The type of funding that is right for your business is entirely dependent upon the type of business you are starting and your own financial means. Some businesses, especially when providing expertise-driven services, require little to no capital to start. Some businesses, such as retail, or any form of manufacturing, may require considerable capital to open their doors. This is an overview of the most common types of small business funding as well as some exciting new developments in crowd-sourced finance.
Do-it-yourself / Bootstrapping
Bootstrapping refers to starting and building a business without any external investment. Growth is achieved from resources provided by the entrepreneur, and later through revenue. A resource does not have to be cash. For example, if you are setting up as an independent accountant, you might simply use a computer you already own, rather than providing the cash to buy new equipment.
Advantages of Bootstrapping
- You control your own company and own it outright rather than giving away a slice of the pie before you even start.
- People tend to be more frugal with their own money than with other people’s money.
- No time is spent finding investors. All of your time can be focused on the business.
- Should you require investors for expansion later, they will look favorably on the fact that you are a going concern rather than just a business plan with potential.
Disadvantages of Bootstrapping
- If the business fails, you will lose most, if not all, of what you have put in.
- Growing a company organically tends to be a slower path than using investment capital to accelerate growth.
- Bootstrapping will not be an option for you if the business requires considerable capital investment in assets, machinery, stock, or staff, and you have limited personal resources.
Loans from friends and family
Many successful businesses have been built with money loaned from, or invested by, parents, aunts and uncles, or siblings. But this type of business financing comes with some serious risks.
Advantages of family financing
- It may be easier to convince your family member to lend you the money than a bank as personal relationships take on a more involved form.
- Repayment terms and interest rates may be more flexible and favorable than an institutional lender.
Disadvantages of family financing
- Sometimes family loans lack the formality and documentation that are expected with other sources of finance. Should there be any disputes, or should the business struggle to meet repayments, this could cause considerable problems for both you and your relative. Ensure that legal documents outlining the terms and conditions of the loan are drawn up and ensure that they are legally binding for both parties.
- Family members who lend you money sometimes think they now part own the business. This can lead to interference that takes time away from focusing on building your business. Make sure the loan agreement states which party is running the company.
Banks are the most common organisation that entrepreneurs approach first for financing. Bank loans can be very hard to get with stringent requirements, although there are banks with dedicated small business lending specialists. Many more bank loan applications are rejected than are accepted.
Advantages of bank loans
- You are not giving away any equity in your business and retain control.
- Banks tend to offer lower rates of interest compared with other commercial lenders.
- You may receive some tax relief on part or all of the repayments.
- Banks are generally very convenient for businesses, especially if the same bank is being used for the business’ day to day banking.
Disadvantages of bank loans
- Bank loans can be very difficult to get approved for. The application process may be complex and lengthy, and the evidence required may feel excessive and be more than you can produce.
- Banks prefer lending to existing businesses, rather than startups.
- You may be required to put down considerable collateral, most likely your house, if you own one. If you default on the loan you stand to lose it.
Angel investors tend to be wealthy individuals that provide capital for start-ups. They usually provide the first round of funding for a business, also known as the seed money. Some angels band together to form networks where they collect and share intelligence. Sometimes they pool their investment resources. Angels are generally open to high risk, as they will spread their risk across multiple investments and expect most to fail. Angels tend to invest smaller amounts between £10,000 and £200,000. Advantages of angel investment
- When you find the right angel for your business sector, he or she will often make a decision quickly.
- They will have knowledge in your sector, which can aid you, plus their interest should motivate you to remain focused.
- You are giving away equity so there will be no loan repayments to make.
Disadvantages of angel investment
- The right angel for your business can be hard to find, and then hard to approach. They receive many more proposals than they can accommodate so you will have to work hard to catch their attention.
- The size of equity you may have to give up for the amount of money you receive may become problematic at a later stage should you require additional rounds of investment.
Venture capital, also known as VC, is private equity money provided to early-stage businesses, usually after they have received seed money or have made some progress bootstrapping. This type of investment targets businesses with high growth potential. They aim to recoup a multiple of the original share value through an initial public offering or acquisition by another company.
Advantages of venture capital
- Venture Capitalists often possess knowledge that can be transferred to the business. It is not uncommon for an executive from the VC firm to sit on the board of the recipient business.
