Importance of Raising Funds to Start-ups – Choose the Right Funding Option
Working capital is the lifeblood of every company. In an ideal scenario your business utilizes internally generated funding to meet business plans, however there are times when leveraging on external resources may be necessary.
In the startup scene you may have heard of the term bootstrapping. Bootstrapping is a traditional method used by smaller businesses to grow without the help of outside capital. If you choose to use this method, you must be prepared to sacrifice your time and effort as you’ll be wearing a lot more hats. In a new market, it may also lead to slower growth and many missed opportunities. You may also miss out having a particular established and well-connected investor on your board. There are many businesses out there that started out by bootstrapping and there are also businesses who have benefited from utilizing the best suited external financing method.
Why Start-ups Need Funding?
Business plans and aspirations can come in multiples and be of varying scale, however your company’s growth is often limited by the financial ammunition available. Increasingly you may see fellow entrepreneurs going all out to raise funds, this is so that one can accelerate the growth of their company. Through the additional ammunition, you can outpace your market peers in driving visibility and marketing strategies as well as increasing product and service verticals. These leads to potentially unprecedented growth opportunities for your company. On top of this, if you choose to use the bootstrapping strategy, you must be prepared to hustle a lot harder! With less budget for recruitment and retention of talents, it may be difficult to hire particular talented and passionate people who will drive your next growth vertical.
With external funding, you are able to pursue opportunity as they avail themselves. Exciting opportunities that may come your way include expansion into a new market, purchasing critical equipment or hiring talents with new capabilities and skills. When deciding whether to pursue the new opportunity, it is always good to consider whether the potential growth in cash flow outweighs the cost of raising capital as well as the maximum downside if the opportunity turns out to be not feasible.
Running out of money is one of the common causes for business failure. Lack of cash flow will reduce your chances of survival even if you have an amazing and in-demand product or service. As such, you should always budget and review your cashflow periodically. If through the budgeting process, you discover that your company may take longer than planned to make a profit, then you may need to make the necessary preparations to source for external funding to bridge the gap and maintain operations until your business is profitable.
Problems Faced by Start-ups
Asymmetric information is one of the problems facing the participants of the fund-raising scene, between suppliers and requestors of funding. This occurs when either party is less informed about a key piece of knowledge to a transaction. Other limitations include the self-serving mentality of banks, professional investors and other suppliers of funding who due to their narrow and specialised understanding about their form of financing, to recommend only within their own field of specialisation.
Financing Methods – The Funding Options
Debt financing is raising of funds by borrowing from a lender. The lender becomes a creditor and receives your promise that the principal and interest on the debt will be repaid on a regular schedule. Failure to make repayment and other agreed terms may result in severe consequences. There are two different categories of loans; Secured and unsecured debt. Secured debt is those for which you put up an asset as collateral for the loan whereby in the event of default, the lender can use that asset to as repayment. Typically the asset is such as real estate, motor vehicle or machinery. Unsecured debt requires no collateral backing from you, if you default on this type of debt, the lender must initiate a lawsuit to collect what you owed. With the increased downside, lenders typically charge a higher interest rate on such unsecured loans.
Equity financing is raising of funds by selling of shares in your company. There are various stages of equity fundraising. At a very early stage of your company such as during the ideation phase, angel investors will often write very small checks. Also known as angel funding stage, funding ranges up to USD 100,000 and is meant to take your idea into the first Minimum Viable Product. Though the amount raised is not huge, but angel investors can be valuable partners with future fundraising, recruiting and product development. Following that is the seed funding stage, funding ranges between USD 100,000 to USD 1 million. This is meant to launch your first iteration of product or service to the market in search of demand and fit, enabling you to develop a track record of user base, revenue and other performance indicators. Thereafter it is followed by Series A, B and pre-IPO representing post-launch and post-market fit stages of growth. With earlier funding used to lay down the foundation, you now require more funding to accelerate your growth. With funding ranging beyond USD 1 million, at this stage you have an existing growth strategy. Investors are looking for strong traction, growth, defensibility, and unit economics. Being able to write significant cheques, investors will be carrying out greater due diligence process that includes deep financial and business underwriting.
Hybrid financing, also known as crowdfunding, is the use of small amounts of capital from many individuals to finance a new business venture. As a relatively new form of financing, the crowdfunding model can be broken down into three different roles; you propose for the idea to be funding, people who support the idea and the platform that connects both parties to launch the idea. There are three types of crowdfunding. The first is debt-based crowdfunding. Also known as peer-to-peer lending, individuals provide funding to you and in return receives your promise of repayment as a borrower. This form of campaign is popular with businesses who do not want to give up equity ownership stake while also not having access to the traditional types of loan facilities. Next would be equity-based. In this type of campaign, individuals provide funding to you and in return receives part ownership in your company and hence participating in future returns from your company. Following that is rewards-based crowdfunding. This is where individuals provide funding to you and in return receives varying levels of rewards that correspond to their contribution amount. Rewards are commonly product or service-based.