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SOURCES OF FINANCE
So! You want to set up your own business!
All right – but one big question:
Where are you to get the capital?
Finding the capital is usually the biggest problem faced by those wishing to set up a business. There are, in fact, two problem faced by those wishing to set up a business. There are, in fact, two problems involved. One is how much capital will be needed. The other is how it can be raised.
In setting up a business, the first thing to do is to estimate how much capital will be needed immediately. What fixed assets will be needed? What current assets?
There is then the question of how long it will be before the product, or service, becomes established and cash starts flowing in. This will mean estimating carefully the expenses for this initial period, and how much working capital will be needed to cover them.
The amount needed will depend entirely upon the type of business, how large it is going to be, and how large it is going to be, and how long it will be before the business will begin to ‘pay its way’. Once these amounts have been calculated, a serious look can be taken at how the money is to be obtained.
Sources of finance for a small business
There are a number of sources of capital which can be considered by small business men.
Owner’s private savings
The most obvious source is personal savings. Any entrepreneur should have sufficient faith in his project to back it with his own money. If not, he can hardly expect others to risk their money.
The advantage of an owner using his own money is that the business remains free of commitments to partners or outside lenders. It also means that all the profits will be his. They will not have to be shared with partners, nor will heavy interest charges have to be paid on loans.
Personal savings are not, however, ‘free of cost’. The cost is the interest that it could be earning elsewhere. There is also the ‘opportunity cost’ of not being able to do with the money what might otherwise be done. Despite this, personal savings remain the cheapest form of finance available.
‘Own resources’ are not limited to savings. One of the advantages of taking out an endowment life assurance early in life is that, later, it can be used for raising capital either by surrendering it for cash or as security for a loan from the insurance company or the bank.
Capital can sometimes be obtained in the form of loans from friends, neighbours or relatives. One difficulty here is a friend or relative, though not keen to lend the money, not like to refuse. Another disadvantage is that, with any business, there is always risk. This means that, if money is
obtained in this way, the borrower may one day have to look the friend or relative in the face and tell him that all the money has been lost – a distinctly unpleasant task.
Take on a partner
It may be possible to persuade a person with capital to become a partner in the business. This means that the capital would be interest-free and, unlike a loan, would not have to be repaid. Profits, however, would have to be split. This may be particularly frustrating if the particularly frustrating if the partner is a ‘sleeping’ one.
Loan from a bank
All commercial banks are involved in leading money to suitable businesses. The first problem is to convince the bank that the proposed business is likely to succeed. The second is that the bank will probably want some form of ‘security’ for the loan which they can take if the loan is not repaid. Examples include a paid-up life assurance policy, a mortgage on a houses or a pledge of reasonably valuable personal possessions.
Banks may lend money by a formal loan or simply by allowing the customer to over-draw his account (know as an overdraft).
A loan is usually for a fixed, clearly stated period. Interest is charged on the full amount of the loan whether it is taken out of the bank or not. Security for the loan is usually required.
On an overdraft, interest is paid only on the amount actually over-draw on a day-to-day basis, but the rate is usually higher than on loans. Banks usually retain the right to call an overdraft in (that is, to require repayment) without notice.
Lease and lease-purchase schemes
Leasing means, simple, renting. The asset does not become the property of the person leasing it. However, many leasing arrangements include a special provision allowing the asset to be purchased for a purely nominal (that is, very small) amount once it has been leased for a substantial period. Strictly, this makes them lease –purchase schemes. For all practical purposes, there is little difference between ‘lease-purchase’ and ‘hire-purchase’, though the respective interest rates should be carefully compared together with the detailed clauses of the agreements. The professional advice of a banker or a lawyer should also be taken regarding the tax position regarding the different types of agreement.
Are you in need of some cash? Historically, borrowers have had limited options for a personal loan. You could ask a family member, a friend, or find a personal finance company that offered fixed-rate loans, typically at exobrtantly high interest rates.
Today, however, finding a personal loan brings several more options to the table. While you can still ask a family member, or get a high-rate loan from a finance company, you can also consider using a social lending network. These networks, also called peer-to-peer loans, generally have much lower overhead and as a result can offer much lower interest rates. They're facilitated by professional companies familiar with this type of lending, to simplify things for all parties.