External Financing

4 Key excerpts on "External Financing"

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  eBook - PDF

  The Illusions of Entrepreneurship

  The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By

  • Scott A. Shane(Author)
  • 2008(Publication Date)
  • Yale University Press

    (Publisher)

  21 The growth process is what makes many new businesses go cash flow negative and makes External Financing important. But because very few founders manage to grow their busi-nesses, most entrepreneurs never need to raise capital from an external source. They can capitalize their businesses just fine from their savings, their personal borrowing, and their businesses’ retained earnings. In short, most entrepreneurs don’t get external capital because they don’t ask for it, and they don’t ask for it because they don’t need it. But some entrepreneurs do seek External Financing, and not all of them get it. Why are some new companies more likely than others to ob-tain External Financing? Our popular perception focuses on the entrepre-neurs and their business ideas. Talented entrepreneurs who network well with investors and who are pursuing business ideas that are in vogue, the story goes, are the ones who get External Financing. The oth-ers do not. Although entrepreneurial talent and valuable business ideas un-doubtedly affect whether or not founders get External Financing, some more basic things also have a big effect on which new businesses get financing and which do not. One is the age of the business. The odds that a new business will get either external debt or equity financing increases as the business gets older. 22 Simply surviving for a few years improves the odds that a new business will get money from external sources. Another often-forgotten factor is the business’s level of development. Informal investors, and banks and other debt providers, tend to put their money into new businesses that have sales, positive cash flow, and em-ployees. As a result, new businesses that have made sales or achieved positive cash flow are more likely to get capital from outside sources. Sadly, making sales or generating positive cash flow is no mean feat; only a third of start-ups manage to do this.

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  Types and Sources of Finance for Start-up and Growing Businesses

  An Instant Guide

  • Guy Rigby(Author)
  • 2011(Publication Date)
  • Harriman House

    (Publisher)

  In practice, lenders will not make unlimited loans, so the ability to gear the equity with borrowings will be dictated by market conditions and the assets or cash flows available to secure or service them. In addition, businesses that are highly geared (i.e. those with large borrowings in relation to their equity) are more likely to face difficulties in the event of a slowdown in demand or an unexpected loss.

  As always, it’s a question of balance. The equity, which is the fixed capital of the business, needs to be sufficient to support the business after all other factors have been taken into account, with sufficient headroom to weather unexpected storms, should these occur.

  One well-established principle is that a business should not borrow short to invest long – for example, the use of an overdraft facility that is repayable on demand to finance property or equipment that will be used by a business over many years. If the overdraft is called in, it may be difficult to realise the assets or secure alternative finance, potentially causing the business to commit the ultimate sin – running out of cash.

  “Trying to fund growth in the long term using short-term finance is not going to work,” says David Molian of Cranfield School of Management. “Historically too many businesses have relied on short-term debt funding, principally overdraft arrangements from their bank, which are liable to be vulnerable in recessionary periods.”

  There are four main financing options: equity, debt, sales and asset financing. All of these, bar equity, involve the business taking on borrowings. In practice, most businesses will use a number of different sources over time.

  Financing options

  TYPE: Debt or equity

  SOURCE: Friends and family

  Many businesses start with funding from friends or family, aka the ‘Bank of Friends’ or the ‘Bank of Mum & Dad’. In practice, this will often be the cheapest and easiest route to gaining early stage funding, with loans often being made on a low interest or even an interest-free basis. This is not to be confused with commercial funding.

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  Entrepreneur's Toolkit

  Tools and Techniques to Launch and Grow Your New Business

  • (Author)
  • 2004(Publication Date)
  • Harvard Business Review Press

    (Publisher)

  The entrepreneurial firm usually finds start-up financing in the same pockets as its lifestyle cousins: the personal savings and credit of the owner, loans or ownership capital provided by friends, relatives, and members of the management team, and perhaps a small bank loan. However, if the founder and the management team have strong reputations in the business or scientific community, they may attract capital from angel investors or even a venture capital firm. This is especially true if the founder has enjoyed past entrepreneurial success. Financiers love people with a demonstrated Midas touch, and they pursue them actively. In these cases, the company may attract investors long before it has a marketable product or service, and certainly before it enters the growth phase.

  Growth Phase Financing

  During this phase the business expands its sales and develops a growing base of customers. As a result, more capital typically is required— for operational expansion, the hiring and training of new personnel, and even acquisitions. Some of that capital may be generated internally from positive cash flows. But more is needed if growth is strong or if the business’s strategy is to build brand visibility. Having proven its credibility as a business operation, the enterprise can generally tap external capital more easily than it could previously.

  Debt capital in this phase often comes from local banks. Debt is one of the lowest-cost sources of external capital because interest charges (in the U.S. tax system) are deductible from taxable income. This deductibility, of course, doesn’t do a company much good if it has no taxble income to report, a common situation for early-stage companies.

  The degree to which the activities of a company are supported by liabilities and long-term debt as opposed to owners’ capital contributions is called leverage

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  Finance Director's Handbook

  • Glynis D Morris, Sonia McKay, Andrea Oates(Authors)
  • 2009(Publication Date)
  • CIMA Publishing

    (Publisher)

  Chapter 24. Sources of Finance

  24.1. The Search for Finance

  At a Glance

  ■ The business development giving rise to the need for additional funding will often indicate the most appropriate source of finance. ■ Grant funding should always be considered, but this is unlikely to meet the full cost of any project. ■ It is generally unwise to attempt to finance major purchases or business development from a bank overdraft. ■ Any application for finance will need to demonstrate the credit-worthiness and viability of the business to the potential financier. ■ Issues such as overall cost, flexibility and level of security required will all need to be taken into account in deciding on the best option.

  24.2. P lanning the S earch

  Sound business structures and operations need to be financed properly, and there will come a time in the life of every business when additional funds are needed, either to purchase fixed assets, to fund a particular initiative or development within the business or to enable the strategic plan for the business to be put into place. The business development giving rise to the need for funding will usually indicate the most appropriate source of finance, and the term of the finance should generally be matched as far as possible with the life of the asset or project. Grant funding should always be considered, although this is unlikely to meet the full cost of any project; thus, the business will usually need to raise some funds from other sources as well. Some form of loan finance, including options such as leasing, will usually be the most appropriate method of funding asset purchases, whereas funding from other investors may be needed to finance the longer-term development of the business. It is generally unwise to attempt to finance major purchases or business development from a bank overdraft – the rate of interest will usually be unacceptably high and overdrafts are repayable on demand, allowing the bank to withdraw the facility at any time if it was unsatisfied with the progress or management of the business.

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