Answers to “What is the best way to fund my new business?”
From bank loans to crowdfunding to bypassing funding altogether, Hatty Fawcett of Focused For Business talks finance options with start-up founders
One of the fundamental questions at the front of most founder’s minds – and the question I am most frequently asked – is “What is the best way to fund my business?”
A quick question to ask, but a complex question to answer. And, of course, it depends on the stage of your business, your objectives for the business, your reasons for seeking investment, and the speed at which you require funding.
It will also depend on what you are willing to offer in exchange for investment.
Will you sell shares in your business, for example? Or are you looking for a loan which will eventually be paid back?
Ahead of Global Entrepreneurship Week 2017, I asked 10 UK founders – those who have grown their business organically and those who have recently raised investment – on what they see as the pros and cons of the different funding options available…
Bootstrapping – a good way to get your business off the ground (if you have the money)
Bootstrapping your business usually means funding your business with your own money to get if off the ground, and then continuing to fund it with revenue generated by the business.
When I started my first business, I wasted a lot of time talking to potential investors explaining why they should back my business. At the time, “the business” was little more than a well-crafted business plan and financial forecast.
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I remember the moment when the “penny dropped” for me and I realised no one was going to invest in my business until I had actually created it and was generating some revenue – and that meant investing my own savings to get things moving. I had to put my money where my mouth was.
A big advantage of starting a business in this way is that you are in control of your business and it puts you firmly in the driving seat. When it comes to the direction you want the company to take, the key decisions are down to you.
Tim Martin, CEO of WorkInConfidence, bootstrapped his business and puts it very succinctly: “You do it because you have to. It means you can build value before funding and get [the business] going.”
Assuming you have some money you can invest, there are some disadvantages to this route:
Martin advise that you “are often unable to make key decisions, such as spending more on marketing” so keep in mind that a lack of money can slow down the speed at which your business grows.
Bank loan or a Start-Up Loan – a helpful cash injection to achieve an important milestone
Even a bootstrapped business will find there comes a point when you need a cash injection to achieve an important milestone.
It might be that you need money to pay for tooling for product manufacture, or you need to purchase materials or premises in order to start generating revenue. A bank loan or a Start-Up Loan can be great way to find funding in these circumstances.
Jaya da Costa, founder of Pause Cat Café, saw a number of benefits in applying for a Start Up Loan:
“It gave me the opportunity to maintain my own vision for my business and was a quicker option. I was asked to complete a business plan to gain funding, which has been very useful during the set-up and also since opening.” The Start-Up Loans Company also offers mentoring to those companies who successfully secure a Start Up Loan.
However, one drawback of using a loan to fund your business is that you will always have to pay interest on the loan.
Costa highlights that “the repayments can take a big chunk of your cash flow especially in the early stages of your business, try to negotiate an interest-only period to help with this.”
Angel investment – investors bring cash, skills, experience and contacts
Angel investors (high net worth individuals who have very often run and sold their own businesses) do not expect an immediate return on their investment.
They don’t ask for interest or dividends but want to see any revenue generated by a business put back into the business so it can grow faster.
Business angels don’t just bring cash when they invest in your business, but they also offer their skills, expertise and contacts too. They may also have useful sector knowledge which can help you grow your business faster than the cash injection alone would. They often act as mentors and can provide practical help and hands-on support.
Sue Frost, co-founder & CEO of Curamicus, says she “was fortunate to find business angels with a wealth of business experience in particular areas who were willing to share with us for the benefit of the business. The best business angels can become key people in your start-up team.”
Jason Lowe, founder and director of FYB London, echoed this: “As well as the capital investment, the most valuable advantage [of accepting angel investment] is having an experienced business mentor to work with. They help you avoid common potholes and provide an outside view on long term strategy for scaling the business.”
One of the challenges of raising investment from angel investors is that it does require a lot of time and effort.
Frost points out that “this route to funding can be very time consuming as [business angel] groups meet probably only once per month/quarter and they only see a handful of startup pitches per meeting. We found angels within these groups can be looking for specific kinds of businesses such as entertainment apps or traditional retail businesses [and this may not coincide with your business sector].”
Lowe also advises that, with angel investment, although you benefit from mentoring and practical advice, you are also relinquishing some control in your business: “You may have to compromise on some of your ideas and plans to attract investment.”
Therefore, it is important to find angel investors with whom you are aligned with in terms of strategic direction for the business. It also helps if you build good rapport, openness and trust.
Business angels may be more patient than banks in getting a return on their investment but they will expect a return so you do need to offer a clear “exit”. Typically, this will involve selling the business in a three to five year time frame so that angel investors can sell their shares at a profit.
Crowdfunding – a good way to raise funds, test product demand and build brand ambassadors
On the face of it, crowdfunding seems to offer a quick and easy route to raising investment.
