A business must start with its own funds and graduate to seek outside financing. That is a smarter choice. If the idea is good and if the entrepreneur shows promise, there are angel investors who will find it worth financing a business. It is a win-win as it ensures a good return on your money while supporting a new business.
But it is not easy to raise money. We are not talking about small businesses with a great idea that will make it worthwhile for the formal funding market to take an interest. We are talking about a small operation in a small town, a sole proprietorship. So we don’t need a shark tank approach of selling shares and getting the investor interested in the idea.
That doesn’t mean the business isn’t generating value or profit. We have millions of companies that operate at a micro level, managed mostly with their own funds. These companies routinely lack working capital. They are also struggling to find the scale at which they can operate, and any expansion needs money. In this case, the entrepreneur seeks personal assets to finance the expansion of the business. I had to put my list up for his consideration.
First, calculate your working capital needs. Yours is a distribution business where you buy some goods and sell them to another market. Purchase orders are placed after closing the sale with the customer. How quickly the seller needs the money and how quickly the customer will pay determine working capital needs. Estimate this for annual turnover. Know that number as the money needed to keep sales going.
Second, negotiate with both the seller and the buyer for a close match. If the buyer pays in 90 days and the seller can’t wait more than 60, the business needs 30-day financing. The credit that both parties offer and request depends on market conditions and competition. Explore the possibility of negotiating a better deal. Would the seller offer a better credit period for a higher price? Would the buyer pay earlier at a discount? Would the buyer be willing to pay an advance? Can a payment structure based on milestones be set up?
Third, examine the buyer’s profile to see if there is enough diversity. Large buyers will mostly have process-driven bill payments that take a certain amount of time. Some buyers may take too long to pay. Except for following up and persuading them, there aren’t many options to speed up payments. Relying too much on a few big buyers can make it even more serious.
Fourth, look for working capital hosting. Banks, NBFCs and other smaller financial companies may be willing to discount the bill and make a loan. This is one of the most common categories of loans available to providers of goods. The interest rate is also a reference point for the scope of the margins that your company must generate. If the money is available at 14% and your margin is greater than 20%, you can finance the working capital of your business and expand it if you get funds against your invoices.
Fifth, make sure business records are in place. Even if it is a small sole proprietorship business, have a bank account for the business. Make sure all receipts and payments are recorded. Have a billing and monitoring system. Pay applicable taxes. Disclose all information and file statements. Without knowing your business numbers with historical track record, financing of any kind will be difficult. You cannot raise angel funds or any other long term capital without audited verifiable business numbers.
Sixth, do not borrow from friends and family. It’s always tempting to look for funds from sources that are easy to tap into. But such funding does not come with responsibility. If you are serious about your business and want it to be a constant source of profit for you, you need to keep an eye on price, margin and be willing to pay the cost of funds. That keeps the responsibility for trade choices higher. Easy money is a trap to take undue risks and skip the necessary due diligence and process.
Seventh, do not mix your personal life and your business. Putting your home, assets, and jewelry on the line for a business is too big a risk for your family to bear. Separate company assets from family assets. Do not indulge the family with expensive gifts and expenses from business profits. That creates a continual flow of money in your mind that makes you feel entitled to tap into family assets in times of need.
Eighth, build some assets for the business. Even if it is a commercial business that does not need capital investment. Reinvest earnings to create assets in investments in treasury products such as deposits, bonds, liquid funds. It would be easier to borrow against these assets when needed. In an extreme emergency, these assets can be liquidated and rebuilt.
Ninth, expand the business taking into account the financing requirements to be implemented. It can feel good to receive a large order from a large customer. Getting that account might seem prestigious and the steady order book might be just the jump you needed. Make sure you are prepared to expect payment delays and have the funds to support it.
Tenth, build and monitor performance metrics for your business. Know the exact days of seniority of your creditors and your debtors. Know the growth rates of income and its seasonality. Know the margin and costs, and account for them diligently. Set standards that you will measure and meet. Many businesses have been unable to celebrate revenue without considering the impact late payments and rising costs can have on their survival.
Entrepreneurship is such a common and widely prevalent trait in India. We celebrate our ability to spot an opportunity and turn it into a business, no matter how small. Be careful not to overdo native wisdom and common sense when running a business. Not everyone intuitively knows how to keep a business afloat. It can be a punishment to learn the hard lessons.
(The author is president of the Center for Investment Education and Learning.)