April 18, 2019
There are a wide range of funding resources available when starting and growing a business, which generally fall into one of three categories: bootstrapping; debt; and equity.
In the beginning, it’s likely to be just you and your own savings and this is known as bootstrapping - funding the business through your own means. There a number of hugely successful bootstrapped start-ups that delayed taking external investment, such as GoPro and Spanx. However, for obvious reasons, bootstrapping is not available to everyone. Few of us have the means to fund our own businesses for any length of time.
So, if you’re starting a business it’s important to plan ahead and think about your long-term goals from day one. Think about what type of funding will work best for you and your business and how you intend to manage your finances as your business grows. Is your aim to accommodate a better work life balance by being your own boss or do you want to build an empire and make millions? The drivers behind your decision to start a business are crucial to determine your plans for growth and therefore impact on your funding options.
What you may not know is that the decisions you make in the early stages of your business can have a big impact later down the line when looking for investment. Investors will scrutinise the detail of your company to assess the risks of their investment. By taking steps early on to ensure you have strong company structures and processes in place, you can maximise your potential to secure that cash when you need it most!
This guide will provide you with a basic understanding of the different finance options available as you expand your business and what you can do to be ready for it.
Getting the company started is by far the toughest part. Turning your idea into reality is all about the execution. It’s the riskiest phase of a company’s life, which is why finance options are usually more limited. During this early stage, founders will usually look at business loans or co-founders for financial support.
When borrowing for the business, the lender will want to see that you have a solid business plan and company structure in place. They may also want a personal guarantee from you and any directors of the business.
Finding somebody with the skills and expertise in your industry who is both enthusiastic and passionate about your idea can give you the edge you need to take the business to the next level and they often bring their own investment with them. However, introducing a co-founder often means splitting the pie. You’ll need to decide how much equity you’re willing to give up and in exchange for what. What ever you decide, make sure you have an agreement in place to cover it.
You’ll need to think about whether you need public liability insurance, employers’ liability insurance, professional indemnity insurance and/or product liability insurance amongst other insurance for more niche aspects of your business. Insurance should always be considered against the cost of the policy and the overall risk that you’re insuring.
Your brand is what sets you apart from your competitors and in essence, is the identity and personality of your business. If you have commissioned your logo or branding, make sure your designer has assigned the intellectual property rights and register your trade marks as soon as cash-flow allows. Also make sure you have a non-disclosure agreement in place before you start sharing your business plans with any potential business partners – or anyone else for that matter.
Before you start working with business partners or selling your good and/or services to customers, make sure you have appropriate agreements and terms and conditions ready to go. Selling or buying anything without an agreement in place could leave you exposed to all sorts of risks and claims later on.
All of the above will help to keep your company in good shape ready for your next growth and financing stage.
Angel Investors or Crowdfunding?
Two ways that start-ups often look to secure extra cash is through what we call a “funding round”.
Crowdfunding is a way of raising finance by asking a large number of people for a small amount of money each. There are three main types of crowd funding: donation; debt; and equity.
Donation crowdfunding is where people invest simply because they believe in the cause. Donors tend to have a social or personal motivation for putting money into the business and often expect nothing back in return.
Debt crowdfunding allows you to borrow money whilst bypassing traditional banks. Investors will expect to receive their money back with interest.
Equity financing is where people invest in your business in return for a slice of the pie. Money is exchanged for shares in the business and depending on how successful the business is, those shares will rise or fall in value. The great part about equity finance is that you don’t have to pay the money back.
Angel investment is a kind of equity finance. An angel investor is a high net worth individual who provides finance at an early stage in the business’ life in exchange for either a convertible debt or ownership in the business. Angel investors tend to offer expertise as well as their money and usually take up non-executive positions on the board of the company.
Be aware that with each investment you will be diluting your ownership of the business. Before you flinch, this isn’t necessarily a bad thing. The investment allows you to expand so, although you’re giving away some equity, hopefully the value of your share is increasing!
You need to think about the documents you’ll need to put in place to govern the debt or equity investment at this stage. This will include documents such as loan agreements, security documents such as debentures, share charges and mortgage documents etc.
Shareholder Agreement and Articles of Association – but wait a minute, we’ve already got a Shareholders’ Agreement? Why do we need to think about this again? If you have a Shareholders’ Agreement between you and your co-founder, this will not cater for Angel investments where a new individual is going to have a stake in the business. You should review your existing Shareholder Agreement and Articles of Association (the document that governs how the company is run) to ensure that you’re comfortable with the level of control that you’re giving to the investors. Certain powers of the company are reserved to the owners so if there ends up being a dispute between your board of Directors, your investments might have an influence over the decisions of the business.
A venture capitalist is a form of private equity investment, where a business receives funding in exchange for a share in the business. The aim of venture capital is to make investments in early and mid-stage businesses and profitably exit at a later stage (usually within 5 to 10 years).
Venture capitalists often make an investment from professionally managed pools of money in exchange for a high stake in the business and can offer valuable management and industry expertise as well as introductions to potential customers, suppliers, partners, employees, and much more.
Your senior management will be responsible for participating in the daily supervision, planning and administrative processes of the business to help meet its targets and objectives. Investors will want to see that you have a strong management team who are capable of making the business successful. Ensure that you have proper employment and directors’ service contracts in place and that these are updated regularly as the business grows, particularly if you have given someone a promotion or taken on new Directors. Think about including appropriate restrictive covenants in your employment contracts, particularly for your senior management, so that your business is protected against ex-employees setting up a competing business and stealing all of your know-how.
Investors will look at the overall risk of the business and its potential. Having policies and procedures in place to govern the way the business operates will enable investors to make a decision about whether the business is likely to succeed. You’ll need to think about the measures you have in place to protect not only your products or services, but your software, platforms, databases, personal data as well as your intellectual property and your premises.
When you start a business it’s hard to imagine how you will exit the business. Will you hand the business over to your children, sell the business or possibly float it on the London Stock Market (IPO - the gold nugget of exits!)? You need to think about your long-term goals from an early stage and what you hope to achieve so that you can take all the right steps along the way.
Our biggest tip for exit:
Get Ready! – an IPO or selling the business will involve a lot of due diligence. Your contracts, intellectual property, processes, management teams, employees, financials, essentially every nook of your business will be scrutinised. This is where all your hard work in the set up and design of your company will pay off. If you have set up well and put strong and sound processes in place from day one, here is where you will reap the benefits!!
A funding path is unique to each business and there is no right or wrong way of going about it. The most important thing is to ensure that you have the right protections in place from an early stage to ensure that you can explore the options available and adapt as your business grows.