The Importance Of Your Own Contribution
Phil Stone is a successful management consultant with a background in business banking. He has written numerous books aimed at startup businesses, writing marketing plans and dealing with the financial issues.
Your investment in your business is your risk capital. If you won’t take a risk why should anyone else?
In this chapter, three things that really matter:
- ˜ Making your own investment
- ˜ Gaining the support of your family
- ˜ Using your assets to raise money
Without a financial contribution from you, your request for finance will fail. At the same time, even if you do have a substantial contribution your request may still fail. The size of the contribution is not always relevant. The underlying business proposition is the primary factor. Without a coherent proposal that stands a good chance of success you will not gain finance.
The potential funder will also be looking for total commitment from you. This means that you must have an adequate investment in your business. This has, in part, been explored in the previous chapter. The question of what amount is adequate cannot be satisfactorily defined. It will depend on the proposition.
This shows that for every £1 of capital there are debts of £1.50. Gearing of more than 100% or 1:1 is considered high. Gearing of less than 100% or 1:1 is considered low. This means that with low gearing the owner is shouldering the majority of the risk. Conversely, with high gearing, the lender is assuming more risk than the owner.
For a small business looking to raise finance for the first time any lender will probably be looking for gearing as close to 100% as possible. Having said that, there is no ‘perfect’ gearing ratio and each proposition is considered on its merits.
Consider the example given in Chapter 1. In this case, there was capital of £26,750 and debts of £39,500 which, under those specific circumstances, was not unreasonable. This would give gearing of close to 148% if you ignore the grant funding. If you include the grant of £3,750 which is, in effect, also being invested in the business as capital, gearing reduces to 130%.*
Is this you?
I’ve got a really great business idea but I can’t get anyone to finance me, even though it stands to make a lot of money. • My investment in my business is the skills and experience I have, surely that’s enough? • My family life is not going to be affected by starting my business because I’ll still work the same hours.
Making your own investment
Before you can even consider raising funds from external sources you must make your own investment. This investment can take two main forms:
- ˜ Financial
- ˜ Non-financial
Financial investment, as the name suggests, is a direct injection of cash into your business. If you are operating as a limited liability company, this could take the form of share capital or director’s loan. If you operate either as a sole trader or partnership, it will be classified as owner’s or partner’s capital.
The decision as to which type of business to operate can be complex. There are advantages and disadvantages to operating as a sole trader, or partnership, or as a limited liability company. From the outset you need to seek professional advice on this aspect.
Non-financial investment is the introduction of assets that you may already own. For example, motor vehicles and tools and equipment. These need to be carefully valued for inclusion in your financial records. If you are introducing assets into your business in this way you are advised to seek the help of an accountant. This will ensure that your assets are correctly valued and that they comply with any Inland Revenue guidelines.
As I have outlined previously, there can be no hard and fast rules on how much capital is required.*
In this book, however, we are looking at raising finance for your new business. It is important that you understand the basic criteria used by funders — that of ‘gearing’.
What is ‘gearing’?
’Gearing’ is the relationship between your funds in the business, the owner’s capital, and borrowed money or debt. Let us assume that your new business has £5,000 capital and you are seeking £7,500 of borrowed funds. Gearing is calculated by dividing one by the other and can be expressed in one of two ways:
- ˜ Gearing percentage — £7,500 ÷ £5,000 x 100 = 150%
- ˜ Gearing ratio — £7,500 ÷ £5,000 = 1.5:1
Gaining the support of your family
Starting your own business can be very daunting and can affect your family or home life in many different ways. If you have previously been in employment you can, for example, say goodbye to the standard nine-to-five working life. You may find that your home life and your business life suddenly become less distinguishable from each other.
You must also remember that if you are giving up a job to start your own business, the regular salary or wage payments will cease. Your income will depend entirely on how successful your business becomes. This emphasises the need to have proper funding in place from the start and the importance of having something in reserve.
If you have a family you will require their strong support. Working for yourself is not an easy option and it will require hard work, with the probability of long hours. Remember that paid holidays and days off sick will be a thing of the past. Weekends will also probably be encroached upon to enable you to deal with basic administration.*
Your family or other relatives could also be a source of financial support. The more resources you have at your disposal, the better. That does not necessarily mean that they have to invest financially in your business, but they may commit to helping you should things go wrong in any way. There may also be the option of family loans. As an example, if you are starting as a limited company, your relatives may be prepared to buy some company shares. Remuneration can then be made to them by the payment of dividends when the company becomes profitable.
Another way that families can help is with shared skills. If, for example, you are starting your own business and you have a partner, they may be capable of dealing with basic administration. This may leave you clear to get on and run the business.
Many small businesses start in this way. It also has the advantage of demonstrating total commitment to a potential funder. This can be important when it comes to assessment of the non-financial aspects of your business plan, i.e. the additional resources that you have at your disposal.*
Using your assets to raise money
By this stage you will have realised that without an investment in your own business you will be unable to raise finance. Many small businesses start up without adequate capital resources. This problem could have been solved quite readily with a little lateral thinking.
Looking at your lifestyle
If you are starting up your own business, your whole life will change. This means that you need to reflect upon your lifestyle. It may be that many assets that you hold now, perhaps things that have been built up over many years, could be put to better use. Let me be clear – I am not suggesting that you consider selling the family heirlooms in order
to finance your business. What I am saying is that you need to take stock and look at how your life will change. Some of the assets that you have now could be used to invest in your business.
It is an unfortunate fact that each year many people are made redundant. This can give them a number of choices, the most common of which are probably:
- ˜ Try to find a new job.
- ˜ Undertake training for a change of career.
- ˜ Accept early retirement.
- ˜ Start a new business.
All of these options will mean a possible change in the things that people value. Even with retirement packages being available from around the age of 50, it could mean a substantial drop in income. If you have managed to build up sufficient financial resources over the years this might solve the problem. If this is not the case, especially with the labour market as it presently is, this could mean that you have no option but to consider starting your own business.
You must remember that your new lifestyle will be affected drastically by the success, or otherwise, of your new business. Just by starting your business you are taking a risk. Your lifestyle will need to reflect that risk. Be in no doubt whatsoever that starting your own business and raising finance can be a traumatic experience. You need to be prepared for that trauma.
Converting assets into cash
You also need to take care if you are considering converting assets into cash. For example, let us assume that you have an endowment life policy. Many people make the mistake of surrendering such policies. This is a bad mistake, as you will never be able to realise the true value of that policy. As an alternative, you could investigate whether the insurance company would consider granting you a loan against the invested value.*
By the same token, many people do not appreciate the assets that they already have
which, if necessary, could be sold. For example, as children, many people collect items of little value at the time which in later years languish in a loft. Postage stamps would be a good example. It may be that 30 or 40 years on those stamps will have some value. Perhaps very little, but possibly quite a lot. The point is that they are no good to you where they are now.
- * You must have an adequate investment in your business before you can attempt to raise finance from other sources.
- * Gain the backing of your family for your business and enlist them as much as possible to support you.
- * Evaluate your lifestyle and consider the changes that will be necessary when you start your new business.
- * Look at the assets that you have and see whether their value could perhaps be used to raise finance.