Firstly, what is business funding? Business funding refers to the money required for starting a business or to run an existing business. Business funding covers the financial requirement of a company for manufacturing, product development, expansion, marketing, etc. Every business, be it short term or long term requires funding to manage its assets, debts and to reach its objectives. The business funding that a company acquires can be used for a lot of purposes based on the decision of the owners or board of directors, but at times, the investors or the fund providers can also have a part in that decision making.
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Why Is Business Funding Required?
The requirement of the business funds may vary from organization to organization but there is no denying the fact that money plays an important role in the success of an organization. Raising the required money by projecting their forecasts and making their investors believe in their roadmap is what determines the future of the company.
Startups usually face more problems in generating funding as their ideas are new, with no background as such, the owners of startups have to convince others on how their ideology is going to be a good investment and how they can convert their business plan into a money-generating scheme for the investors as anyone who is investing only thinks of 2 things, getting back the investment amount, and profits.
A well-established company on the other hand, gets funding in much easier ways due to their business history and the trust they have gained of the investors in the market. Some of the requirements of business funding are:
Meeting Short Term Requirements
Short-term requirements of a business can be things like product manufacturing, Research and Development of company products, working capital needs, raw material purchase, etc. Having proper finances for these short term, yet important requirements help maintain the cash flow in the company and ensure its smooth functioning. For these things, usually, a small loan amount is required which can be easily paid off by not disturbing the fund reserves of the company.
Meeting Long Term Requirements
Long-term requirements can be to kickstart a company or purchase important machinery or other assets like building or plot for the factory and offices of the company, expansion of the business, etc. These are long term requirements as the company usually requires a large amount of funding to carry out these purchases, thereby requiring a heavy investment from the investors which is to be paid off in the long term.
Business funding for such long term. Usually, this kind of funding is provided after a lot of talks and meetings as the amount is large and unless the investors are convinced of the plan, the requirements, which are important for the survival of the company, won’t be fulfilled.
Meeting Financial Goals and Getting Licenses, Certifications:
Every company, be it a startup or a well-settled organization has some or other financial goals for a particular time period. For eg- if a company is valued at Rs 100, over a span of time, say 1 month, they would want that value to reach Rs 120 after all the gains and expenses. For this to happen, they would need to make efficient use of resources and manage them properly and that involves taking loans at times to ensure that they reach the targets and when they have set the growth trend, they tend to return the money with interest.
There are several licenses, certifications, documentation, etc. that would be required on their way to success in order to have the authority to do, whatever they were doing. At times, there may be legal battles as well for which they would have to hire legal consultancy services, which aren’t cheap, especially in corporate matters, all this requires funding without which the company could cripple or be forced to use their reserves thereby staggering their growth rate for years to come.
Types of Funding and Their Sources:
Equity financing is the method of acquiring funding when the investor or a group of investors buy shares of the company to raise capital for the company. Getting equity funds is never easy as the stakes are higher for the investor rather than the owner, there is no direct repayment as such, so there is no guarantee against the investor’s investment.
The organization can launch an IPO and bring its shares to the market would be interested in buying them, as it all depends on the growth record of the company. Gathering equity funds may seem like a nice way for the investors to gather funds without bothering for repayment, but for them, it is like giving up a chunk of their house to other people who are more interested in making money out of their business, rather than helping them.
There is also the added pressure of investors for growth on the owner. The investors get capital gains out of their investment in due time, provided the company shows positive signs of growth and the trend continues in the long run. There are chances that the share price of the company may fall due to management issues, and that would mean a direct loss to the investors. The investors also have a say in the decision-making of the company as they share some percent of the ownership.
Sources: Sources of equity financing include Angel Investors, Friends and Family, Venture Capitalists, Crowd Funding, etc.
Angel Investors are usually those who are interested in the business plan and thus want to invest in the organization and at the same time provide, guidance and consultancy to help the company grow.
Crowdfunding as the name suggests involves several investors rather than a single investor and it involves the small business owners seeking potential investors for their business via online websites.
Venture Capitalists are private investors who are handy for small businesses or startups who are not eligible to launch an IPO and thus don’t have access to the equity market. The venture capitalists, in such situations, provide the funds in return for equity stakes.
Debt Financing is basically acquiring funds through loans. In this case, unlike equity funding, the money acquired as funding needs to be paid off along with interest, but again, the investor or the loan provider doesn’t acquire the stakes of the company in return for the investment unlike in equity funding.
The loans acquired by the businesses can be short-term loans or long-term loans depending upon the needs of the business and the interest rate, time for repayment, etc also varies from provider to provider. The risk factor for the investor is low in this case, as they’re usually the involvement of collateral against the loan to safeguard the investment.
The business on the other hand, although doesn’t have to give up stakes in the company, yet they have the pressure of repaying the loan in due time with added interest else they might lose some assets which could stagger their growth and degrade their credit score, reputation in the market.
Startups face more problems by acquiring such funding due to the pressure of repayment which creates a pressure to generate cash flow to meet the payments with interest and that too at a stage when they might just be showing signs of growth, thereby slowing their progress curve. Acquiring debt funds is easier than equity funds as these days loans are being provided under several schemes, at reasonable rates.
The involvement of collateral makes it even easier to get the loan as the risk on the investor gets lower and the banks are assured of repayment and that too with the added interest that acts as the profit margin for the investor. Unlike in equity financing, the debt investors don’t get a say in decision making within the company as they don’t hold company stakes and usually the debt investors are not bothered about the company growth till they receive their payments on time.
Sources: The sources of debt financing are banks, several Non-Banking Financial Corporations (NBFC), Govt. loan schemes like the MUDRA yojana or MSME loans.
Govt. schemes usually are meant for the small businesses so that they can fight with the corporate giants and don’t have to struggle, just to acquire loans. The loans under these schemes are provided at much lower interest rates as compared to other loan schemes, and although the loan amount is small, it as acts a big help.
Businesses can get grants from the central government, state government, corporate entities having grant programs, etc. Grants are like a donation to the business which acts as monetary support without any pressure from the provider for repayment. There is no risk factor involved in grants for the business as there is no requirement of repayment.
The grant provider also doesn’t get any monetary benefit in return from the investment, although grants may be provided to improve the public image of the investor or as goodwill for establishing business ties in the future. The grant providers don’t have any say in where and how the business utilizes the grant money, though they can consult and guide if the business is struggling to make the right investments.
So, basically, there are several ways in which a business can acquire funding for its several requirements and operations but choosing the correct type of funding, depending upon their current financial status matters, as they would not want to make wrong decisions and further burden themselves for acquiring something that was meant to get them out of trouble in the first place.