Liquidity and financing: how to get liquidity for your company or startup

If you’re about to start a project, you’ve surely thought about the topic of liquidity and financing.

These are two concepts that go hand in hand and that can be a nightmare and a real headache for entrepreneurs, at least in the early stages of the business.

However, despite the aversion they may cause in people, it is a key topic for every startup, since your company’s financial future depends on them, and on it staying stable in the long term.

Of course, other factors come into play too, but for the most part, liquidity and financing play a crucial role.

But what are liquidity and financing, and why are they so important for entrepreneurs? We’ll talk about this and related topics in this post, so let’s start with the basics: their definition.

What is liquidity?

Liquidity is a company’s ability to convert its various assets into cash, without losing their value and in as short a period of time as possible.

This money is generally used to cover the various short-term expenses a company has.

Now, it’s common for a company, and in fact even an individual, to hold various “assets”, which in general would be any property that can be transferred for money, from cash such as banknotes, coins or bank deposits to properties or goods such as real estate, cars and the like.

And it’s important to keep in mind that one asset can be more or less liquid than another. Let’s start, for example, with the banknote, the coin or the bank deposit.

These are considered an asset of the company, but with the peculiarity that they have total liquidity, that is, you can hand over a €500 banknote, which would be an asset, as a direct representation of money, since it takes effect immediately; the same happens if you make a transfer or pay for a product with coins.

On the other hand, this isn’t the case with other assets such as a company’s shares or a piece of real estate, since both take more time to turn into cash, as you have to wait for a buyer willing to pay for that asset, to the point where the value of that asset may change.

This means they are considered less liquid assets.

Why is liquidity important for a startup?

As an entrepreneur, you need to cover a variety of expenses, whether an investment in acquiring raw materials, machinery or renting premises, or production costs and paying your employees.

To cover all these expenses, most of which are regular and necessary, you need good liquidity, that is, assets you can convert into cash immediately and that allow you to cover these needs at any time so you can keep your business running.

It sounds obvious, but it’s very important: keep in mind that there are many variables in the market, so a company’s operating costs can change from one day to the next, and your income has to keep pace to cover those cost changes in the shortest time possible.

Of course, you can always estimate what your business can generate in a given period, but that’s all it is, an estimate, and just like costs, it is subject to change.

And that’s not all, because the situation described only applies when we’re talking about an established company or business, with a track record that gives it a sufficient foundation to sustain itself and meet its expenses, but what happens with a startup?

How does a new business that hasn’t started making money cover all these practically mandatory expenses? Where does it get the liquidity it needs?

Well, this is where financing comes into play.

Financing, a relief for new entrepreneurs

Earlier, I mentioned that liquidity and financing can be a headache for any entrepreneur, but not because they’re negative in themselves, but because, normally, when we want to start a new business, the amounts of money needed are no small matter.

Imagine you want to have a restaurant because you’re passionate about cooking and it has always been your dream to have your own restaurant chain. Starting from this idea, the amount of money you’ll need to get going is quite high.

We’re talking about the fact that, for an establishment, however small, you’ll need to rent a place, fit it out to match your idea, pay for the necessary machinery and equipment, and you also need employees who must be paid a fixed salary, and raw materials to cook with, among other obligations.

You need a lot of things and you need money in the short term for all of them, but where do you get such amounts from?

Or, for a more familiar example from online business, imagine that you create an eCommerce store and want to start gaining visibility on the Internet thanks to a blog:

You need to hire a professional or agency to manage your company’s blog, someone to take care of your social media, a web designer to implement everything to your taste, etc.

This is where financing comes into play, which is nothing more than the act of providing money to an entity, company or individual with a previously established goal, such as, in this case, “opening a new restaurant”.

It is a viable alternative for getting the funds you need in the short term to get your business started, and it helps you sustain your venture during the early stages.

What happens with startups?

If we go back to the earlier restaurant example, we know that this type of business has higher costs and therefore requires a larger investment.

In the case of startups, the situation is a bit different, since we’re talking about a type of venture that, in the first instance, leans heavily toward the technology sector and requires much lower investment costs.

In addition, the business models used by startups tend to aim at minimizing production costs as much as possible.

This means that the initial expenses to launch the business are considerably lower than those of many other businesses.

Even so, covering all the expenses required during the initial stage is not something an entrepreneur can do on their own, at least not when it’s an average entrepreneur who is just entering the market.

For this reason, financing is still an important factor for startups.

Types of financing

Another important thing you should know about financing is that there are many ways to get it, that is, there are many ways to finance your different projects, some of them more viable for a startup and others with better benefits for more traditional business models.

The best part is that they are not mutually exclusive, so it’s always a good idea to draw up a financing plan that includes more than one of these methods.

Now, we can group the different types or methods of financing into two groups: the first is self-financing and the second is third-party financing.

