How should I fund my start-up?


3 Nov 2010

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Financing your business Decisions regarding how you finance your business should be taken very seriously. This is one of the most critical decisions you will make at the start-up phase and you need to spend some time learning about the pros and cons associated with each type. A glance through mainstream newspapers indicates that raising […]

Financing your business

Decisions regarding how you finance your business should be taken very seriously. This is one of the most critical decisions you will make at the start-up phase and you need to spend some time learning about the pros and cons associated with each type.

A glance through mainstream newspapers indicates that raising start-up finance remains difficult and that many UK banks are simply not lending money to businesses (especially start-ups).  As Luke Johnson of Beer & Partners argues:

“Currently, banks are barely open for business, or tend to offer loans on unattractive terms, so the need for equity capital is greater than ever … more and more angel investors are emerging that have a strong appetite for direct investment in small companies.”

Regardless, bank loans as a source of funding for start-ups has never been an ideal form of early stage finance, as debt obligations typically mean monthly repayments at precisely the time when cash flow is at its most uncertain.

Angel funding

As Johnson indicates, we have witnessed a growth in the number of angel investors seeking to fill the equity gap in seeking to support entrepreneurs through the provision of early stage capital. The growing number of angel investors is in part due to the fact many of these angel investors are struggling with returns from other asset classes as a result of low interest rates, a volatile stock market and property losses. Hence, some high net worth individuals have turned their attention to alternative investment opportunities, such as angel investment, as a means to drive capital growth.

Angel investment has grown in popularity as a means by which entrepreneurs secure early stage investment in their fledgling businesses.  It is simply equity investment known as seed capital which is designed to fund you as you test the assumptions you are making in your business plan.  It is high-risk capital, so the terms associated with it can be quite onerous, but it is naturally very welcome at a stage when you have no proven sales history which would prove the viability of your plans. However, angel investment is not for everyone as giving away equity is far from ideal. If you do go down this route, though, be sure to gain what is known as ‘smart money’, ie, investment from someone who can bring more to the table than just the finance. Ideally, the investor will have a large network which they can tap into so as to help you gain access to key markets.

Bootstrapping

An alternative to raising angel investment is to bootstrap. When you bootstrap your business you look to (a) start your business without any external finance and to (b) manage the business with a very tight control on costs. There are numerous benefits to start-ups in avoiding outside investment (particularly at the pre-revenue stage), eg, creating a strong cost discipline from Day 1, galvanising staff against profligacy, helping to maintain a focus on driving revenues (while controlling costs), and finally helping to ensure an ongoing focus on innovation.  As Greg Gianforte author of ‘Bootstrapping: The Secret to Entrepreneurial Success’ declares:

When you’re bootstrapping, you’re forced to deal with customers and to fulfil their needs from Day 1. If you have a lot of external funding, on the other hand, you can be fooled into thinking you’ve already created an actual business just because you’re paying salaries and rent. But you haven’t. You only have a business when you have paying customers. Bootstrappers know this instinctively, and never lose that customer focus.’

In short, bootstrapping is an excellent way to grow your business (particularly an internet business), as you really focus on the need to generate profits that can be reinvested to drive further growth. 

Investment from friends and family

Finally, a step up from bootstrapping is securing investment from friends and family. This is a very popular source of funding for entrepreneurs and has a lot of obvious benefits, given the financing is not typically subject to onerous terms and conditions. However, this source of capital is in all likelihood coming from an inexperienced investor who may not be fully cognisant of all the associated risks, ie, this source is commonly referred to as the Three F’s – ‘family, friends and fools’. Hence it is incumbent on you, the entrepreneur, to make sure these investors are fully aware of the risks, as there is a good chance that they will not get their money back and hence should only invest in what they can afford to lose. Given the very personal nature of the relationship you should only explore this avenue as a last resort or if you need it to fulfil an existing order.

Alan Gleeson is the managing director of Palo Alto Software Ltd, creators of Business Plan Pro®. He holds an MBA from Oxford University and an MSc from University College, Cork, Ireland. Further information on Business Plan Pro is available at (www.paloalto.co.uk and www.bplans.co.uk )

 

Monday 18th October 2010, 8:37 am

By Alan Gleeson

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