Guide to Venture Capital and SME Financing Options
Risk Capital for SMEs
All companies at different stages of their existence need resources, either to grow, to finance their day-to-day operations, or simply to survive, especially in times of economic uncertainty.
Financially speaking, there are only two ways to obtain fresh capital: through debt or by raising capital. Typically, debt financing for small and medium enterprises involves products offered by commercial banks, such as overdraft lines, working capital lines, leases, factoring, consumer loans, or credit cards.
Venture Capital
Venture capital, as the name suggests, is a form of financing through capital.
Venture Capital Funds
These funds invest in business expansion. They operate like typical investment funds but take less risk because they often have government backing or leverage.
Key Considerations for Investors
- Company History: Historical performance, primarily accounting data, is crucial. Inflating recurring expenses to reduce taxes can be detrimental when seeking funding.
- Future Prospects and Opportunities: Is there a clear future project? Why are external resources needed? What is the potential for growth and return on investment?
- Management Team: Investors often prioritize the people behind the project. The team’s experience, vision, ethics, and ability to inspire confidence are essential factors.
Choosing a Bank for SMEs
Several factors should be considered when selecting a bank for your SME:
- Online Services: Businesses operate beyond regular office hours, so 24/7 access to online banking services is crucial for managing transactions, payments, and account information efficiently.
- Incentives and Long-Term Benefits: Evaluate the long-term value of incentives offered by different institutions. A tempting initial offer may not be as beneficial in the long run.
Bank Loans for SMEs
One of the most traditional ways for entrepreneurs to obtain funding is by requesting a loan from a bank. The most common types are commercial and consumer loans. The interest rates will depend on the business’s needs and its ability to meet specific requirements.
Trade Credits
Trade credit is an amount of money provided by a bank to businesses of different sizes to meet working capital needs, procure goods, pay for operational services, or refinance liabilities to other institutions and suppliers.
The difference from consumer credit lies in the payment flexibility, allowing for deferred payment of fees and the use of funds for business activities.
Requirements
To access trade credit, companies must provide the bank with detailed information about their operations, revenue streams, and expenses to demonstrate their ability to repay the loan.
Ability to Pay
To determine a person’s ability to pay (the maximum amount they can borrow), you must calculate their monthly net income and subtract their fixed monthly costs (food, rent, utilities, etc.).
For other expenses like gasoline, clothing, entertainment, estimate a monthly amount. Also, subtract any existing debt payments. If the result is close to zero, there is little to no capacity to pay, and taking on additional credit is not advisable.
Consumer Loans
A consumer loan is a short or medium-term loan that provides readily available funds. It is typically used to finance the purchase of consumer goods (e.g., appliances) or the payment of services (e.g., dental treatment).
Repayment schedules usually range from one to three years, with payments made in equal, consecutive installments.
Requirements
Requirements vary depending on the bank. Each institution assesses the applicant’s creditworthiness and future income to determine their ability to repay the loan.
Costs Associated with Credit
When applying for credit, be aware of associated costs, including:
- Stamps and Stamp Tax: A percentage of the transaction amount.
- Notary Fees: Required for formalizing the loan agreement.
- Expenses Related to Collateral: Appraisals, registration fees, insurance premiums, etc.
- Insurance Premiums: Life, unemployment, disability insurance, etc., if the borrower chooses to purchase them.
Financing Options for Entrepreneurs
What are the best instruments to finance a business entrepreneur?
The easiest options are often equity financing or seeking funds from close contacts (family, friends, and fools). When starting a business, securing capital from third parties can be challenging without a proven track record or established trust.
Essential Requirements for Funding Applications
Requirements vary depending on the business stage and the investor. However, four key aspects are generally considered:
- The business, product, or service and its unique characteristics.
- The market opportunity and estimated demand.
- The management team’s experience, expertise, and credibility.
- Scalability plans, growth projections, and exit strategies for investors.
It’s recommended to “under promise and over deliver” and demonstrate a clear path to profitability and investor returns.
Addressing Insufficient Working Capital for SMEs
For small and medium-sized companies, the easiest way to overcome working capital issues (if not excessively large) is to renegotiate payment terms with customers and suppliers.
Other options include using financial tools like factoring (selling future payments) and/or leasing capital goods. Traditional bank financing and seeking new partners are also possibilities, though the latter can take time.
Managing Company Cash Flow
Planning cash flow at least six months in advance, considering potential variations, is crucial. This allows you to anticipate future shortfalls and find solutions proactively.
Even a simple cash flow management tool, like an Excel spreadsheet, can provide valuable insights into short-term income and expenses, enabling entrepreneurs to make informed decisions and manage their finances effectively.