ABC PTY Ltd. is planning for a business project to manufacture children toys. The company has planned its manufacturing premises, sources of raw materials and target market and now has to arrange funds to purchase machineries, invest in working capital, etc because studies have shown that 94% of start up business fails in their 1st year of operations due to lack of funding (Mittal and Madan 2020). The relevant assumptions about the business that can affect the financing options of the business are:
ABC is required to be clear about its future goals for at least one year ahead or more and determine the capital required achieving those goals, this is how investors and lenders will get excited and willing to invest in the company.
The company should have a unique value (or selling) proposition in its toys. ABC will manufacture the safest toys.
ABC is going to target the children of all age groups (Andaleeb and Singh 2016).
The following are the best options for ABC to finance its business requirements:-
Now since the company is a start up organization, therefore it is advised to first look for the surroundings including relatives and friends to invest into the business as this money flows into the business without any monetary cost (or at very low cost). This source of funding can be coined as equity or internal long-term unsecured zero-interest debt.
Angel investors are individuals with high cash pools and are interested to invest in startups. Similarly venture capitals are funds which are professionally managed funds that invest in companies with huge potential (Ryu, Kim and Hahn 2019). This type of funding is generally of equity nature as company has no fixed obligation of interest payments and will share profits with these investors as the company starts generating profits.
Banks are the first place where entrepreneurs reach for funds, negotiate the banks for lower interest rates, and ask for Government approved subsidies and programs. This are external debt financing and comes a fixed charge. The company might require depositing some collateral security against the loaned amount (Shetty 2017).
The most appropriate sources of financing for, ABC Pty Ltd will be self financing or bootstrapping followed by angel investors and venture capitalists (Herciu 2017). All these sources of financing are equity in nature and the business have minimal burden of repayments. The money invested by the entrepreneur or arranged from relatives or friends comes with zero monetary cost and with angel investors and venture capitalists, the company is just required to just do its business efficiently, moreover these investors provides technical, managerial and operational support which is generally absent in start up businesses but these are hard to seduce (Ryu, Kim and Hahn 2019).
This type of financing can be both long term and short term, but generally bootstrapped entrepreneurs rely on their own savings, lean operations, sweat equity, cash runway and quick inventory turnover. All these sources seem to be short term, however large loan from friends or family can be considered as long term financing. And it has been typically observed that such loans are later converted into equity capital as the company establishes.
The bank loans or debt financing can be the first place where entrepreneurs search for funds, but debt funding does not come in handy, but the business is required to regularly repay a fixed payment including an additional charge of interest. This external debt financing not only includes a fixed charge but are also not easy to get (Shetty 2017). The company is required to have a healthy credit score (or better), there must not be any past credit defaults, and the entrepreneur might require depositing some collateral security against the loaned amount. Hence, bank loan might not be relevant as sources of financing if other sources (as mentioned above) are available (Mittal and Madan 2020).
Andaleeb, U. and Singh, S.D., 2016. A study of Financing Sources for Start-up Companies in India. International Review of Business and Finance, 8, pp.1-4.
Herciu, M., 2017. Financing small businesses: From venture capital to crowdfunding. Studies in Business and Economics, 12(2), pp.63-69.
Mittal, T. and Madan, P., 2020. Impact of financing patterns on business performance of e-startups in India: a research model. International Journal of Business Innovation and Research, 21(4), pp.490-508.
Ryu, S., Kim, K. and Hahn, J., 2019. Crowdfunding Success Effects on Financing Outcomes for Startups: A Signaling Theory Perspective. Available at SSRN 2938285.
Shetty, K.K., 2017. A comparative study on impact of venture capital financing on startups in India. In International Conference on Education, Humanities and Management (ICEHM-17) March (pp. 14-15).
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