How Small Businesses Can Use Funding Options for Raising Capital
A substantial amount of money is needed to operate a business. Capital can exist in a variety of forms, including human and labour capital as well as economic capital. But when the majority of people hear the word “financial capital,” money is typically the first thing that comes to mind. Knowing how to acquire cash can frequently be quite a task, whether you’re an entrepreneur, a startup, or an established business owner. However, you will discover in this article many other options organisations must be open to and how to go about them when their incomes and other assets fail to cover the expenses.
To finance the needs of your small business or even if you plan on starting a new venture, crowdfunding is an excellent option. It refers to the collection of small amounts of capital from a large number of individuals (“crowd”). Its main intention is to expand the pool of investors beyond the traditional circle of venture capitalists, owners and relatives. Crowdfunding has enabled small business owners and entrepreneurs to raise considerable amounts of money from anyone who can invest. On the other hand, crowdfunding platforms, whether online or offline, make their bit of money by taking a certain percentage cut from the money raised. Any fraudulent organisation planning to raise funds for bogus reasons must note that the law will take charge of it.. This is because all crowdfunding platforms ensure that even the smallest of investors are legally protected and making a well-informed decision.
You should note that there are four main types of crowdfunding:-
- Lending Crowdfunding:- Mainly unsecured, these platforms match lenders with borrowers to raise loans that are paid back with interest.
- Equity Crowdfunding:- A platform where private companies offer their securities to a group of people for investment. It is part of the capital market and is subjected to securities and financial regulation.
- Reward-based Crowdfunding:- A platform where individuals make donations to businesses in expectation of a non-financial reward in return, such as a particular good or service.
- Donation-based Crowdfunding:- This refers to a platform where individuals raise funds to support personal or social causes with no financial returns.
Angel investors are usually wealthy individuals who provide new ventures with equity capital to meet their working capital needs. They provide this money in exchange for equity. Compared to venture capitalists, angels are more patient with the owners of the enterprises they invest in and are usually more open to providing smaller amounts for longer periods. However, at some point in the business, they demand clarity on an exit strategy to pocket their profits. This exit typically happens through buying of their stake by VC/PE firms, an acquisition by another bigger company, or a public offering. Angel investing is a billion-dollar community, and many small business ventures from various sectors have received billions of dollars from angel investors in exchange for equity. However, it has a set of advantages and disadvantages. One major benefit of raising capital from angel investors is that you do not have to repay the money at regular intervals like debt, as you give up a specific portion of ownership in exchange. It is perfect for small/new businesses which have shown a fair bit of promise but still need capital to develop new products and grow in the industry. Also, as it is the angel whose money is on the line, they will be highly interested in your success either by mentoring or providing direct management help. However, there is one small drawback. Angel investors typically want at least 20 % of your company in exchange for funding. You must always be vigilant and ensure that in no scenario do you land up giving up more equity than you want. Angel investors usually expect a high return on investment (ROI); however, the expectation may vary from investor to investor. Considering all the merits and demerits, it can be said that raising capital from angel investors is a viable option.
Profitable Micro, Small and Medium enterprises (MSMEs) play a vital role in driving economic growth. The sector has immense potential to tap individuals to associate with economic activities through self-employment. The ministry of MSMEs is completely determined to support small businesses. Several schemes have been introduced by the government of India, including bank credit facilitation, raw material assistance, single point registration, bill discounting and a complete infrastructure consisting of business parks and special economic zones (SEZ) in strategic locations throughout the country. The government encourages Indian MSMEs to participate in international exhibitions, trade fairs, and buyer-seller meets in foreign countries and in India, where there is international participation. This motivates small businesses throughout the country to aspire higher and provides them with a network to expand their business. Pradhan Mantri Mudra Yojana is an example of a government scheme where loans can be availed to meet working capital needs. This yojana does not require any collateral whatsoever. Governments are interested in the growth of small businesses and several entrepreneurs as they generate employment and help the nation in Gross Domestic Product (GDP) growth.
Venture capitalists are usually well-off investors, investment banks and other financial institutions. A type of financing provided to new ventures and small businesses that are believed to have long-term growth potential. Usually, those companies are preferred that have immense growth potential and have acceptance for their product by the market. Although a great deal of risk is involved in such investment, the payoff lies in the exponential investment returns.. Like angel investors, they even help in providing companies with networking services and secure talent as well as growth.
There are three stages of venture capital investing:-
- Pre-Seed:- It is the earliest stage in the business development journey of a company, a time when founders try to turn an idea into a concrete business plan. As a result, they enrol themselves in many business accelerator programmes to secure early-stage mentorship and funding.
- Seed Funding:- A stage where the business plans to launch its first product. Sadly, as there are barely any revenues generated, the company will require venture capital to fund its operations.
- Early-Stage Funding:- As a company has entered the later stages of their business life cycle, the funding will be required to ramp up production, sales and profit generation. This is usually one amongst a series of funding that will be required before a company can become self-funding.
Working Capital Loans
A working capital loan is taken by an organisation to fund its everyday operations. The money borrowed is used to meet short-term operational needs which include payroll, rent and other operational expenses. The company may have to borrow as they have a shortage of liquidity to cover day-to-day expenses. Usually, companies with high seasonality or cyclical sales may rely on working capital loans to help with periods of reduced business activity. It is important to note that any missed payments on a working capital loan may hurt the business owner’s credit score, especially if the loan is tied to their (proprietor’s/partner’s) credit score. The most important benefit of a working capital loan is that it is easy to obtain and lets the owners efficiently meet any gaps in funding their operational capital expenditure. Being a form of debt financing, the business owner can maintain full ownership and control over the company. Companies with a good credit rating are much more likely to be eligible for a working capital loan without requiring to furnish any collateral. However, sometimes companies with little credit history or low credit score have to securitise their loan with a tangible asset.
Depending on the circumstances, each of the aforementioned possibilities can be thought of as a viable way to meet your organisation’s fundraising needs. However, there are a few important things to keep in mind while trying to raise money for your company. Always make sure to validate your product or idea with the target market, assemble a solid team, comprehend your finances, locate the ideal investors, it can be a tedious process to get enough finance for your business, weigh each of your available options thoroughly before raising funds and understand your debt obligations if any.
Frequently Asked Questions (FAQs)
What are some reasons small businesses seek financing?
The primary purposes may be to open up a new branch, acquire inventory, expand operations, etc. A variety of financing methods can meet these intended objectives.
What records do I need to keep?
You must ensure that the primary financial records are maintained, like journals and ledgers, accounts payable, accounts receivable, sales records, inventory, cash receipts and cash disbursements, bank statements.
What is Bootstrapping in funding options?
Bootstrapping occurs when the company is founded and run using only personal finances or operating revenue. Here the entrepreneurs can maintain sole control but may face pressure on their personal finances. Zerodha, Zoho are examples of bootstrapped Indian start-ups