How to obtain Finance for your business?

Small Business Funding.

Are you thinking a way to startup your own business? Are you worried about the cost of such finance will badly impact to you? Will my finance gives me a better return? Well financial management has answers to all of these. Let’s discuss small business funding in detail.

So If you are reading this article for the first time I would recommend you to read our first three articles which will give you a hindsight on financial management and from now on it will be a detailed discussion on how to fund your business.

To manage finance we need to have Finance. This is basically small business funding

One simple classification of Finance is,

We can obtain fund by owner’s capital (Self Funding) or issue of shares- Equity Finance   or money got from your friends family members, That is called private equity and the next option you have is obtaining a short term loan from the bank, we can issue bonds/debentures Which we call Debt Financing.

Owner’s Capital

First and easiest and safest way of funding your small business is putting your own funds. But there are few concerns. We now we put our money to get a good return. But when its come to business it cant assure you a guaranteed return, it may vary on the performance of the business and how it operates in the foreseeable future. But you could have invested that money in place where you can get a guaranteed return and earn more. So we cant say there is no cost when putting your own money to the business. We call it “Opportunity Cost”- the next best alternative forgone investing money in your business. Therefore, always compare the options and then select the best one. But even if there are no short term profits business can grow in the future. That’s the nature of this investment. If you are planning to start your own business. You must invest some part of your own money as capital. This is the first choice you have relation to small business funding

Private Equity

Private equity is another way of small business funding. It’s a form of finance that you could get from a bunch of investors (Private equity funds) they mainly focus on company’s equity, which means the fund providers will ask for an proportion of ownership in the business. Private equity funds (PE Funds) are mainly focused on financing Private Companies so first you have to incorporate your business as a company and then seek for private investors.

PE Funds prefer investing in specific types of target companies based on the Life cycle stage of this target.

Some PE funds are interested in young companies with high growth prospective and controlled by good management team. While other PE funds are focused on established companies with stable cash flows. Where some are preferred to invest in Distressed Companies through Hedge funds

So how are they going to invest in your company?

First, they invest in your company shares and they may own majority of share capital in the organization and they probably change the management as well. This is also called a management buy-in in financial management. They will improve your financial performance of the business. Then they wait till few years to see whats going on with the business and they find a way to exit from the business with a good return in their hand. This is actually a good way to improve your business.

For your information there are two types of private equity firms

  1. Limited Partnerships (Most popular in United States)
  2. Close-end funds (Most popular in European Countries)

Venture Capital

This is another form of private equity and globally has been a growing source of small business funding. So who are venture capitalists?

                    “Venture Capitalist (VC) are the organizations that provide money in return for an equity stake of the organization”

Same as PE funds venture capitalist is also seeks an ownership in the company but not majority maybe 20%-30%. VC will then ask for dividends and capital gains from the business. Then VC will look into profitability and growth prospects. If VC believes company is not growing, VC might not invest. He is just a money lender although he owns a proportion of shares. Therefore VC asks short term profits as return this is sort of a disadvantage for original owners. So if your company has just started business and company may have losses in the initial stage of the business, then perhaps it could lead to an equity ratchet. Equity Ratchet occurs when VC cannot get proper returns VC would confront the owners and say

“Look I gave you money, but I haven’t got a proper return for past few years, therefore I need more shares”

Like this vc might increase his shareholding which dilutes the ownership from original owners. This is the main disadvantage of private equity. But you could obtain quick funds without having to pay dedicated interest payments.

Bank Loans

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The next option you have is obtaining a bank loan as a Source of Finance. That also depends on where your business stays in the business life cycle. If you have just started operations then it will be very difficult to obtain a bank loan.

This is because of the risk– Established companies could have a good history of making profits rather than small businesses. So bank think they have the ability to repay the debt. But still there are lot of banks where you can obtain a loan for smaller business but with bit higher interest rates and a good security (eg- Land Deed). So if you can afford these two things there are banks who will ready to grant you a loan.

