How to Attract Funding from Banks, Equity Investors and Donors: A Beginner’s Guide for SMEs
About 50% of all small and medium-sized enterprises (SMEs) fail globally within 5 years of their existence. This rate is even higher in Nigeria due to a number of factors that are peculiar to our operating environment, such as poor infrastructure. However, the leading cause of the high mortality rate experienced in the SME segment around the world is poor access to finance.
Poor access to finance arises when a business is unable to attract the capital that it needs to maintain its daily operations or expand into new markets and business lines. A number of factors can give rise to poor access to finance.
On the supply side, it can be the result of insufficient capital among the investors, meaning that there isn’t enough funding to go round. This phenomenon is rare, but it has nonetheless starved many businesses that are otherwise well-positioned to receive funding of much-needed capital.
On the demand side, it can be the result of the poor frameworks existing in many companies due to the low managerial skills and financial literacy levels of their operators. An overwhelming proportion of the challenges faced by SMEs in accessing funding can be attributed to this demand-side factor.
Beyond having a clear vision, a good business plan, and a marketable product or service, there are critical frameworks that business operators need to put in place in order to make their companies better prepared to receive and leverage funding. In this piece, I will be focusing on the financial management aspects of such frameworks.
Separate your personal and business finances
The first thing that you must do as an entrepreneur to make your company more attractive to investors is to separate your personal and business finances. As you know, personal and business interests do not mix well. A sign of financial and business management competence that all investors appreciate in any business is a clear distinction between the owner or manager of the business and the business itself.
One of the best ways to achieve this distinction is to open a corporate bank account for your company where all the transactions related to it will be performed. This will help you to maintain accurate records of your company’s cash flow, analyze trends in consumer behavior, and project the future more empirically. It will also help you to resist the temptation of indiscriminately dipping into your company’s finances to meet your personal needs.
Document all your transactions
It should be a no-brainer that you must document all the transactions of your company, yet many entrepreneurs, especially those managing service-based SMEs, fail to do so. As an entrepreneur, you must have a digital or, at the very least, a paper-based journal where all your company’s transactions, both revenues, and expenditures, will be recorded.
In today’s highly digitalized economy, it is not difficult to find basic bookkeeping apps that will help you to achieve this. Many of them can even be downloaded free of charge from your smartphone’s app store. At periodic intervals of your choice (daily, weekly, quarterly, half-yearly, annually, etc.), these apps will give you a breakdown of your company’s financial and sales performance and a helicopter view of the business as a whole.
Pay yourself a salary
I mentioned earlier that opening a corporate bank account for your business will help you to resist the temptation of indiscriminately dipping into its finances to meet your personal needs. Well, that is only the first step. The next step is to pay yourself a salary from your company.
The only way that your company can really grow is by reinvesting the profit earned by the company into the company. If you use funds from the business to finance your lifestyle, you will be stifling its growth and it will remain rooted to the spot for many years. What’s more? You can even resort to perpetually borrowing from banks, cooperatives, and other sources to keep it going, which is costly and difficult to come by as an SME.
Periodically assess your company’s finances, place it side-by-side with your personal needs, and how much you think you are worth, and figure out how much you can realistically pay yourself.
This advice is every bit as relevant for SMEs with employees as it is for sole proprietorships. As an entrepreneur managing an SME with employees, you should include yourself in the payment structure just like your employees. Any funds you take from your company beyond what your salary permits should be treated as a loan from your company to you, which you must repay as quickly as possible.
Of course, there is no rule preventing you from drawing from your company’s profit at the end of your financial year, but you should only do this when your company is mature and stable enough to withstand the outflow.
Brush up your accounting knowledge and skills
You don’t need to be a chartered accountant to run a successful business, but acquiring foundational accounting skills certainly helps. You can place your company on a trajectory of accelerated and sustainable growth by taking out time to improve your understanding of accounting and financial management.
Business is all about money, so there’s no escaping this. This advice especially comes in handy when you cannot afford the services of a qualified accountant or a financial advisor.
Digitalize your business
With the devastation wreaked by the COVID-19 Pandemic, every business owner now appreciates the importance of going digital. It is no longer a secret that digitally compliant companies were able to navigate the worst of the crisis better than their brick-and-mortar-oriented counterparts were.
Digital technologies have made running a business easier and more profitable than ever before. It has taken many businesses to the doorsteps of their customers. But companies that are yet to adapt risk getting steamrolled and completely run out of business.
Digitalizing your company can be as simple as creating a website or social media pages, to make it easier for your target audience to reach you. From a financial perspective, it can be as simple as installing a payment gateway on your website that customers can use to purchase your products and services.
Understand the type of funding your company needs
Finally, not all funding is the same. Some come in the form of loans, while others come in the form of equity capital and grants. It is important to identify the type of funding that your company needs before approaching any bank, angel investor, venture capitalist, a private equity firm, or donor agency.
A loan is a type of financing that is typically given by banks. You must repay a loan, often at periodic intervals, along with the interest. Loans are more suitable for businesses that are already generating significant revenue.
Equity capital is typically given by angel investors, venture capital firms, and private equity firms. It is given to a business in exchange for a certain percentage of ownership and control in that business, called equity.
The investor hopes to recover the equity capital alongside a profit by selling this share of ownership and control to other investors in the future at a higher price. Equity capital is more suitable for startups with innovative business ideas and aggressive growth plans.
A grant is a type of financing that is given to a business that usually does not need to be repaid or exchanged for a share of ownership and control. It is given by donors to businesses that are making a positive social impact or solving a social problem or making a great breakthrough in their industries.
Understanding these types of funding and identifying the one that best suits your company will increase your chances of succeeding in your quest to raise business capital.