Forecasting and Obtaning Capital for Your Small Business

Forecasting the need for capital, whether debt or equity, has already been
discussed.

The capital to finance a business has two major forms: debt and equity.
Creditor money (debt) comes from trade credit, loans made by financial
institutions, leasing companies, and customers who have made prepayments on
larger–frequently manufactured–orders. Equity is money received by the
company in exchange for some portion of ownership. Sources include the
entrepreneur’s own money; money from family, friends, or other
non-professional investors; or money from venture capitalists, Small
Business Investment Companies (SBICs), and Minority Enterprise Small
Business Investment Companies (MESBICs) both funded by the SBA.
Debt capital, depending upon its sources (e.g., trade, bank, leasing
company, mortgage company) comes into the business for short or
intermediate periods. Owner or equity capital remains in the company for
the life of the business (unless replaced by other equity) and is repaid
only when and if there is a surplus at liquidation of the business–after
all creditors are repaid.

Acquiring such funds depends entirely on the business’s ability to repay
with interest (debt) or appreciation (equity). Financial performance
(reflected in the Financial Statements discussed in Chapter II) and
realistic, thorough management planning and control (shown by Pro Formas
and Cash Flow Budgets), are the determining factors in whether or not a
business can attract the debt and equity funding it needs to operate and
expand.

Business capital can be further classified as equity capital, working
capital, and growth capital. Equity capital is the cornerstone of the
financial structure of any company. As you will recall from Chapter II,
equity is technically the part of the Balance Sheet reflecting the
ownership of the company. It represents the total value of the business,
all other financing being debt that must be repaid. Usually, you cannot get
equity capital–at least not during the early stages of business growth.
Working capital is required to meet the continuing operational needs of the
business, such as “carrying” accounts receivable purchasing inventory, and
meeting the payroll. In most businesses, these needs vary during the year,
depending on activities (inventory build-up, seasonal hiring or layoffs,
etc.) during the business cycle.

Growth capital is not directly related to cyclical aspects of the business.
Growth capital is required when the business is expanding or being altered
in some significant and costly way that is expected to result in higher and
increased cash flow. Lenders of growth capital frequently depend on
anticipated increased profit for repayment over an extended period of time,
rather than expecting to be repaid from seasonal increases in liquidity as
is the case of working capital lenders.

Every growing business needs all three types: equity, working, and growth
capital. You should not expect a single financing program maintained for a
short period of time to eliminate future needs for additional capital.
As lenders and investors analyze the requirements of your business, they
will distinguish between the three types of capital in the following way:

1) fluctuating needs (working capital); 2) needs to be repaid with profits
over a period of a few years (growth capital); and 3) permanent needs
(equity capital).

If you are asking for a working capital loan, you will be expected to show
how the loan can be repaid through cash (liquidity) during the business’s
next full operating cycle, generally a one year cycle. If you seek growth
capital, you will be expected to show how the capital will be used to
increase your business enough to be able to repay the loan within several
years (usually not more than seven). If you seek equity capital, it must be
raised from investors who will take the risk for dividend returns or
capital gains, or a specific share of the business.

 

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