Raising Finance for your New Business Venture
Raising Finance – Introduction
Before you consider applying for any form of business finance, you should have considered the needs of your business very carefully. There are common pitfalls if you get it wrong and potentially other problems, even if you get it right.
Entrepreneurs should consider what the money will be used for and exactly how much they require. If you under fund your business, then it will fail. If you over fund your business then; any repayments you have to make could place a heavy burden on your profits, through high repayments.
Take the time to determine exactly what the money you raise, will be used for. Your previously prepared business plans should give you a very close idea how much business finance you will need to raise and what it will be used for.
Some particular uses that entrepreneurs raise finance for are as follows:
- Working capital, otherwise known as your businesses “Burn Rate”. These represent your fixed costs of running the business, such as:
- Building rental or mortgage.
- Production costs
- Sales costs
- Purchasing of fixed capital equipment
- Expansion project.
- Other project development costs.
Predicated on the amount of money your business requires, you should consider raising finance from a variety of different sources. There is no right or wrong way to raise money.
Various Funding Options
Question: What is the best way to raise finance for a new business venture?
Answer: Any way that you possibly can without bankrupting yourself.
Justification: There is no “best, right or even wrong.” way to raise finance for a new business. The truth is; there are many ways to raise finance for your business. The correct way for you depends on a number of complex variables, such as your product or service, your market positioning, how much funding you require, the cost of running the business, and most importantly, your personal financial circumstances.
Irrespective of what financing method you choose, you need to thoroughly investigate the options that are unique to your circumstances and research the pros and cons. Going into business for yourself can radically improve your living or totally destroy it, leaving you saddled with debt for a very long time.
Option 1: Your Life Savings
The first thing you should consider when thinking about raising finance is your own savings. At DATIX Startups, wherever possible, we advocate this approach, for the following reasons. You are answerable to none. There is no interference from an investor, business angel or venture capitalist. If your business fails, then nobody will come knocking on your doors demanding your hide or some other critical asset, such as your house. The bad thing is that it if things do go pear shaped, it is your money that goes down toilet. If you’re not willing to risk your own money, then you shouldn’t be willing to risk anyone else’s either.
Option 2: Borrow from Friends and Family
After dipping into their own cash reserves, many entrepreneurs turn to friends and family to help raise finance. This works well for some, but here’s a little bit of advice: NEVER mix friends and family with your business matters. If you do, then you will pay a terrible price. What tends to go wrong with the business, will spill over into your personal life and vice-versa. It is possible that you may drain their nest egg or reserves and unintentionally jeopardise their security. Under such circumstances, the result has a tendency to destroy relationships, irrespective of how close that person is to you.
Option 3: Borrow from Credit Cards and Loans
Financing a business on credit cards and unsecured loans is an incredibly silly thing to do. given the fact that your business could fail and leave you with thousands of pounds in credit card debt and loan interest that you would take forever to pay off.
This is a very expensive way to fund your business and you will pay over the top in interest charges. Unless your business takes off like a bat out of hell, you will be drowning in a quagmire of debt. If your business suffers a downturn, then there is no avenue left other than bankruptcy or an IVA.
Raising finance from loans normally requires regular payments and interest payments to the lender. For some purposes fixed term loans are more appropriate than overdrafts and vice versa. Much depends on how quickly a business can generate cash for payments. Leasing or hire purchase may be another way of financing some requirements.
Option 4: Re-Mortgage or Second Mortgage
In today’s market, raising finance via bank loans are next to impossible to get if you don’t have good security and an equally good track record of business success.
These days most of the banks will provide money on a secured basis, because their underwriters are now practicing “Risk Mitigation”.
As a general rule of thumb, banks will either look for a personal guarantee (PG) or they will look for some form of security, such as a bricks and mortar.
Many entrepreneurs use the equity in their homes to raise finance for their business after being turned down for a bank loan. While this makes more sense than building a business on credit card debt, the financial risks are no less risky. You must pay this money back through increased mortgage payments whether your business succeeds or not. However, this mechanism is a good source of low interest money to get you started in your business and the interest may be tax deductible (check with your accountant to make sure).
Option 5: Grants
Another way of raising finance is via grants which are available from a variety of sources. There is a lot of grant money available from a variety of sources and it is worth researching to see if there is anything about you or your business that could qualify for grant funding. There are several considerations when considering grant funding.
- Applicability of available grants to your business requirements
- The time it takes to qualify for a grant
- What you have to do to qualify for the grant
Option 6: Small Firms Loan Guarantee Scheme
Raising finance via the SFLG is another alternative. The SFLG is an initiative set up by the DTI (Department of Trade & Industry) with several lenders. The scheme was designed to help businesses with little or no equity to grow and prosper. The main features and criteria of the scheme are:
- A guarantee to the lender covering 75 per cent of the loan amount, for which the borrower pays a 2 per cent premium on the outstanding balance of the loan, payable to the DTI.
- The ability to guarantee loans of up to €250,000 and with terms of up to ten years.
- Availability to qualifying businesses with an annual turnover of up to €5.6million and which are up to five years old. This is generally determined by the date the business came within the charge of corporation tax (for a company) or became liable to pay class 2 National Insurance contributions (for a self-employed individual). In the case of a business transfer the five-year age limit applies to both the business making the acquisition and the business being acquired.
- Availability to businesses in most sectors and for most business purposes, although there are some restrictions.
Option 7: Empire or Private Investor
A business angel or private investor is typically a high net worth individual who invests in start up ventures for a share of the ownership or a better rate of return on their money than they would otherwise earn from a bank or other saving scheme.
Private investors are usually the first formal investors in a business and provide the seed money to get the business up and running. Some investors will write you a check and leave you alone to run your business while others consider their investment a license to “help you” manage and make decisions.
If you do accept money from a business angel, you need to make sure the terms are clearly defined on both sides. Money from a business angel or private investor, always comes with a shareholders agreement.
You must ensure you understand the terms and conditions contained in the shareholders agreement. You must also ensure that both sides will benefit from the agreement equally. Before you take any money from a business angel or a private investor, you should always review your shareholders agreement with a solicitor or lawyer and an FSA (IFSC) (Financial Services Authority) approved financial adviser.
Option 8: Venture Capitalists
Venture capital is another option for raising finance. Venture capitalists typically get involved in larger funding efforts. Most venture capitalists do not get involved with any business for less than €500,000.00 That’s not to say all venture capitalists are only after big business, however, they tend to get involved with businesses that require several rounds of funding and their exit strategy may be a floatation or for a fixed value beyond that of yours.
We have known of some entrepreneurs that had grown their businesses to a specific size and turnover and were trapped into staying in the business, because their venture capitalist investors would not permit them to sell the business off for less than the Investment Rate of Return (IRR) agreed when the venture capital money was injected.
When dealing with venture capitalists, there is a lot of legal work, concerning “Due Diligence”. The funding agreements tend to be complex and the exit strategy for both parties is defined by a lawful and legal contract. When dealing with venture capitalists, it is definitely a case of buyer beware.
If your business ever attains the level where VC money becomes a viable option, don’t jump at the first offer. Shop around. If one particular VC likes your business, then others will. Present your case carefully to as many VC investors as you can and carefully consider each offer before you accept their money. Take your time and exercise prudence.
There is also equity finance, a risk-bearing investment provided by shareholders or partners in the enterprise. Equity capital normally carries no fixed charges and is particularly valuable in a start-up or expansion phase when cash flow may be tight. Equity finance can also be provided by specialist financial bodies.