Michael O’Brien, head of technology at accountancy firm Kreston Reeves, explains all the different funding options available to tech startup founders.
Wherever you are on your life cycle, knowing the financing options available to you is a crucial part of growing and running your business.
A key element of securing any funding is having a robust business plan in place and knowing the direction you want your business to take.
Funding for a business can be provided in many ways and will depend on where the business is in its life cycle. However there are two main categories:
- Equity funding
- Debt funding
Equity finance can be used at various stages of your business life cycle and giving up equity can be a big decision.
Whilst the right investors may bring invaluable support, experience and resources to the business and provide you with access to market experts, raising equity finance can be a long and expensive process and your own share of the business will be diluted.
It is also important to have investors on board that you can work with and who share the same vision and strategy for the company.
Some common forms of equity investors include:
Business angels are individuals who often invest in startup businesses as they usually have first hand experience of growing a business and can offer access to a network of contacts.
From their perspective, the investment is high risk and so they usually request a significant amount of equity in return.
Venture capitalists will invest in the business with the objective of achieving high returns and usually require a proven track record.
They rarely invest at the pre-revenue stage. Securing venture capitalist investment can be an expensive and relatively long process and requires a robust business plan.
Private equity focuses on more medium to long term investment and will usually involve the development of the product and a new management structure to improve the performance of the business.
Private equity investors would typically sell their investment in the medium term once the value of company has significantly increased.
Crowdfunding aims to connect businesses with a large number of potential investors via a shared online platform.
Crowdfunding allows the business to attract thousands of potential funders that each contribute a small amount in exchange for a share in the business which can be particularly attractive to startups.
Debt finance is usually used as a means of long term investment or funding working capital.
This can range from bank overdrafts to loans or asset finance but will not involve you relinquishing any share or control of the business.
Some common forms of debt financing include:
Bank overdraft and loans
A bank overdraft is often used as a short term measure to fund the working capital requirements of the business.
A bank loan is typically used for more long term investment or significant capital purchase.
Some form of security will usually be required to secure this.
Peer to Peer (P2P) lending
P2P lending brings individual borrowers and lenders together via an online platform by by-passing traditional banks with the aim of achieving better rates for all.
It is very flexible and is a direct alternative to a traditional bank loan.
Assets can be purchased via leasing or hire purchase agreements which can assist the cash flow of the business. The asset is not fully paid for upfront but over a fixed period of time and the lease or hire purchase agreement is secured on the asset being financed.
A debt factor will take on the sales ledger of the business and chase money owed by your customers. The factor will advance most of the value of the outstanding sales invoices to the business with the balance being paid once the customers have fully repaid their debt.
Therefore there are various different ways of raising finance for your business depending on the stage of growth and your cash requirements. Some of the more common methods summarised above range from short term cash flow improvement to more longer term investment and support.
However there are many other forms available and choosing a method which fits with your current business model and future plans is key.