Introduction to Financing

At every stage of a business, there would be differing financing needs. The risk appetites of business owners influence the funding decisions of businesses. Some business owners choose not to borrow but take a slow and steady path to growth. These business owners may not be able to seize certain business opportunities if they do not have the required funding but they may be able to build the businesses on strong foundations. On the other hand, there are also aggressive business owners who may take on more financial risks than they can manage and as a result, drive their businesses into financial woes.

To borrow or not to borrow?

So, is borrowing good or bad for business? There is no right or wrong answer here.

For example, a customer is prepared to give your business a 3-year contract for a trade that requires the business to invest in new capital expenditure of $100,000. The business is able to generate net cash of about $50,000 per year on the trade for the next 3 years. Total cash the trade would generate for the 3 years adds up to $150,000. The business owner pays $20,000 from his personal savings and takes a 3-year hire purchase loan of $80,000 to fund the required capital expenditure. The loan has a fixed interest of 5% per annum. Total cash outlay to repay the hire purchase loan and interest amounts to $92,000. Without considering the time value of money, the net gain on the trade would be $38,000 for the 3 years. If the business owner chooses not to borrow, he would have missed the opportunity to make the $38,000.

Is this a sure business? In reality, no one can give you any assurance. Anything can go wrong and it may also turn out that the business fails as the order is terminated pre-maturely by the customer due to unsatisfactory services. What happens when there is no confirmed customer order and the business owner is only pitching for prospective business? To add on, the new trade is something that the business owner has no prior experience in executing and there is little resale or scrap value for the equipment. Should the business owner borrow? If the business owner has the drive and is confident of his team, he may still borrow and there is a chance that he can succeed and create a new business empire out of it.

What business owners should do:-

(a) Know your own capability, understand your threshold for risks and find the right level of leverage for your business.

(b) Inculcate the right mindset of borrowing responsibly.

(c) Conduct detailed feasibility study, run the financial modeling and review the sensitivity analysis to understand your downside risks. Borrow only after you have done your sums and have reasonable confidence of repaying the loan.

(d) Have "Plan B" or even "Plan C" in place so that there is no chance that the business will be completely wiped out if the trade does not take off as planned.

Seeking Financing

The best financing is to tap on government assistance, which are in the form of grants, loans, tax incentives and even equity financing. These are made available to qualifying SMEs. Find out what suits you best and tap on the relevant schemes to help you start and grow your business.

(a) During Start-up

Most businesses are initially funded by owners' personal money. Bank financing is usually not an option for start-up businesses, especially in the first couple of years of operation. Start-up businesses are seen to be riskier as there are no proven track records of success.

Seeking external financing at this stage is an uphill task. The most common funding that the business owners seek at this stage would be through personal loans from friends and relatives, credit cards and/or personal credits, trade credit from suppliers and equipment hire purchase loans.

(b) At the Growth Phase

As the business grows, more cash may be required to buy new equipment to expand the capacity, rent more space to cater to expansion needs, hire more people to support the operations or to finance the increasing working capital needs of the business. The business may need to seek external financing to fund the growth.

Growing businesses can seek funding from banks, financial institutions and private equities. Financiers assess the risks and rewards of funding a business case. If you have a compelling business model that can generate steady stream of cash flow and a management team with proven execution capabilities, you will have a strong case for seeking financing. If the business owners' interests are aligned with the Financiers', as illustrated by the substantial capital that has been injected into the business, and business owners have valuable personal collaterals to offer as security to the financiers, it will be relatively easy to obtain external financing.

Healthy and growing companies with track records of good profits and good growth prospects may also tap on the capital market to raise equity funding through an Initial Public Offering ("IPO"). There are pros and cons in seeking funding through an IPO. It is an expensive exercise for most SMEs and hence, before you embark on it, your are encouraged to seek professional advice.

(c) When in Distress

Most businesses will find that it is almost impossible to seek external financing in times when the businesses are facing cash flow crunch and have defaulted on loans. Financiers would not be able to support a business case during times when the risk of failure is high and when the business owner is seen to be losing credibility. The business owner would need to initiate a thorough assessment of the situation and find out the root cause of the problem. You need to conduct this fact finding exercise so that you are able to address the fundamental questions that any financier would be asking:

(i) Is the business still viable?

(ii) What does it take to nurse the business back to health?

(iii) How much is needed and when would you need the cash?

(iv) What are the resources required and do you have these resources?

(v) How long will it take?

Typically, you would need to quantify the current exposure and estimate the future cash flow and profitability. From the financier's perspective, the information is necessary for the assessment of risks and returns of funding. It is extremely important to not avoid your existing financiers and creditors but to face them forthrightly by engaging in open and honest discussions. Give them the assurance that you are in control of the problem and are committed to resolving the issues.

Matching the right type of financing to your business needs

Remember the golden rule of financing - do not take short term borrowings to fund long term assets, such as leasehold property, plant and equipment.

This is one of the reasons that have caused many good businesses to fail.

A food and beverage company ("F&B Co") embarked on an expansion track to open new outlet. Instead of seeking term-loan to fund the renovation cost, it obtained 120 days trust receipt financing for the purchase of food costs and took the cash to pay rental deposit and renovation cost of the new outlet. The new outlet was not able to generate the sales as desired due to low traffic during the initial periods. When the trust receipts were due for payment, the F&B Co found that it has no cash to repay the trust receipt fees.

In another situation, a lifestyle business owner had a profitable business. He formed a new company to embark on new venture that required $1 million cash outlay. The new venture had long gestation period and he was not able to obtain any funding for the new venture. As the lifestyle business has proven track record, he obtained a working capital loan through the lifestyle business and the money were advanced to his new company to fund the new venture. Very soon after that, the lifestyle business faced liquidity strain as the cash generated from the lifestyle business was insufficient to repay the loans.

You can refer to the following chart as a guide to help you select the type of financing that match to the needs of the business.