There are both advantages and disadvantages using this method as a method of finance.

Advantages

1.Money is available in the business for a certain period (Unless there are no breach of loan covenants)

2.No need of giving an ownership to the bank in return of the loan.

3.Since interest rate are available, we can predict future interest payments and see whether there’s an negative impact coming from the interest payments.

There are disadvantages as well,

1.You have dedicated interest payments for bank loans.

2.You balance sheet may stacked with debt (highly geared)

3.The bank will be secured with the property if your business fails to meet the payments. Then business has to transfer the assets and settle debts prior to shareholders.

4.Lack of flexibility- you can’t take loans customized to your nature of business & has to agree to standard terms and loan covenants.

Share Issue

The next method of finance is share issue, but before going to deep dive lets understand the concept of Financial Markets.

Money Markets and Capital Markets

So from where we obtain finance for business funding – There’s a concept called Market in Financial Management.

In traditional definition, a market is where the buyer and seller meets. But now along with the introduction of e-commerce concept of Market Space came into play instead of Market Place.

Market Space is where the buyer and seller interacts rather than meets. (through online,Phone,texts..etc).

Same thing is with Financial Markets,

Financial Market is where the person who needs money (Borrower) and the person who gives the money (lender) interact.

 Financial Surplus – Financial Deficit

There are two classification of Financial Markets

Money Market

Short term capital requirements are fulfilled- If your requirement is short term

Capital Market

Long term capital requirements are fulfilled-If your requirement is long term.

What are Money Markets?

The money market is the field in which financial institutions make accessible to a wide range of borrowers and speculators the opportunity to purchase and offer various forms of short-term securities. There’s no physical “cash showcase.” Instead it is an casual arrange of banks and dealers connected by phones,  and computers using online mechanisms.

So basically money market is where short term instruments are traded and the instruments have maturities ranging from one day to one year and are liquid (can convert the instrument into cash quickly).

Normally for business purposes we don’t pay much attention to Money Market because of its inherent limitations and the business goals are long term and they have long term financial requirement instead of short term.

What are Capital Markets?

The money market is the field in which financial institutions make accessible to a wide range of borrowers and speculators the opportunity to purchase and offer various forms of long-term securities. 

The basic capital market that we all know Is Stock Market (Stock Exchange).

Stock Markets are accessible to the companies which are listed

Stock Markets are two types.                     

1.Primary Market

Where organizations can raise new funds through issue of fresh (new) share to the public.

If your company is planning for a listing in the stock exchange then at first you must place your offer in the Primary Market. So basically this is where you raise Funds to your business.

So investors can visit your prospectus issued and after critically evaluating your business they will buy shares.

What happen afterwards….?

2.Secondary Markets

Investors need a space to trade the shares that they have bought with other investors.

Why is secondary market important?

In the primary markets company issue new shares and for those new share company gets money, but in the secondary market they do not issue new shares, what has been previously issued is now sold by one the investor and bought by another investor further that does not add more funds to the company.

For a moment will think you as an investor. Assume you have bought some shares of company XYZ Inc. from the primary market. Time passes and you will now want to sell the bought shares. As a rational investor would always like to have a gain by way of receiving dividend or selling those share to a higher price keeping a margin with you. So if there’s no Secondary Market in place how would you sell the shares?? If I cant sell back what I’ve already bought will Primary Market works? Answer is NO.

So this is where the secondary markets comes into play and that is a big issue that secondary market addresses.

