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Small Business Finance: What you need to know

Written by Anni-Mari van Wyk

On Jun 8, 2020

Most small businesses are now having to find financing solutions to keep their businesses alive and surviving through the lockdown.

Small businesses are the ones that are expected to be hit the hardest by this pandemic. Therefore, carefully managing and responsibly finding financing should be at the top of your list as an entrepreneur looking for funding.

A lack of precise and timely knowledge about how secure your business finances can lead to risks or even failure.

It is also important for you to understand the types of small business finances that are available for you before you make any decision.

Here are some of the small business finances that are available for you out there:

  1. Debit/Credit:
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This is a type of business financing where you borrow money. This usually happens through taking a loan from a lender (such as the bank) and pay it back with interest later.

Types of small business debt:

  • Short-Term Loans: These are usually given for smaller amounts and shorter repayment terms and usually used for emergencies. They tend to be more expensive as they are offered at a higher interest rate than other forms of loans that have longer repayment terms.
  • Medium-Term Loans: These are usually available to more established businesses with specific goals such as expansion, new product launches, new marketing or advertising campaigns, etc. These loans are for larger amounts, and have longer-term lengths and lower interest rates than short-term loans.
  • Business Credit Card: Some business credit cards offer high credit limits, special deals for small businesses and flexible repayment options.
  • Asset-Based Loans: Small business owners apply for loans by putting up assets like equipment or inventory as collateral against the borrowed amount. The collateral may be seized if the borrower is unable to repay the loan.
  • Microloan: For small business owners with no assets or prior credit history, getting a commercial bank loan may be difficult. In such cases, they can apply for a microloan from a microlender, who may be willing to offer small loans with less documentation and more flexible underwriting criteria than traditional banks.

2. Equity Funding, 

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In the context of start-ups, equity funding is when a person or an organisation provides you with finance to grow or develop your product. Equity investors require a long-term ownership stake in a venture in exchange for capital.

There are three main types of investors that require equity in return: angel investors, venture capitalists and strategic partners.

  • Angel Investors: Angel investors can either be an individual or group of individuals who use their money to finance start-ups, rather than professionally managed funds. Most of the time, angel investors are friends and family of the founders. Other times, founders would reach out to their community to get investment. Angel investors are often ex-entrepreneurs, business leaders or wealthy individuals.
  •  Venture Capitalists (VC): Venture capital firms invest in new ventures using funds raised from limited partners such as pension funds, endowments, and wealthy individuals. These firms are run by professional investors, often referred to as venture capitalists. Venture capitalists focus on investing in start-ups that are believed to have long-term growth potential, so that they can hopefully tenfold their returns on investment.
  •  Strategic Investors: Strategic investors are extremely similar to venture capital firms, and are sometimes referred to as corporate venture capital. As the name suggests, the investments made by strategic investors are often strategic (such as getting access to technology important to the firm’s initiatives), as well as financial.

3. Other Types of Small Business Financing

  • Crowdfunding: Small business owners can use crowdfunding sites like Kickstarter to fund their new ventures. Quid pro quo would depend on the site and the investors’ equity (percentage stake in the business).
  •  Peer-To-Peer Lending (P2P): P2P differs from crowdfunding in one crucial aspect – a small business owner who opts for P2P does not give away any equity in their business, but rather pays interest on the money borrowed. Thus, P2P is more like debt financing than equity financing.
  • Government Grants: The South African government has released funds for SMMEs in the country to help them cope during the lockdown. For more information about these funds, I suggest you visit: https://www.gov.za/taxonomy/term/924 to learn more.

Dos & Don’ts of Small Business Finance: 

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1. Do Your Homework

This first step – proper financial planning – is critical for any business, but more so for a small business that doesn’t have the luxury of a huge cash pile to fall back on in times of trouble. Without a proper business plan or financial budget/forecast, you risk overspending and overall poor financial decision-making. You may need help from a professional financial advisor to help you make the right decision for your business.

2. DO Keep Track of Your Records

Small business owners need to be diligent about keeping their financial records (receipts, statements, invoices, purchase orders, bills of lading, etc) in good shape. Many lenders are particular about proper documentation so when you apply for finance, proper paperwork will be essential.

3. DO Explore Your Options

As we have discovered, there are several financing options are available to small business owners. And interest rates should not be the only consideration. You can also look into exploring the following factors before you decide which option works for you:

  • What are the terms and conditions of each?
  • What repayment options are available?
  • What is the repayment period? Is it flexible?
  • What are the penalties for defaulting on repayment?
  • Is there a holiday on interest repayments?
  • What guarantees – e.g. collateral – do you need to provide?

4. DO Borrow the Right Amount at The Right Time

Your financial plan will help you understand how much you need to borrow and for what purpose – expansion, marketing, hiring new personnel, new value proposition, new equipment, etc. You also need to be strategic by understanding the options available and by choosing the right time to borrow

5. DON’T Over or Underestimate ANYTHING

Overestimating your income and underestimating your expenses are both counter-intuitive actions with potentially devastating outcomes. Review your budget and financial forecast and adjust the numbers based on market/industry trends, political realities, competitors’ performance and your performance. Add a margin of error if required.

6. DON’T Forget Your Elevator Pitch

For a small business owner, negotiating with a lender can be like applying for a job. Before doing so, you need to prepare your business’ elevator pitch: know your firm’s mission, purpose and track record. You must also know your people and remember that they can make or break your business. Also, very important, you must know your budget and your financial forecasts – simply preparing them is not enough; you must be able to recite important statistics. If you cannot convince a lender that you believe in the viability of your business, they won’t either.

7. DON’T Panic

Risk appetite differs from person to person and business to business. However, business owners must remember that risk is an inherent part of commerce, especially for small or new firms. Therefore, in the beginning, don’t stress about finances, but focus on preparing your business plan, budget and financial forecast. Then look for clients, create a marketing plan and build your business. If you have the right plans, proper documentation and believe in your firm’s mission, you will get the right amount of money from the right investor.

8. DON’T Be Afraid to Take Risks

Bank loans are not the only option available to small business owners. Be strategic in applying for financing by keeping an eye on your credit score (and how it can be affected), by understanding the costs associated with each lender and by understanding which assets you may have to sacrifice if you can’t repay the loan. At the same time, don’t worry even if you have to start from scratch. Even with no revenues, customers or employees, small businesses can get financing to get their operations going.

9. DON’T Forget to Pay Your Taxes

Starting and running a small business is challenging, and paying taxes can take a back seat in the overall scheme of things. But accidental forgetfulness (or ignorance) can have a boomerang effect later. Your firm’s tax status may depend on several factors, including the type of business and country of operation. Educate yourself on tax rates, slabs, rules, filing deadlines and penalties in your country/industry, and make sure you honour your tax obligations.

If you’re still not sure about the type of financing that might be suitable for your business, feel free to drop me an email and we can further have a detailed discussion about this. Email me on: an@cvwab.co.za

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