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The pros and cons of finance sources for your business

Posted date:
24/11/2016
Author:
Guy Freeman, Director and Financial Planner

Angel Investment

Australia has a long and storied history of individuals embracing the entrepreneurial spirit. Taking the plunge, going it alone and starting your own business is an exciting proposition, but it’s important to keep in mind that, for better or for worse, the decision to go for it will inevitably change your life.

Whether that change will be for better or for worse is the key question to be answered, and there are an enormous amount of variables that will go into whether or not your venture is a success. Sounds daunting, but with the right mindset and amount of nuance, you can assuredly come out ahead.

One of the biggest decisions you’ll have to make as the operator of a new small business is how to finance it. Not only is this one of the most important decisions, it’s also one of the earliest. We’re going to take a look at some of the ways you can go about rounding up the necessary funds to make your dream a reality. Deciding which one is right for you will be your decision, but we hope to give you the information and tools to make it correctly.

Heading to the banks

This is the single most common method most small businesses will use to get up and running. Banks provide the equity you need to purchase and manage all the things that go into a business, but they will expect a return on their investment in the long term. There are two main forms of financing, each with pros and cons.

Secured

This type of loan is secured against an asset, such as property. In essence, financing a business works much in the same way as financing other large purchases, such as buying a house.

Securing against an asset provides several benefits. Firstly, the bank will be more likely to grant larger amounts of equity, as the property acts as an insurance. With an asset backing you up, you should be able to secure a larger loan with a smaller deposit, coupled with a lower rate of interest.

However, the obvious flipside of the coin is that if for some reason your business is unsuccessful, the bank will have every right to seize the asset you put up as security. Before going with a secured loan, make sure you’ve carefully thought out your business plan and have a good idea of the sort of cash flow you will be enjoying early on, as well as the long-term viability of your venture.

No business is without risk of course, so don’t let this weigh unduly on your mind. Simply approach the situation with caution.

Unsecured

An unsecured loan is one obtained without the fallback of a large asset as insurance. Loans of this sort are harder to obtain, as the bank needs to be confident in your ability to make repayments.

Without the secured asset, the bank stands to lose much more if the venture does not pan out. Most money lenders will be very careful about approving these loans. You’ll need to show that you have a comprehensive business plan and a good idea of your forecasted cash flow.

A big deciding factor in approval will be industry experience and prior success, so try to look at ways you can show the bank you have this. Whether that’s by going into business with a more experienced partner or some other method, doing so will go a long way towards helping you argue your case.

Unsecured loans will also generally feature high interest rates and require a larger deposit. The most important thing when considering this type of loan is to have a comprehensive plan that you can articulate well to your financial institution of choice.

Funding through venture capitalists

Venture capitalists are generally looking for a high return on their investment in a relatively short amount of time. However, there’s plenty of give that comes with that take.

A venture capitalist is your business partner – they bring with them industry contacts, mentoring and advice, deep pockets for expansion, and experience with stock trading. However, due to their focus on high returns, they will generally be very selective with whom they do business.

Startups with high growth potential are their preference, so you will need to have the right business and plan to gain their attention. You will also lose some control over your business as you are essentially taking on a partner. Before trying to attract the attention of venture capitalists, make sure you have a strong case for growth potential, and be fully aware of the creative control you will be giving up.

Cash from crowdfunding

No modern, progressive business should discount new and creative ways to raise capital. The digital world and the rise of the internet has changed nearly every facet of our lives, and the case is no different for the world of business.

Crowdfunding is an extremely flexible finance option – you’re able to set your own commitments and goals, and present them to a very wide range of potential investors. This reduces the pressure on you to perform, as you’re able to set your own, completely realistic goals.

However, crowdfunding is still in its infancy and can be hazardous. Investors will also require a return on their investment. This will be either in the form of a share of the profits or the business itself. Take care, as you may find yourself giving up a larger share of the pie than you had anticipated to raise the capital you require.

Keep it in the family

For the individual with a big idea but without the resources to get it off the ground on their own, or the ability to attract the attention of traditional financiers, turning to friends and family can be tempting.

If this is something you want to consider, be very sure beforehand that you have a solid plan and a minimal chance of risk. This is because if your business does fail you won’t just be hurting yourself but also the people you care about most.

If you do have a solid chance of success, then you probably have the ability to attract more traditional finance options anyway, and should go in that direction instead.

Formulate your exit strategy early

While sometimes unavoidable, it’s preferable that your leap into the world of business is not an “all or nothing” situation. It’s important to remember that an exit strategy is not something to consider only when things are not going well, it can also be a very lucrative proposition for the successful business owner as well.

Take the time to consider how you might eventually move on from the business you have created in the long term. This can be achieved in a variety of ways, from buyouts to initial public offerings to liquidation.

Your exit strategy will depend on your situation when the time comes, so familiarise yourself with the different ways you might go about it. Don’t plan for failure, plan for the future.

Life is short, and a good idea can be worth more than gold. While taking the plunge into the world of business can be daunting, the potential rewards and life experience you gain will almost always be well worth it. Steel yourself for the adventure of a lifetime and dive in.

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