4Ms of Business Foundation Series – Part 3:

Money – 14 Top ways to fund Start-ups

 

Welcome to the third instalment of the 4Ms of business foundation series. The first article examined Business Models for the digital economy. If you missed it, see it HERE. The second part of the series looked at Management Models. See it HERE. The final post in the pack will shed light on Marketing for small businesses. So be sure to check in on next month’s update.

Access to money drives the small business economy. Without money, capital, budget or whatever you want to call it, entrepreneurs and owners are just unable to run or grow their start-ups. Financing has always been a challenge for small businesses. In the good old days, small businesses would routinely rely on borrowing from traditional lenders – that is the local bank. Today, small business owners consistently argue that it’s often difficult to secure a commercial loan.

As a consequence of getting traditional bank loans, the trend in small business financing today is toward alternative sources of finance – short-term funding sources that are quick and open to most businesses. This post examines the need for capital in small firms and startups. We provide a top 14 list of alternative funding sources to consider.

I have not gone into too much detail about each funding option in this post. Otherwise, it would become an encyclopaedia. Instead, I give you an overview of the available sources and how they work to get you started.

 

Where capital fits into business

In simple terms, no money means you can’t purchase essential tools, equipment or services required to run a business. If you can’t pay yourself or your team, no one can be expected to work while starving, losing their home, etc. Regardless of your vision and passion, without money a start-up cannot challenge competitors if they can’t invest in essential business services such as marketing, IT systems and support, consultancy, premises, etc. So it is true that money makes the small business world go round!

According to Dun & Bradstreet, businesses with fewer than 20 employees have only a 1 in 4 chance of surviving for four years and less than one in ten chance of surviving for ten years. The great news is that 90% of failed startups close because the business was not successful, did not provide the level of income desired, or was too much work for the owner. So take comfort in the fact that only 10 percent close involuntarily due to bankruptcy.

A key factor in firms remaining open includes an ample supply of capital. Furthermore, access to finance is a significant barrier to business growth. This challenge is particularly stark for more early-stage companies due to the higher levels of risk involved (Maria Dee). So do not be in any doubt that it is vital for all businesses, regardless of where you are in the business life-cycle (inception, growth or maturity), to have access to money.

 

Money in start-ups

Generating a lot of income from day one is the ideal scenario for start-ups to be able to cover their costs sustainably. Stories of today’s corporate giants that started in someone’s bedroom or garage with the bare essentials litter history – a great idea, a vision to make it happen and willingness to work hard (think Microsoft, Facebook, The Cambridge Satchel Company, etc.). There is no doubt that making lots of money along the way helped them to become sustainable and grow into the giant machines that they are now.

However, it is rare to find a start-up that is flush with money at the onset. It is even more uncommon for such rich start-ups to plan to start small and grow their business organically. In this sense, there is probably some truth in the saying that ‘money corrupts the mind’!

Here’s the reality: with money in the bank, a wealthy entrepreneur is arguably best served by buying an existing business rather than starting from scratch. Should they choose to start from scratch, the likelihood is that they will be tempted to think ‘bigger’ everything – bigger goals, bigger premises, bigger company, bigger payroll, bigger everything! It is not uncommon for such businesses to fall into the pitfalls of overspending and overreaching far too quickly.

It is unmistakable that the world is also full of cash-rich start-ups that have failed after squandering vast amounts of money they have made or raised: See Whistl, Sequoia Communications, and Amp’d Mobile for eye-watering corporate obituaries.

Declining availability of traditional bank loans

Banks still make loans to businesses. However, the largest banks are not making nearly as many loans to small businesses as they used to. According to a recent Wall Street Journal report, big banks have reduced the volume of loans to small businesses by more than 38 percent since 2006.

One reason for the decline in willingness to lend to small businesses is that it simply is not profitable for banks to make business loans of less than half a million pounds, which is far more than most small business owners qualify for or need.

The real likelihood that small businesses will die at an early stage, do not have the requisite track record or assets and do not meet banks’ lending criteria further add to the unnecessary risks from which banks are actively shying away. While tightening lending standards is understandable, small businesses are left in limbo asking ‘how are we meant to survive and grow without access to money?’

 

Sources of money

 

You don’t have to borrow to achieve your business dreams. You could gamble your way into money although some bets are more sensible than others.

Like millions of people, nothing stops you pinning your hopes on winning a life-changing windfall on the weekly lottery, perhaps buying several lottery tickets for every Lotto draw. Be aware that more than 52% of people have never won a penny on the lottery. Furthermore, the odds of winning the National Lottery (roughly 14 million to one), means that you could be waiting for a very long time and may never see that windfall!

Maybe you prefer Premium Bonds with 54,502 to one odds of winning, better. With Premium Bonds, you invest your cash, and then each month, millions of investors are picked at random to win one of the several prizes. There are two £1 million prizes, four £100,000 prizes, nine £50,000 prizes, 15 £25,000 prizes, and millions of smaller prizes. The more you have invested in the bonds, the more chance you have of winning. National Savings & Investments say that you could get the equivalent of a 1.35% return on your investment. So you’d have to buy a big lot of bonds to get any meaning windfall. Of course, there’s around a one in 100,000 chance that you will never win anything at all.

