Getting Ready for Investment
Types of Funding Available
Typically new businesses will make losses in each of their first three years; even when they do start to turn a profit, the business will struggle to grow from purely reinvestment of some of that profit in the business. It is not surprising therefore that what a business needs during these periods is cash. Fortunately for start-ups, funding is available from a variety of different sources.
Traditionally a company’s main external source of cash was from a bank; debt funding. Today many companies will still have some form of debt funding. Often this will take the form of either:
- An overdraft: a repayable on demand, short-term funding option usually on the lender’s standard terms with minimal documentation requirements;
- A term loan: a facility providing for the borrowing of an ascertained sum (that may be drawdown in tranches) over a fixed period of time; or
- An invoice financing facility: often this facility takes one of two forms, either where you sell invoices for a percentage of their full value or where you borrow against unpaid invoices.
These options can be particularly useful for providing financial flexibility to young companies who may otherwise have to negotiate some difficult periods in respect of their working capital and cash flow, whilst providing a stronger long-term outlook by having not given up any equity. However, such debt financing does come with its drawbacks; often a personal guarantee or other forms of security will be required by the lender unless your company has some substantial covenant strength, which takes time to build. They can also prove not only difficult to get hold of if your start-up is in its very early stages but also expensive depending on the length of time used and rate of interest secured.
As an alternative to traditional debt funding, equity funding is also available. Equity funding / investment is the process whereby individuals or firms buy shares in a company in return for profit in the form of capital gains or dividends.
Some examples of equity/alternative funding include:
Family & Friends
The likelihood is that if you have your own new business, or have considered starting one, you are already familiar with this type of funding. A substantial proportion of any primary investments (whether that be equity or debt) in new businesses are made by a family member or friend. This is often the case as any new business will struggle to attract investment from any bank or other third party investors before it has proved itself to some extent. Nevertheless, many will have reservations when it comes to asking friends or family members for investment and for good reason. You should give careful consideration the position that you may be in should your business fail and whether, in light of such consequences, you may decide that bootstrapping/self-funding or the alternatives set out below might be a better option for you.
Similar to the ‘family and friends’ funding approach, just on a much larger scale; any potential investor will typically be an individual who is willing to make a show of faith in your business. It also has the added benefits of receiving funding from a source at arms length (thereby avoiding any awkward circumstances that are a risk of the family and friends funding option) and gaining your business some early publicity and potentially an immediate customer base for the next stage of its life cycle. However, this funding option does have its drawbacks; for example, some platforms will require that you reach a certain percentage of your funding goal prior to joining the platform, or may require you to hit your full funding goal for you to receive any of the money raised and thus you may be left with no investment despite having raised 95% of your target sum. Furthermore, you often have to make a significant time commitment before the campaign begins. Tight deadlines will likely have to be kept to in order to keep funders
satisfied and your business will almost certainly have to be in some way innovative or unique to stand out from the crowd and attract investors in the first place.
A business angel is a high net worth individual who not only invests in your business by providing money to help your business grow (in return for a slice of the equity) but who may also be able to bring knowledge and experience to help with your growth plans. Business angels make their own decisions about their own personal disposable finance, in contrast to the venture capitalist approach. Support from a business angel is often called ‘patient capital’ because business angels are generally prepared to support the business through its growth journey and exit over a longer timescale. Typically business angels invest anywhere between £10,000 and £500,000 in a single venture, although ultimately this amount depends on the business in question and its growth needs as against the business angel’s attraction to the proposition. It’s not unusual for angels to invest as part of a syndicate. By pooling together with other business angels they can bring increased value to the investment as well as increased capital. Finance in excess of £1.5m can be raised in this manner.
If your business is looking for funding from a venture capitalist the likelihood is that your have already been through one or both of the aforementioned alternative funding options. Venture capitalists will often be looking to invest a substantial sum in your business to take it to the next stage of its development. In addition to the direct injection of capital into your business, venture capitalists will often also be able to provide expertise in your business’ sector and mentor your business’ early development potential providing your business with an edge over the competition. Subsequently, venture capitalist may also be able to provide a range of further contacts that can further benefit your business. Yet venture capitalists are not without their downsides; in exchange for their substantial investments they will almost always require a substantial share of your business. Sometimes this may be for a controlling share in your business, which may go against the very reason your starting your own business in the first place.
If you would like assistance in sourcing funding, please contact Kirsty Simmonds or you can call 0345 070 6000 so that we can help introduce you to the right experts.