DIP – Sources of Finance

DIP – Sources of Finance Lim SeiKee @ cK

Introduction • Often the hardest part of starting a business is raising the money to get going. • The entrepreneur might have a great idea and clear idea of how to turn it into a successful business. • However, if sufficient finance cannot be raised, it is unlikely that the business will get off the ground.

Finance needs of a start-up [$$$] • Set-up costs (the costs that are incurred before the business starts to trade) • Starting investment in capacity (the fixed assets that the business needs before it can begin to trade) • Working capital (the stocks needed by the business –e.g. raw materials + allowance for amounts that will be owed by customers once sales begin) • Growth and development (e.g. extra investment in capacity)

One way of categorizing the sources of finance for a start-up is to divide them into sources which are from within the business (internal) and from outside providers (external). • Personal sources • Internal sources • External sources

Personal sources • Savings and other “nest-eggs” • An entrepreneur will often invest personal cash balances into a start-up. • This is a cheap form of finance and it is readily available. • Investing personal savings maximizes the control the entrepreneur keeps over the business.

Personal sources • Re-mortgaging • The entrepreneur takes out a second or larger mortgage on a private property and then invests some or all of this money into the business. • The use of mortgaging like this provides access to relatively low-cost finance, although the risk is that, if the business fails, then the property will be lost too.

Personal sources • Borrowing from friends and family • Friends and family who are supportive of the business idea provide money either directly to the entrepreneur or into the business. • This can be quicker and cheaper to arrange and the interest and repayment terms may be more flexible than a bank loan.

Personal sources • Credit cards • Each month, the entrepreneur pays for various business-related expenses on a credit card. • 15 days later the credit card statement is sent in the post and the balance is paid by the business within the credit-free period. • The effect is that the business gets access to a free credit period of around 30-45 days!

Internal sources • Retained profits • This is the cash that is generated by the business when it trades profitably – another important source of finance for any business, large or small.

Internal sources • Share capital – invested by the founder • The founding entrepreneur may decide to invest in the share capital of a company, founded for the purpose of forming the start-up. • Once the investment has been made, it is the company that owns the money provided. • The shareholder obtains a return on this investment through dividends (payments out of profits) and/or the value of the business when it is eventually sold.

External sources • Loan capital • This can take several forms, but the most common are a bank loan or bank overdraft.

External sources • Bank loan • Itprovides a longer-term kind of finance for a start-up, with the bank stating the fixed period over which the loan is provided (e.g. 5 years), the rate of interest and the timing and amount of repayments. • Bank loans are good for financing investment in fixed assets and are generally at a lower rate of interest than a bank overdraft.

External sources • Bank overdraft • An overdraft is really a loan facility – the bank lets the business “owe it money” when the bank balance goes below zero, in return for charging a high rate of interest. • Bank overdrafts are excellent for helping a business handle seasonal fluctuations in cash flow or when the business runs into short-term cash flow problems.

External sources • Share capital – outside investors • For a start-up, the main source of outside (external) investor in the share capital of a company is friends and family of the entrepreneur. • They may be prepared to invest substantial amounts for a longer period of time; they may not want to get too involved in the day-to-day operation of the business. • Both of these are positives for the entrepreneur.

External sources • Business angels • Business angels are professional investors who typically invest $10k - $750k. • Angels tend to have made their money by setting up and selling their own business – in other words they have proven entrepreneurial expertise. • In addition to their money, Angels often make their own skills, experience and contacts available to the company.

External sources • Venture Capital • Venture capital is a specific kind of share investment that is made by funds managed by professional investors. • Venture capitalists rarely invest in genuine start-ups or small businesses (their minimum investment is usually over $1m, often much more). • A start-up is much more likely to receive investment from a business angel than a venture capitalist.

EXERCISE. In a group of 3: • 1. List down at least five reasons of why a start-up needs financing. • 2. What are the sources of finance of a start-up? List at least five. • 3. For ALL the sources of finance from Q2 , list down: • A) three characteristics • B) three advantages • C) three disadvantages

TASK 1: OneBiz • Do you still remember? • Individual assignment: Submit your MIND MAP anytime before the end of October 2014.

TASK 2Bring this next session: • Go to JPKE Official website (www.depd.gov.bn) • Look for current survey / census: • Preliminary Report of The Economic Census 2011 • Print the report (9 pages) • [PAGE 3 – 8]

Other Sources of External Finance • Leasing • Hire Purchase • Debt Factoring • Government Finance

Leasing • Leasing is like renting a piece of equipment or machinery. • The business pays a regular amount for a period of time, but the item belongs to the leasing company. • Example: The business pays a monthly fee for the car and at the end of the period, the business return the car / swap for a newer model.

Advantages of Leasing • Cheaper in the short run than buying a piece of equipment outright. • If technology is changing quickly or equipment wears out quickly it can be regularly updated or replaced. • Cash flow management easier because of regular payments.

Disadvantages of Leasing • More expensive in the long run, because the leasing company charges fees which make the total cost greater than the original cost.

Hire Purchase • Business hires the equipment for a period of time making fixed regular payments. • Once payments have finished it then owns the piece of equipment. • Hire purchase is different to leasing in that the business owns the equipment when it has finished making payments.

Debt Factoring • A business sells its outstanding customer accounts (those who have not paid their debts to the business) to a debt factoring company. • The factoring company pays the business - say 80-90% of face value of the debts - and then collects the full amount of the debts. • Once it has done this it will pay the remaining amount to the business less a charge.

Pro and Con of Debt Factoring • √ It is a good way of raising cash quickly, without the hassle of chasing payments. • X It is not so good for profits since it reduces the total revenue received from those sales.

Government Finance • The government provide help to businesses for the following reasons: • Protect jobs in failing/declining industries. • Help create jobs in areas of high unemployment. • Help start up new businesses. • Help businesses relocate to areas of high unemployment.

Brunei Government Finance: • Local Enterprise Application and Products (LEAP) • Promising Local Enterprise Development Scheme (PLEDS) • Ignite Competition • BEDB - Youth Development Resources (YDR) programme • Aiti financial assistance

Work individually: • Survey about any of the Brunei Government Finance [LEAP, PLEDS, Ignite Competition, YDR programme, Aiti financial assistance] and share it with everyone NEXT WEEK! • - What is it? • - How to apply? • - Who is eligible? • - Returns? • - How much money?

DIP – Sources of Finance