Cash is the lifeblood of any business, especially a small business. A small business is “small” with limited capitalization and fewer options to raise cash to finance operations. It thus follows that cash management to record and control cash coming in and out of the business is of paramount importance. Everything about the small business must be structured to maximize cash operations, including retaining cash if possible, while ensuring that cash due to the business is collected as soon as possible.
The first consideration given to cash management is how the business is financed. If a small business is financed the wrong way, it will bleed cash. Too often, the only finance available to small businesses is bank loans, which is unfortunate. A bank loan taken too early by a small business will burden the business with interest costs, which will slow down growth.
Bank loans in Nigeria are expensive and determined on the possession of enough collateral. Many small businesses cannot afford to pay double-digit finance costs, nor do they possess enough collateral to secure funding from a bank. Small businesses must consider seriously the equity option in funding, especially in the early parts of the business life cycle.
Every business has four unique phases: Startup, Growth, Maturity and Renewal/Decline. In each of these stages, the type of finance needed by the business will change.
Every business has the initial startup period of high growth, where their products or services are being evaluated in the marketplace, and if consumers like the offering, business sales start to grow and customers are added. At the growth stage, the business enters a period of rapid acceleration of sales, with operational growth. Activities become more scalable during this process.
When the business enters maturity, sales and growth will plateau, as the company reaches all her identified customers and/or competition reduces the company’s share in the market. Next, either the business reinvents itself, records growing sales and cash flows, or dies. What sort of equity financing can a small business explore at these stages?
At startup, the business is either at idea conceptualization or mapping, where the initial idea is being developed into a viable business plan for adoption by customers. The business at this stage has no clear laid down process, as everything is new. The risk of business failure at this stage is extremely high and lenders know this; thus, financing is a challenge. What sort of financing is useful here?
Founders’ own savings: The first person to fund business should be the founder(s)—they created the idea, so they should put their own money in first. It’s also the cheapest form of finance available.
Family, friends and employees: If family and friends accept the business model and pay to use the product or service, then there is a possibility that the larger market will be accepting as well. This funding type allows the founder tap into the first local base of support, removing the need to make costly interest payments. How does a paid employee invest in a company? By accepting to work for equity in the business, instead of a salary. Founders and families and friends financing takes place at the startup stage.
If a business has successfully navigated through startup and is now at the growth stage, the next form of financing is seed funding. Seed financing is raised by offering equity in the business, in exchange for cash. Seed financing can be done by families, friends, and by investors known as “Angel Investors.” Seed funding is generally used to support and sustain business growth. It generates cash flow to the business without a mandatory repayment with interest, as with traditional loans.
Series A: this is the first round of funding done by the business outside the tight closure of family and friends. Series A finance will come from angel investors, accelerators and micro venture capital firms, and is usually done via selling preferred stock to these investors.
Series B: is intended to take the business to the development stage, and scale up and build market share. At the growth stage, the business has shown that it’s a viable business concern, duplicating best practices to generate revenues. Series b funding is done by venture capital firms.
Series C funding: also called later-stage funding. This funding round occurs when the business has been successful in acquiring and retaining market share whilst remaining a viable going concern. This funding is usually to take the business public via a private or public offer; this is usually when the angels and venture capital firms exit via the public offer.
From founder to family & friends to series funding, these are all equity. Why? because it’s patient capital, equity that does not impose mandatory interest payments thus, allows the small business grow without the heavy burden of fixed repayments on loans.
But does the company need bank loans? Yes, to finance working capital, which is used in day to day operations, i.e. liquidity. While a business may be financed by equity sources, it may still require loans to fund certain operations like filling orders to customers. What are sources of working capital to an SME?
- Bank overdraft
- Bank loan
- Equipment Finance
- Invoice Factoring
- Trade Credit
These finance sources are short-term in nature, repayable from cash generated from operations, and are specific in nature. In essence, they are self-liquidated from earning and are not designed to fund non-sales transactions like salaries.
Many small businesses has died, either due to lack of financing or taking too much bank loans at the start of operations, without having the subsequent cash flow to cover these open positions. Granted, the private equity and venture capital space remain limited in Nigeria, but small businesses, especially startups, need to refocus initial capital raising away from debt into Debt/Equity.