Should I mortgage my house to fund my business? This is the question a relative asked and a longish discussion ensued. This young boy had studied commerce and had also completed a course for small business strategy at a management school. But applying theories to practice and transitioning from concept to application are always challenges.
A business must begin with own funds and graduate to seeking external funding. That is a smarter choice. If the idea is good and if the entrepreneur shows promise, there are angel investors that will find it worthwhile to finance a business. It is a win-win as it ensures a good return on their money while supporting a new business.
But it is not easy to raise money. We are not talking about small businesses with a great idea that will make it worthwhile for the formal funding market to be interested. We are talking about a small operation in a small city, a sole proprietorship. So we don’t need a shark tank approach of stake sale and getting the investor interested in the idea.
That does not mean the business is not generating value or profit. We have millions of businesses that operate at a micro level, managed mostly by own funds. These businesses are routinely starved of working capital. They also struggle to find the scale they can operate at, and any expansion needs money. In this case, the entrepreneur is seeking personal assets to fund business expansion. I had to put out my list for his consideration.
First, estimate your working capital needs. His is a distribution business where one buys some goods and sells it to another market. The buying orders are placed after the sale is closed with the customer. How soon the seller needs the money and how fast the customer will pay determine the working capital needs. Estimate this for the annual volume of business. Know that number as the money needed to keep the sales rolling.
Second, negotiate with both seller and buyer to achieve a close match. If the buyer pays in 90 days, and the seller can’t wait beyond 60, the business needs 30 days funding. The credit both parties offer and ask depend on the market conditions and competition. Explore the possibility of negotiating a better deal. Would the seller offer a better credit period for a higher price? Would the buyer pay earlier with a discount? Would the buyer be willing to pay an advance? Can a milestone based payment structure be set up?
Third, examine the buyer profile to see if there is enough diversity. Large buyers will mostly have process driven payment of bills that take a certain amount of time. Some buyers may take too long to pay. Except for following up and persuading them, there isn’t much choice about speeding up payments. Depending too much on a few large buyers might make it even acute.
Fourth, seek working capital accommodation. Banks, NBFCs and other smaller financial companies may be willing to discount the bill and make a loan. This is one of the most common categories of loan available to suppliers of goods. The rate of interest is also a benchmark for the extent of margins your business must make. If money is available at 14% and your margin is higher at 20% you can finance the working capital of your business and expand it if you get funding against your bills.
Fifth, ensure that the business records are in place. Even if it is a small sole proprietorship business, have a bank account for the business. Ensure all receipts and payments are recorded. Have a system for invoicing and tracking. Pay the applicable taxes. Disclose all information and file returns. Without knowing your business numbers with history history, funding of any kind will be tough. You cannot raise angel funding or any other long term capital without audited verifiable business numbers.
Sixth, do not borrow from friends and family. It is always tempting to seek funds from sources that are easy to tap. But such funding does not come with accountability. If you are serious about your business and like it to be a steady source of profit for you, you need to keep your eyes on the price, margin and be willing to pay the cost of funds. That keeps the responsibility for the business choices higher. Easy money is a trap for taking undue risks and skipping needed diligence and process.
Seventh, do not mix your personal life and business. Staking your house, assets and jewellery for a business is too much of risk your family will have to bear. Separate the business assets from family assets. Do not indulge the family with expensive gifts and spends from business profits. That creates a seamless flow of money in your mind that makes you feel entitled to do into the family assets during times of need.
Eighth, build some assets for the business. Even if it is a trading business that needs no capital investment. Ploughing back the profits to create assets in investments in treasury products like deposits, bonds, liquid funds. It would be easier to borrow against these assets when in need. In an extreme emergency these assets can be liquidated and rebuilt.
Ninth, expand the business keeping in mind the financing requirements that will kick in. It might feel great to get a large order from a large client. Getting that account might seem prestigious and the steady order book might be just the leap you needed. Make sure you are prepared to wait the payment delays and have the funding to sustain it.
Tenth, build and monitor performance metrics for your business. Know the exact days of aging of your creditors and your debtors. Know the rates of growth in revenue and its seasonality. Know the margin and the costs, and diligently account for them. Set yourself to standards that you will measure and perform to. Many businesses have failed from celebrating revenue without considering the impact delayed payments and mounting costs can have on their survival.
Entrepreneurship is such a common and widely prevalent feature in India. We celebrate our ability to spot an opportunity and make a business out of it, however small. Be cautious to not overdo native wisdom and common sense in running a business. Not everyone knows intuitively how to keep a business afloat. It can be punishing to learn the hard lessons.
(The author is Chairperson, Centre for Investment Education and Learning.)