The age-old challenge that every entrepreneur faces is how to fund their business. This challenge comes with an equally ancient set of options – to fund the enterprise using debt or through one’s own capital.
To use your own money, or to borrow it?
Many believe that starting a business is always an expensive undertaking, which must require millions of rands in funding, and that taking out a business loan is therefore unavoidable.
The truth is that a number of successful businesses were started with minimal funding. Michael Dell, for instance, started Dell Computers with a tiny amount of seed capital – only $1 000. Today, Dell employs more than 100 000 people around the world.
The most common source of start-up or working capital is through the entrepreneur themselves. Often, the business person will find funding through their personal resources, whether in the form of home loans, credit cards, or loans from friends and family.
In most cases, it makes complete sense to start a business on a small scale. The principles on which the business might become viable will still apply, but the lessons learned will not be as expensive!
This is not to say that new entrepreneurs should not consider debt as a means of financing their business. Once the enterprise has established itself and begins to attract customers, the time may be ripe to upscale the operation.
Banks are more willing to lend money to businesses that have a track record, and have already built up a customer network and some assets. The main determiner of whether a business is worth investing in is whether the business concept will be viable.
This is more a function of the service being offered, the target market, and the company’s unique selling proposition. If that concept is valid, it can be developed into a business plan and may well attract funding.
Conversely, when a business fails, this can just as easily be due to a weak business concept as a lack of funds.
Banks are in the business of lending funds to promising ventures. As such, they are there to extend loans.
Whether lending from a financial institution or a relative, a business person should not have an aversion to debt. Well-managed and appropriate debt facilities will grow your business wealth over time. This is the principle of leverage, which underpins much of modern finance.
A key to creating wealth through your business asset is to leverage the capital that you have invested, with borrowed capital. Your business asset is the one asset for which you should be willing to take on debt. Gearing or borrowing is an excellent way of creating wealth from the limited capital that you may have available.
The fundamentals of lending are well established. Debt financing or a loan may be issued by a bank, private company, friend or family member. The borrower agrees to pay back the loan amount plus interest, according to certain terms and conditions.
These conditions are pivotal. No matter who you borrow money from, ensure that you retain the majority rights in your business. Beware of signing away your business just to get funding. This will leave you in the position of working just to pay off your debt. Review all contracts to ensure you understand exactly what you’re getting into.
As an entrepreneur, one needs to have a healthy relationship with debt. It is a useful source of funding, and can help you achieve more than you could through organic growth, and more quickly.
It doesn’t make sense to fund all business requirements with your own capital. Use funding wisely, and leverage what you’ve built to create further wealth out of your business asset.
- Desiree Raghubir is a Certified Financial Planner® Professional, BDO Wealth Advisers
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