This is Part 2 of our How to Start, Run, Grow & Fund a Business in South Africa. Please read How to Start, Run, Grow & Fund a Business in South Africa (using what you currently have) before reading this. This is part of the Funding a Business section.
You have to read up Part 1 before reading this page to get a primer as you won’t fully grasp what I am saying.
In Smuse the initial funding needed to start, the working capital needed to run and the debt and equity that may be needed to grow the business.
The framework we use for small business in SA, Smuse is about starting with what you have and then using formal funding to grow that business (if you want). I say this because Smuse is aimed at normal people and if you don’t have collateral or connections you are not going to get funding for your start-up in South Africa (if you don’t want to, believe me, you are more than welcome to try). You will get sent from pillar-to-post and you might get one of the above if you are lucky. But we don’t work on luck we start actual businesses not dream about it.
The most common way that people start businesses in SA is probably by monetizing a skill. When it comes to the capital component usually savings are money leant in a personal capacity or from friends and family. There is virtually no way to fund a startup business using formal means in South Africa, yet many people go around chasing this unicorn instead of trying to start with what they have.
Let’s get onto to funding your business. I will look at funding for starting, funding for running and then for growing the business. Personal vs corporate finance, formal and informal finance, unsecured vs secured. As well as debt vs equity finance. The definitions are as follows:
Finance to start business – Initial Funding
Finance to run business – Working Capital
Finance to grow business – Debt & Equity
Finance to start business – Initial Funding
If you have nothing before you can approach a bank or investors you need to raise initial or seed funding in your personal capacity. Remember what I said last time about business vs personal:
You & Your Business
When you register a Pty Ltd. that business will become its own legal entity. So there will be you and your business. It is important to look at these two as separate entities or even separate people. You might quality for finance but your business won’t and you can do with your money what you want to if you bought a property in a business name that business might qualify for funding (using the property as collateral) but you won’t in your personal name.
Money lent to you in your personal capacity which you are liable to pay back. You should qualify for a personal loan providing you have a good credit history and have an existing income like a fulltime job.
Informal vs formal finance
Informal finance is defined as “contracts or. agreements conducted without reference or. recourse to the legal system to exchange cash in the present for promises of cash in the future”. This is a very important thing to remember, any type of formal finance (bank or investor) is a legal contract with legal recourse.
Within our context, we have something we call Friends, Family, Fools, these will either be the first people who invest in you or buy from you.
Friends and Family want you to succeed so they going to support you if they can. Fools are your first investors, they are inexperienced and unsophisticated and don’t know the risk of investing in an idea stage business.
Informal agreements are usually between friends and family. If your mother lends you a few thousand rands if you don’t pay it back, what is the worse that will happen? Maybe she shouts at you or throws you with a shoe etc.
Do not abuse this form of finance, make the risks clear beforehand and if it fails sit down with them and explain how you spent the money and how it went wrong, you will lose your relationship friends and family over this. Another thing I want to touch on is the problematic mindsets of many of South African entrepreneurs, where they have less respect for money if it came from a family member that will not make a big fuss than say if it came from a bank, they will come up with all kinds of excuses, as the person owed them for whatever reason and they are not a registered credit provider blah blah blah. This is a very problematic mindset that won’t get you far – a mindset that may carry over into formal finance ensuring you never get finance.
Formal finance is legal agreements with institutions that lend you money (which has to be repaid with interest).
I have always been surprised by South Africa’s cavalier attitude towards legal agreements where they just sign and don’t think about it. If you don’t come from a business background, this is an attitude you have to change. Any formal agreement has consequences if not honoured and should not be entered into lightly. One wrong move here and you can be locked out of accessing finance for life.
If you’ve come this far then you’ve already looked at your business’s supply value logistics chain and bird in hand and your affordable loss and you should know. You should know:
How much money you need to start, do you have the means to start, if you cannot on your own do you know people that can help you start.
Finance to start the business / Initial Funding
If you start a new business that business is its own legal entity it has no trading history it has no assets it has no cash flow. No bank is going to lend that business money as it is too risky and they have no recourse if you cannot pay it back. Banks are like casinos “the house always wins”. They don’t make a move unless they are sure they are going to get their money back with interest.
Personal vs business finance
I briefly introduced personal finance above and it can and often is used to fund a business. Unlike business finance, if the business fails the person is liable in their personal capacity.
Personal finance to fund a business startup (all unsecured) / Personal finance to start a business
Personal finance is money lent to you in your personal capacity that you are liable to replay. Smuse’s affordable loss is applicable here as well, at the moment in time when you take out a loan in your personal name are you able to meet those repayments even if the business that you want to use to fund fails? If the answer is no, then you don’t take out any type of personal finance. We are not interested in your projections, right here right now can you afford to meet the instalments? I say this as I am going to touch on some controversial techniques some of which has high-interest rates. Risky business!
