Friends or Family – A Risky Gamble

Remember as a teenager you would probably ask your parent(s) to “borrow” money to go to the mall, movies or purchase something you admired for what seemed like forever. With this request, you probably were greeted with responses like: ‘I will give you some of the money, but you must earn the rest’ or ‘How are you going to pay me back the money you are borrowing”. I am not sure why the word borrow was often used but let’s be real, how often did you really pay your parents back.The term borrow is a very interesting word. According to dictionary.com, borrow is defined as taking and use (something that belongs to someone else) with the intention of returning it. As a teenager did you really intend to borrow money from your parents or were you saying whatever you thought would increase your chances of getting the money you wanted to see that movie, got to the mall or purchase something.Borrowing money as a teenage to invest in your hobbies and wants is completely different that borrowing money as an adult to invest in a business venture. I highly doubt that your parents stopped speaking to your because you never repaid the money you borrowed to buy the sweater you just had to have. I also doubt that your friend or cousin unfriended you on social media because you never repaid the money you borrowed for pizza.


While those scenarios seem trivial and petty, it is never either when it comes to those very same people investing in your business venture. Yes, those close to us want to see us succeed. Yes, these very same people will cheer us on along our journey. And yes, a couple of right arms would be given to assist us along the path to success. However, things may turn extremely ugly when there is a bump in the road, or your business venture has fallen into a ditch and lying next to the venture is the money of your friends and family members.Receiving money for investing from friends and family has some perks. For one, you get to avoid the most dreaded process of securing money… dealing with banks. Two, you get to set your own terms and guidelines on how the money will be used. Three, you will most likely receive the money much quicker than you would from a bank. And four, if needed, the ability to adjust the repayment deadlines may be a little bit more flexible with much less harsh repercussions.While all those perks may paint a picture of borrowing from family or friends ideal… well, it is not. For every perk, there are at least two disadvantages. Yes, you get to avoid the banks, set your own terms with a soft repayment plan. This would be an entrepreneurs’ utopia, however, if things should ever not go according to plan the perks would quickly fade and be replaced with an unimaginable nightmare.Could you imagine your parents, cousin, uncle or close friend whom you have had a lifelong relationship with abruptly stop speaking to you? Could you imagine being uninvited to your best friend’s wedding? Even if you were the maid of honor or best man. Could you image a Christmas, Thanksgiving or Birthday without those you love? How about being the recipient of unpleasant text or voicemails from these very same people.


If you should ever default on a loan with the bank, you never have to worry about running into them at the supermarket resulting in an awkward and negative exchange however that is a plausible situation if you default a financial agreement with a family member.While doing business with family may have good intentions for both parties, remember that entrepreneurship is a risky avenue and if you are not comfortable with gambling the future of your relationships, then keep your financing formal. It is important to remember that within the realm of business and entrepreneurship the only feelings that should be allowed is your passion for your business.

Sources of Business Finance

Sources of business finance can be studied under the following heads:

(1) Short Term Finance:

Short-term finance is needed to fulfill the current needs of business. The current needs may include payment of taxes, salaries or wages, repair expenses, payment to creditor etc. The need for short term finance arises because sales revenues and purchase payments are not perfectly same at all the time. Sometimes sales can be low as compared to purchases. Further sales may be on credit while purchases are on cash. So short term finance is needed to match these disequilibrium.

Sources of short term finance are as follows:

(i) Bank Overdraft: Bank overdraft is very widely used source of business finance. Under this client can draw certain sum of money over and above his original account balance. Thus it is easier for the businessman to meet short term unexpected expenses.

(ii) Bill Discounting: Bills of exchange can be discounted at the banks. This provides cash to the holder of the bill which can be used to finance immediate needs.

(iii) Advances from Customers: Advances are primarily demanded and received for the confirmation of orders However, these are also used as source of financing the operations necessary to execute the job order.

(iv) Installment Purchases: Purchasing on installment gives more time to make payments. The deferred payments are used as a source of financing small expenses which are to be paid immediately.

(v) Bill of Lading: Bill of lading and other export and import documents are used as a guarantee to take loan from banks and that loan amount can be used as finance for a short time period.

(vi) Financial Institutions: Different financial institutions also help businessmen to get out of financial difficulties by providing short-term loans. Certain co-operative societies can arrange short term financial assistance for businessmen.

(vii) Trade Credit: It is the usual practice of the businessmen to buy raw material, store and spares on credit. Such transactions result in increasing accounts payable of the business which are to be paid after a certain time period. Goods are sold on cash and payment is made after 30, 60, or 90 days. This allows some freedom to businessmen in meeting financial difficulties.

(2) Medium Term Finance:

This finance is required to meet the medium term (1-5 years) requirements of the business. Such finances are basically required for the balancing, modernization and replacement of machinery and plant. These are also needed for re-engineering of the organization. They aid the management in completing medium term capital projects within planned time. Following are the sources of medium term finance:

(i) Commercial Banks: Commercial banks are the major source of medium term finance. They provide loans for different time-period against appropriate securities. At the termination of terms the loan can be re-negotiated, if required.

(ii) Hire Purchase: Hire purchase means buying on installments. It allows the business house to have the required goods with payments to be made in future in agreed installment. Needless to say that some interest is always charged on outstanding amount.

(iii) Financial Institutions: Several financial institutions such as SME Bank, Industrial Development Bank, etc., also provide medium and long-term finances. Besides providing finance they also provide technical and managerial assistance on different matters.

(iv) Debentures and TFCs: Debentures and TFCs (Terms Finance Certificates) are also used as a source of medium term finances. Debentures is an acknowledgement of loan from the company. It can be of any duration as agreed among the parties. The debenture holder enjoys return at a fixed rate of interest. Under Islamic mode of financing debentures has been replaced by TFCs.

(v) Insurance Companies: Insurance companies have a large pool of funds contributed by their policy holders. Insurance companies grant loans and make investments out of this pool. Such loans are the source of medium term financing for various businesses.

(3) Long Term Finance:

Long term finances are those that are required on permanent basis or for more than five years tenure. They are basically desired to meet structural changes in business or for heavy modernization expenses. These are also needed to initiate a new business plan or for a long term developmental projects. Following are its sources:

(i) Equity Shares: This method is most widely used all over the world to raise long term finance. Equity shares are subscribed by public to generate the capital base of a large scale business. The equity share holders shares the profit and loss of the business. This method is safe and secured, in a sense that amount once received is only paid back at the time of wounding up of the company.

(ii) Retained Earnings: Retained earnings are the reserves which are generated from the excess profits. In times of need they can be used to finance the business project. This is also called ploughing back of profits.

(iii) Leasing: Leasing is also a source of long term finance. With the help of leasing, new equipment can be acquired without any heavy outflow of cash.

(iv) Financial Institutions: Different financial institutions such as former PICIC also provide long term loans to business houses.

(v) Debentures: Debentures and Participation Term Certificates are also used as a source of long term financing.

Conclusion:

These are various sources of finance. In fact there is no hard and fast rule to differentiate among short and medium term sources or medium and long term sources. A source for example commercial bank can provide both a short term or a long term loan according to the needs of client. However, all these sources are frequently used in the modern business world for raising finances.