2.9 - Sources of Business

Equity Finance (Internal Sources of Funds)

• Definition of Equity:

• Refers to funds contributed by business owners to start and expand their business.

• For companies, this is referred to as shareholder’s equity.

• Advantages of Equity:

• No repayment obligation:

  • Funds do not need to be repaid unless the owners leave the business.

• Cost-effective:

  • No interest payments as seen in other financing methods.

• Control:

  • Owners retain control over the use of their contributions.

• Disadvantages of Equity:

• Investors may expect a good return, which can impact profit margins if the funds yield low returns.

Common Sources of Equity Finance

Self-Funding:

• Using personal finances to start a business.

• This approach is known as bootstrapping.

Family or Friends:

• Quick and easy source of financing.

• Risk involved: possibility of damaging personal relationships.

• Legal agreements are recommended to protect all parties.

Private Investors:

• Angel investors that seek returns on investment.

• May offer advice to business owners.

• Ownership and control might be shared with investors.

Selling Shares:

• Only companies can issue shares.

• Involves Initial Public Offering (IPO) for public trading.

Crowdfunding

• Definition: Raising money through donations via social media or crowdfunding platforms.

• Process: Businesses outline project goals and invite public contributions.

• Platforms: include GoFundMe. Allows for rapid funding but requires significant effort to generate interest.

External Sources of Finance: Debt Finance

Definition of Debt Finance:

• Funds provided by banks, financial institutions, etc. that must be repaid with interest.

• Characteristics:

• Higher risk due to mandatory repayments and interest.

• Tax deductions are available for interest payments.

Short-Term Debt Options

Bank Overdraft:

• Allows businesses to overdraw their bank accounts.

• Useful for managing temporary cash shortages.

Bank Bills:

• Short-term securities issued by businesses.

• Usually issued for amounts over $100,000, maturing in 90-180 days.

Trade Credit:

• Enables purchasing of goods/services with deferred payments.

• Generally interest-free payment terms.

Long-Term Debt Options

Business Loans:

• Can be secured (backed by collateral) or unsecured (higher interest rates).

Mortgages:

• Long-term loans secured against property.

• Commonly used for real estate and facility purchases.

Leasing:

• Renting equipment without large upfront costs.

• Payments are tax-deductible but often come with higher interest costs.

Government Grants

• Support entrepreneurship and job creation.

• Available from federal and state levels.

• Specific projects can receive funding (e.g., Victorian Government’s Regional Jobs Fund).

Factors Affecting the Choice of Finance

• Terms of Finance:

• Aligning the finance type with the asset lifespan for manageable repayment.

• Business Structure:

• Larger businesses generally have more equity options compared to smaller businesses.

• Overall Cost:

• Importance of calculating the costs of finance against expected profits for informed decision-making.

• Flexibility:

• The ability to adapt financial agreements in response to changing business circumstances.

• Level of Control:

• Sourcing external finance may dilute ownership control.

• Consideration of potential conflicts with partners or investors.

Key Points

• Types of Finance:

• Internal (equity) and external (debt).

• Assess flexibility, availability, and control when choosing finance sources.

• Continuous evaluation of financial choices is crucial for business survival and growth.

Business Support Services

Legal and Financial Advice:

• Regular consultations with solicitors and accountants are recommended.

• Focus on tax and operational insights.

Technological Assistance:

• IT consultants can help establish an online presence.

• Improvements in efficiency are also possible.

Community-Based Services:

• Access to networks and mentoring provided by local organizations (e.g., BEC Australia or Small Business Centres Victoria).

Formal Networks:

• Organizations like chambers of commerce provide resources and support for compliance and training.

Mentorship:

• Engaging with experienced mentors can provide tailored guidance and strategies for business growth.