How to raise the right funding for your business

  1. Funding and finance
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    Christian Annesley

    Christian Annesley Contributor Full Member

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    Raising funds for an early stage business can sometimes feel like a catch-22; you need the money for the business to thrive, but to get the money you want you are told you need a business that’s already thriving.

    Luckily, a lot of funding for business is not quite the paradox it looks at first glance. The reality is not impossible so much as challenging. 

    For every business, there is real work to do in order to unlock the right funding stream.

    The common thread here, for a business looking for early stage finance of any kind, is presenting the proposal in the right way to the investor or audience that needs to be reached.

    So just how do you raise the cash to grow your business, and particularly if you don’t have the luxury of accounts going back several years, coupled with a rounded business plan that backs up those accounts? Or how can you find the funds to grow really fast in order to seize on a market opportunity?

    Here are some of the options – and how to weigh them:

    Venture capital finance

    Those seeking out finance from venture capitalist firms looking for fast-growth businesses in which to invest will normally need sufficient evidence that what they’ve got as a product or service has strong commercial prospects. That’s something that can be proved even if actual, paying customers are not yet a reality.

    Venture capitalists – VCs, for short – usually want to take an equity stake in a company with potential for strong growth. The venture capitalists themselves are investing on behalf of funds supported by investors who want a high-growth return on the risks involved.

    To invest with confidence the VCs will therefore be looking for a detailed, compelling business story they can believe in, before and after any due diligence is undertaken. And they will need to be convinced by the management team too.

    Business angels

    Business angels are private investors, normally with a track record in business themselves. They have capital to invest in new business propositions they believe in – often in return for an equity stake.

    How big is the opportunity for those seeking investment? And how does it differ from VC investment?

    The UK Business Angels Association (UKBAA), which is the national trade association representing angel and early stage investment, reckons £850m per annum is invested by angels annually in the UK.

    This is more than two-and-a-half times the amount of venture capital invested in early-stage small businesses annually, but it isn’t a number that’s been independently verified.

    The UKBAA says there are about 18,000 angel investors in the UK, and makes the point that angel investment differs VC finance in that the venture capitalist manager is always investing the money on behalf of a fund, which has to be profitable and make a return for the fund’s investors.

    “Unlike investing in a managed fund, business angels make their own decisions about the investments they make and generally engage directly in meeting the entrepreneurs, often seeing them pitch their business. Angels also engage directly in the due diligence and investment process, and are signatories on the legal investment documentation.”

    For many in search of investment, this will sound like an attractive opportunity to explore, but the point here is that the fit has to be right. One pitfall that sometimes crops up is that an individual will have to turn away potential funding due to the technical detail of the relationship an angel want to forge.

    Grant and public funding

    Some innovation-led companies have just the right profile to tap into the various pots of public money that are available for businesses.

    In the UK, grants and funding for certain types of innovation are managed by Innovate UK, an executive non-departmental public body, sponsored by the Department for Business, Innovation & Skills.

    Among other responsibilities, it works to determine which science and technology developments will drive future economic growth, and meets UK innovators with great ideas with a remit to fund the strongest opportunities. Since 2007 it has committed over £1.8bn to 7,600 innovative organisations – a figure that’s matched by a similar amount in partner and business funding.

    Asset based finance (including invoice discounting and factoring)

    For many businesses, raising financing against assets is the best option for securing funds for working capital (it’s not really a fit if you need funds to invest strategically in the business).

    It provides many companies with security, and without giving up equity along the way. But it is still important to structure the finance to limit risks: companies need to be able to afford delays and issues from time to time, because no business goes perfectly to plan.

    What’s changed in particular in asset-based lending in recent years is the greater flexibility in invoice discounting and factoring market.

    There are lots of new players and it’s a more flexible market now. Around 10 years ago, many accountants would have warned companies against it as an option because a business could build up a dependency it was hard to break out of, but now it can be flexible. That means companies can dip in and out easily and call on it as a short-term resource.

    But these are still relatively expensive forms of debt finance. You need to go in with your eyes open and an exit plan.

    Malcolm Durham, chairman of part-time finance director business FD Solutions, says: “Asset based finance is under-rated partly because people are suspicious of factoring in particular and borrowing in general. But the advantage is that you keep all the shares and therefore most of the control.

    “I organised the management buy-out of a small (single office) employment agency using invoice discounting. The manager acquired the business that she ran for £30,000, with the balance of the funds being loaned to the company secured on its debtors. It was a good option.”

    Crowdfunding

    Crowdfunding websites raise finance by asking a large number of people – normally just private individuals – for a small amount of money each. Unlike most business finance, which asks a few people for large sums of money, crowdfunding sites can talk to thousands – if not millions – of potential funders.

    For businesses, debt crowdfunding is what’s usually on offer. Investors receive their money back with interest, with the rate that’s set being determined by a range of factors, including the risk profile of the business and market demand.

    Also called peer-to-peer lending, the returns may be financial but, when all goes to plan, investors can also feel the warm glow of having contributed to the success of an idea they believe in.

    Crowdfunding has grown in profile and popularity in recent years, with lots of crowdfunding websites, like Crowdcube and Funding Circle, now well-established.

    There are some things to remember, however. First, companies will need two years of filed accounts – plus a story that the wider world could potentially believe in: it’s not just about the numbers stacking up, when it comes to attracting lots of investors.

    Crowdfunding may usually be a debt deal, but it can sometimes be for equity. The attraction of crowdfunding, however, lies in its relative simplicity and in the fact that, for the right profile of business, it can be an uncomplicated way to secure funds speedily in order to get stuff done. That makes it particularly suited to debt rather than equity.

    Crowdfunding is often associated in the public eye with young, tech-savvy entrepreneurs raising money only, but its reach is clearly now far broader than that.

    Many investors opt for crowdfunding because they like the returns and because of the buzz of investing in something that excites them.

    The other side of the coin, for businesses looking to raise funds, is that finance raised this way normally carries a personal guarantee. So there are risks. You cannot write off a crowdfunded debt – once it is on the books it will need to be repaid. And it’s a very public kind of debt, which is also something that should be understood when it comes to building and protecting reputation.

    The other appeal with crowdfunding is that company owners can access it themselves, without the services of a corporate finance adviser. That can make it a speedier option than some of the other funding options outlined here.

    We'll take a look at crowdfunding in more depth next week; but for now, what do you think is the best option when it comes to funding a small business? Log in or sign up to comment.

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  2. Ian J

    Ian J Factoring Specialist Full Member - Verified Business

    4,886 1,373
    That's always been a bit of a chestnut. If a company is receiving funding at a level of (say) £100,000 and wants to get out of factoring they have to find some way of paying the money back but if they are receiving funding by way of a bank overdraft of £100,000 that they want to get out of they still need to pay it back so there is absolutely no difference in flexibility
     
    Posted: May 5, 2016 By: Ian J Member since: Nov 6, 2004
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