Briefing | Stages of financing and different financial needs for businesses
Different firms at different stages of the business life cycle might require a different approach to solicit investment capital.
Stages of financing
• Seed capital: the seed
capital stage or the pre-commercialisation stage is the phase at which the product or service is analysed and tested for long-term viability. During this phase, the entrepreneur requires capital to develop their prototype, conduct feasibility study, evaluate the business idea thoroughly, and also protect their intellectual property, which is a stage often overlooked by Jamaican product developers. The entrepreneur should know whether or not the business is worthwhile at the end of the seed phase.
n Pre-launch phase: If the research indicates that the product or business is worthwhile, then pre-launch creates the necessary foundation for the business. A detailed business plan must indicate the overall plan and structure that the business will follow. It is time to register the business and properly outline its legal structure.
• Start-up phase: The product is launched in the start-up phase. The firm hires employees and production begins. Sufficient financing is needed to ensure the smooth transitioning of the business from the pre-launch to the start-up phase. Financing is necessary to bridge the gap between the time of production and the time of making profit.
• Early stage: First-stage capital is needed to expand production to satisfy market demand. At this phase, the firm ramps up production and sales. Venture capitalists are more willing to lend to firms that display the ability to break even or earn a profit at this phase.
• Expansion stage: Sometimes a company might be expanding but it is not yet profitable. The second stage of funding is required at this stage to further expand production, offset shipping and other distributional cost and satisfy accounts receivables and payables.
• Third-stage capital: As the sales volume increases and the company becomes profitable, it will need third-stage financing to facilitate plant expansion, increase advertising and marketing, product improvement and further research and development.
FUNDING YOUR SMALL BUSINESS
Investing in start-up businesses is associated with higher risks than more established business due to the limited information available, lack of product penetration in the market, among other factors. Nonetheless, providing funding to these firms is essential. The type of funding they receive will depend on their investment needs as well as the stage of the product cycle that the company is at. Before discussing the different phases associated with small business funding, let us first discuss the types of small business and new idea funding that exists.
1. WORKING CAPITAL
The working capital is money (short-term assets) that the company needs to cover its short-term liabilities to ensure the day-to-day solvency of the business. It is used to cover its short term financial-obligation to ensure continuation of the business. Many businesses do not have working capital, which is one of the paramount most important financial needs of small business and start-ups.
2. LOANS FINANCING
Loan financing is one of the common practices of small businesses and start-ups - to receive funding. Accessing loans through the formal sector is a challenge for small businesses and start-ups. Due to the nature of these businesses, they have insufficient collateral, and their products not being tested and proven on the market provides a big risk for investors.
Microfinancing is a useful source of working capital for small businesses and start-ups to help offset their financing needs, who sometimes do not qualify to receive funding from the banking sector. In recent times, micro financing is provided by benevolent agencies that are more interested in national development rather than for profit, due to the high risks associated with funding these businesses.
4. EQUITY AND ANGEL FINANCING
To mitigate the limitations of loan financing, equity financing provides a source capital for businesses in return for part ownership of the company. Equity financing provides medium or long-term capital for small firms to operate their business without the regular loan-servicing payments, which might deplete a company's cash flow. The investor can contribute to decision-making in the business. One stock equals one vote. Companies which seek funding are at different stages of their business cycle and, therefore, require a different approach to their funding needs.
- Dr Andre Haughton is a lecturer in the Department of Economics on the Mona Campus of the University of the West Indies. Follow him on Twitter @DrAndreHaughton; or email feedback to email@example.com.