Image Source- marketbusinessnews.com

A public listed company is a company who has listed their shares in the stock Markets such as

  1. New York Stock Exchange (NYSE)
  2. NASDAQ -USA
  3. Japan Exchange Group (JPX)
  4. London Stock Exchange (LSE)
  5. Shanghai Stock Exchange (SSE)
  6. Hong Kong Stock Exchange (SEHK)

What are the advantages of a Stock Exchange

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A public listed company is a company who has listed their shares in the stock Markets such as

  1. New York Stock Exchange (NYSE)
  2. NASDAQ -USA
  3. Japan Exchange Group (JPX)
  4. London Stock Exchange (LSE)
  5. Shanghai Stock Exchange (SSE)
  6. Hong Kong Stock Exchange (SEHK)

Since we discuss about raising funds for an organization In this article, lets discuss how to gain a good income by investing in secondary market in a separate article.

So basically if your shares are listed in above stock markets you will enjoy following benefits

Advantages of Stock Market

  • Access to more funds– Not like in private equity we are able to access more investors to our business through listing in a stock exchange, also if you have a finance requirement for a new investment you can sell your shares to raise new funds. Its easier than taking a bank loan and waiting it to be approved and paying additional interest. Further its easy and convenient way to obtain finance.
  • Business can grow via acquisition.- every entrepreneur’s, Shareholder’s dream is to grow their business, So by listing in the stock exchange you can purchase other company’s shares through secondary market, so if you can purchase a higher Percentage gradually & can acquire that company & have controlling power as the parent company. (If more than 50% is acquired)
  • Enhance public image – A listed company is known with general public and if the company performs well they can find new shareholders to invest in the business because they wont go and invest in a private company where there’s no details available to the public. This further improves our brand name.
  • Marketability of Shares- As discussed above shares of a listed company can be traded in the secondary market. So if you’re listed then its more convenient for your business and you have a readily available market price for your business.

On the Other hand there are few drawbacks of being listed in a stock exchange that you should be aware of,

Disadvantages of Stock Market

  • Strict Regulations- There will be essentially more prominent public regulation, responsibility and scrutiny. The legitimate requirements the company faces will be more noteworthy, and the company will moreover be subject to the rules of the stock trade on which its shares are recorded.
  • A wider circle of investors with more exacting requirements will hold shares.

Shareholders will always be looking at the business performances, will they make profits in future, how much dividend they will declare what is the share price next month…etc.

  • Additional costs involved in making share issues, including brokerage commissions and underwriting fees.
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Financial Intermediaries

Who are financial intermediaries?

So far we have discussed what are Capital Markets and how they work, So If you plan to obtain funds to your organization this concept is also very important. So in a market there should be a supply and a demand and it should be effectively managed in order to be a successful market. So apart from the stock exchange there are other options that you can seek to obtain finance. Therefore financial intermediaries are the institutions that will create a link between the Fund Provider-(Supply of Funds) and the Borrower (Demand of Funds) to meet financial objectives of both the parties.

Image Source- www.theinvestorbook.com

 

Well he had a brief understanding regarding the ways that you could obtain finance to your business. You have to evaluate the each method with your condition. If you need any help regarding specified scenarios feel free to contact us in the comments section.

What are the main business Goals?

What are the main Business Goals ?

                                             
                                                                                                                                                                                              Image Source- www.experfy.com                   

 

“We all need lots of powerful long-range goals to help us pass the short-term obstacles"

As they say goals are long term, that could be one’s dream. But we must work on that dream to achieve that dream one day. Same principle applies to your business. You may have started small but some day you want your business to grow big. That’s the dream of every entrepreneur. The problem is how would you reach there? You will have to face many short-term obstacles in achieving that business goal.

Business Goals are the goals that your business expects  to accomplish during a specific time period. Business goals can be general, as well as specific to your departments, employees, customer related..etc. Business goals are long term outcomes that your business wishes to accomplish,

What are objectives and what’s the relationship between a goal and an objective?

Objectives could be defined as course of actions that requires to reach the goal. If your goal is to become the most successful businessman in your town among your competitors, so you decide to maximize your profit every year (your objective). So now you know that you must pay more attention on the objectives of your business. Is your business on the correct path?

