When starting a business, some people have enough money on their own for their business idea to become a reality. This raises the temptation to be financed the business exclusively with one’s own funds. This can be good but it is generally not better than going for external financing.
External financing brings with itself, a sense of special responsibility. This is so because the money is not from the company’s coffers but from an external source which entails the responsibility to return it. But this can also lead to an overpowering fear of a future insolvency. This fear is quite understandable but it shouldn’t be the deciding factor when you are looking for financial fuel to power your entrepreneurial spirit. There are several advantages to having external financing when you are initiating a startup. Here are six of them:
The financial leverage brought about by external financing can bring several advantages with itself. It is a way to attract resources for business growth, for the company funds projects to reach a larger size and thus benefit budding businesses to help meet their resource needs. It can help curtail one of the problems of face by small business: being in the trap of small, which can lead to the missing of big opportunities of profitability that are seen as too financially demanding.
Financial leverage is also a way to improve the profitability of one’s own resources, to help achieve the funding required to obtain financial benefits with a lot less dependence on equity. While it is true that it also increases the risk for a company, but it gives the notion that your company is successful. And everybody loves to invest in successful businesses.
Risk reduction for personal assets
By using external financing to reduce the risks of your business to your own assets you will get an additional ally at your disposal: the use of some form of capital company (corporation or limited partnership) as a legal form of your business. In this situation, you can lose every dollar that you have put into the company, but the company’s debts are not debts that affect your personal assets.
In this regard it is important to note that, by providing external financing for your business, financers may ask for any kind of warranty that affects your personal assets, such as guarantee, a pledge, or a mortgage.
Interest is partially deductible from income tax
Although with limitations, the interest that you pay on borrowed funds are tax deductible, while dividends to remunerate one’s own funds are not. That means you can get a higher profit after tax by opting to finance a portion of your assets with borrowed funds.
By going for external financing you will critically examine your business plan
There are many good business ideas that, unfortunately, have not come to fruition due to lack of proper planning. With any startup, a viable business plan is a prerequisite for success. When starting a business, every entrepreneur should keep in mind that what a business plan should be and what it should not be to achieve positive results for the company.
Thus a proper business plan is necessary to serve as a tool to convince others to put their money in your idea. Obtaining external financing can be one of the goals of most business plans but, along the practical way, you will have strengthened and increased the feasibility of your idea, while also having devised ways to leverage your advantages and mitigate your weaknesses.
The external financing at the start of a business is the first test of your communication strategy
One of the most important challenges of the company is its communication strategy, both internal and external. And when the company is going for external financing its main objective is communicative in nature, to show that their project is a worthwhile one. You have to convince the lenders that the company will be successful, will offer a good product/service that will be competitive, will pay back on time, will provide good job opportunities, etc.
Thus going for external financing is the source of the first major effort to convince others that your project is worthwhile. This experience will help you immensely further down the line as you hone your communication strategy.
The ability to contrast your ideas with the external environment
The opinions of the financial institution or other potential funders about your project can be of great value, particularly when they deny funding. Every good entrepreneur acts firmly convinced of their projects but also hears everything that you sheds light on potential improvement.
An important aspect is that often the external environment, particularly the general economic conditions, modify the possibilities of your business. It is therefore very important to note that what, at a given moment, is impossible to finance, later perhaps might be become eligible. So all companies must be prepared to improve their projects and to undergo continual improvement in the face of criticism from external authorities until an enhanced stage is achieved which is an attractive recipient of financing.