1) Self-financing

As the name suggests, self-financing is the kind that is borne by the entrepreneur or entrepreneurs behind the business.

This particular type of financing is a constant in every business, since it is impossible to start a startup without a minimum of your own funds, or, put another way, the business wouldn’t be yours.

In general, this type of financing is done through a capital injection by those involved; in some cases other assets are also used as a means of investment, such as a property, or necessary equipment or machinery.

Because of the advantages of investing your own money (not taking on debt through loans, among other things), many people choose to start a startup in partnership, that is, to gather a group of people interested in the project and all invest together to launch it on the market.

One case worth highlighting is “Bootstrapping”, a model in which the entrepreneur starts their business with their own funds and also grows it without needing to turn to external financing methods.

Despite having many long-term advantages, startups that use Bootstrapping require much more work and effort, and also need to be careful with every step they take, since the slightest risk can be fatal for the business when your funds are limited.

For example, that was my case, since I started by investing from my own savings to launch my own website offering blog management and SEO optimization services for entrepreneurs.

On the other hand, those who succeed with this financing model tend to inspire greater trust in potential partners and customers, and they will also have a better chance of opting for external financing if they want to expand or start new projects.

2) External financing

In this case, entrepreneurs get the money they need through third parties or entities.

Generally, the third parties who choose to invest in a new business do so with the aim of obtaining returns, whether in the form of interest, shares in the company, or other benefits.

Unlike self-financing, external financing gives you a less limited fund that you can work with comfortably and use to take your business’s first steps, at least until it starts to generate enough liquidity to stand on its own.

Another advantage is that there are many ways you can access this type of financing.

Of course, it’s not all good, and as I said, those involved in this type of investment generally seek a return, mostly financial, that is, a debt is created. This debt can be a double-edged sword, because although the borrowed money lets you get your business off the ground, you depend on it entering the market and generating enough profit to pay off the debt resulting from the financing.

What should a startup keep in mind when applying for financing?

We’re saying that financing is basically a loan, but how do investors know whether your business is worth it?

We’re not talking about a business with a track record that can back the risk of financing with its liquidity, but about a startup that is just about to take its first steps and isn’t generating income that could reassure investors.

Or would you lend large amounts of money to someone you’ve only just met, without anything to assure you that you’ll get it back?

Obviously not, and investors won’t either.

For this reason, every startup needs a business plan and, above all, a financial and economic plan that backs up its idea objectively, so that investors can estimate the viability, profitability and potential liquidity of your company; that way they can be sure their money can not only be recovered, but that financing your business will be worth it.

What is a financial plan?

In short, a financial plan is one more section of your company’s economic plan, and it contains as objective an estimate as possible of the viability and profitability of your business in the medium and long term.

In this particular plan, the following factors must be taken into account:

⮚ Financing required

A total of the money estimated to be necessary to get the startup going and carry out its operations, considering all the aspects this involves.

⮚ Self-financing

This is the money the entrepreneur or entrepreneurs have available to carry out the project.

Personally, I advise you to try to have between 30 and 50% of the money needed to finance the project, since that is what many types of investors require.

⮚ Third-party financing

This is the financing from third parties that you estimate is needed to carry out the project.

In short, in this part of your plan you tell them how much money you need from investors; keep in mind that it is usually split across different financing methods, so it’s not all the responsibility of a single entity or individual.

Related information is also taken into account, such as the estimated time in which the investment is expected to be repaid and the estimated interest rate for each loan.

⮚ Working capital

Basically, it corresponds to the funds needed to finance the company’s current assets, and both self-financing and third-party financing are usually taken into account.

⮚ Cash flow forecast

This is an estimate of the receipts and payments the startup will make during its first year of operation. Some related concepts you should know are:

− Payment: This covers everything related to money going out for financial obligations, such as expenses and payments to investors.

− Receipt: As opposed to payment, this refers to all the money coming into the company, generally from invoice collections, among other things.

− Expense: This refers to money going out for raw materials, machinery and other goods and services involved in the company’s production.

− Income: This refers to the amounts obtained from selling products or providing services.

⮚ Income statement

Also known as Profit and Loss. In this part, the aim is to estimate the company’s economic performance over a given period.

It takes into account all the operations the company carries out during that time, from income to expenses, and also considers other aspects such as sales revenue, the production cost of each product, the number of products expected to be sold, etc.

⮚ Balance sheet

Finally, in the balance sheet, the aim is to give an estimated view of how the company will be doing at a given point in the future, whether months or years away.

All possible financial aspects are considered, such as the state of the investments made and the state of its assets and liabilities, among other aspects.

Remember that, even though they are estimates, it’s very important that you make them as specific and realistic as possible. And the best way to achieve that is to use clear figures at all times, so you’ll need to thoroughly research the current market and potential suppliers.

This way, you’ll have a better chance of getting external financing by showing the profitability, viability and liquidity of your idea to potential investors.