In this section we identify Objectives of your business. Profit maximization is often assumed to be the most objective of a business. But are you still happy if you have more profits?

Are other objectives therefore also important?

Yes. You can earn profits in many ways, but will you survive in the long term? Because your business goal is to grow a value to your business called as wealth maximization. What is this?

Conflict between profit and maximization of owner’s wealth

Assume you have a plant which is used to manufacture the products you sell. You meet a buyer who is willing to pay a good sum of money to that plant which is profitable to you. If you sell the machinery your short-term target is achieved with a good profit however, the income which could be generated over the period from the machinery is no longer there to the company.

As you can see just because you make profits does not mean that you are maximizing owners’ wealth through that decision. So we need to make decisions in balanced way.

Strategic financial management is ‘the recognizable proof of the conceivable strategies capable of expanding an business’s net present value, the assignment of scarce capital resources among the competing openings and the execution and monitoring of the chosen procedure so as to attain expressed objectives.

Therefore, the primary objective is to maximize the shareholder’s wealth & it could be a long-term business goal. In order to achieve a long-term growth, increase the value of the business or owner’s wealth, there can be short term objectives as well. Those can be expressed as targets.

So as mentioned in the introduction maximizing profit is mere a short term phenomenal, whereas there are other objectives and targets that will lead to maximize the overall wealth of the owners

So, it is much important to balance these objectives and always analyses the impact on the owner’s wealth maximization due to the decisions we take

Strategy depends on expressed objectives or targets. Therefore, an obvious starting point is the identification and formulation of these objectives. Strategy could be a course of activity, counting the determination of resources required, to achieve an objective.

Setting Goals

Characteristics of Goals

First step of setting a goal or objective is to identify its nature and characteristics.

Identifying a Goal through SMART criteria is much easier as its considered as most recognized method for structure and evaluate your goals. SMART goals take broad or vague goals and turn them into small goals which could be executed by someone easily. Each letter has its own meaning as shown in the picture.

We must turn this method into business goals and use them as a key to our success.

Let’s take a Goal

This is Martin and he has started his own toy manufacturing business recently he was thinking what he is going to achieve.

Lets see how he is going to set his smart goal by looking at each criteria.

S-Specific

SMART begins with asking yourself to which degree your business goal is specific. Well, this is arguably most important part of establishing your value in your business goal. The less specific a goal more difficult it is to determine how long the business goal should take to complete or how to measure success. Here the Martin has specified his goal and he is going to “Increase Net Asset by 1 Million” . which seems to be more specific. Rather than having an overall idea, its clear we have to be more precise when setting goals.

M- Measurable

The next question How is your goal measured? What determines success? Some goals are measured by a simple Yes or No, where other goals are measured by different matrics such as Currency, Length, weight. Etc. The key is whatever the measure you choose it accurately reflects your business goal.

Here Martin is planning to increase his net worth so he has taken currency matric to measure. Currency is the best measure in this situation. If you cannot measure a matric search for alternative measures that would indicate the same fact.

A- Attainable

This is very important.! How are you going to achieve your Business goal? What is our action plan to achieve this goal? Do we have the adequate resources? Where are we lacking? all points have to be addressed in your business goal. Well-designed goals provide clarity of actions. If the actions are not clear or there are large number of actions have to be taken we could break It down to small manageable sub-goals.

Back to Martins case,

He has mentioned that he has sub-divided his main target into pieces, he is planning to achieve a quarterly profit of 200,000 USD and plans to by a plant in next 6 months’ time. He is very clear in his sub-goals, but he is lacking in one area that is his debtors are not settling dues. So he may need to take corrective actions on that as well. So his goal is attainable

R- Relevant

Your business goal should be relevant and achievable. Common issue we have is pursuing too many business goals at the same time or pursuing the wrong goals. We need a mechanism to monitor whether we are pursuing relevant sub goals. One popular mechanism is more output with less efforts for example- follow 80/20 rule, this means what are the 20% of goals which will contribute to achieve 80% of my return. This means we should focus on low energy & high valued goals, and those are said to be more relevant

 Here in Martin’s case we can see that he is more relevant in achieving his goals he has selected the most critical sub goals (Increasing profit and increasing his asset base, efficiency and debtor management). Which means he has selected relevant goals to follow.