- They can help forge relationships with important stakeholders such as potential business partners and customers.
- They have the expertise to facilitate exits, such as IPOs or acquisition.
Disadvantages of venture capital
- VCs usually limit their window on realizing a return to 5 years or less. If your business plan looks to longer period, or you have no interest in an IPO, it is unlikely this is a potential source of funding for you.
- They will place conditions on the deal. For example, restrictions on future dilution and executive pay, and will insist on some level of control over major decisions.
- While it can be an advantage to have an expert on your board, it can also be a disadvantage if there are major conflicts, or differences over how to run the business.
- You will be committed to providing regular reports on progress, which may feel intrusive to the entrepreneur.
Incubators and Accelerators
Incubators provide shared office space and facilities for up to 20 businesses at a time, all funded by the same private equity fund. On top of cash and facilities incubators provide mentorship from seasoned entrepreneurs and executives. They also encourage group learning and communication within the network of members. There is no limit on how long you can stay, but eventually your business should grow to the point where it strikes out on its own. Accelerators are slightly different in that businesses are given space for a limited period of time, usually six months or less. The experience is best described as an entrepreneurs’ boot camp with a whirlwind of seminars and workshops.
Advantages of incubators and accelerators
- They are ideal for first time CEOs/entrepreneurs who lack general business knowledge.
- As well as providing seed capital they provide all the facilities you need to get to work, from desks to printers to meeting rooms. You just have to show up.
- They run their own PR & Marketing programs which have trickle down benefits for their members.
- They usually have a network of experienced and successful CEOs and entrepreneurs that provide expertise and mentoring.
- These programs can open many doors for the budding entrepreneur.
Disadvantages of incubators and accelerators
- A large number of mentors often have a large number of differing opinions, which require critical appraisal before they affect your actions.
- Sharing space is not always idea, especially if someone is potentially competitive to you. And fighting over use of the meeting rooms can become tiresome.
- The investments amounts are often small but the equity stakes can be high.
- The network of companies in the program may offer little benefit to you. It is important that you research the program and its current members thoroughly.
The UK government operates hundreds of funding and assistance schemes for small businesses. There are regional schemes to encourage establishing businesses outside of the South West, especially in the North, Scotland, and Northern Ireland; grants for research and development; capital grants for purchasing plant and machinery; and industry specific grants in fields as diverse as marine biology and the arts. At the time of writing there are 809 available schemes on the Gov.UK web site, too many to write about. You can research available options here
Advantages of government grants
- They incur no financial liability.
Disadvantages of government grants
- They can come with strict restrictions on how the money is used.
- The processes for application can be long, bureaucratic, and littered with red tape.
- There is often stiff competition for government grants.
Crowdfunding enables businesses to receive funding from large groups of people, each donating small amounts. Typically the process is conducted over the Internet. Through sites such as Kickstarter.com, entrepreneurs can promote their business and set a target amount of investment. Individuals, who collectively make up The Crowd, can donate as much or as little as they wish to this business in return for equity, rewards, or special consideration, like being the first to receive the finished product.
Advantages of crowdfunding
- The act of promoting your business through a crowdfunding web site exposes you to large numbers of potential customers as well as investors. It is a great form of publicity.
- It can be used for almost any type of project, from setting up a business, to funding an independent movie.
Disadvantages of crowdfunding
- Instead of large amounts from a small number of investors, or just one, you are receiving very small amounts from a very large number of investors.
- Most projects fail to reach their investment target.
- You will miss the important feedback and knowledge transfer that comes with traditional financing means.
- Crowdfunding can expose the inner workings of your business, or just the fact that it exists, to potential competition.
There are many different ways to obtain small business funding. You can borrow money but your business must be able to support the repayments. You can receive investment but in return you will have to give up some of your company and possibly some of your control. Deciding which course is the right one for you is something that only you can do, based on the uniqueness of your needs and your business’ needs. Always seek advice and expertise. Whichever course you take, it is important to remember the following:
- Your money is always at risk. Businesses fail and not always for reasons internal to the business.
- If you have agreed a loan or investment, do not spend the money before it clears in your bank account. Things can go wrong with loan and investment deals.
- Never spend other people’s money without clear legal documentation than spells out the rights and responsibilities of both parties.
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