As an adult, you take full responsibility for your actions and life otherwise you don’t use Smuse, Smuse mindset dictates you take responsibility. So if you try this, any of this without doing proper research, don’t put hashtags on your Twitters saying “Ken said I must do this, now I’m living in a van down by the river #badadvice”.
Now even though the bank is not going to lend the company money, that doesn’t mean they won’t lend you money. If you are gainfully employed with a good credit record, you may qualify for an unsecured personal loan (with interest of course) for an amount based on your “affordability” – can you afford to repay the instalments. The bank will look first and foremost what you can afford and not how much you want and they will then structure that over a certain period and set an interest rate. The longer the period the more interest you will pay. This loan is given to you based on the fact that you have permanent employment and money coming into your account every month. They will require a bank statement if you are not banked with them you have to provide a certain amount of statements covering certain months and they will see how much you spend as well. Remember one thing this loan is not secured (no asset has been put up as collateral), they not going to repossess your car or house (unless it’s a large amount and they get a judgement), but not paying back this loan, or not paying it back on time will have an adverse effect on your credit history and if large enough to warrant it they will obtain a judgement to take some of your possessions to sell to cover the loan. Even if they don’t instruct the sheriff to attach that judgement will show on your credit history and will cause your problems in future, up until you pay the loan and get it rescinded.
Personal Overdraft loan
Another option people tap into to fund a business is an overdraft loan. So when you have a bank account and that account hits zero as you know, that’s it, you cannot get any more money. With an overdraft loan, the bank allows your account to run into negative – up until a certain amount (like any other financial product you will have a credit limit). This amount you are borrowing from the bank and has to be repaid with interest and an overdraft fee. There might be instances in which you will get interest free if you can pay if back after a certain amount. Which can be great for bridging/working finance.
Personal Credit card
We are now getting into controversial business funding means: personal credit cards. We hear fables all the time when people started their businesses they “maxed out all their credit cards”. This is a controversial way of funding a business startup as credit cards usually have high-interest rates and a new business has no guarantee of success, it’s not compatible especially in an anti-business country like South Africa. That being said, remember what I said at the beginning, do not lend more than what you can afford without depending on the business to succeed. When you signed up for that card or when you can an increase in credit limit (if under the CPA) then they provided you with a document saying how much money you will pay if you use the full amount and how much interest. If you don’t have that document go back and get a copy. South Africa is not a country to have a “go big or go home” mentality with putting money into a startup. Sure, people have done it and succeeded but many have done it and failed and ended up way worse than what they were before (even homeless).
Personal store card
This is the most controversial of all, and I debated whether I should add it here. But Smuse is about helping ordinary people and some ordinary people do not qualify for loans or overdrafts or credit cards.
If you had formal employment in the past you might have opened store card account at various shops, food, clothing, electronics etc. This card was probably not hard to get (and was way easier before CPA) but it let you buy products from that shop “on credit”, essentially the store (or whoever underwrites that card), provides you with a credit line to buy from that shop (or from a group of shops) and gives you 6, 12, 18, 24 months etc. To pay it back.
So what some people do to get money to start a business is they either offer to buy something on behalf of someone else who is paying cash and buy the item on credit and pocket the money or they buy products or gift vouchers to resell (both times it is sometimes done at a discount), as the goal is to obtain liquid cash or cash money like the youngsters say these days. The problem here is if you are buying a product to resell quickly, oftentimes you have to sell at a discount, on top of this you have to pay the shop back with interest so like a credit card this is an extremely risky way of getting money – for some it is the only way. Again, make sure you can afford to pay it back. Repercussions are similar to taking out any type of personal finance above. Behind the scenes, this is actually no different than a loan being extended to you but you can only use it at that shop, so don’t think if you bought food or clothing its not as important to pay back as a personal loan, it still is.
Personal finance secured
TL;DR you should not put up collateral for startup capital until a business has proven itself (value proposition, the business model has proven itself).
Now we come to the next question. If you have assets like a property or piece of land in your personal name, should you put that asset up as collateral to start a business? The short answer is no, the longer answer is it depends. If you are a first-time entrepreneur and the asset in question is a primary residence the answer is no. If you are a first-time entrepreneur and the asset in question is a piece of land in the middle of nowhere that you don’t care about, then the answer probably also depends. The bank will not lend you a lot of money if the plot is not worth much, ask yourself would you get more if you sell it?
If you are an experienced entrepreneur with a family and the asset in question is a primary residence the answer is no. There is no idea in the world you should put your family’s house up as collateral in a country where employees and their trade unions regularly shut down businesses. Do not risk your asset in a country where it is not respected.
That being said, you are an adult and you can make your own decisions. The threshold is can you afford to lose that asset?