MODULE 7

FINANCING THE VENTURE

Learning Objectives:
 Define what capital is and its kinds
 Enumerate the sources of capital
 Identify the kinds of source for a type of business
 Enumerate the risks involved in each kind of source

A new business project need not have substantial start-up capital requirement nor does one have to be a
millionaire to start an entrepreneurial business endeavor. In fact, many entrepreneurs have commenced
their businesses out of shoestring capital or with little amounts as what is in their savings account. Others
literally do not have capital, but have good business ideas and the guts, as well as courage to start the
business using someone else’s money.

CAPITAL REQUIREMENTS

From an entrepreneur’s viewpoint, capital is not all about or does not necessarily mean money. In fact,
some entrepreneurs consider idea (an innovative idea) as a form of capital that is much more precious
than money. From financial viewpoint, however, capital comes in monetary terms and in three forms as
follows:

1. Fixed Capital. Fixed capital refers to the money needed to purchase fixed assets or capital goods.
This includes amounts meant for the acquisition of machinery, buildings, office equipment, and
all those fixed assets or the items needed in the provisions of services to the customer.
2. Working Capital. After putting up the business with all the basic amenities and capital items in
place preparation for operationalizing the business, the other capital requirement, which refers to
the working capital, is needed to fund the day-to-day operations of the business. Working capital
represents the money or hard cash to support its normal short-term operations. It is generally used
for inventory, payroll, utilities, and stock/inventory, and also to take care of the unexpected
emergencies, as well as to keep the business an ongoing concern.
3. Growth Capital. Unlike working capital, growth capital is not related to daily or seasonal
requirements for funds of the business. Instead, growth capital requirements are needed when an
existing business is set to expand, diversify, or change its directions.

THE FORMAL OR INFORMAL SOURCES

Formal Sources – it means sourcing or borrowing funds from organizations or institutions duly authorized
by government or by law to extend financial assistance or other forms of support services to business and
industry. It include banks (private commercial banks and government-owned or controlled financial
institutions), investment houses, lending investors, mortgage bank, pawnshops, credit card companies,
and others.

Informal sources – it include those fund sources other than formal sources other than formal sources
mandated by law to provide capital or financing to business organizations. This group includes the
entrepreneur’s parents, brothers and sisters, relatives, friends, suppliers, and other fund providers outside
of the financial system. (i.e., informal sources including usurers).

OWNERS’ EQUITY

In a corporation, the contribution of the owner to the capital of the business is called equity and is
evidenced by the issuance of stockholder’s certificate issued by the corporation. It is also oftentimes
referred to as the ownership in the corporation and the holders of stock certificates are called
stockholders.

As the owner/stockholder of the business or corporation, there is no other party in the organization that is
anxious about seeing the business growing and expanding. Hence, should there be a need for funds to
expand the business or to open up a branch or a subsidiary, the business organization can look forward to
the owners/stockholders as immediate source of funds, which can be done wither by additional equity
infusions or personal loans by the owners/stockholders to the business as an organization.

Long-Term Borrowings

Long-term, as well as medium-term creditors, refer to organizations whose main businesses are generally
meant for providing such form of financial assistance. Generally, they include banks and mortgage houses
that provided funds or capital whose payments are made on a long-term basis, say 1 to 3 years (for
medium-term loans) and 3 years or more (for long-term loans). These fund sources take the form of the
following:
 1. Mortgage. A mortgage takes the form of fund generation by way of pledging a designated
property as security or collateral for the loan. If the need arises, the company can mortgage its
equipment or real estate property to the bank, a mortgage organization like a pawnshop (in case
of smaller amounts), or by way of special arrangement with a individual who is in position to
help an entrepreneur in dire need of funds.
2. Bonds. These are forms of indebtedness of the issuing company that promises as a fixed amount
of interest to the bondholders upon maturity or call by its holders. Companies and business
organizations with good track record in the industry can arrange for an issuance of a bonds
requires approval from the Securities and Exchange Commission (SEC) and traded in the stock
market, or it may necessitate a third party (e.g., investment bankers, trustee bank, stockbrokers) to
handle the bond floatation. Bonds generally carry a fixed investment or holding period of at least
one year, running two to five years or even more, depending on the terms of the bond issued.
3. Long-term commercial papers. LCPs are commercial documents issued by large companies with
credible track records. Like bonds, LCP’s carry a fixed return promised by issuer, and hence,
LCP holders are guaranteed returns by buying the LCP, regardless of the operational outcome of
the business of the issuer. Issuing LCPs also requires clearance and approval of the SEC and may
be traded just like the shares of stocks.