 

Business finance considerations

• Inherent risks: There are several benefits to securing external funding and investment for your business. It’s important to remember that finance is not a ‘get out of jail card’ and it is not free, but if it is right for your business, it can unlock a world of new opportunities and fuel rapid company growth.
• Business lifecycle: companies go through the stages of the business lifecycle and encounter different challenges that require different financing sources. For example, the company will need a different strategy when it comes to market penetration, business development, and retaining market share. As the firm mature, operations and priorities will change therefore the options for acquiring business financing also change as well.
• Make a strong case for ‘yes’: An entrepreneur is not guaranteed to get investment or external funding from the sources mentioned in this post just because they are willing to accept less favourable terms than traditional lending sources. It should come as no surprise that investors will be unlikely to want to throw their money at someone who has a poor credit history, a history of late payments or an enterprise that does not have a detailed business plan, for example.
• Preparation: Planning to get external funding for a business requires serious consideration, discussion, and analysis. You may want to complete this 10-point checklist to assess your readiness for financing: Are You Ready to Seek Funding? This 10-Point Checklist Will Decide.

 

Funding Options for businesses

The funding sources are organised into four main categories to make the options easier to navigate:

• In-house funding
• Loan/Debt
• Equity funding
• Mixed funding models

Let’s get straight into your business funding options.

 

In-house funding

Entrepreneurs do not always have to get external funding to enable their businesses to survive and grow. The first port of call when money is tight is to look within – at the owner, the business, and networks – to establish if the company can raise funds without having to turn to external funding sources. The benefit of in-house funding is that there are likely to be less restriction and less stringent strings attached to the money. The downside is that you may be giving away some level of control of the company or valued possessions depending on the precise terms of each particular course of action you choose.

1. Organic funding – The business funds itself. As the firm grows, it spends money on what’s needed to enable further growth. This approach works best for companies that can generate sales from the start and have enough customers in the pipeline to produce the sales and revenue that is needed.
2. Self-funding – Owners fund the business themselves. They use savings, other income sources such as earnings from another job or personal debt (such as a second mortgage or credit cards). Owners could also sell high-value assets to raise money for the business (e.g., investments, a second home, jewellery, art collection, etc.).
3. Friends and family – Friends and relatives can provide either equity or debt funding. While this may initially seem like a good source, be careful about selling part of your business to this group. Unfortunately, businesses fail. The loss of capital can then cause hurt feelings, ruin friendships and make for unpleasant family gatherings. Be sure that your investors know the actual risks and keep to your commitments.

4. Partners– entrepreneurs can take on strategic partners to bring additional funding into a business. The partner may or may not become a direct employee of the company; instead, it may be a reciprocal service-based agreement in which the firm provides services in return for guaranteed regular income.

 

Loan

Entrepreneurs who take out a loan typically commit to repay the borrowed amount to the lender, with a specified interest rate, timescale and terms and conditions. The benefit of using debt-based financing is that is that you retain complete ownership of the business. The downside is that you have an obligation to repay the loan and failure to meet your commitments, under certain circumstances, can enable the lender to force the company into liquidation.

 

 

5. Equity-backed loans – Business owners can borrow money with their property as the security. Higher loan-to-value of the assets present greater the risk to the lender, so they usually come with higher interest rates. Loans are typically for an agreed period, say 15 years, by which time borrowers must repay the amount in full otherwise face punitive charges. Borrowers also pay a substantial percentage of the loan amount annually in return for the money. There is often the possibility to extend the loan beyond the initial repayment period

6. Equity-based crowd-funded loans – Lendinvest is a debt-based lending platform that relies on many small investors. Unlike equity crowdfunding, where investors become shareholders in a particular property, these investors lend to property-backed loans. Borrowers, typically UK property entrepreneurs who need short-term finance, borrow against their assets. That means that the LendInvest platform secures every loan by a registered legal charge against the relevant property at Land Registry. Their lending criteria are relatively conservative as they prefer to work with low loan-to-values, and they always do extensive searches and due diligence on both a borrower and property before lending. See the image above for the parameters LendInvest works within. They can give investors returns on investment of up to 9 percent a year by charging significantly higher interest rates than traditional finance and giving investors a fixed return per loan.

7. Federation of Small BusinessCash Advance – The FSB gives members (small business owners) access to an unsecured business loan with an 80 percent acceptance rate. If successful, funds can be in your account within 15 working days. Their business loans have a little impact on the borrower’s bottom line with flexible repayments linked to your cash flow. Entrepreneurs make repayments through an agreed percentage of future credit and debit card transactions or a fixed direct debit.

