Starting a company? Need to know how to pay for everything?

When you start a company in New Zealand, you will normally need some money to get the venture off the ground.

How should you get this money?

Should you take out a bank loan? Sell shares in the business? Or fund the venture yourself?

Entrepreneurs will normally fund the business themselves, at least initially.

When you start a business, it usually doesn’t have any value.

It’s an unproven concept.

Or you don’t have any customers, clients, or assets.

So of course there isn’t any value.

YET.

In order to generate that value, you need to go out and build the business.

That takes money.

The easiest way to obtain the money required is by providing it yourself. This is normally how businesses in New Zealand begin.

This is what’s known as a shareholder loan.

If you look at the balance sheets of 100 businesses in New Zealand, I will bet you that 95 of those will have shareholder loans.

It’s a very flexible, cheap way of providing your business with the initial capital it needs to begin its life.

These loans, because they are normally from the founder and or the founders family have very generous terms; interest free, no repayments, and unsecured. So, a great option for a founder as there’s very little pressure placed on the founder (unless you pressure yourself..!)

Once the company begins to make a profit, then it can begin to repay the shareholder loan, as and when it or the founder sees fit.

That’s great, Ryan, I hear you, but shouldn’t I issue shares?  

You could, but it’s difficult to sell shares to someone when the company has not proved itself.

From an investors point of view, buying shares is highly risky. If things with the company go wrong, shareholders have very little recourse on the company and will likely not receive any of their money back.

In a liquidation, or recovery scenario, lenders have preference to shareholders. They will be repaid first.

And if the lender has secured their lending against an asset of the company, they will be repaid first, before any unsecured lenders.

In saying that, your company WILL issue shares when it is incorporated. However, these will have a nominal value of $1 per share, to represent that there is no value. There’s more to it, but its really just a technicality for accounting purposes.

Any who, it is much easier to sell shares in your company once it has proved itself and has a value.

For example. Company ‘X’ has $100 of share capital for 100 shares that were issued when the company was incorporated.

After five years of being in business, the directors believe the company is worth more like $900,000. This means they believe each of the 100 company shares is worth $9,000 each.

The directors would like to raise $100,000 to fund an expansion and the purchase of additional machinery. The therefore believe after raising the $100,000, the value of their company will be $1,000,000.

The directors will therefore need to issue and sell an additional 11.1 shares at $9,000 each, for a total value of $100,000.

Now, what about a bank loan?

Banks in New Zealand love property, it’s no secret.

They are also averse to unsecured business lending…and who wouldn’t be, right? Business is risky.

They will lend to your company as long as it’s secured over property. So, if you own property, great, you have this as another option.

The interest rate will be slightly higher than your mortgage to account for the additional risk and cost of recovering their money if things go south.

What about a second-tier lender like Prospa? Or Harmoney?

These guys will often provide unsecured business finance, but it’s expensive.

You’ll be looking at interest rates of 13%+ and a raft of finance fees on top of that.

They can be great if you don’t have an alternative, but in my opinion should be avoided.

In conclusion, if you can, you should fund your business with your own money (or your families, if they’re nice).