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Archive for May, 2015

What is Bootstrap Financing?

Bootstrap financing means using your own money or resources to incorporate a venture. It reduces the dependence on investors and banks. While the financial risk is ubiquitous for the founder, it also gives him absolute freedom and control over the management of the company. It’s usually meant for small business ventures and is considered as an inexpensive option. The key to succeeding with this type of funding is to ensure optimal management of business finances and maintain adequate cash flow. Let’s look at the common sources of such funding.

Sources

Trade Credit
When a vendor or supplier allows you to order goods, by extending credit for net 30, 60, or 90 days, it’s called ‘trade credit’. Not every vendor will provide you a trade credit, they will, however, make all your orders through c.o.d (cash or check on delivery) or take an advance payment through your credit card. In such instances, it’s best to negotiate credit terms with your vendor. While setting up your order, approach the person who will approve your credit personally. You will be taken more seriously, if your financial planning is sound, detailed, and informative. If your business is successful in its initial stages and has cleared the payments before they are due, then you have generated cash flow, without using your own resources. Your plan should ensure avoidance of unnecessary losses through forfeiture of cash discounts or incurring of delinquency penalties.

Customers
The most important aspect of any business, the customer, can be a source of capital too. You can obtain a letter of credit from them to purchase goods. Since your company’s goodwill and ethics play an important role in this, it’s important not to default. For example, if you are in a venture for producing industrial bags, you can obtain a letter of credit from your customer, to source the material from a supplier. In this way, you don’t have to block your limited capital and still can generate cash flow.

Real Estate
Generating capital using owned assets, by way of refinancing, leasing, and borrowing is another option. You can lease your facility, as it would reduce your startup cost. Negotiate your lease amounts to correspond to your growth or payment patterns. If your business needs you to buy a facility, try to cover the cost of the building over a long-term period. Make optimum use of your loan by having low monthly payments, to help your business grow. You can even refinance it as per your needs. Outright purchase will always provide you the advantage of price appreciation and creation of a valuable asset. Borrowing against its equity can also be an option in future.

Equipment Suppliers
If your equipment will end up locking your capital and leave nothing for the operating expenses, it’s best to take a loan for the purchase; that way you would pay for the equipment over a longer period of time. There are two types of credit contracts used to purchase equipment. First is the ‘chattel mortgage contract’, in which the equipment becomes the property of the purchaser on delivery, but the seller holds a mortgage claim against it until the amount specified in the contract is paid. Second is the ‘conditional sales contract’, in which the purchaser does not receive title to the equipment until it is fully paid for. Another way of getting your equipment is to lease it for a certain period of time. Leasing is advantageous for both; the supplier of the equipment (lessor) and the user (lessee). The lessor enjoys tax benefits and a profit from the lease, while the lessee benefits, by making smaller payments and the ability to return the equipment at the end of the lease term; maybe, even move towards better technology.

Joint Utilization
This is a method where you can save the cost of running the business by sharing the facility, supplies, equipment, and even employees with another startup. It’s also a great way to build your network.

Angel Investors
Angel investors are affluent individuals, often retired business owners and executives, who provide capital for small business startups, usually in exchange for ownership equity. They are an excellent source of early stage financing as they are willing to take risks, that banks and venture capitalists wouldn’t take.

Credit Cards
Credit card limits can also be used as a source of finance. The card offers the ability to make purchases or obtain cash advances and pay them later, the only disadvantage being that it is expensive in the long term.

Peer-to-Peer Lending
This is a method where borrowers and lenders conduct business without the traditional intermediaries such as banks. It can also be known as social lending and depends on your social acceptability. Peer-to-peer lending can also be conducted using the Internet.

Money Pooling
Small sums of money can be borrowed from several family members, friends, or colleagues. They will have no legal ownership in the business, but remember to pay back, as nothing causes more tension in a family than money matters.

Advantages

– Since you borrow less, your equity will be secured.
– You won’t be losing money in the form of high interest rates.
– Lesser debt means better market position for dealing with lenders and investors.
– Complete control of your company will allow you to be free and creative in your dealings.

Disadvantages

– The complete financial risk lies with the entrepreneur.
– Raising finance can be time-consuming, which can impact business operations.
– In the long term, this can be an expensive commitment between you and your supplier.

