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Sources of business finance


Date Posted: 4/17/2012 9:14:33 AM

Posted By: sashoo  Membership Level: Silver  Total Points: 382

This is the amount of money you need to start your business. It enables you to buy machinery and equipment, build your business premises, hire labor and meet daily obligations of your business. Finance needed to start your business is commonly known as capital.

As an entrepreneur, the primary types of capital that you are likely to arrange for include start up capital, working capital and expansion capital. Start up capital is the capital you will require to begin a business while working capital is the amount you would need to meet the day to day activities of the business. Expansion capital is the capital you will require to help your business grow.

1. Equity financing:
The main source of equity financing is your personal savings. Some experts say that one half of the money needed to start a small business should come from the owner. This may mean ‘you’, as the future owner must work and save for several years before having enough money to start the business.

Another popular source of equity financing is money from your family and friends. Equity financing can also be obtained by selling part of your business to others. This can be done in several ways e.g. you could get one or more partners. With the partners putting in a portion of their own money, you will find it easier to raise the total amount needed. Equity financing can also be obtained by selling part of your own property.

2. Borrowing from lending institutions:
When your sources are not enough, you have the option of borrowing from other sources. Lenders will usually lend you money for starting a business if they know and trust you. Lenders want to be sure they will not lose their money on businesses that

fail. Most lenders, therefore, will want to review your business plan carefully. The plan should describe how the business will operate, how much money will be needed, how it will be used and when the business will be profitable. Most people think of banks when borrowing money. Banks lend money when the risks of losing it are extremely low. Usually, they will only lend to customers whom they have known for a long time.

3. Borrowing from cooperative societies:
If you are a member of a co-operative society, you may be able to borrow money for business use. Some loans can be obtained with just your signature. Cooperative society interest rates are usually lower than bank rates. Commercial finance companies may lend you money to start your business. Because they take greater risks, commercial finance companies usually charge high interest rates.

Some people borrow money against their life insurance policies. This is an easy way to obtain some of the money needed to start the business. Life insurance policy loans are based on cash that is already paid in. Life insurance companies offer these loans at low interest rates. If you need to buy land or building for a new business, you will be able to borrow money from a savings and loan institution. They specialize in real estate finance. The loans they give out are called mortgages. Their interest rates are similar to those of banks.

4. Borrowing in the form of trade credit:
This is another source of business finance. It is where a business receives, on credit, raw materials and also other goods used to start up business. Suppliers grant credit to their clients for a period of 3 to 6 months. The seller finances the buyer who wants to start a business.

5. Borrowing through factoring:
This is a financial service designed to help a firm in managing their debt books and receivables in a better manner. The debt books and receivables are assigned to a bank or an institution called the “factor”. The bank then advances cash to the firm.

6. Bank Overdrafts financing:
Overdrafts are allowed by banks to current account holders, who are allowed to withdraw from up to a certain limit of a given amount.

7. Youth Enterprise Fund:
This is managed by the Ministry of Youth and Sports. It mainly funds youth projects. A youth in this case is regarded as a person between the ages of 18 and 32 years.

8. Kenya Women Finance Trust (KWFT):
This is a women’s enterprise fund managed by the Ministry of Gender, Children and Social Development. Currently, it also serves men.

9. Micro finance institutions:
Examples of these are:
• K-Rep micro finance institution.
• Faulu micro finance institution.
• Kadet micro finance institution.
• Rupia micro finance institution.
• Pioneer micro finance institution, among others.

10. Other sources:
• Welfare Associations (Chamas)
• Leasing property etc.


For small companies, this is personal savings (contribution of owners to the company). For large companies equity finance is made of ordinary share capital and reserves; (both revenue and capital reserves).

Debt finance is a fixed return finance as the cost (interest) is fixed on the par value (face value of debt). It
is ideal to use if there’s a strong equity base. It is raised from external sources to qualifying companies and
is available in limited quantities

3. Bills of Exchange
Bills of Exchange are a source of finance in particular in the export trade. A Bill of Exchange is an unconditional order in writing addressed by one person to another requiring the person to whom it is addressed to pay to him as his order a specific sum of money. The commonest types of bills of exchange used in financing are accommodation bills of exchange.

4 Lease Finance
Leasing is a contract between one party called lessor (owner of asset) and another called lessee where the lessee is given the right to use the asset (without legal ownership) and undertakes to pay the lessor periodic lease rental charges due to generation of economic benefits from use of the assets. Leases can be short term (operating leases) in which case the lessor incurs the operating and maintenance costs of the assets or long term (finance leases) in which the lessee maintains and insure the assets.

5. Overdraft Finance
This finance is ideal to use as bridging finance in sense that it should be used to solve the company’s short term liquidity problems in particular those of financing working capital (w.c.). It is usually a secured finance unless otherwise mentioned. Overdraft finance is an expensive source of finance and the over-reliance on it is a sign of financial imprudence as it indicates the inability to plan or forecast financial needs.

6. Plastic Money (Credit Card Finance)
This is finance of a kind whereby a company will make arrangements for the use of the services of a credit card organisations (through the purchase of credit cards) in return for prompt settlement of bills on the card and a commission payable on all credit transactions. This is used to finance goods and services of working capital in nature such as the payment of fuel, spare-
parts, medical and other general provisions and it is rare for it to finance raw materials or capital items.

7. Debenture Finance
A form of long term debt raised after a company sells debenture certificates to the holder and raises finance in return. The term debenture has its origin from ‘DEBOE’ which means ‘I owe’ and is thus a certificate or document that evidences debt of long term nature whereby the person named therein will have given the issuing company the amount usually less than the total par value of the debenture. These debentures usually mature between 10 to 15 years but may be endorsed, negotiated, discounted or given as securities for loans in which case they will have been liquidated before their maturity date. The current interest rate is payable twice a year and it is a legal obligation.

8. Venture Capital
Venture capital is a form of investment in new small risky enterprises required to get them started by specialists called venture capitalists. Venture capitalists are therefore investment specialists who raise pools of capital to fund new ventures which are likely to become public corporations in return for an ownership interest. They buy part of the stock of the company at a low price in anticipation that when the company goes public, they would sell the shares at a higher price and therefore make a considerably high profit.

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