Sources of Business Finance

1Why this matters

Umutoni runs a small bakery in Huye that is genuinely profitable, but she is turning customers away because her old mixer cannot keep up. A new dough mixer costs 6,000,000 Frw and would last about eight years. She has 1,500,000 Frw saved. The other 4,500,000 Frw has to come from somewhere — and the somewhere she chooses will decide whether the mixer makes her richer or buries her under repayments she cannot meet.

Every business faces some version of Umutoni’s problem: a good idea, or a good opportunity, needs money before it can earn money. This lesson does two things. First it lays out where start-up and growth money realistically comes from in Rwanda. Then it teaches the skill that actually separates surviving businesses from failed ones: matching the right source of finance to the particular need.

2The two big divides

Before the list, fix two distinctions that organise all of it.

Internal versus external. Internal finance comes from inside the business or the owner — own savings and profit that is kept and reinvested. External finance comes from outside — loans, investors, suppliers, grants.

Debt versus equity. This is the one that matters most. Debt is money you borrow: you must repay it, usually with interest, but you keep every share of ownership. Equity is money an investor gives you in exchange for a share of ownership: you never repay it, but you hand over a slice of all future profit and some control. Hold that difference; it decides the whole shape of a financing choice.

3The sources, one by one

• Own savings. Internal. No interest, no repayment, and you keep full ownership — but the amount is limited to what one person has put aside, and it risks everything you own.
• Retained profit. Internal. Profit the business already made, ploughed back in. Cheap and dilutes nobody — but it is slow, and limited to what you have earned so far.
• SACCOs. A Savings and Credit Cooperative — there is an Umurenge SACCO in every sector — where members save together and borrow from the pool. Loans are smaller and easier to get than a bank’s, often backed by a group guarantee rather than land, which is why SACCOs reach people banks turn away. The ceiling on loan size is the trade-off.
• Bank loans. Larger sums, but the bank demands collateral (such as a land title) and a business plan, and charges interest on a fixed repayment schedule. A term loan funds a long-term asset; an overdraft covers short-term gaps.
• Trade credit. A supplier delivers stock now and lets you pay in, say, 30 or 60 days. Short-term, and interest-free if you pay on time — effectively a free short loan that funds your stock.
• Leasing and hire purchase. Instead of buying an asset outright, you use it for regular payments. This preserves cash. With a lease you may never own the asset; with hire purchase you own it after the final instalment.
• Grants. Money that never has to be repaid, from government funds such as the Business Development Fund (BDF), from NGOs, or from competitions like Hanga Pitchfest. No repayment and no ownership lost — but grants are competitive, limited, and usually tied to a specific purpose.
• Equity finance. Selling a share of the business to an investor (a ‘business angel’ or a venture-capital fund) in return for capital. No repayment, and the investor shares the risk — but you give up part of the ownership, part of future profit, and some control.

Worked example — solving Umutoni’s 4,500,000 Frw

The mixer lasts about eight years, so it is a long-term asset. Two realistic options:

Option A — a bank term loan. Borrow 4,500,000 Frw at 16% simple interest per year, repaid over 3 years. Interest = principal × rate × time = 4,500,000 × 0.16 × 3 = 2,160,000 Frw. Total repaid = 4,500,000 + 2,160,000 = 6,660,000 Frw. She keeps 100% of her bakery.

Option B — equity. An investor offers 4,500,000 Frw for a 30% share of the bakery. She repays nothing and the investor shares the risk if things go badly — but she now keeps only 70% of the business, and 30% of every future profit goes to the investor. The deal also implies a value for the whole bakery: if 30% is worth 4,500,000 Frw, then 100% is worth 4,500,000 ÷ 0.30 = 15,000,000 Frw.

Which is better? It depends on how well she expects the bakery to do. If it grows strongly, 30% of it will soon be worth far more than the 2,160,000 Frw of interest — so the loan is the cheaper choice, because she keeps the upside. If the bakery might struggle, equity is safer, because there is nothing to repay in a bad month. What is not in doubt is that a mixer needs long-term finance: paying for an eight-year asset with 30-day trade credit or an overdraft would mean the repayment falls due long before the mixer has earned its cost back.

That last point is the golden rule, stated plainly next.

4Matching finance to the need

Do not ask ‘where can I get money?’ Ask ‘what is this money for, and for how long?’ Four tests decide a good match.

1. Purpose and time horizon — the golden rule. Match the life of the finance to the life of what it buys. A long-term asset (machine, vehicle, building) needs long-term finance (a term loan, a lease, or equity) whose repayments spread over years. A short-term need (a month’s stock, a wage gap) needs short-term finance (trade credit, an overdraft, a small SACCO loan). Never buy a building with an overdraft, and never fund a week of stock with a five-year loan.
2. Cost. Compare interest rates and fees. A grant is the cheapest money there is; a bank loan costs interest; equity charges no interest but costs you a slice of future profit forever.
3. Ownership and control. Debt keeps the business fully yours, but must be repaid whatever happens. Equity needs no repayment, but you share ownership, profit and decisions.
4. Availability and risk. A brand-new business with no collateral and no track record often cannot get a bank loan at all, and must start with savings, a SACCO, family or a grant. And however you finance it, do not borrow so much that a single bad month cannot cover the repayment.

Practice

Answer. Interest = 2,000,000 × 0.18 × 2 = 720,000 Frw. Total repaid = 2,000,000 + 720,000 = 2,720,000 Frw.

Answer. Whole business = 6,000,000 ÷ 0.40 = 15,000,000 Frw. The founder keeps 100% − 40% = 60% — with no repayment to make, but 40% of all future profit now belonging to the investor.

Answer. (a) Timber is a short-term need, so trade credit from the timber supplier (or a short SACCO loan) fits — it is repaid quickly, out of the sales the timber generates. (b) The machine is a long-term asset, so a term loan or a lease fits, repaid over years as the machine earns its cost back. Funding the machine with 30-day trade credit would fall due long before it had paid for itself.

Answer. A bank loan must be repaid, with interest. A grant need not be repaid at all. Equity need not be repaid either — but unlike a grant, it costs the founder a permanent share of ownership and future profit.

Answer. A bank normally requires collateral and a track record to secure repayment, and a brand-new business has neither, so the bank sees too much risk and refuses. More realistic sources are the owner’s own savings, a SACCO loan (smaller and often group-guaranteed rather than needing land), family, or a grant from a fund such as the BDF. New businesses almost always start on these before they can access bank finance.