These methods encourage entrepreneurs to utilize personal resources, and have shown some outstanding results among small setups, that have grown into large companies such as Roadway Express, Black and Decker, Coca Cola, Dell, Eastman Kodak, UPS, Hewlett-Packard, and many more.
Read more at Buzzle: http://www.buzzle.com/articles/bootstrap-financing.html

An Overview of Commercial Financing for Business

Financing a business, keeping the economic perspective in mind, is very different from obtaining a loan for personal reasons. From an economic perspective, the expenses that have to be borne by a business can be broadly classified into fixed costs and variable costs. Fixed costs remain the same, regardless of the level of production. In other words, whether or not a business is in operation, the amount of fixed costs will remain the same. Expenditure on machinery and equipment is an example of fixed cost. Variable costs, on the other hand, change, depending on the level of production. Variable costs are directly related to the level of production. The cost of raw materials is an example of variable cost. Hence, from the point of view of an economist: Total Cost = Total Fixed Cost + Total Variable Cost

From the perspective of accounting, costs can be classified as implicit or explicit. Explicit costs are expenses which can be accounted for in monetary terms. Both, rent and wages paid, are explicit costs. On the other hand, a businessman who does not pay his wife for assisting him in day-to-day workings of a business, is said to incur implicit costs. Hence, for the purpose of accounting, total cost can be defined as: Total Cost = Explicit Cost + Implicit Cost

Commercial financing is needed, not only during the start-up phase, but also during the development, operating, and growth phase.

Pioneer Phase/Start-up Phase

Seed Capitalists: Seed capital is usually provided by friends and family members of an entrepreneur. This funding is necessary for activities like market research in order to test the feasibility of the business venture. The amount of seed capital is usually small.

Angel Investors: A business can also be funded during the start-up phase by angel investors. Angel investors are affluent people who finance a business for reasons best known to them. In other words, return on investment (ROI) may not be the sole criteria for funding. Angel investors may not demand participation rights in the business and they generally provide finances on a small scale.

Venture Capitalists: Venture capital is provided by institutional investors like banks, hedge funds and pension funds, who believe that the enterprise is capable of generating long term profits. Venture capitalists usually come into the picture after the business has established a few basic operations. Since venture capitalists invest other people’s money, they are very particular about the return on investment (ROI). Moreover, they demand participation rights in the form of preferred stock, and they may also be a part of the Board of Directors.

Development, Operating, and Growth Phase

Commercial Construction and Real Estate Financing: Banks, credit unions and other lending institutions provide commercial construction loans. US Small Business Administration loans (SBA loans) are also available for small entrepreneurial ventures. Depending on the needs of the business, an entrepreneur can avail of acquisition and development loans, bridge loans, mini-perm loans, take-out loans, joint venture loans and loans for purchasing real estate . These loans supplement loans provided by venture capitalists and angel investors.

Asset Sale Leaseback: Asset sale leaseback is common in case of real estate. In this case the entrepreneur sells an asset only to rent it back from the buyer. The main reason for asset sale leaseback is to remove the asset from the balance sheet of a company while retaining its use. Asset sale leaseback is undertaken for accounting and tax purposes.

Leasing Equipment: Generally buying equipment does not pose a problem even if the business does not have adequate finance. This is because the equipment functions as collateral against which a business borrows money for purchasing the same. However, start-ups prefer leasing equipment. The business is required to make monthly payments towards the rent of leased equipment. At the end of the leasing period start-ups have the choice of either buying the equipment or continue leasing it.

Invoice Factoring: Many a time, a business uses invoice factoring in order to convert its accounts receivables to cash so that it can meet its expenses in case it encounters delay in receiving payments from the customer for services rendered. In case of invoice factoring, the business sells its invoice to a third party and receives up to 80% of the value of the invoice. Once the customer pays for the services rendered, the business obtains the remaining value of the invoice, less the amount of fee charged by the third party.

Lines of Credit: Lines of credit are usually obtained by the business to meet its working capital requirements and avoid cash flow problems. A line of credit, unlike a loan, is not a lump sum amount on which the borrower is expected to pay interest. Using a line of credit is similar to using a credit card. Depending on the needs of the borrower, the amount of money required can be withdrawn from the sanctioned loan, and interest is paid only on the amount used/withdrawn, and not on the amount sanctioned.

These are some ways of financing a commercial business. In addition to these, entrepreneurs can obtain a number of other short-term and long-term loans. They can also make use of credit card advances in case of good credit history. Financing is a prerequisite for the establishment and the successful operation of any business. Regardless of whether the business is in the pioneer, growth, or mature phase, the importance of commercial financing never diminishes, although the amount of finance required may vary.