All businesses must have the necessary financial means to ensure the proper start-up and functioning of their commercial activities. At the time of creation of the business and in terms of financing, a distinction has to be made between:
- contributions made by partners/shareholders;
- capital and reserves;
- and financial resources provided by third parties such as banks or the State.
To assess the viability of the business project and its financing requirements, entrepreneurs first have to draw up a business plan. The plan is generally drawn up to cover a period of 3 to 5 years.
The financing by third parties often requires the presentation of supporting documents to the financiers, such as a business plan, personal guarantees (sureties) and/or real guarantees (mortgage on property), etc. The documents requested and the level of detail vary in practice and must be confirmed with the financier.
Although recourse to capital borrowing is often inevitable and even recommended for all businesses in order to compensate for a lack of capital and reserves and to benefit from a leverage effect, it is important that there is a sufficient proportion of own capital and reserves compared to the balance sheet amount (ideally a third or more).
Financing with own capital and reserves
Financing with own capital and reserves involves the contribution of private funds by partners/shareholders, mainly in the form of contributions in cash: the partners/shareholders transfer money from their own bank account to the company account.
Contributions in kind are a second form of contribution (e.g. buildings, machinery, patents, etc.). The transfer of ownership of movable or immovable assets to the company is done in return for an equivalent amount in terms of company shares. Depending on the form of the company (SARL, SA, SE, SECA, SECS, SENC), such contributions in kind must be valued by an expert or registered auditor (réviseur d’entreprises).
A high proportion of own capital and reserves in the total financing of a business increases its solvency. In addition, financing with own capital and reserves is considered to be a 'safe' means of financing which often acts as a guarantee for third parties. Personal investment in the project by the entrepreneur demonstrates that he has confidence in his plans.
Given that, for a sole trader (sole proprietorship), private and professional assets are indistinguishable, he automatically contributes all of his private assets to the business.
Financing with third-party capital
Financing with third-party capital is achieved through temporary loans (short, medium or long-term) provided by third parties external to the business. The traditional method consists in taking out a loan from a bank. In return, the future entrepreneur undertakes to pay a fixed or variable sum in the form of interest. To guarantee repayment of the loan, the bank may require guarantees such as surety and/or a mortgage. This solution allows the future entrepreneur to benefit from external resources without having to accept a third-party intervention in the management of the business. In practice, this is the most widely used solution.
Specialised State financing bodies
For certain SMEs, the creation or takeover of a business may be eligible for low-interest loans granted by the national credit and investment institution (société nationale de crédit et d’investissement - SNCI), a public banking institution. The SNCI specialises in medium and long-term financing for Luxembourg companies, granting them start-up loans, credits for capital goods, innovation loans or shareholding loans. The purpose of this government instrument is to boost the capital and reserves of entrepreneurs who have no guarantees or sureties to back up traditional bank financing. It operates as a sort of co-financing that covers part of the overall financing of a new business.
One method that can be used as a complement to financing with third-party capital is public aid, which can take different forms. In certain cases, the State can provide new businesses with the benefits of tax exemptions and capital or interest subsidies in certain cases.
However, the success of the business plan of a new company must never depend on this type of financing.
Another less frequently used financing method, which only applies to a limited number of activities, is to resort to the networks of 'Business Angels'. When creating a new business, this practice is often very useful in reality, especially for niche businesses or innovative ideas. In general, persons who act as Business Angels are in a comfortable financial situation and have solid experience in a certain type of business. They give the benefit of their knowledge and experience to the entrepreneur whilst injecting capital into the business.
Venture capital companies
Companies who specialise in high-risk/high-return investments can offer substantial financing possibilites. These companies perform their business project selection based on multiple rigorous criteria, and are often geared towards innovative projects that carry hopes of very substantial returns. These companies may also request to be heavily involved in the day-to-day management of the company.
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