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Raising capital

Equity

Once you have worked out your capital requirements, you need to calculate how much of that figure you need to raise as equity. There are no hard-and-fast rules as to the amount of capital you need to raise; amounts vary markedly by industry.

You should draw up a detailed list of the cash, savings and tangible assets that will be invested in the business. To increase the amount of equity in the business, you can bring in a business partner to invest and work in it. Depending on your circumstances, you may want to consider bringing in a silent partner/shareholder whose only involvement in the business is to provide capital.

Be aware that these shareholders/partners are also entitled to a share of the profits from the business. You should clarify liability for any losses at an early stage to avoid disputes.

The difference between your equity and the total amount of capital you need has to be made up by borrowed capital.

Borrowed capital

The primary source of borrowed capital is usually credit. The main types of credit are:

Investment loans

Investment loans should be used to finance fixed assets (e.g. land, buildings, machinery, vehicles, office furniture). Loans provided as investment loans are long-term, and are usually for a term lasting between four and 20 years.

Loans are usually provided as either annuity loans or instalment-based loans. The advantage of annuity loans is that the repayments remain constant throughout the term of the loan, which means your outgoings in the first few years will be lower than for an instalment-based loan. This can make it easier to weather any early difficulties you might face when setting up your business.

With an instalment-based loan, the amount you pay in repayments and interest will be higher in the first few years than it would be with an annuity loan. However, that amount will reduce steadily as you pay off the loan.

Don't fall into the trap of calculating the cost of a loan purely on the basis of the interest rate!

To calculate the true cost of credit, you need to know all of the following information:

  • The interest rate
  • The term of the loan
  • The number of instalments and when they are due
  • Ancillary costs associated with the loan, including issue and processing fees
  • How the interest will be calculated (i.e. the date used to determine what the interest rate will be)
  • How the repayments are credited to your account (when your repayments are deducted from the principle)

Check whether you are eligible for a subsidised loan.

Leases

Leasing is often an alternative option for funding your business. Under a lease, you effectively rent items you want to invest in. If you still want them after the relevant period of time specified in the agreement, you can buy the items by paying off the rest of the previously agreed purchase price.

The great advantage of leasing items is that it protects your equity, because you do not have to pay the entire value of the investment up front. Until such time as you enter into the contract, you can negotiate repayments to suit your circumstances.

However leases also have some disadvantages, for example:

  • Once you have concluded a lease, you cannot change it
  • The interest rates payable on your lease are affected by changes to overall interest rates
  • If you terminate the lease or fail to make repayments on time, the associated fees and charges can end up costing you more than a loan would have done

Whenever you are considering leasing an item, you should seek advice from a leasing specialist (for example a certified accountant or business adviser).

Overdrafts

Overdrafts can help you meet current business expenses and make payments. Getting agreed credit from your bank can help you handle your current expenses and make payments. You can use your overdraft up to the agreed limit as you see fit, without burdensome paperwork. Interest will only be charged on the portion of the overdraft that you actually use. However, additional fees and charges will be attached to overdrafts, which is why they should only be used to raise short-term funding.

If you are considering an overdraft, make sure you get detailed advice from your bank and compare the conditions associated with the different overdrafts available carefully.

Supplier Credit

Supplier credit is the most expensive form of credit – even if that isn't necessarily obvious at first glance. There is no specific form or procedure for this type of credit; you simply agree with the supplier that you will pay for the goods it supplies in arrears by a given deadline (for example, 30 days from delivery) rather than paying for it immediately.

If you see the sentence "Payable within ten days with deduction of two per cent discount, or within 30 days with no discount" on an invoice, that means that two per cent will be deducted from the invoice if you pay it within the first 10 days. Effectively, this means that if you do not pay within 10 days, you are being charged an annual interest rate of 36 per cent, so you should ideally pay all your invoices within the discounted period. You may want to consider using an overdraft facility to make sure you can do this.

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Last update: 18 January 2021

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