3.5 Financial Capital

Many entrepreneurs start by bootstrapping: using personal savings, personal bank loans or personal credit cards. To decide whether that's enough, they compare their own funds with what the business needs at first, and they find the break-even point, the number of units they must sell in a period to cover all costs for that period.

Break-even quantity = fixed costs ÷ (price − variable cost per unit). Each unit sold earns its price minus its variable cost, and that amount goes toward covering fixed costs.

If the owner can't pay startup and operating costs until sales reach break-even, they need external financial capital. Established businesses look for it to develop new products, replace fixed assets (equipment, buildings) and grow sales. Both new and established businesses also borrow to smooth cash flow, since customers pay at irregular times but bills are always due.

• New businesses (usually under about two years old) often borrow from friends and family or sell ownership shares to friends, family or outside investors.
• Established businesses (usually at least two years old, with proven revenue and the ability to repay) can get business bank loans.
• Corporations can issue bonds or stock. A bond is a loan from an investor to the business. Stock is an ownership share, sold privately or publicly.

Lenders and investors receive financial assets: loans (including bonds) or shares of stock. They can later resell these in a secondary market, such as a stock exchange. If you buy a corporate bond there, you become a lender to that business; if you buy a share of stock, you become a shareholder.

Lenders earn interest. Investors may earn dividends, a share of the profits, though many corporations reinvest earnings instead of paying dividends. Anyone who sells an asset for more than they paid earns a capital gain. Prices of stocks and bonds move with the business's performance, investor demand and PESTEL forces.

Annual rate of return = (income + capital gain) ÷ price paid for the asset.

The risks: lenders lose if the business can't pay interest or repay. Investors lose dividends and stock value if profits fall, and can lose everything if the business shuts down. People differ in risk tolerance, their willingness to take financial risk, and anyone funding a riskier business expects a higher return.

Lenders and investors usually want a business plan: the value proposition, market research, marketing strategy and financial projections that justify how much money is requested, the expected return and the risk. The owner sums this up in a short, polished pitch.

For an established business, funders also look at financial reports and industry data to estimate its valuation, what the business is worth. That tells investors what a share is worth and tells lenders whether the business can repay. Requests do better with evidence of product-market fit, a clear basis for the projections, a qualified leadership team, and a mission that matches the funder's goals.