Financial risks of business start-up financing methods

Financial Risks of a Business During Start Up

The contemporaneous society reveals a tendency of every man for himself. Within the business community, this has materialized in the opening of numerous small businesses, run by former corporate employees, who became motivated by the desire to be their own bosses. We see examples of successful entrepreneurs every day and each of us may be tempted to try and open a business. It must however be mentioned that the risks of opening a business are rather complex and more numerous that one may seem to think. And they spread on numerous levels, such as marketing or management risks, financial risks of human resource risks.

Financial Risks of a Business during Start Up

In terms of financial matters, the owner of a new business has to consider his funding opportunities. This is mostly valid when the owner does not possess the entire sum of money required for the venture. "A company's operations and investment can be financed from outside the business by incurring debts, such as though bank loans and the sale of bonds, or by selling ownership interests. Because each method of financing obligates the business in different ways, financing decisions are very important" (Fabozzi and Peterson, 2003). In order for the owner to acquire the necessary capital, he has three alternatives, all with adherent risks. They refer to contracting bank loans, the issuing of stocks or a joint business with a partner; their risks are succinctly presented below:

Financing through stocks

The issuing of stocks sees that the business owner would issue securities onto the market. Several small investors would purchase them and the money used to pay for the stock would constitute new capital for the organization. The organization would remunerate the investors through dividends, generally at the end of a fiscal year. Some risks posed by this financial opportunity could refer to:

since the investors pour their money into the organization, they could desire to become involved in the decision making process - their involvement could however be limited the actual issuing and selling of stock onto the market implies additional costs there is also the risk of not attracting sufficient investors in the case of bank loans, the rates are seen as debt and not taxed; with stocks on the other hand, the shareholders receive their money from profits, which is subjected to taxes - this means additional expenditure

Finding a partner

In this scenario, the business owner will look for another individual who possesses the required capital. This means that not bank loans or stock issuing would occur. The two partners would share rights and responsibilities directly derived from the amounts of capital deposed.

Using a partner is rather similar to the issuing of stocks, but a major difference however occurs. While the issuing of stocks generally occurs within an open market, the shares would be likely purchase by numerous small investors. The amount of stocks purchased will be controlled by the business owner and most importantly, the power of the shareholders would be limited. With a single investor however, this has more power to become involved and influence organizational decisions. Ultimately, having a partner is a direct investment method, whereas selling stocks onto the market is an indirect investment method.

Once the matter of having sufficient funds to invest in the new venture has been resolved, the owner, or owners, has to consider the foreseen return on investment. Most importantly, he has to be prepared for the eventuality that his business may not be a real success within its first moths since opening. In order to cope with this possibility, the owner has to constantly conduct management and financial analyses. A most important analysis in this instance is the break-even analysis, which reveals the number of items that have to be sold in order for the business not to register losses.

A broader analysis of the risks implied in a start-up phase reveals that is imperative of the return on investment to be obvious is a reduced amount of time. The empirical and theoretical results on the matter tend however to disagree. In this order of ideas, Bender (2002) argues that it is not as important for a start-up business to register a rapid return on investment as it has initially been stated. The explanations for this are various, including such reasons as follows:

the start-up organization is unique, small and easily adaptable the risks should only be associated with the market and industry features the company adapts and develops and a negative initial return does not imply subsequent losses it is normal for the rate of return to be initially lower, but for success, it has to steadily increase in time

3. Conclusions

Today's business community stimulates the individual to run their own businesses and be their own bosses. The venture does however imply several risks, including financial ones. These are quite extensive and may refer to founding opportunities or the registering of a favourable return on investment.

Each of the three financing possibilities presents both advantages, as well as limitations. Working with a partner and contracting a bank loan are methods of direct investment and grant more control to the secondary party. The issuing of stocks on the other hand, however implies the loss of some control, is an indirect investment method and only limitedly reduces the power of the owner.

In terms of return on investment, the practice shows that it is not a tragedy if the initial profits are reduced to inexistent. What is important is for the entrepreneur to persevere.