Types of Business Funding

Tuesday, August 9, 2016 12:06

Seed money

Do you need funding?

Start-up businesses often think that they need to find an investor. We only have to read in the papers about the latest internet billionaire to know that big funding means big success.

Yet most businesses can get going, or even grow without external investment. It depends on the amount required to gain entry into your market and whether you have sufficient funds to make a start, perhaps growing organically through sales.

The injection of funds into a business can however jump-start a project, or allow a more rapid growth. So if funding is desired it’s useful to think about the options for doing so:

Investment cycle

There is a natural progression of how a business is funded. Initially it may be that the business is financed by the owner or by approaching family and friends. This may be sufficient by itself for your business.

Alternatively, or perhaps as a follow-on, a local bank might be approached. Although nowadays these have been less helpful for young businesses, so after proving the concept, many tend to seek business angels.

At the next stage beyond this, venture capital firms might be brought in. Few companies go straight out and raise multi-millions; those that do are often high-tech businesses with known entrepreneurs, or ground breaking technology.

Types of funding:

Self-funded
Traditionally the way that the majority of businesses get going. For further investment it also shows your commitment in that you have put your own money into the concept and is invaluable in gaining that first bit of traction that Investors look for.

If the start-up business is taking the form of a partnership it will need to be made clear in the partnership agreement exactly how much of the funding each partner is providing and whether this entitles them to a greater or lesser proportion of the partnership profits. See Partnership Agreements

Loans
Banks will normally only loan money against you having security to offer. These may be assets of the business or personal assets such as your house. They are not entrepreneurial and don’t take risks based on you having a good idea.

Many Business Angels will include a loan in addition to purchasing equity in the business as part of the way in which the funding deal is structured.

Private equity funding
This is the generic name for sources of funding, normally in exchange for equity in the business. It includes both Business Angels and Venture Capital companies. People sometimes confuse the two. The differences are:

Business Angels

  • Anything from £1000 to £1M (although that would require several banded together).
  • Will look at start-ups and young businesses
  •  Since they are investing their own money they can take more risk.
  • Often want to contribute knowledge or contacts

Venture Capital

  • £1M plus (normally)
  • Not for start-ups or just at idea stage
  • They are investing a fund comprised of other people’s money, so have to take less risk than Business Angels.
  • May place own people on board and require strict reporting

When exchanging equity in a business for funds a legal document must be agreed that specifies the terms of the investment. Venture Capital companies will have a range of agreements to use from Investor Rights Agreements, Stock Purchase Agreements and Term Sheets. It can be expensive and time consuming to raise money.

Agreements with Business Angels can be quicker and much less costly to organise, but never be tempted to cut costs so much that a well thought out signed agreement is neglected. There has been much woe and falling out of parties when issues occur that haven’t been previously considered and placed in a legal document.

Private equity funding can come in stages as the business grows:

• Seed funding
• First round
• Second round
• Later stage
• Mezzanine
See Types of Private Equity funding

Grants
There are only a few government or institutional grants available to businesses. These tend to be market sector and geography specific. Whilst serving a useful purpose for those able to claim them, they are so few that they are not applicable to most businesses and so not covered here.

For young businesses, the more you can do in proving your concept works and gaining what is called “traction” the more offers of help you will get and be in a better place to negotiate terms.

 

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