Funding Your Business: Choosing And Attracting Debt Or Equity Investors
3rd February 2015
In an ideal world every entrepreneur would start off with the savings they need to get their business off the ground, or even better, every good business would be self-funding from early days. The reality though is that growing a business burns cash quickly – salaries, rents, product design and creation all cost money up-front, even if the long-term benefits justify the investment.
There is of course, no one-size-fits-all style of funding for a growing business. Some businesses can be very inexpensive to operate in the early days – key staff may be willing to work unpaid for a period (if they’re founders or have an ownership stake) and the business may be able to operate out of a home with just a PC and a couch to work on for a period. Alternatively the business may require large-scale development, manufacturing, and all sorts of professional consultation to get it off the ground, which will necessitate a large up-front investment. As an entrepreneur you’ll need to think objectively about what costs you’re likely to incur, when you’re likely to incur them, and when the business is likely to start generating cash – because unfortunately these don’t often happen at the same time.
Choosing the right funding structure could be the single most defining decision you’ll make for the trajectory of your business. It may determine how long you’re able to concentrate on building the business and how much you can invest on the product before profit and cash-flow become a priority. It may also have an impact on how much of the business you own in the long-run, who you work with and how big your customer base is – marketing and geographic reach often both require investment. It’s very easy to get carried away in the excitement and potential that comes from starting a new business, but everyone’s heard the expression about failing to plan, and laying out what your costs are likely to be can avoid a lot of unpleasant surprises.
When you decide you need to start looking for funding, remember that anyone providing cash to your business – be it a bank, a venture capitalist, or a partner – will be very likely to expect a return on the money they provide. You’ll need to factor this into your expectations in order to treat them fairly, because keeping them happy will improve your ability to access funds again in the future. If you’re unsure whether the more appropriate route for your business is debt funding or equity funding, in simplest terms it comes down to whether or not your historic profits show that the business can cover debt repayments, in which case you may be looking at debt financing. If they don’t, and you’re asking investors to look to profits you intend to make, then you’re likely to have more success obtaining equity funding. The pros, cons, and opportunities in debt and equity will be the focus of subsequent articles.
Before you start thinking about raising funds, here are a few exercises you can do to get your business and yourself ready to have those tough conversations:
The What’s-In-It-For-Me response: Think about what you have to show as proof of your ability to give investors or lenders a return on their money. For equity investment this will generally be growth in the value of the business, and for debt this will mean being able to demonstrate your ability to cover the debt and interest payments.
The Sceptic Response: Take a few moments and write down all the potential pitfalls, risks, and vulnerabilities of your business – the crunch points where it could potentially go wrong. This will feel really uncomfortable for an enthusiastic investor like yourself, but the more you beat up the concept, the better your proposition will be. Next, consider all of the strengths in your business that will counter each one. Some will be easy, and the others not so much – but when you’ve finished your list you’ll know where to focus your attention and it will be apparent to investors that you understand your challenges.
Knowing the Figures: Write out the next 12 months, and underneath each one, list out what your expenditures are likely to be for each of them. Some you may be able to juggle between months, and some might span multiple months (if so, divide them accordingly). Now for each month give a worst-case scenario figure for income, and a best-case scenario of income. Tally it up at the bottom of the page, and without even trying you’ve created a cash-flow forecast, which shows where you’ve got a deficit and where you’re building cash. When a potential investor or the bank manager asks you for it, you may surprise yourself by confidently and calmly being able to give them your forecast figures, which will go a long way to building your credibility as a business.
Author: Craig Snider, firstname.lastname@example.org
Please also read the article on: http://thestartupmag.com/funding-business-choosing-attracting-debt-equity-investors
Past performance and forecasts are not reliable indicators of future results. Your capital invested is not covered for compensation in the event of a loss by the FSCS. Tax treatment will depend on the individual circumstances and may be subject to change. Please see our Risk section before making an investment decision.