7.03 – Determining Your Best Source of Finance
Selecting the right external source of finance is partly a matter of personal preference, but it also requires a strategic approach to managing your business’s financial affairs. Maintaining good lines of communication with various funding sources and choosing the most suitable option for your specific needs at any given time are crucial tasks. This lesson explores the main considerations when determining your best source of finance.
Considering The Costs
Raising capital can be expensive, especially for smaller amounts under £500,000. You need to cover the costs of lawyers and accountants, both for your business and your investor or lender, to prepare agreements and conduct due diligence. It’s not unusual for initial set-up costs to consume 10 to 15 percent of the first £500,000 you raise.
For example, setting up an overdraft or factoring agreement is relatively cheap, usually costing a couple of percent. However, long-term loans, leasing, and hire-purchase agreements often involve additional legal costs.
Sharing ownership and control
The source of your funds impacts how much ownership and control you may have to give up. Venture capitalists typically require a significant share of stock and a substantial say in business operations. In contrast, providers of long-term loans usually leave you alone as long as you meet the interest and capital repayment terms. Finding the right balance for your business is essential.
Parting with shares inevitably leads to some loss of control. Letting go of 5 percent of your business might be a minor irritation, but giving up 25 percent or more can significantly influence how you run things. With over 51 percent ownership, you maintain control, but it becomes precarious beyond that point as you can be outvoted.
Valuing your business to determine how many shares investors receive for their investment can be contentious. Differences in perceived value between you and outside investors are common, and finding a mutually acceptable balance can be challenging.
Hands-On Capital Providers
Some capital providers take an active interest in your business operations, offering guidance or expressing views on how you should run the business. While this can bring valuable expertise and insight, it can also lead to conflicts if their vision diverges from yours.
Securing Loans and Personal Guarantees
Most providers of long-term loans and overdrafts require additional security if the business assets are insufficient. You may need to provide a personal guarantee, such as using your house as collateral. Only by raising new share capital through selling more stock in your company can you avoid increasing your personal liability. Even then, new investors may ask for warranties to ensure full disclosure of the company’s history.
Conclusion
Determining your best source of finance involves balancing costs, ownership, control, and the level of involvement from capital providers. By understanding these factors and strategically managing your financial options, you can make informed decisions that align with your business goals and risk tolerance. This approach will help you secure the necessary funds while maintaining the stability and growth potential of your business.
