Business Models and Financing

A good idea needs two things to become a working enterprise: a business model that pays for itself over time, and enough money to get started. This lesson covers both. You don’t need to be an accountant to follow it. You need to understand a few simple ideas well enough to ask the right questions and spot a plan that doesn’t add up.

A business model in plain terms

A business model answers four questions.

• What do we offer? The product or service.
• Who pays for it? The customers, and anyone who pays to have material taken away.
• What does it cost to deliver? The materials, people, equipment, energy, transport and overheads.
• What is left over? The margin, which pays back debts, funds growth and provides benefits to the owners and the community.

If you can answer these four questions clearly, you understand your business model.

Four numbers that matter

Revenue is income earned from products, services, gate fees and other operating activities. Show borrowing and owner investment as financing flows, separate from earned revenue.

Costs need clear categories. Variable costs change with activity, such as packaging and processing fuel. Fixed operating costs include rent, insurance and core staffing over the planning period. Show capital purchases, financing flows and loan principal repayments separately in cash flow; their accounting treatment differs from operating expenses.

Contribution per unit is selling price less variable cost per unit. It shows what each additional unit contributes towards fixed costs. Gross profit is revenue less cost of sales under your accounting policy; operating profit also reflects overheads. Define your measures consistently.

Operating break-even is the volume at which total contribution covers fixed operating costs. Divide annual fixed operating costs by contribution per unit. Then test cash requirements separately, including capital purchases, debt repayments, taxes and the timing of customer receipts.

Illustrative example in Canadian dollars: an operation has $120,000 in annual fixed operating costs. Revenue averages $60 per input tonne, after allowing for product yield and sell-through, and variable costs are $20 per input tonne. Contribution is $40 per tonne, so operating break-even is 3,000 input tonnes per year. Capital spending, financing payments and working capital require a separate cash-flow assessment.

Where the money comes from

Most community enterprises need money before they earn it, for equipment, a site, permits and the first months of operation. There are several sources, each with its own strengths and conditions.

• Grants. Funding subject to the conditions of a particular programme. Grants may support planning, feasibility, training, capital or specified activities. Check eligibility, payment timing, matching requirements and ongoing obligations. Recurring operations need reliable funding for the period in which they will run.
• Loans. Borrowed money that must be repaid with interest. Loans suit equipment and assets that will generate revenue. They require a credible plan and often security.
• Equity. Money invested in exchange for ownership. Equity brings partners who share the risk and the reward, but it also means sharing control and profits.
• Impact investment. Investment from people or funds that want both a financial return and a social or environmental one. It is often more patient than conventional investment.
• Community investment. Money raised from local people, through community bonds, co-operative shares or similar structures. It keeps ownership and benefits local, and builds support.
• Different funders bring different repayment expectations, decision rights, time horizons and reporting requirements. Compare the complete terms against the needs of your enterprise.

Patient and pooled finance

Some of the most powerful financing in our case studies came from communities pooling their strength.

Pooled borrowing, co-operative finance and partnerships can help communities combine their strength. Examine eligibility, costs, security, decision rights and obligations using the funder’s current information.

A conservation fund, community lender or impact investor may support a different part of a project than a conventional bank. Identify the specific use of funds and test each source against that use.

The lesson is that communities don’t have to accept finance on whatever terms are offered. By pooling, partnering and planning, they can often find money that is cheaper, more patient and better aligned with their goals.

The capital stack

Most projects combine several kinds of money. This combination is called the capital stack. A typical community enterprise might use a grant for planning and part of the equipment, a loan for the rest of the equipment, some community or partner investment, and early revenue to cover operations.

A good capital stack matches each kind of money to the right use. Grants pay for things that won’t generate revenue directly. Loans pay for assets that will. Equity and community investment share the risk. Revenue keeps it all going.

Match finance to the stage

Different stages need different money.

• Idea and planning: grants, partner contributions and the community’s own time.
• Pilot: small grants, partner support and modest borrowing.
• Launch: a mix of grants, loans and investment for equipment and site.
• Growth: loans, investment and reinvested revenue.

A common mistake is seeking large loans or investment before the model is proven. A small pilot that shows the numbers work makes every later conversation with a lender or investor much easier.

Honest limits

Financial plans are estimates. Prices change, costs rise and markets shift. Build in a margin for error, test what happens if revenue is lower or costs higher than expected, and get advice from an accountant or financial adviser before taking on debt or selling ownership.