With that in mind, it’s positive that in recent years a wider range of funding options have become available, beyond the traditional venture capitalist (VC) route. VC funding is great, but often it’s only available to a small proportion of businesses.
So where do you look when VC funding isn’t for you? In this blog post, I’m going to explore the alternative options out there for both start-ups and scale-ups.
An angel investor is someone who puts their own finance into the growth of a small business at an early stage, usually in return for a percentage stake in the business. What makes this type of -investment such a positive force for start-ups is the fact that angel investors contribute their expertise, contacts and business experience to help their investment grow.
You could have one angel or many angels; when this form of investment arrives, it’s a good choice for businesses at the very beginning of their journey.
Bridge financing occurs when investors lend money to a start-up on a short-term basis. The loan is normally used to get the start-up to their next investment – it’s used to ‘bridge’ the gap – and the investor will expect to receive their money back when this happens. In this way bridge financing is quite like an IOU note.
It can be a lifesaver if you need it, but this is definitely an option to consider carefully.
Overdraft & credit cards
In the very early stages, start-ups can turn to the same sources of funding as private individuals. This includes credit cards and overdrafts on a bank account.
This is a good standard option for a start-up looking to increase its cash flow. It’s not the right choice if you need major amounts of capital. A start-up should only rely on credit cards for fairly small amounts that banks or private investors wouldn’t be interested in lending.
There are hundreds of government grants available for small businesses, so you’re likely to find one that’s right for you. The advantage of a start-up loan is that you receive capital you need, whilst retaining control of your business.
R&D tax credit
Research and development (R&D) tax credits allow a start-up to recoup some of their expenditure on research and development projects. For every £100 spent on R&D activity, the taxable profits are reduced by an additional £130 – which means a start-up can completely eliminate their corporation tax bill.
Crowdfunding is helpful, as long as it’s treated as a real route to securing “true” investors, and not just a marketing exercise. However, it comes with both benefits and dangers.
It allows companies to raise funds when they might not be in a position to otherwise – and often at very good valuations. Of course, this isn’t always the best thing for every company, and it can result in some organisations raising capital only to fail. Crowdfunding can also create issues by causing a very fragmented shareholder base.
Invoice financing allows you to borrow money against amounts due from customers – meaning a third party agrees to buy your unpaid invoices for a fee. It can help scale-up businesses improve cash flow, allowing them to pay employees and suppliers, and reinvest in growth earlier than if they had to wait for customers to pay their balances in full.
It’s especially helpful if you’re facing cash flow difficulties due to late payments, an issue which disproportionately impacts small businesses.
Peer-to-peer (P2P) lending is useful for established small businesses who are looking for some additional funding that’s too small to be worthwhile for an investor or a bank. It involves borrowing relatively small amounts of money (typically no more than £35,000) from your peers, who could be other business people or even just interested laymen.
Initial Coin Offerings
Initial Coin Offerings (ICOs) are an increasingly popular choice. The risk is that many scaling businesses see ICOs as a panacea, on the basis of a small number of success stories.
Ultimately the coins being offered need to have some intrinsic value; a B2B software as a service business, for example, is unlikely to need a cryptocurrency as part of its business model and therefore is not appropriate for an ICO.
One of the overlooked funding options is debt. This is available from traditional sources such as overdrafts and invoice financing facilities, through to venture debt, where a small number of funds will look to lend to venture businesses in the place of equity, saving a founders’ shareholding.
So, how do you know which is the most appropriate source for your business? It’s vital to always know and understand what it is you are offering in return for funding and investment, and what it will mean for your business.
Let’s look at debt vs equity.
Debt comprises the borrowing of money which needs to be repaid, whereas equity sells the interests in the company.
Debt might be more expensive to service in the short term but can be better value in the long term than equity due to retaining control over your assets, whereas equity might be very costly when it comes to selling the business due to all the different stakeholders. However, it is important to remember that early stage businesses are unlikely to qualify for most debt products.
Equity on the other hand can come with other benefits, not simply money. By having an investor with equity in the business, they can contribute their knowledge and contacts access to investor resources for instance, which can be used to help nurture and grow the business.
A business’s best source of funding is its customers, since generating more revenue and collecting cash more quickly gives the business more ‘funding’ to allow it to grow.
Ultimately, what’s critical is that young businesses find the right funding source for their strategy, to ensure that funding has the right attributes to help them to achieve their ambitions.
So you need to make sure to choose a source of funding that’s appropriate for you depending on your size. A start-up has very different requirements from a scaling business, and this comes to bear across all aspects of investment from the amount of capital to the degree of help needed from an investor.
The way that investment is secured can have long-term implications for a business. For example, if a start-up is valued too highly at the beginning, it will be much harder to secure further funds down the line. Again, this is why an appropriate choice is so important in the long-term.
Navigating all of the funding options available can be tricky, but ultimately businesses should hold out for the right investment for them.