Short-Term Creditors

Short-term creditors take the form of financiers on a short-term basis lasting to one year or less. In some
cases, they include fund providers who may not demand voluminous documents like business plans or
feasibility studies. These creditors can serve as a stand-by credit facility to the entrepreneurs, which can
be tapped as needed. These types of creditors are briefly described as follows:

1. Commercial banks. As its charter provides, commercial banks 7. While banks prefer loans and
financing on a medium or long-term basis (as they earn more transactions), there are special
financing packages involving short-term financing for periods of six months or even less.
2. Merchandise suppliers. The company’s inventory or stock can be procured either through cash or
credit terms. Entrepreneurs that can stock their shelves with items procured on credit terms are
not only daring, but smart entrepreneurs as well. Credit terms, with the merchandise suppliers
being a form of financing, should be explored to the fullest with the merchandise suppliers.
Terms like consignment basis, lay-away plans, and similar arrangements can be made with the
suppliers. This will spare the entrepreneurs’ hard cash that can be used for some other purposes
or simply deposited in the bank or invested in high-yielding instruments. Depending on the
quality of relationship between the company and merchandise suppliers, some suppliers provide
such terms as pay-when-able or payment terms up to 120 days.
3. Credit card companies. Credit card is the most convenient, yet the most expensive loan terms you
can find in town. Credit cards are actually one of the most overlooked avenues in obtaining start-
up capital. Though it offers stringent term loans, it would appear as cheap because one does not
need to have business plan or collateral to get the amount needed. All that is needed by a credit
card-bearing entrepreneur is to walk to the ATM machine and withdraw the amount needed.
4. Capital equipment suppliers. In their desire to sell equipment, suppliers will often make every
favorable term available even to new companies. This is possible because the equipment itself
secures the loan. The contract may be a lease, held by the seller or leasing company, or
conditional sales agreement, whereby the seller retains ownership or title until the last installment
payment is made and received.
5. Leasing companies. They make possible the procurement of capital items or equipment for the
company. This arrangement, however, can work the other way around if the entrepreneur holds
the design of the capital equipment. In such a case, capital equipment suppliers can make it
possible for entrepreneurs to buy the equipment, especially if it is a custom-designed, one-of-a-
kind equipment.
6. Receivable factors. There are many specialized organizations like credit and collection
companies or even individuals who take the risk of buying receivables at discounted rates. By
selling the receivables, the entrepreneur is relieved of the delay and cost of collection efforts at
the same time generate funds needed by the business.
7. Deferral of payables in general. When the economy is in difficult situation or there are industry
or region-wide financial crisis or when the money (cash) position of the company is tight, most
companies (including the very large ones) lag behind in their payment of bills and loans.
Entrepreneurs should not be afraid or shamed to negotiate for payment of bills and loans by not
necessarily or immediately going into restructuring arrangement (this would cost you more in the
long-term). Moreover, entrepreneurs should not overlook the fact that in financial crisis periods,
some of the employees (especially the professional managers) might be willing to defer portions
of their salary or other benefits either as gesture of solidarity, loyalty, fellowship, or practical
measures to avoid being laid-off.

The C’s of Credit

1. COLLATERAL. All formal sources of funding generally require a collateral in the form of real
estate, equipment, or any other form of easily saleable property. The collateral is the entrepreneur
or borrower’s guarantee, such that in case the borrower fails to repay the loan, the collateral will
 be foreclosed by the fund provided. The entrepreneur should be aware that a loan application
with a guaranty cover or collateral has the higher chances of being approved.
2. CAPACITY. This refers to the capacity of the entrepreneur or borrower to pay for the loan.
Personal possessions and assets or the existence of real estate property on the part of the
borrower, whether they are declared as collateral or not, is an indication of the paying capacity of
the borrower. The business plan of the proposed venture itself is also another indicator that the
business has a high profit potential, and that it has the capacity to pay for its debts.
3. CHARACTER. This is more of the personal standing of the entrepreneur or borrower in his
community, as well as his own personal credibility. A track record of being a constant borrower
and regular payor of his loan is an indication of his character, which means a lot to creditors or
lenders. In fact, some individual with good credit or moral standing in the community are
sometimes given special privilege, known as character loan, which does not need any form of
conventional collateral.
4. Contract. Each loan or borrowing transaction has to have contract or agreement defining the
obligations of the contracting parties. On the part of the entrepreneur, he has to be extra careful
about the provisions of the contract/agreement, seeing to it that provisions should not be too strict
or stringent to the extent that the existence and profitability of the business shall be protected.
5. CONDITIONS. Forming part of the major content of the contract are the terms and conditions
set forth in the contract or agreement. The conditions essentially refers to the terms or mode of
payment, interest rates, penalties, and sanctions in case of default, as well as provisions for
settlement of disputes as necessary. Terms and conditions of the contract/agreement has to be
mutually agreed upon by both parties seeing to it that mutual concerns are addressed upon.

Known to many is the other “C” of credit, which is connection or network. It is said that in this world, it
is not much of what you know but whom you know. True enough, the connection and network of friends
or entrepreneurs (or anybody else for that matter) can go a long way not only for entrepreneurial or
business ventures, but also in some other aspects. Oftentimes, the connections or network even overrun a
policy that can redound to business transactions despite some doubts in the business proposition.
Entrepreneurs, however, should be extra careful and cautious in dealing with personal connections or
network, seeing to it that they are not abused or availed of contrary to law and business ethics.