Getting Funding
27 May, 2010 -
The old adage is true: you need to spend money in order to make money. So where do you look for the financing you need to turn your business plan into reality?
In a nutshell, you have two options: debt financing and equity financing. Debt financing (e.g., bank loans) enables you to retain full control of your business, but you must be prepared to assume all of the risk. Equity financing entails selling partial ownership of your company, while allowing you to share some of the risk with your investors. The correct approach depends on the type of business you are starting, your financial requirements, and your personal and business goals. Your business plan should already include this information, and can be instrumental both when deciding what type of funding is appropriate for your business, and later on when you’re ready to approach potential lenders or investors.
The first place to look when starting a business is your own bank account. This is the fastest way to get started and allows for maximum flexibility, but it can be risky. While many successful entrepreneurs have been able to get their business up and running with little or no external funding (also known as “bootstrapping”), another option is to use your own funds as an interim solution to get your company operating and well-positioned to seek funding from outside investors at a later time.
Credit cards can be a great resource for immediate short-term capital when you are funding your own business. The low introductory rates on some cards make them an attractive short-term option (in the US – Israel is another story). Managed well, they’re extremely effective; managed poorly, however, they’re extremely expensive.
For long-term debt financing, loans are usually better than credit. However, it can be difficult for a new company to obtain a loan without backing (e.g., assets or third-party guarantors). If you are unable to secure a commercial bank loan, consider approaching commercial finance companies or private lenders. Private lenders typically specialize in an industry and may be willing to take on more risk if they see that your business has potential. Friends and family may also be willing to help fund your business, either as a loan or an investment (e.g., by buying shares). Beware the temptation to accept informal arrangements or zero interest terms, though, as this can cause problems down the road, whether or not your business succeeds.
Some businesses may qualify for a grant or government support (e.g., a subsidized or zero-interest loan). These support schemes may also provide expert advice or subsidized consultancy. Keep in mind, however, that grants often apply to a specific project rather than general business costs. Moreover, the application procedure is lengthy and complex, and there is typically strong competition, meaning you may spend a lot of time on an application which is not successful.
Incubator
One way to jump-start your business with minimal funds is to lease major assets such as equipment, office space and even support staff. If this sounds like a viable option, and if you would appreciate having an experienced team of professionals help form your company, consider launching at an incubator. Incubators are essentially ready-to-go space and support infrastructure for startup companies. Incubators generate most of their revenue from client rents and fees, and may also offer investment capital for entrepreneurs, allowing them to share in the upside should the company be successful. Different incubators will become more or less involved in the running of your company and offer varying degrees of business advice and legal assistance.
Crowd Funding
Crowd funding, contests, and group financing represent a fairly new trend in financing. Social media, online communities and micropayment technology make it relatively simple to engage and secure funds from a group of interested supporters at minimal cost. Customers invest as little as $1 in a product and help promote the product on the Web. These customers/investors receive a cut of the profits in proportion to their investment. Bear in mind, however, that soliciting investments from the general public is often illegal, unless the opportunity has been filed with the appropriate securities regulatory authority (e.g., the Securities and Exchange Commission in the U.S or the Financial Services Authority in the U.K).
Angel Investor
If your business has a high potential for growth, you may be able to attract the attentions of “business angel”. Angels are generally not looking to run the firm; they want you to do it and they can offer support in return for a minority stake. Most business angels will expect to exit your company in 2-3 years with a substantial return on their investment (e.g., once you are bought or go public). Angel investors can be just as important for their skills, experience and contacts as money, so do your research before choosing. It’s also a good idea to enlist a savvy financial adviser to structure the deal.
Joint Venture
Platonix does joint ventures – which are similar to angel and VC investments in that we typically work with companies in the seed stage (like angel investors), and in that our deals are fundamentally equity financing. A big difference, however, is that we do not invest cash, but rather provide technology work (R&D) for equity. Our incentives are aligned with the companies we invest in as our success comes from your success – but the risk is diluted among the many companies in our portfolio.
Venture Capital
Venture capitalists (VCs) present another option for new businesses with rapid growth potential. Like business angels, VCs will usually bring their managerial and technical expertise as well as capital to their investments. However, VCs generally demand higher shares in your business, and may require you to make significant changes in your company’s management structure. When pitching to a VC, your executive team should be able to demonstrate that you can operate successfully on a technical and financial level, meaning you probably won’t be able to attract VC funding within the first few months of starting your business. Moreover, it can take several months to complete negotiations, so make sure you have sufficient funds to carry you safely through this stage. Contacting prospective investors through a respected referral such as an attorney, consultant or business broker will usually establish a higher standard of quality and accelerate a response. These individuals are also invaluable when you’re ready to negotiate a deal.
There is no one-size-fits-all financing solution for starting a business, and different options may be appropriate at different stages. Take the time and get to know your options before you get started, then choose the ones that feel like the best fit for your company.
© Image courtesy of David Goehring