The media is full of stories of businesses raising phenomenal amounts of money in remarkably short time periods. Crowdfunding brings other benefits too:
For Kellie Forbes, co-founder of YUU World, crowdfunding proved a brilliant way to market test a new product and boost sales:
“[Crowdfunding provided] amazing feedback regarding the new product. This has been insightful as we know we have a desired product, but we now realise there is another way to deliver this – as an add-on option rather than a bespoke product. It was feedback from the crowdfunding campaign that led us to re-think this decision. We now have a better product as a result.”
Peter Ramsey, founder & CEO of Movem, has ran two successful crowdfunding campaigns, he agrees there are benefits to crowdfunding that go above and beyond the money raised:
“Crowdfunding gives you a lot of business exposure…I know that our shareholders talk about Movem all the time, so there’s an unknown amount of network effect going on there. But that’s the biggest benefit, the exposure.”
Forbes also sees PR and marketing exposure as a big upside to crowdfunding: “Our sales are up almost 20% which is thanks to the crowdfunding campaign exposure.”
However, it would be wrong to assume crowdfunding is a quick route to investment. There is a lot of work done behind the scenes to ensure a successful crowdfunding campaign; as explained by James Courtney, founder and CEO of Lux Rewards:
“For early stage start-ups, it is very difficult to get viral spread like Monzo and other campaigns have managed to. Realistically you need to bring 50% to 80% of the raise through your own connections or angel investors.”
Ramsey echoes Courtney’s warning:
“Crowdfunding isn’t as simple as just ‘making a video’. Months of work go into a pitch, and even before then you have to be pre-raising and getting momentum. My advice would be to be realistic on the amount of money you need.
“Raising £500,000 might sound glamorous and you might be pleased that you’ve got three years of money in the bank, but it’s considerably harder than you think. Only raise as much as you need.”
Venture capital – the holy grail of start-up investment?
For some founders and entrepreneurs, venture capital (VC) investment feels like the holy grail of raising investment.
VCs typically manage a fund made up of other people’s money. The funds can be large which means VCs are in a position to make big investments, and cash-starved founders may be tempted to see pound signs in front of their eyes.
VCs are also generally very well connected and, like angel investors, they want to see the businesses they back succeed.
Rajeeb Dey, CEO of Learnerbly, found he benefitted from his VC’s network by being introduced to one contact who became CTO and another contact with very specific skills whose advice helped them develop proper, scalable systems.
Dey says he would recommend VCs for “their connections and expertise…as well as potential business development connections.”
However, as a general rule, VCs are unsuitable for a majority of new businesses, particularly those that don’t operate in the tech space.
VCs are looking for businesses which offer not just fast growth but exponential growth. They are often focused on particular sectors and industries, and have a preference for companies that disrupt the status quo, not just “me to” products. A number of VCs won’t invest at “seed” stage – although there are many that do – and will instead wait until the business has proved the market and is ready to grow.
As VCs manage other people’s money, they have to be ruthless in managing the investment. This drives a different agenda and a certain amount of governance and bureaucracy. Dey advises that “the amount of governance increases – i.e. monthly board meetings in our case – I doubt it would be so frequent had we just had angel investors.
“That said, I’m actually finding these meetings useful…it’s something to schedule, prepare for and ensure you are aware of the reporting/governance requirements VCs may have.”
However, Harinder Sandhu, founder of EmpowerRD, wasn’t comfortable with the “overbearing beaurocracy” and loss of control that came with VC money.
He describes his situation: “I hadn’t appreciated the level of control the VCs would look to exert – they had a specific mould they were looking to shape each company into. I decided to execute a break-clause I’d baked into our contract to cut short the funding and therefore the VC’s equity stake.”
Thomas Beverley, co-founder at Fy, also felt uncomfortable with his VC situation: “The VC will typically be operating [on the basis that] ‘one-in-20 of my investments are going to be huge; five [will provide] okay returns and 14 [businesses will be] write-offs’. VCs obviously want you to be successful but they have 20 bets to your 1 so [motivations] aren’t entirely aligned. Therefore, they might push you to do irrational things post investment.”
The consensus with regards to VC investment is, before you take the money, make sure your motivations and expectations are aligned. Taking references can be a good way of ensuring this.
So, what is the best way to fund your business?
The real answer? There is no one best option when it comes to funding.
The best investment for your business will be the finance option that is right for your stage of business, your ambition for growth, and what you are willing to offer to investors in return.
Weigh up your options and consider each finance option carefully; if you’ve got enough money to bootstrap then take that route, or if you want a whole load of brand ambassadors, as well as cash, then consider crowdfunding.
Alternatively, if you want a large sum of investment and are happy to give away equity then look to VCs – but don’t be naive in thinking that VC money is “the holy grail”.
Hatty Fawcett understands first-hand the challenges facing start-ups when raising investment. She runs Focused For Business and offers free, online funding clinics to make it quicker and easier for founders to raise early-stage investment.