Sources of Financing Business

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Financial Sources

Financing entrepreneurial business from external sources is required either for the inception of the business i.e. to prove the viability of the concept (seed capital- 80%), to get the venture running (start-up capital- 60%) or for daily business operations, expansion of the business or to go public (expansion stage capital- 30-50%). There are two options or sources of financing business- equity and debt. Both serve as the sources of capital for a company. All financial sources fall under either of these two options. 

Sources of Financing Business: A Detailed Study

Understanding the Key Sources of Project Financing- 

Debt: It is cheaper since long-term interest on loans is less than the investment return of stock markets. It also offers a tax shield. However, debt requires regular repayment. Lenders are mostly conservative and require collaterals. 

Equity: The various sources of finance for entrepreneurs under equity are- i. Inside Equity (founders, family, friends), ii. Private Equity of Angels iii. Venture Capital and iv. Public Offering. 

The Various Financial Sources for a Startup are:

  • Personal Investment or Personal Savings: Often, one of the first sources of project financing is the entrepreneur himself or herself. Personal investment from the entrepreneur builds his/her corporate reputation showing long term dedication to the project.

  • Venture Capital: Venture capitalists are major financial sources in the corporate world. They invest in companies promising high potential in growth with efficient teams in the management and less capacity of leverage. In this type of financing business, investors participate in the business as a clause in sheer exchange for the cash and strategies they provide. Some of the major venture capital financial sources in India are Helion Venture Partners, Accel Partners, etc.

  • Assistance from Government: This comes as one of the sources of finance for entrepreneurs in the form of grants and subsidies.

  • Business Angels: One of the most promising sources of funds for business comes in the form of business angels. Such are professional investors investing a part or at times the entire capital they possess along with their time on the development of innovative businesses. Estimations have revealed that the total investment by angels is equal to thrice of the venture capital.

  • Financial Bootstrapping: Financial bootstrapping aims at building a business of sustainable nature with dedicated employees and the constant growth of customers without the help of any bank loan. Financial bootstrapping examples include owner financing, sweat equity, joint utilization, minimizing the payable accounts, delaying of payments, subsidy finance, minimizing inventory, among others. 

  • Buyouts: A buyout process might include the selling of assets that are non-core in nature, redefining and refocusing of the organizational goal, process of streamlining, replacement of the existing management and reddening of the product lines. Such sources of capital for a company tend to change the ownership form of a company. This can change a company’s public ownership to a private one.

  • Commercial Bank Loans and Overdrafts:  One of the main sources of long term financing comes in the form of loans from banks. In the case of bank loans, the loan tenure is specified by the financial institution along with the rate of interest, timing and the repayment amounts. Some collateral is kept as an exchange for the provided loan. For the funding of fixed assets, loans serve as one of the most significant long term sources of working capital.

Sources of short term finances include overdrafts. In case the entrepreneurs face business falls with the bank balance going down below the minimal limit, overdrafts can be availed by them from the very bank as a source of assistance. Such short term sources of working capital help in assisting the seasonal fluctuations and short-term liquidity crisis.

The rate of interest is high for overdrafts compared to bank loans. Loans from banks are however less flexible.

Sources of Long Term Financing

A list of sources of long term financing looks something like this:

  • Equity shares

  • Preference shares

  • Profit ploughing back

  • Lease financing

  • Foreign capital

  • Term loans

  • Debentures

  • Financial institutions

  • Debt capital

  • Internal sources

Sources of Short Term Finances

A list of sources of short term finances has the following options:

  • Trade credit

  • Overdrafts from banks

  • Secured Loans

  • Commercial paper

Finally, a startup can go for public offering- the most important of all sources of money or wealth creation. It is also a type of equity and is the best option for startups looking to take off.

FAQ (Frequently Asked Questions)

1. What are the Points that can Limit Investors to Invest in a Business?

Ans: The key points that can limit the sources of money for a business by limiting the investor inclination are:

  • Market trends

  • The uncertainty of the venture considering the possible developments along with the outcome distribution.

  • Investors may provide less credit against soft assets owing to their spread over the market.

  • A communication gap among various players related to the information on investment decisions.

  • The volatile nature of the market that might have a significant impact on the venture and its profitability.

2. What are Things that an Investor Should Take Care of Before Financing Entrepreneurial Business?

Ans: Before financing entrepreneurial business, an investor should ensure the following:

  • Cash burn rate

  • Methods of dilution minimizing external financiers

  • Conducting a detailed analysis of the existing scenario and devising plans for contingencies

  • The value of time and money that is to be invested in the business

3. What are Critical Determinants for a Venture Having External Financing Requirements?

Ans: The critical determinants that a venture needs financing are:

  • One-time expenditure calculation

  • Projected growth and sales of along with the possible profit figures

  • Determination of the cash needed for the daily running of the business through the projection of the working capital involving the payment policies, the inventory as well as the credit

  • A clarified estimation of the recurring expenditure