When funding a new business there are two
types of funding sources, internal and external.
Internal funding is the cheapest method
of funding as you are not relying on the
External funds are those that come from
outside of your business and may come from
Banks, commercial lenders, your Franchisor,
suppliers or venture capitalists such as
When funding your venture you should always
look to internal funding first. Most businesses
use a mixture of both. The advantages are:-
1. Using internal funds lowers the cost
of gaining external funding.
2. Lenders like to see that the business
owner has some “hurt money”
invested in the venture. This shows a
greater commitment from the business owner
to the business.
3. It is unlikely that a lender will give
you 100% funding. If they do then they
will want ownership of the business.
Importance of internal/self funding
In most cases a business is started out
of the cash reserves of the owner. For small
business most financers will not lend unless
the owner/s have a vested interest in the
business. If you are unwilling to commit
some of your own funds into starting the
business then it is unlikely that a lender
will and it may be that you need to re-assess
the idea of going into business.
While some lenders will lend a larger amount,
they will ask for greater returns to match
their greater risks. This will result in
higher interest rates or they will take
an equity stake in the business. The result
is that you may not risk your money initially
but in the long term you risk having ownership
of the company that you have built..
When assessing deals lenders will look at
key ratios such debt/equity and times interest
cover. The less that you have to borrow
then the better that these ratios are and
greater your opportunity of gaining funding
and the lower the cost of borrowing.
Debt financing is the most common way of
raising money and it is usually in the form
of the borrower receiving a loan based on
security of some sort being offered. When
the loan is repaid the security is released.
If the loan goes into default then the lender
will call on the security to repay the debt.
There are various types of security that
can be offered:
1. Residential real estate:- This is a
favourite of Australian Banks
2. Commercial real estate:- The banks
will lend less against this as often it
has been built for a “special purpose”
and resale in the event of default can
3. Guarantor:- May come from a relative,
supplier or franchisor. The guarantor
signs the loan deeds and agrees to make
the loan repayments if the borrower is
unable to meet their commitments.
4. Equipment:- Often these loans are in
the form of leases, Hire Purchase or Chattel
5. Finished goods:- The value of stock
6. Debtors List:- The lender will advance
money based on the value of your receivables
7. Business Assets:- In the case of certain
franchise systems in Australia the lenders
will lend against the assets of the business
/ new business, including the good will.
While banks have been wary in lending to
new business in Australia they have shown
that they are starting to understand franchising
and regard franchise businesses start ups
to be lower risk than other forms of small
business start up and as such most have
a franchise lending policy
When assessing the deal the lender will
assess both you and your business model.
Therefore, you will need to be prepared
to supply both business and personal data.
When applying for a loan based on an accredited
system you will need to supply a business
plan, a projected cash flow analysis and
your personal debt position.
The franchisor is also a potential source
of funding be it in the form of a guarantee
for your bank loan, or reduced establishment
costs. These are generally repaid by increase
royalty and are usually at a higher rate
than bank finance.
Other forms of finance are equity investors
and venture capital. These entities will
generally lend money to more risky ventures
than the banks, however, the trade off is
that they will charge significantly higher
fees. Venture capitalists also only fund
a small proportion of the deals that they
see each year. The disadvantages are that
it is hard to secure funding and they expect
high returns and an exit strategy. As they
fund higher risk opportunities they will
lose money on a number of deals so this
is factored into the cost of your funding
. If your business is successful the financier
will end up with 20 –70% of the equity
of the company.
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