Manyara Chigunduru The Business Gateway—
“Where will I get funding to finance the business operations(whether it is a start-up business or an existing business)?’’ This is one of the main questions that business people are grappling with nowadays as the opportunities of getting cheaper funding are becoming a fading dream as each day passes.It appears to be an endless talk among corporate leaders and entrepreneurs as they try to find lasting funding solutions for their businesses.
In this difficult environment, there seems to be no hope of getting any funding for new projects, SMEs or start-ups given the liquidity crisis that has hit the market and on the other hand the rigorous process that one has to undergo to access funding from financial institutions.
With such difficulties, many entrepreneurs have either closed shop or parked their business ideas while waiting for an opportune time to come when the business play ground will be awash with funding options and investors willing to put up huge sums of money into any business.
That time may not come immediately but one thing for sure is that time will be moving at a constant pace. It is unfortunate that this is one commodity which can never be recycled no matter how much we want to defy the laws of nature.
With such a scenario, it becomes imperative to all entrepreneurs to look around for different business financing options, be it traditional or alternative financing options.
Sources of funding
There have been two main traditional sources of finance to aspiring or existing entrepreneurs to fund their businesses which are mainly debt finance (borrowing funds) and equity finance (selling of ownership interest in exchange for capital).
These two types of financing will be discussed in detail bringing out what each type of funding entails, its advantages and disadvantages and when each type of funding can be adopted by a business and why.
We shall initially explore debt financing in detail and then equity financing will be looked at later.
This is when an entity raises money for working capital and or capital expenditure by obtaining money from lenders or by issuing debt instruments to individuals or institutional investors.
In other words, this is a method of financing in which an entity receives a loan and gives a promise to repay the loan.
In return for lending the money, the lenders become creditors and receive a written promise that the principal amount and interest on the debt will be repaid.
Debt comes packaged in different ways and with different terms and conditions outlining the purpose of the loan, the tenure of the loan, the repayment structure, any collateral that may be needed and any other essential information or conditions.
The fundamental principle is to ensure that the debt package matches the business needs and that the business is able to produce cashflows that can repay the amount borrowed including interest within the stipulated tenure (match funding).
Debt financing packaging
Debt financing can be packaged differently as either assets based or cashflow based: Asset based finance is when debt is packaged based on the nature of the assets to be purchased.
Normally the tenure and repayment requirements are determined by the useful life of the asset.
For example, a car loan may have a tenure of 5 years simply because that is the useful life of that vehicle.
Cash flow based finance is when debt is packaged to reflect the cashflow forecasts of the entity which are normally prepared by management in their budgeting process.
Forms of debt financing
There are different forms of debt which companies can adopt in pursuit of capitalisation of their operations and these include but are not limited to the following:
Debt Instrument — this is a paper or electronic obligation which is binding between the lender and the borrower which allows the issuing party (the borrower) to raise funds by promising to repay the lender in accordance with terms of an agreed contract. Such types of instruments include promissory notes, bonds, debentures, certificates, mortgages, leases or other agreements between a lender and a borrower.
Factoring — A business may decide to sell a percentage of its accounts receivable to a factoring company and get cash almost immediately.
The company must pay back the debt with interest which may normally be high.
If the factoring company fails to recover its money from the adopted debtors, the borrower still has to pay the factoring company.
Bank loans — This is money extended to an entity by a financial institution under certain repayment terms and conditions which include the loan tenure, the interest component and the monthly repayment of both the capital portion and the interest component.
Trade Credit- A business is able to receive trade credit from the supplier where the supplier agrees to be paid later.
A payment can be made normally after 60 or 90 days instead of making payments for goods and services immediately.
Overdraft Agreement — This method is an agreement between a business and its bank where the bank allows the business to withdraw up to a certain limit even if there are insufficient funds to cover the amount withdrawn.
The overdraft amount is charged interest and every time a deposit is done into the account, the overdraft reduces.
To be continued . . .
Disclaimer: The information contained in this article is of a general nature and does not address circumstances pertaining to any individual or entity. While we will strive to provide accurate and timely information, we urge readers to engage the appropriate professional advisors before acting upon it.
Manyara Chigunduru is the Managing Partner of Marianhill Chartered Accountants and the Managing Consultant at Marianhill Capital (Pvt) Limited. For feedback and comments she can be contacted at [email protected]