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How to Fund a Start-Up

In these unusual times while many people are unfortunately having to close their businesses, many people also see the opportunity of starting a new business.

How to Fund a Start-Up

Background

This could be a necessity, as a consequence of being retrenched and not being able to find suitable employment, or something that you have always wanted to do.  Whatever the reason there are a few key steps in funding your start up that I highly recommend you follow.

Just for the record, I do not profess to be the know-all guru with the fool-proof process of starting a new business and securing funding, but having been in the position of both wanting to and having to start a number of businesses I have learnt a few lessons along the way which you may hopefully find useful. And while I may also be a chartered accountant, and understand the numbers, it has been many years since I was in a purely accounting role. 

Invariably, the biggest obstacle in starting a business to trying to secure adequate funding. Countless brilliant ideas have never seen the light of day because the business could not get off the ground – so how do you solve this issue. 

Having assisted a number of business start-ups, the standard process is for the entrepreneur to prepare a business plan. Many of these documents look quite impressive and have spreadsheets showing increasing sales forecasts and income statements that show a nice profit. As a very wise man I once worked with used to say 

“I have never seen a bad business plan, but I have only seen a handful successfully implemented”. 

And therein lies the crux of the matter – why do so many business plans fail in their execution. 

When you understand this issue, you probably also go a long way in solving your funding issues.

Put simply, it is your Marketing Plan.

Credibility of Sales Forecasts

As I often say to aspiring entrepreneurs, “do not show me your business plan, first show me your marketing plan”. And when they do, this is often a couple of paragraphs which is meant to support a detailed income statement with an impressive set of sales figures. People get so fixated on producing a business plan with all its financial information they neglect the fundamental premise on which all businesses are built. 

A sales plan (what you hope to achieve) is very different to the marketing plan (how you will achieve) and when potential funders see sales numbers that cannot be supported by a realistic marketing plan, then those numbers become just that! And upon interrogation, many entrepreneurs admit to increasing the sales numbers to achieve a rate of return they believe funders will be interested in. 

Until you have a really thorough understanding as to how you are going to generate your sales numbers, your business plan is not worth the paper it is written on, and funders will not take you seriously.

Putting together an appropriate marketing plan is beyond the scope of this article but if you need to do this you can get more information by reviewing the articles in the Business section of Money101

The Nature of Funding Required

So the question is “How to Fund a Start-Up”?

Once you have established a realistic sales forecast supported by your marketing plan, you then need to determine your funding requirements which must also be categorised by its nature. 

Long-Term Funding

Should your business require capital (fixed) assets then then the cost of these assets is typically amortised over a period of the asset’s useful life. As the cost of these assets is often quite high, the funding of these capital assets should match their useful life i.e. do not use an overdraft facility. The repayments on a 5-year loan will obviously be less than a 1 year loan (but always understand the interest that you will be paying over this period).

Longer-term funding is normally provided by shareholders or with a long-term loan/capital facility through a financial institution. Apart from the banks, institutions such as the IDC, DBSA, NEF etc. are usually willing to look at funding these assets. This is because:

  • The funding can be backed by the tangible security of the assets and
  • The funding requested are usually higher. Remember that the business consultants at these institutions have annual targets to meet and the amount of work that they need to commit to a funding request of R500k or R5 million is probably about the same. Therefore, higher requests are taken more seriously and given more attention.  

Short-term or Working Capital finance

Your cash flows should distinguish between funding required to generate your sales and the expenses required to maintain your business. 

To generate sales, your business will require working capital to buy stock, and fund other value-adding and sales related processes. Depending on the nature of your business this may also provide an opportunity for your business to negotiate a funding facility that is secured by the stock/inventory that it is funding. This type of funding is typically in the form of short-term loans, credit facilities, or vendor financing.  These are short-term that should match the period of the sales cycle e.g. 30 – 90 days.        

Funding to maintain your business (expenses not directly related to the sales process) is usually the hardest to secure as there is no security. Many potential funders expect the shareholders to fund these expenses. This type of funding is represented by shareholder’s loans, overdrafts, or short-term loans. If your capital/fixed assets or inventory have not already been encumbered, then there may be capacity to use these as a source of security for this type of funding. Apart from any asset-backed security that you may be able to provide, potential funders will probably also insist on personal guarantees to evidence your commitment to the business. 

Summary

It is apparent that you will not be successful in securing funding for your business until you are able to clearly demonstrate to potential funding providers that you have a very clear idea of

  • How the business will be able to achieve its sales forecasts
  • What funding is required.
  • What the nature of the funding is and
  • How the funders will be repaid.

As I said previously, a good idea is just that until you are able to get the funding to be able to turn that good idea into a reality. Following the steps above is not rocket-science but a logical process; however, if after following these steps you cannot produce a feasible funding plan then that idea will always just be a dream. 

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