Funding is a very vital aspect of a business, therefore this article discusses the various ways of raising capital for business start-up. It is not only for a business that is just starting up but also for an existing business. Apart from funds acquisition, management of funds in business is also important.
Money is needed to operate and grow or expand a business. Business may need money for start up, to purchase equipment, inventory, create awareness, restructure or even renovation to be properly positioned to handle challenges. It is often a great challenge for new business ventures to find or accumulate the needed fund to commence or expand operation.
Financing is the use and manipulation of money. Raising money for a business is one aspect of financing. There are various ways of raising capital for business start-up that are open to the entrepreneurs. These ways vary in terms of the volume of fund that can be accessed, the cost of the funds and the security required to obtain the funds. The choice of individual entrepreneur will be determined by knowing the number of sources of funds available, risk involve, the duration of financing whether it is short term or long, the cost of borrowing from each source, government restrictions and institutional constraints and the value and nature of assets as security or collateral.
The Various Ways of Raising Capital for Business Start-up
The various ways of raising capital for business start-up are classified under the following:
- The Personal and family sources,
- The Internal sources,
- The External sources
1. The Personal and family
This source of finance is peculiar to a new venture, although it may also be applicable to an existing venture particularly loans from friends and relations such as ;
- Personal savings: It is expected that an individual that wants to start a business should be able to have saved part of the funds required for the business. This is necessary because relying on borrowed funds may be too dangerous for a new venture. It is also a way of motivating the owner to know that if the venture fails the life saving will be lost.
- Loan from family and friends: Family members often want to support other family members venturing into business, hence part of the venture funds are contributed in form of loans or gifts. Also, friends support through loans and sometimes gifts to encourage their friend that is starting a business.
2. Internal Sources
One of the various ways of raising capital for business start-up is through internal sources. This type of funds is peculiar to an existing business venture. The internally generated funds can be emanated from the;
- Retained profits: It is an accepted practice to finance the fixed and working capital requirement from profits generated from the previous business activities of the venture.
- Provisions: Provision for tax and depreciation are another internal source of finance. Since business tax are payable a year after profits have been declared, this amount could serve as a source of fund for small business firm. Furthermore, annual provisions for depreciation represent cash retained by the enterprise over and above the normal undistributed profit.
- Reducing current asset: Reducing current assets is a source of fund and large amount of money could be made available for financing the activities of the venture.
3. External Sources
The external sources of funds raising are those that are obtained outside the business venture. The external sources can be divided into three, which are;
- Short- term finance
- Medium term finance
- Long term finance
A Short term finance
Short term financing involves obligation debts that have maturity date of less than one year. The typical example of short term finance includes goods purchased on credits, outstanding short term loans from banks/ accrued payment such as deferred taxation, salaries and wages etc. Some of the methods of short term financing are;
- Open account or Trade credits/ Account payable: It is a form of financing in which the seller extends credits to customers. The credit is reflected on the entrepreneur’s balance sheet as accounts payable, and in most cases it must be paid in 30 to 90 days.
- Account receivable financing: It is a short term financing that involves either the pledge of receivables as collateral for a loan or the sale of receivables (factoring). Accounts receivables loans are made by banks, whereas factoring is done primarily by finance companies and factoring concerns.
- Bank overdraft facilities: An arrangement which allows a person who keep a current account with a bank the opportunity to draw above the balance in the account. The customers who overdraws his/her account pays both the overdrawn account plus the interest on the amount overdrawn.
- Notes payable: These are payments to banks (commercial) individuals or firms in which the maker of such notes endorses them in Favour of the payee. A typical example of notes payable is a promissory note which is a short term marketable debt security in which the borrower promises to pay a stated sum on a stated future date, also known as one- name paper or commercial paper.
- Commercial draft: It is a short term credit instrument, it is similar to a promissory note, except that the payee creates the draft in which the drawer indicates the time on the draft or sight draft requiring payment on presentation.
- Bill of exchange: – A bill of exchange is a marketable short time debt security in which one party (the drawer) directs another party (the acceptor) or draw to pay a stated sum on a stated future date.
- Loans from acceptance houses: It is a method of borrowing on short term basis from banks; this method has the advantage of securing funds needed and at the required time. A letter of credit is a good example.
- Specialized Institutions: Some specialized institutions were established to provide credit facilities to the small and medium scale enterprises, such institutions include microfinance banks, Cooperative banks, Agricultural development banks etc.
- Factoring: It is a method of short term financing, where debts are sold to a factor by an arrangement. A factor then assumes all the credit risks associated with the account receivables. Though costly, factoring has the advantage of converting an account receivable into cash and thus saves the seller the stress of pursuing payment.
- Discounting bills: Similar to factoring in many ways, discounted bills are used by firms with lump sum of funds tied in receivables or marketable securities who require immediate cash. Instead of approaching their banks for loans, the firms approach finance houses to discount their receivables and marketable securities upfront by receiving cash lower than face value of the receivables.
Medium term Finance
This type of finance fills the funding requirements of a firm in the medium term. In essence, medium term finance is not intended for long or short term use. By way of durational availability, medium term finance can refer to funds made available for use between two and five years. Generally, such funds are used for acquisition of small tools and light equipment with a few years life span. Medium term financing are debts, often obtained by borrowing. They have implications for interest payment. The main source of medium term finance is bank loans. The requirements for bank loans are usually tedious and cumbersome for young entrepreneurs to meet, this is not to say it is not possible.
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