What is Finance? Types of Finance Part 2
Elaboration of more types of Financing:
In the previous articles, I covered What is Finance, its types and what are the various ways of financing.
Link to last article – http://universeofthoughts.com/financing-types-1/
In this article, some more conventional ways of financing are mentioned. Other than debt and equity finance, these are also widely used ways to finance a business.
1.Venture Capital/Investment Banking
Many institutional firms represent sources of equity financing involving investment approaches which are typically characterized by specific, often demanding investment criteria for their financing interest, result in substantial due diligence investigations, and can require significant ownership sharing. The bulk of this capital source is focused on more developed enterprises with few start-ups or early stage opportunities. Of the entire equity market for small businesses, venture funds represent less than 5 per cent.
2.Friends & Relatives
For most start-up situations or early stage enterprises, capital is typically generated by persuading available friends or relatives to bankroll the venture. Although requiring less in the way of written business materials and perhaps more accessible, there are substantial risks beyond economic considerations which should be seriously evaluated, not the least of which may be disrupted relationships should the business not perform as expected. Since the funding primarily results from the personal relationships involved, complete business plans, a professional support team, and significant due diligence investigations are not characteristic of this funding mechanism. Ownership sharing may or may not be required. Many family members will enter into an agreement through the use of a simple promissory note.
This is often treated as an extra measure to arrange finances. People in the early stages of financing their business, may not have required or adequate sources, in that case taking help to finance from friends or relatives can be considered.
3.Angel Investors/ Angels
Angel Investors represent an informal market of individual investors and business persons/entrepreneurs who may or may not frequent the small business investment area. Access can be through any business contact but is usually the result of professional sourcing through a financing consultant, attorney, accountant, and/or other types of business adviser. A solid business plan with professional support is usually required to achieve an investor comfort zone which also usually includes due diligence review. Risk evaluation and pricing are usually the major issues, as opposed to ownership sharing.
Seed money is used in the beginning planning stage of a small business. The following are the 3 stages of seed money acquirement:
Stage 1 – Usually refers to the stage after the product has proven viable
Stage 2 – A follow-on funding round based upon sales progress
Stage 3 – Later stages to fund growth
Bridge – any short-term financing to provide interim funds between funding cycles or until the next imminent event
5.Private Equity Placements
This form of financing is subject to several regulatory and legal requirements. Accordingly, direct support and continuing assistance from a professional team of financial, legal, and accounting advisors are required to assemble the necessary written materials and establish a successful financial marketing plan. A complete business plan is necessary and due diligence should be expected. Ownership sharing and valuation can be significant issues.
This evolving area of equity financing in its most basic form, represents some other business enterprise(s), related or unrelated to your venture investing to achieve some advantage, economic or non-economic, by providing goods, services, support, and/or attractive credit arrangements to you in return for goods, services, and/or a potential equity position. For example, a major product or material supplier may grant very favourable payment terms to allow extended time for receivables recovery and be improving and/or stabilizing cash flow in return for exclusive dealing, the prospect of larger orders by tracking a firm’s success, handsome interest charges, and/or even potential equity involvement.
This type of financing is extremely effective and, due to its focus, quite efficient. It can occur in a wide variety of forms and can even involve direct competitors in teaming arrangements. Sourcing is usually with professional financial and business advisors requiring a good professional support team, and solid business planning.
This is perhaps the easiest way to finance a business because there is no one else to answer to. A person’s resources might include savings and checking accounts, stocks, bonds and other investments, or the equity in their homes (through a second mortgage or a home-equity loan, for example). Using home as collateral for a business loan is the riskiest of all, because if a business fails one could lose their home. But if the option is available this is definitely the easiest way.
Crowdfunding is a fantastic alternative source of financing for businesses who aren’t able to qualify for traditional financing options, such as bank loans. Crowdfunding is the practice of using the internet to fundraise small increments of money from a large number of people to help start or grow one’s business.