8. Alternative lending – As the name suggests ‘alternative’ funding is a borrowing from non-traditional sources such as bank loans. The Internet has made alternative lending widespread as the lenders who typically let businesses borrow small amounts they need, can be found relatively quickly on search results and social networks. Furthermore, lenders gain access to a wealth of information about borrowers via the Internet in the form of digital data (online records, online presence, analytics, sophisticated algorithms and risk analysis software).

Alternative lenders fill a necessary gap in the absence of widespread access to bank loans. Like all businesses, their primary aim is to make profits from the loans that traditional lenders usually deem to be unprofitable of too risky. They can make lending decisions faster than the traditional banks using the readily available data they have, making decisions in days rather than weeks and months.

       Bob House warns of these dangers of alternative finance:

• As the borrowers cannot get traditional funding, hence turning to alternative lenders, the loan often comes at exorbitant (if not predatory) interest rates.
• Since the alternative lending space is largely unregulated, small business owners can find themselves forced to pay much higher rates than they would have been required to pay with traditional financing

     9. Small business lenders– Many companies want to lend to small businesses. An Internet search for ‘small business loans’ should bring up hundreds of choices. Most lenders will want the loan to be secured by assets of some type, and rates may be astronomically high.

Equity

Entrepreneurs who use equity to fund a business offer over a stake of the business to an investor in exchange for the latter’s money. The major advantage is that there is no obligation for the business to repay the financier. The downside is the owner has to give up a part of the ownership of his or her business. Which could lead to losing control over how to manage and run the company.

     10. Angel investors– These are typically wealthy individuals willing to invest in businesses in particular sectors or geographical areas. They give entrepreneurs money based on a belief in a business idea, in return for getting their money back at a future date and often an interest or partial stake of ownership in the company. Increasingly, angel investors are forming investment groups to spread risk, and to pool research. You can find angel investors in an Internet search.

     11. Cloud funding– There are now many platforms that facilitate entrepreneurs pitching their ideas to investors using the Internet (Think web-based Dragon’s Den). Typically, when this type of funding is successful, many investors contribute funds to the business following one or more webinars where entrepreneurs present the investment opportunity and respond to questions from investors. Investors take a share of ownership and share of profits in return for their investment in the businesses.

    12. Venture capital– These investors provide early-stage funding for start-ups in which they have strong belief in its potential to grow exponentially. Venture capitalists are typically looking to make relatively significant investments and often take a controlling interest in the company. TheWhen approaching Venture Capitalists, the entrepreneur’s mindset should be along the lines of: ‘it’s better to have a part of something that’s worth millions than own 100% of something that is worth nothing.

Mixed model

These funding options do not fit neatly into the other categories we have looked at so far.

 

    13. Crowdfunding– These are web-based platforms that allow business owners to showcase their need for funding and seek investment by appealing to a large number of investors to contribute funds towards an idea or business. Crowdfunding Investments can be debt, equity or rewards-based.

    There are hundreds of crowdfunding platforms, so you will need to do your research before launching into this funding stream. Bear in mind that Crowdfunding campaigns are required to set a       target amount they want to raise. If successful, the entrepreneur gets the money, whereas if the fundraising falls short of the goal, all of the money pledged is returned to the donors. Examples of current projects, and where they stand against their fundraising target, can be found here: http://www.crowdfunder.co.uk/projects/search/order/funded.

   The ability to give a compelling narrative about why people should invest in your idea/project can make the difference between success and failure to secure crowdfunding. New research suggests that investors seem to care most about having the proper management of businesses, and high-quality products or services. The company’s valuation and business performance projections do not influence these investors as much.

   14. Factoring – This is a type of debtor-finance in which a company sells its monies-owed (i.e. invoices) to a third party (called a factor) at a discount (that is a fee charged for advancing the payment). Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. Invoice factoring is an easy and flexible way to ensure finances.

There are more options for funding small businesses than are covered in this post. However, with the tips below, a good business plan, diligence, and persistence, you can secure funding for your small business or start-up.

 

Tips for Small Business Owners

As a current or future small business owner, financing will likely play a role in helping your business achieve its full potential. However, the changing shape of small business financing doesn’t mean that you have to settle for high interest rates and costly lending scenarios.

Bob House advises that there are several things to consider in your search for the right lender to protect your company’s future:

• Evaluate your options. Choosing a funder is serious financial decisions so make your choice carefully. While it can be time-consuming and challenging to secure funding through traditional lenders, evaluate all of your options instead of settling on the first person that is willing to approve your application.
• Understand rates and terms. Whether you are seeking to fund through a traditional bank or an alternative lender, it’s important to understand the rate, fees, and terms of the loan. The same principle applies if you want investors. Be sure to have loan documents and Equity Agreements reviewed by a competent legal adviser before you sign on the dotted line.

I hope you have enjoyed reading this post on a critical part of making a small business work today. I also hope you find the content useful to grow your business.

Next instalment

Modern businesses would likely quickly lose everything without the right level of structure, management and money. The final part of the 4Ms of business foundations for success is Marketing. See you next month!

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