Doing Business Financing the Right Way

Do you know anybody who has ever said: “No thanks, I don’t need more money for my business”? Probably not. More money is always welcome, and there are several points in a company life cycle where cash is especially needed. Most entrepreneurs raise capital to grow their business but this term is somewhat vague and can mean different things, according to the stage of development your business is in. For example, if you’re a startup, growing your business can mean that you also start selling your product to foreign markets, while if you’re an established business, you might grow your business by performing an acquisition. There are many ways to raise capital for your business, but

The question is, what is the best way for you to raise capital, and how do you increase the chance of a successful funding round? This depends on the current situation your company is in. Today, we will have a look at the 4 stages of business financing. What is the right path to achieve business growth?

1. Bootstrapping

If an entrepreneur starts a business with little capital, this is called bootstrapping. In this case, a founder does not attract external capital, but rather uses his personal savings, and maybe some money from friends and family to finance his business. He stretches all kind of resources as far as he can, which requires a lot of creativity and a good network to get things done for no or little money. A pro is that the founder maintains full control over his business. Moreover, there are less financial obligations like interest payments. On the other hand, the entrepreneur faces a large financial risk if the business fails as he’s put his personal savings in the company.

Trade credit can be a useful way to finance your expenses while bootstrapping. Suppliers often extend credit to regular customers for 30, 60 or 90 days without charging interest. You probably still have to pay something upfront, until you have proved you can pay your bills on time. A detailed and solid financial plan will help you in giving your suppliers more certainty.

Although bootstrapping is associated most with starting a business, entrepreneurs can pursue this financial strategy in other phases. However, it’s not a long-term plan, since spending as little money as possible can keep your company from growing. It is rather a short-term plan to keep the costs as low as possible until you have developed a first product, or at least a detailed business plan and your business becomes more attractive to external investors. Still, it’s good to keep the basics of bootstrapping in the back of your mind: think carefully about each expense you make and consider if you can spend the money better on something else.

2. Angel Investment

At one point, bootstrapping might not be sufficient enough anymore, and external capital is necessary to further roll-out your product. Here, angel investors are a very useful source for small businesses. A Business Angel is an individual investor who invests his or her own money in your company. They’re often experienced entrepreneurs who successfully founded one or more businesses in the past. They might be people you already know, but you can also actively search for angel investors at events or via angel networks.

Business angels are very popular among small businesses, since they don’t only invest their money in your business, but they also share the experience and knowledge they gained over the past years. Instead of being only driven by profit, they invest in the entrepreneur behind the company, which makes it more personal and informal than most sources of financing. Moreover, you might benefit from their large network they’ve built up in the past years. Angel investors are motivated by the high returns they can get when the company succeeds, and the new, innovative projects they can be part of.  A downside of angel investment is that you have to give the investors a say in your company, e.g. he or she becomes a shareholder.

To determine the number of shares to give away for an amount of capital, you’ll need to know the initial value of your company. When angels value a business, they do not only reply upon Discounted Cash Flow method, but also take other methods into account that are especially suited for young, pre-revenue businesses. Equidam applies these methods used by most angel investors, which makes the system a perfect way for entrepreneurs to gain a complete financial picture of their business in a quick and understandable way. Read here how Angel Investors value your business. 

3. Venture Capital

Unlike angel investors, Venture Capital firms do not invest their own money. Instead, they pool other investors’ money in a fund and invest in businesses with long-term growth potential. VCs are usually tapping in later than Angel Investors, when a company is a bit more developed – although not profitable yet. VCs are more formal and less personal than Angel Investments. Typically, small businesses in this stage cannot access the capital market yet and search for other ways to raise capital for their company. Similar to angel investors, a VC also gets a say in company decisions. This might be a drawback for the entrepreneur, but on the other hand, Venture Capital can be very useful to get feedback from experienced investors.

There are several Venture Capital rounds. Series A is the first round,and is used for product development and finding the right market fit. After this round, there are Series B and Series C to scale the business- these rounds involve more money. In exchange for the investment, a VC usually receives preferred shares- shares that have a higher claim on the assets and earnings than common stock. This means they receive dividends first.

The terms Angel Investors and VC funds are often used interchangeably, but as we just explained, there are some major differences to consider. Give your financial knowledge a boost and learn here about main differences between the two!

4. Debt Capital

When a company has a more stable position – it is established in the market, has a good track record and possibly makes some profit, it can get easier access to debt. Besides traditional bank financing, mezzanine is used often and gives a lender the rights to convert the loan into equity if it is not paid back in time. It is often subordinated to debt provided by senior lenders as banks and VC firms and is mainly used for business expansion- like an IPO or an acquisition.

The advantage of debt over equity is obviously that you don’t have to give away shares of the company. On the other hand, it’s quite an expensive form of financing, as you have to pay interest whether the company performs well or not. Moreover, too much debt can force your company to reject profitable projects and increases the risk of bankruptcy.

Another type of debt capital is bridge financing. This short-term financing is often provided by a bank to fill the gap between an investment- for example an IPO, and the future inflow of revenues from this investment. When the activity is completed and the additional cash flows in, the loan is payed back with high interest.

I think the key message today is that there is no one best way to finance your business. There are pros and cons of every type, and it highly depends on the current situation your company is in. What does apply to every stage, it that it’s crucial to be aware of the value of your business as of today. Whether you get a loan from a bank, or raise capital via Business Angels, the other side of the table wants to know where your company is right now, and where it is going in the future.

Do you know where your company stands today? Get started with Equidam!