In practice, most start-ups make use of the personal financial sources of the entrepreneur. This can be personal savings in the building society, a bank balance. It can be providing assets for the business (e.g. a car). It can also simply be working for nothing! The following notes explain these in a little more detail.
Savings and other "nest-eggs"
An entrepreneur will often invest personal cash balances into a start-up. This is a cheap form of finance and it is readily available. Often the decision to start a business is prompted by a change in the personal circumstances of the entrepreneur – e.g. redundancy or an inheritance. Investing personal savings maximises the control the entrepreneur keeps over the business. It is also a strong signal of commitment to other potential investors and banks.
Re-mortgaging is the most popular way of raising loan-related capital for a start-up. The way this works is simple. The entrepreneur takes out a second or larger mortgage on a private property and then invests some or all of this money into the business. The use of mortgaging like this provides access to relatively low-cost finance, although the risk is that, if the business fails, then the property will be lost too. However, the credit crunch falling house prices has made re-mortgaging harder.
Borrowing from friends and family
This is also common. Friends and family who are supportive of the business idea provide money either directly to the entrepreneur or into the business. This can be quicker and cheaper to arrange (certainly compared with a bank loan) and the interest and repayment terms may be more flexible than a bank loan. However, borrowing in this way can add to the stress faced by an entrepreneur, particularly if the business gets into difficulties.
This is a surprisingly popular way of financing a start-up. In fact, the use of credit cards is the most common source of finance amongst small businesses. It works like this. Each month, the entrepreneur pays for various business-related expenses on a credit card. 15 days later the credit card statement is sent in the post and the balance is paid by the business within the credit-free period. The effect is that the business gets access to a free credit period of around 30-45 days!
Working for nothing!
How can this be a source of finance? Simple - by working for nothing, an entrepreneur saves the business cash. By working long hours and multi-tasking, the entrepreneur reduces the need to employ others - and therefore saves cash that would otherwise have to be paid out in wages in salaries. In just about every start-up, the founders look to save cash (i.e. reduce the finance needed) by putting in the "hard yards"
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