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MANAGEMENT: Raising the Required Capital
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Raising the Required Capital

By Marwan Emile Faddoul, Managing Partner of NFG Consulting LLC & Guillaume Michael Lange, Marketing Analyst of NFG Consulting LLC

BT 201609 150 06 Management Should You Raise Funding for Capital Intensive BusinessesWe were glad when a reader from last month reached out to us to share opinions and also asked a few questions. Hana enjoys reading the different articles published in Business Tianjin, regarding Finance and Management as it helps her learn and apply certain concepts to her own company. She has a small cooking operation, where she sells to certain retailers and outlets in Tianjin area. Her annual sales reach $65,000, and after costs and staff she was able to make a $25,000 profit last year.

To get to this level, she had to bootstrap her company with her own resources by starting in her own kitchen, making Baozi like her grandmother had taught her. She has since moved her operation to a bigger kitchen, and employs 2 of her cousins to help with the cooking. Having increased her orders, and now not being able to supply the potential demand, she needed investment to open and operate a bigger operation, outside of her home.

After analysing her needs, and understanding her company's foundation and structure, we shared the different options, which she could utilise in her expansion plan.

The first option which we shared and advised Hana against included the use of credit cards as a mean of financing her expansion. Its edge is the liability as is the speed at which the cash can be accessed if the accounts have already been established. The important point we warned our reader about was the high level of interest with this financing method which would make it an expensive way to access cash. There is also a need to repay the advance, and if for any reason Hana delays a payment, it can ruin her personal credit score. We advised that this can be used as a method for short-term cash flow improvement, but it was not a viable financing choice.

BT 201609 150 02 Management Should You Raise Funding for Capital Intensive BusinessesTo continue on a similar path, we explored the possibility of using another banking service - a bank loan. It is a standard way for companies to get initial funding externally from banks, and compared to credit cards, it can offer a more advantageous interest rate. A major downside however, and reason why this was not our initial recommendation to Hana, is the paper work and the fact that the difficulty to obtain these in China has increased dramatically.

The level of Bad Loans in China has soared to a total of $196 billion (1.27 Trillion Yuan). A percentage of these loans are expected to default, and even if the government is supporting these banks, and has put money aside for it, future loans are now stricter. This is to limit the growth of Bad Loans, which have grown more than 48 percent across the 18 major listed banks in China in the past year. Our recommendation was to formulate a business plan, which she would use to inspire confidence, thus improving her chances of receiving a loan with many financial institutions. Should the bank loan application become successful, her financing issues would be solved, but Lange advised Hana not to depend on this source of financing for survival and growth.

BT 201609 150 06 Management hlWith a much more creative and non-conventional source of financing, we shared what the founders of ThinkImpact have attempted to do. Through a website they have created, young innovators can sell their future earnings. On a personal level, these three entrepreneurs have pledged the future of their personal earning in exchange for an upfront sum of money. Erickson is currently selling 6% of his lifetime earnings for $600,000 and his two partners are following suit with different amounts. They are raising money for their non-profit start-up, but an important aspect of this financing method to keep in mind is that the legality and enforceability has yet to be tested. NFG Consulting decided to advice against this due to the high level of unknowns and continued searching for an optimal funding option.

BT 201609 150 05 Management Should You Raise Funding for Capital Intensive BusinessesGoing back to a more traditional way of raising money for creating and expanding a small business, family and close friends was our next topic of discussion. The reason this is one of the most common way to finance expansion is because family has an emotional connection to one's goals and does not invest with a sole goal of an important ROI. They wish to see their family's business successful, thus they are likely to do what is in their power to support the dream you are trying to build. The major problem with this financing method is that family will invest without looking at the potential and risks involved, making for a very uncomfortable family dinner, if the business goes through slow economic periods.

Family must understand that when they become creditors, there is a financial risk to their placement and that should not jeopardize important personal relationships. However, once money is involved, emotions are hard to control for most. To avoid this as much as possible, supplying formal financial projections and evidence-based assessments can limit the uncertainty. Due to the risk of having negative impact on family relations, Hana decided against this avenue and our discussion continued.

By utilising the community and those who believe in us, without risking family relations, we suggested for Hana to look into Crowd Funding. Western websites such as kickstarter.com and Indiegogo.com have redirected hundreds of millions of dollars from personal investors to entrepreneurs and business people with different projects. Kickstarter.com has alone allowed over 100,000 projects to be funded and Hana's expansion could be another success story.

BT 201609 150 03 Management Should You Raise Funding for Capital Intensive BusinessesIn China, one of the main competitors to these Crowd Funding websites is Jing Dong Crowd Sourcing, currently one of the biggest locally and since 2014 it has funnelled 1,034.370 million RMB to project managers. Project managers must set a monetary goal to achieve as well as set a period of time, entrepreneur must set their objectives and start the campaign. Entrepreneurs will only obtain funds if the goal is reached. Friends, family, and eventually strangers pledge money to projects in exchange for incentives such as a certain product or even naming rights to products and projects. Projects like RideNGo received 1489% of their goals and Forever Spin World Famous was funded at 5283% of its objective.

Mr. Faddoul advised Hana that in order to raise money and achieve her objectives, it was important to offer good perks, create a video explaining the product and allow pledgers to know the project manager on a more personal level. Showing a clear long-term plan aand budget allows contributors to feel a sense of direction and trust in the project. This venue for fundraising is easier than banks and venture capitals in terms of documentation required and time resources. Moreover, there is no dilution of the company which is sometimes important to many entrepreneurs and allows the project manager to retain control over the direction of the project.

Another advantage of Crowd Funding is its ability to test the market for the viability of the product or idea. A project with many backers and which can raise an important amount of capital is a clear sign of demand, showing that the public is willing to stand behind the idea. It can predict a future long-term demand and if funding is successful it gives the entrepreneur the confidence required to move forward.

Another financing method which Hana wanted to explore with us was the possibility of bringing on board a Venture Capitalist. This is a firm regrouping capital from many investors and it is their responsibility to invest and redistribute it to create reasonable and profitable returns. Hana could give up a part of her company as equity in exchange for an influx of capital. Having shares within the company allows them to take control and to a certain extent dictate the new direction of the firm with profit and expansion being their main objectives. VC have a reputation to have little loyalty aand respect for the initial values and directions with which the company started as long as quotas and returns are being met.

MindofaVCMany argue the advantage of having a small share of a big pie versus a large share of a small pie, however this is a decision that each entrepreneur must take. Certain advantages of VC which should not be overlooked include the absence of having to payback the capital and certain VC will have the ability to open doors and opportunities with others in the right industries to facilitate growth. This method of financing is particularly important to look into in China due to the government investing $300 billion into different VC funds to redistribute among start-ups across the nation. This important influx of capital in Venture Capital market can lower barriers for entrepreneurs and facilitate opportunities of financing.

When it really comes down to it, no source of financing is optimal; each company follows different objectives and varies as per circumstances. We advise every company to take the time, aand analyse different options and not jump at the first chance due to being cash squeeze. Bad foundation can lead to dangerous ends.

Our final suggestion to Hana and the one we believe would most suit her need would be an angel investor which we will discuss in our next edition of Business Tianjin.
For more information on funding and financing opportunities, please do not hesitate to contact NFG Consulting to explore possibilities.

Story and names have been created to illustrate the information.


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