5-Financing a Startup Company

Why Capital Is Needed

Capital

  • Simply means money or valuable things that can be used to start or grow a business.
  • Example: If you want to start a food stall, the money you use to buy a stove, ingredients, and rent space is your capital.

👉 Businesses need capital because:

  • Customers usually pay after you provide the product or service, not before.
  • Owners still need to buy materials and pay living expenses in the meantime.
  • For bigger projects (like building a software product), you need even more capital because money is going out long before money comes in.

Examples of where cash is needed

  • Salaries – wages for employees.
  • Rent, heating, lighting – costs of running an office.
  • Equipment, consumables – computers, internet, stationery, etc.
  • Marketing and advertising – to attract customers.
  • Miscellaneous – small everyday things (travel costs, printer ink, paper).
  • Interest on loan – extra money you must pay to the bank if you borrowed.

Business Plan

A business plan is like a roadmap for your company. It explains your idea to potential funders (like banks or investors) to convince them that your plan is realistic.

What it should contain:

  1. Company description

    • What the company will do.
    • Proof that the founders have the skills.

  2. Market description

    • Who your customers are (target market).
    • How big the market is.
    • Who your competitors are.
    • Example: “In this area there are 1,200 repair companies, but only 16 have websites. Only 2 companies are providing websites, and they don’t focus on this market.”

  3. Financial predictions

    • Budget – how much you plan to spend.
    • Cash flow predictions – how money will come in and go out monthly.
    • Balance sheet – what the company will own (assets) and owe (debts).
    • Profit and loss accounts – how much money you expect to make versus spend.

Sources of Finance – Grants

Grants

  • A grant is money given (usually by the government) to help businesses, often for buying equipment or setting up offices.

  • It doesn’t need to be paid back.

  • But it comes with conditions:

    • The business must also raise some money from other sources.
    • Grants usually cover only a percentage of the costs (e.g., 40%).

👉 Grants are usually short-term solutions, not enough to run the whole business.

Sources of Finance – Loans

Loans

  • Borrowed money that must be repaid with interest (extra charge for borrowing).

Liquidation

  • If a business fails and shuts down, it sells its assets (property, machines, etc.) to repay debts. This process is called liquidation.

Security / Collateral

  • Something valuable (like land, buildings, or equipment) given to the bank as a guarantee. If the loan is not repaid, the bank can take it.

Personal guarantee

  • If business assets are not enough, the bank may ask the owner personally to pay the loan from their own money.

Types of Loans

  1. Overdraft Loan

    • The bank allows you to take out more money than you have in your account (negative balance).
    • But the bank can cancel this facility anytime → very risky.

  2. Long-Term Loan

    • Loan given for a fixed number of years.
    • Fixed interest rate = the rate does not change.
    • You must pay interest regularly, and the original loan (capital) at the end of the period.

  3. Soft Loan

    • Loan with lower interest rate than normal.
    • Often given by governments to help new startups.

  4. Corporate Bonds

    • A company borrows money by selling bonds (like IOUs) to investors.
    • In return, it promises to pay back with regular fixed interest.
    • They are called fixed-income securities because investors get steady payments.

  5. Founders lending themselves

    • Owners put in their own money as a loan to the company.

Sources of Finance – Equity Capital

Equity Capital

  • Money investors put into a company in exchange for shares (ownership).
  • Unlike loans, it doesn’t have to be repaid.
  • But investors expect to make profit later by selling their shares when the company grows.

Business Angels

  • Wealthy individuals who invest their own money in startups.

Venture Capitalists (VCs)

  • Professional investors who manage large funds and invest in companies with high growth potential.

Authorized vs. Issued Capital

  • Authorized Capital = maximum number of shares a company is legally allowed to issue.
  • Issued Capital = shares actually given to investors.

Gearing or Leverage

Definition

  • Gearing (UK) or Leverage (US) shows the balance between loan money and equity money in a company.

👉 High gearing = company depends too much on loans. 👉 Low gearing = company relies more on owners’ own money (equity).

Example

  • Owners put Rs. 100 (equity).
  • They take Rs. 100,000 loan at 10% interest.
  • Year 1 profit = Rs. 10,000 → all goes to interest, nothing left for owners.
  • Year 2 profit = Rs. 20,000 → Rs. 10,000 to bank (interest), Rs. 10,000 left for owners.

Why high gearing is bad

  • For shareholders: most money goes to loan repayments, less profit left.
  • For lenders: they fear that shareholders may take risky decisions to cover debts.

✅ That’s the breakdown with all terms simplified.

📌 Quick Test Questions for You:

  1. What’s the difference between a grant and a loan?
  2. Why is collateral important for banks when giving loans?
  3. How are business angels different from venture capitalists?
  4. In gearing, why is it risky for shareholders if most money comes from loans?
  5. Why does a business plan need market analysis?