Financing a business is a tough decision making process – each entrepreneur’s circumstances are different, and equity fundraising is certainly not the best solution for everybody. Here are five common ways that start-ups finance their businesses:
1) Friends, family and fools
Despite the seeming disparagement, these people are far more likely to lend you money on easy terms and to be more forgiving if things go wrong.
My advice on this is a) do it with a proper legal agreement and b) visualise how your relationships will change if you lose all of the money. I speak from experience.
2) Get a hand-out (in old days from a charity, nowadays a grant)
If you qualify for a grant – for example, a product development grant from the Technology Strategy Board, or R&D tax credits from HMRC – then congratulations!
Grants are non-dilutive benefits and all that you have to do is to process a little paperwork and claim the money, after which you are responsible to nobody.
3) Angel investors
Angels are investing their own money.
Some (like me) see it as a diversification of assets into high risk, potentially high reward ventures. I also do it because it is fun – I like helping the companies in which I invest, and feel that I’m doing good by investing in manufacturing / engineering companies and supporting entrepreneurs whom I respect.
Some angels want to roll up their sleeves and have a lot of involvement with the business, whereas others just want to write a cheque and see you return it with a healthy profit on exit in a few years. Some are very wealthy, investing large six or seven figure sums in each business; the average individual investment is £25,000-40,000.
So to raise say £500,000, angels naturally form syndicates, where one (or several, like Qi3 Accelerator) leads the investment, undertaking the evaluation, due diligence and legal work on behalf of the group. But the principle is still the same – we are investing our own money and it hurts if we lose it.
Certainly if you are looking for help to develop the business as well as pure cash, angels are the best route. I have recently been involved in investment rounds ranging from £10,000 to £2.3m led by angels.
Pretty new, but may be effective for some businesses.
My cautions would be on the legality of the arrangements (in some cases) and whether this route will raise you enough cash. On the other hand, it puts you – as the entrepreneur – in a stronger position if you have many small investors rather than a few larger equity-holders breathing down your neck all the time.
5. Venture Capital (VC)
By this I mean investment management houses that manage funds comprising other people’s money. During early stages of small business investment, these are mainly public funds (UK or EU). There are also a few remaining VCs who manage Venture Capital Trusts (VCTs) and other investment groups. VCs are generally interested in investing sums of £2m+ in companies although there are exceptions.
VCs generally seek tougher terms than angels, as the investment manager needs to monitor his investees. He needs to be accountable to his investment house for governance and generate management fees both from the investors and the investee companies.
So how should you decide which route to follow? Of course you may well need different sources of finance as the business develops, but I’d suggest that you start by considering (a) the amount of money you need, (b) the strings attached by lenders / investors and (c) the support that investors can offer in addition to raw cash. My starting point would generally be to model ‘bootstrapping’ the company with revenue from sales and income from grants / collaborative R&D partnerships before considering loans or equity finance. As investors, we are always keen to help leverage these sources of finance, so our interests are well aligned.