T- Time Based

Last thing we want to make sure in our business goal is whether it’s time based or not, We have to include specific time period so it helps us to monitor the progress of our goal.

Here Martin said that he wants to increase the net assets by 1 Mn at the end of next year which is more precise. Further he said that to support that he has set another sub goal of achieving quarterly profit of 200,000 USD. So after 3 months he can re-visit his goals and see the progress. If not achieved he can amend the things in advance so his ultimate goal is not affected. So don’t wait till the last moment.

Factors to consider when setting business goals

By following these simple facts, we could set business goals in advance. Well if your business is in the growth stage and your financial structure is more complex you have to add various parameters to see your success. Further when making decisions we cant only think of ourselves there are lot of people waiting inside and outside who are concerned about our business. In business context these people are known as Stakeholders.

Stakeholders of Business

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For example as owners you need more profits but if you take all the profits you earn, your employees will not be properly rewarded for what they do to your business. Therefore you need to motivate them always and reward properly for there task.

Futher if you going to increase profits you can either increase your prices or reduce your costs. But how your customers will react to this, since high prices will cause reduction in demand. Or if they find your products are inferior sometimes, they might shift to another product

If you are paying taxes for government they will implement more taxes if your turnover is growing so you would have to pay more taxes which will deteriorate your profitability of the company.

Like wise you just cant focus on your growth we have to analyse our stakeholders and prioritize them in order of preference. And what is the impact they can cause to our business.

How a grown company maximize wealth?

A company is financed by ordinary shareholders, favored shareholders, bond holders and other long-term and short-term payables. All surplus funds, however, belong to the lawful owners of the company, its standard shareholders. Any retained profits are undistributed wealth of these equity shareholders. wealth, when a peer comparison of a recorded related substance would be used for valuation.

In the event that a company’s shares are exchanged on a stock exchange, the riches of shareholders is expanded when the share price goes up. The cost of a company’s shares should go up when the company is expected to form extra benefits, which it will pay out as profits or re-invest within the business to realize future profit growth and profit growth.

However, to extend the share cost, the company should achieve its profits without taking over the top business risks and financial risks that worry shareholders.  

Financial targets

On the off chance that there’s an increment in earnings and dividends, management can hope for an increase within the share price as well, so that shareholders advantage from both higher revenue (dividends) and also capital gains (higher share prices).

Management should set finance related targets for factors which they can influence directly, such as     cash flows, profits and profit development.

Examples of financial targets

 

Increasing earnings per share

(EPS)

EPS should increment by 8% per annum.

Borrowing levels

Ratio of debt : value should not exceed 1:1 or finance costs should not be higher than 35% of profit from operations.

Profit retention

Profit cover (benefit for the year/dividends) should exceed 3.5

Profit from operations

Target profit from operations: income ratio or minimum return on capital employed.

These finance related targets are not essential targets, but they can act as subsidiary targets or limitations that ought to offer assistance a company to attain its main financial objective without causing excessive risks.

Non-financial targets

Non-financial objectives such as quality measures, development measures and customer-based measures can moreover be important for a profit-making entity. A company’s non-financial targets may include the taking after.

Non-financial objectives

 

Customer satisfaction

A key target, since of the adverse financial consequences on the off chance that businesses switch suppliers

Welfare of employees

Competitive wages and salaries, comfortable and safe working conditions, good training and career development

Welfare of management

High pay rates, company cars and advantages

Welfareof society

Concern for the environment

Provision of service to minimum standard

For example, directions influencing utility companies (water and power suppliers).