There are many types of investors who can help to finance your venture. You need to understand the implications of accepting each kind of investment, from making repayments to giving up a share of your profits.
How funding works
Any person, group or organisation willing to invest in your start-up can do so in one of two ways:
1. By lending money to your business at a particular rate of interest.
2. By giving you a lump sum in return for equity in your company.
Loan investments: Many people, when considering loan investments, wrongly think that banks are the only potential lender. In fact, anyone is legally allowed to lend you money so long as the loan is covered by a formal contractual agreement that sets out the amount being borrowed, the duration of the loan, the interest rate being charged and how much will be repaid each month.
Equity investments: The other funding option available to businesses is an equity investment which is the process of an investor providing money for an enterprise in return for equity in the business – which usually includes a profit share and control in the decision making of the business. Again, it is not just financial institutions that can invest in a company in return for equity. Friends, family and business contacts are some of the most common investors in small business start-ups.
Types of investors...
1. Family and friends
People close to you may be willing to provide funding for your venture, however raising money from family and friends requires careful management.
Pros...
- May offer useful advice and point of view as well as funding.
- More likely to offer preferential interest rates on loans.
- May be more flexible with repayment dates on loans.
Cons...
- Risk of damaging relationships if things do not go to plan.
- Discussing money arrangements may be awkward.
- Additional pressure for the business to succeed.
2. Peer-to-peer
Potential investors range from business colleagues and staff members to individuals on peer-to-peer (P2P) lending sites.
Pros...
- Peers have a vested interest in helping you to succeed.
- Peers will understand the business environment of your start-up.
- Interest rates offered by peers are usually better than banks.
Cons...
- Risk of damaging your reputation if the business fails.
- Disagreements with peers can arise over how to run the business.
- Your credit rating may be affected if you apply via a P2P site.
3. Crowdfunding
Through crowdfunding you can reach a global audience to raise capital for your start-up in return for early access to your product. In some cases you can sell equity through a *convertible note or even repay customers plus interest.
*A convertible note is a type of debt commonly used in early stage start-ups in their seed investment round, before the business has any inherent value. An investor will provide funds as short term debt which are repaid at a later date in the form of equity when the company has established a valuation.
Pros...
- Wide pool of potential investors that can be targeted online.
- Can raise money quickly and you control the terms of the funding.
- Funding appeals may go viral and raise more capital than expected.
Cons...
- Requires expert marketing and project management to succeed.
- You must reimburse investors if you fail to raise enough to reach your funding target.
- There is high competition for crowdfunding online which increases marketing spend requirements.
4. Banks
While not usually equity investors, banks will still assess the stability and growth potential of your business before lending.
Pros...
- Simple debt agreements with no say in business operations.
- You maintain independence in running your business.
- Banks adhere to government imposed financial regulations.
Cons...
- May require a guarantor or security against the loan in the form of an asset.
- You need an excellent credit rating for the best interest rates.
- You need to provide evidence of your ability to pay back the loan from revenue.
5. Business angels
A wealthy private investor who puts money into a start-up in return for equity in the company.
Pros...
- Can provide mentoring and bring valuable experience.
- Will make quick decisions and have cash available.
- May enhance growth potential with their vision and contacts.
- Could provide credibility to your business offerings.
Cons...
- May wield more control than you feel comfortable with.
- You are giving away a percentage of your future earnings.
- High expectations about your performance and the rate of return.
6. Venture capitalists (VCs)
Professionals who manage pooled funds for investors seeking a return from funding new business growth.
Pros...
- Can provide mentoring and bring valuable experience.
- You do not have to repay the money (as you do with business angels).
- Can give leadership and also advise on day-to-day management.
- Provides opportunities for collaborating with experts.
Cons...
- When you sell the business, your share will be less.
- Board of directors required as well as frequent financial reports.
- Risk of losing your business if it fails to perform at the required standard.
7. Government, local authorities and charities
National and local government bodies, as well as some charities, may award grants to new ventures.
Pros...
- Grants are essentially free and do not need to be repaid.
- Generally easy to access, with plenty of information online.
- Helps to build credibility and promote your business.
Cons...
- Often time-consuming to go through the application process.
- Plenty of competition from other businesses for funding.
- Restrictions and conditions on how you spend the money.
Need to knows:
In most countries, two types of programmes – accelerators and incubators – exist to support businesses at the start-up stage. Joining either type can encourage lenders to invest in your business.
- Accelerators are like intensive study courses, and they are either privately run or publicly funded. Start-up owners apply to join, and if selected, enter for a fixed term, usually 3-6 months. During this period, the owner receives a concentrated, rapid education on how to grow their business under the guidance of mentors. Private accelerators may also offer to invest in your business.
- Incubators are less intensive but still provide education and tactical mentorship. These programmes are usually funded by a university or an economic development organisation. With a focus on innovation, incubators typically run for a year or more and aim to provide an environment in which an entrepreneur can hone their business model.