Which financing methods are ideal for a startup?

At this point, and to wrap up, I’d like to tell you about some methods that are very viable for someone starting a startup who doesn’t know where to turn. Keep in mind that none of them is exclusive, so you can combine them as suits you.

1. Interested family, friends and acquaintances

The first method I suggest is in fact one of the simplest, in the sense that you go through less bureaucratic processes, and it’s more relaxed regarding repayment terms.

It involves turning to friends, family and acquaintances who may be interested in your business idea and want to invest in it.

This method also has a crucial advantage: it usually carries no interest in most cases, since those involved already have a personal relationship with you; that said, they may ask for other kinds of benefits such as a stake in the company or access to your product or service, depending on what it is.

The main drawback, though, is the amount of money that can be raised through this financing, which is really limited. However, even so, it’s an excellent method for taking the first steps, since it lets you cover things related to creating the brand and other bureaucratic processes that require money to set up the company legally.

2. Banks and credit

One of the most viable options for getting the funds needed for a new business is through loans, and these can generally be obtained through credit or loans from the bank.

Obviously there’s a process involved, and depending on your idea or how you structure your economic and financial plan, the loan may or may not be approved. Even so, it’s the fastest way to look for the funds to get your business going.

One advantage of banks is that they don’t usually charge very high interest compared to other loan alternatives, although of course this depends largely on the bank or institution you turn to for the loan. On the other hand, repayment terms are usually relatively comfortable, though not as much as when you borrow from friends and family.

Some banks in Spain even run subsidy programs for entrepreneurs that help to partially offset expenses.

The only drawback, perhaps, is that banks generally require many guarantees in exchange for the benefits mentioned, and, on top of that, banks tend to provide little supervision or follow-up on their side.

3. Equity crowdfunding

This model basically consists of investors contributing money to your company in exchange for shares and stakes in it.

This also includes having a say in its development, creating a kind of partnership that will run the company, each with a percentage of shares set according to the investment made.

Although it’s an effective method for raising funds, it’s a bit risky, since you’re giving third parties a stake in your company; for this reason, it’s important to choose your investors carefully if you go for this option.

If you’re interested, you can always turn to agencies that connect startups and entrepreneurs with potential investors who may be interested in your idea and business model.

Finally, I recommend that you choose this option after your initial stage, when your business is already up and running but still in an expansion phase.

4. Private investors

This is a model in which people may take an interest in your idea and business model or see a future in it.

In general, these kinds of people invest in exchange for shares or, in some cases, provide loans with varying interest rates and terms.

You generally don’t turn to this kind of investor unless your company is already operating, that is, you’ve already taken the first steps and have at least prototypes of your product or service.

They tend to be less limited when it comes to investing large amounts, which is an advantage, and, except in exceptional cases, they usually leave decisions in the hands of the entrepreneurs.

I recommend this option for the expansion stage, when your business is already operating but you want to expand it even further, looking for greater production or a wider reach.

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Conclusion

Entrepreneurship isn’t easy; starting a startup takes time and work, and it’s not a matter of just a couple of months or half a year before you start seeing results.

Often, a company doesn’t get out of its initial phase, even after one or two years, and during this period you have to consider that expenses keep rising and rising.

A company’s liquidity is important, and to have good liquidity in the medium and long term, the company needs a good start; this takes money, money you can get with a good financing plan and hard work.

I recommend that at the beginning you devote yourself to developing your idea and your business model well, so you can go for the best financing options.

Offer them something that captivates and hooks them, so that they are the ones who want to invest in your business.

If it’s possible for you to finance your startup with your own means, do it. Maybe it’s not the most advisable way to start, and the consequences can be big, but the satisfaction and freedom it brings turn into wings that will push you to keep going with more strength.

Even so, never set investors aside.

Remember, a business doesn’t succeed just by having a great idea; it needs dedication and hard, smart work, which is not the same thing. Go for it with your startup, and best of luck!

Financial management doesn’t end with the initial financing: also find out how to avoid the capital flight that makes many companies lose money, and what exactly a CFO does within this management.

Frequently Asked Questions

These are the most common questions about liquidity and financing.

What is a company’s liquidity?

Its ability to pay its short-term debts with the money it has or with assets it can quickly turn into cash.

How is liquidity measured?

With the liquidity ratio: current assets divided by current liabilities. As a guideline, a value between 1.5 and 2 is usually considered reasonable.

What is non-dilutive financing?

Financing that doesn’t require you to give up part of the company: loans, grants or customer advances. Dilutive financing, on the other hand, comes in exchange for equity, as with investors.

How can I get liquidity for my business?

By getting paid sooner (advance payments or shorter payment terms), negotiating longer terms with suppliers, using a credit line or factoring, and selling slow-moving stock.

What is the difference between liquidity and solvency?

Liquidity measures whether you can pay in the short term. Solvency measures whether everything you own is enough to cover all your debts.