-making process or partial ownership. That being said, a fundamental disadvantage to this source of finance is that if the business fails and the money is lost, the underlying relationship may be strained.
Credit Cards: The entrepreneur’s personal credit cards are an easy source of finance that can be used for smaller expenditures, such as the obtainment of relatively inexpensive business equipment. Although these items can be obtained with minor expenses, the main disadvantage tied-into this source of finance stems from the high interest rates that credit card companies will typically charge.
Banks:Financial institutions are the most common sources of finance. That being said, the typical bank—due to the credit crunch and the state of the modern economy—are conservative lenders. The majority of prospective business owners must understand that banks rarely make loans to start-ups unless there are outside assets pledged against the borrowing to make the loan secure.
Venture Investors: This source of finance is a major credit stream for small business owners. That being said, all venture investors will insist on retaining partial ownership of the new business that they are funding.
A formal institutional venture fund will be established as a limited partnership, where passive limited partners, will supply the majority of the funding.
Corporate venture funds are established corporations who provide capital to new ventures whom they deem as worthwhile investment types. Additionally, these venture companies will provide management and technical expertise to the small business. The downside to this source of finance is that the corporation venture will seek to gain control of the business and the delivery of the funds is often delayed.
The last type of venture investor is an angel investor, who is successful entrepreneurs themselves. The money is awarded in the form of investment where the angel investor will act as a business adviser to ensure that their investment is handled appropriately. Angel investors make smaller investments than the other forms of venture capitalists and possess fewer contracts in the baking community.
Government Grants and Programs: Numerous national and regional government programs will offer loans or grants to encourage the formation of small businesses. The Small Business Administration is the government agency who will guarantee these loans, which are made by private lenders, to individuals who would otherwise not qualify for a commercial loan.