Financing Alternatives for Business Essay
This essay discusses financing alternatives for business. A used book store will be used as the model for discussion. The essay begins with a description of various financing sources. Appropriate alternative sources for the used book store will be identified and their risks and rewards will be described. How the business can qualify for financing will be explained. The risks and rewards associated with the financing alternatives will be discussed, along with options for financing future growth.
According to the Small Business Administration, SBA, many smaller start up businesses use equity, or ownership, financing from personal savings, friends, and relatives. The existing financing for the book store comes from a rich relative of the owner. The advantages of this type of financing include ease of qualification and speed of obtaining funds.
The risks involved with this type of financing centers around structure. If the relative issued a personal, no interest loan to start the book store and expects to be repaid, there may be no formal contract outlining the terms. If the owner does not repay on time future financing may not be available. When this is the case, the business must seek more structured forms of debt and equity financing.
Debt financing comes from borrowing funds from outside sources. Equity financing comes from selling ownership to outside investors. (Ebert & Griffin, 2005) Sources of debt financing include bank loans, leasing, and lines of credit. Leasing and a line of credit are the most appropriate sources of debt for the used book store. Sources of equity including selling common and/or preferred stock, or obtaining venture capital interment. Venture capital investment is the most appropriate source of equity for the book store.
Leasing is the most effective way for a small business to finance facilities and equipment. The primary advantages of leasing is ease of credit qualification and low initial cash requirements. In order to finance a business real estate purchase some banks may require a large down payment. With leasing a security deposit is generally to only initial cash requirement. (Business Owners Toolkit, 1995-2009) The same applies to equipment leasing. Credit qualification is less restrictive in leasing because the lessor retains ownership of the property or equipment and can easily recover the item in case of non payment.
As a retail business the used book store will have seasonal needs. There may be a need to make purchases over and above existing trade credit limits in order to keep high demand items in stock. A seasonal line of credit from the bank that handles the book store’s checking account and credit card activities would be advisable. The company would qualify based on existing and previous sales. The bank may require the ability to deduct payments directly from the company account.
When the used book store is ready to open additional retail locations, become a national chain, or become a franchise operation, venture capital will be an appropriate form of growth financing. Venture capital is equity or ownership investment from professional venture capital funds or government venture companies called small business investment companies, SBICs. (Small Business Administration, 2009) The primary advantages of venture capital is that it is a form of equity that does not have to be repaid. Qualification is not based on credit factors, but on the future value that the investment will create.
Some venture capitalists invest in specific industries such as the retail sector. Some invest specifically at the expansion stage. The type of venture capital the used book store will pursue depends largely on the stage of growth at the time. Venture capitalists look to receive a return on their investment and exit from the company within a three to seven year time frame. (National Venture Capital Association, 2009)
The most important qualification for venture capital investment is strong management and a sound business plan. One of the major risks with venture capital is that the investors, as owners, have a say in the management decisions of the company, especially where profits or growth is not at expected levels. The primary qualification for venture capital financing is willingness to relinquish or share management responsibilities.
Like all businesses, the used book store must have adequate funds to meet daily operating expenses, certain seasonal expenses, and long term expenses, and to finance expected growth. For start up financing, leasing equipment and facilities is the least expensive and most easily obtained form of financing. Short term lines of credit will provide on going financing for daily and seasonal operating expenses. For long term growth and business expansion, venture capital will provide equity financing and management assistance.
Business Owners Toolkit. (1995-2009). Leasing advantages. Retrieved March 4, 2009, from http://www.toolkit.com/small_business_guide/sbg.aspx?nid=P04_5150
Business Owners Toolkit. (1995-2009). Leasing your equipment. Retrieved March 4, 2009, from http://www.toolkit.com/small_business_guide/sbg.aspx?nid=P04_5100
Ebert, R. J., & Griffin, R. W. (2005). Business essentials. Upper Saddle River, NJ: Pearson Prentice Hall.
National Venture Capital Association. (2009). The venture capital industry – and overview. Retrieved March 4, 2008, from http://www.nvca.org/def.html
Small Business Administration. (2009). Finance start-up
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