Crowdfunding, venture capital, angel investing – there seem to be so many different ways to get funding for my business. Which one is best and are there any downsides to letting other people own a share of my company?
Eleanor Lawrie of This is Money replies: You could feel like a kid in a sweet shop when it comes to the different forms of investment on offer for your small business.
But while the offer of ‘free money’ may sound tempting, it’s important not to seek outside funding too quickly, get into anything you don’t understand, or give away more of your business than you want to.
Here we look at how to choose the right time to look for an external backer, the different forms funding can take – and how to successfully pitch to investors.
When is the right time to look for outside investment?
While many small businesses would like to take their time expanding, it’s important to be flexible in order to take advantage of opportunities as they arise.
Bivek Sharma, head of small business accounting at KPMG, says: ‘Slow, organic growth can be appealing, especially compared to the alternative of taking on debt or giving up equity, but competition complicates the picture.
‘If competitors secure cash injections and invest in talent, technology or materials that put them in a better position to jump on new business opportunities, they can quickly eat into the territory of the more cautious.
‘For most young businesses, the reality of growth opportunities is that they are often fast and erratic, not slow and steady. In these moments, outside investment rounds can be a great asset.’
If your business is keen to grow and is seriously considering outside investment, there are a few questions to ask first:
Why do I need outside funding?
Sharma says: ‘Being clear in your own mind about exactly why you need extra capital can give you a great steer on which funding route will best suit your business.
‘For example, a start-up may need seed funding to help establish their concept, before going for a larger round when looking to scale-up.
‘Established businesses may need investment that is focused on scaling, whether that’s for additional staff, equipment or new technology.’
How much should I ask for?
Once you know how you would put the money to work, you can start to calculate a good amount to ask for.
Sharma says: ‘Having an appropriate figure in mind is important when approaching investors. Ask for too little and you may need to generate further rounds of funding, which can damage the business’s credibility.
‘Apply for too much and you run the risk of being turned down or out-pricing potential future backers.’
Which type of funding is right for my needs?
Funding options have increased exponentially in the past few years, and it’s worth taking time to consider which route would suit your business best. These can really differ in terms of the amount on offer, the speed of the process and the strings attached.
SMEs need to consider what they are prepared to give in exchange for a cash injection, whether that’s paying interest on a loan, or giving away equity in the business.
Bivek says: ‘My advice is to ignore the hype and focus on your own needs and goals. Just because some businesses raise millions through crowdfunding doesn’t mean it’s right for everyone. Consider every option and whittle them down.’
Peer to peer lending/crowdfunding
Early stage companies may want to investigate peer-to-peer (P2P) platforms such as InvestDen and Funding Circle, which match growing companies directly with organisations and individuals who want to lend to them.
The idea is that, by cutting out the banks, individuals who lend to you get a better rate of return. At the same time, your business may be able to borrow at a cheaper rate than the banks offer – if you have a good credit score.
These loans are collated so that lenders’ money is put into a bucket of different companies or individuals put together by the platform to even out their risk profile.
The risks of this type of financing are borne mainly by the lenders as their money isn’t protected by the FSCS. However, SMEs who borrow through peer to peer lending need to treat it the same as they would a bank loan – you won’t necessarily be accepted, and if you don’t pay it back on time your credit score may be affected and you may be chased by a debt collection agency.
Meanwhile, crowdfunding lets individuals financially back your product or service. On some sites the aim of this is to help charitable or socially conscious projects get off the ground, and the backers get nothing back other than the satisfaction of seeing it come to life.
But usually, businesses offer something in return, like equity (shares) in the business, or debt (bonds or mini-bonds).
Once on the crowdfunding platform, you have a set time-frame to attract the funding you need. In most cases you will not receive any of the investment if you fall short of the target, but you are usually allowed to raise more than your target. This means it’s important not to set a target higher than you can realistically raise.
Crowdfunding can be a useful marketing exercise in itself, helping to raise the profile of your business while (hopefully) attracting your desired level of funding.
Angel investors tend to be successful or affluent business people who want to financially back promising companies, usually in exchange for debt or equity. These investors will sometimes also offer guidance and support, and will often have expertise in the sector they are investing in.
Sharma says: ‘Angel investors can be a good option for the super ambitious, as they often provide a sizeable lump sum. They frequently act as business mentors too, and are happy to invest time to guide start-ups.
‘Making sure you are eligible for the Seed Enterprise Investment Scheme (SEIS) can make the investment considerably more attractive to these investors, and can mitigate the higher risk involved with large amounts of money.’
Venture Capital firms
Venture capital firms usually offer much bigger sums than angel investors – usually at least £1million – but are likely to expect a higher rate of return and/or more equity in your business.
Sharma says: ‘A more established high growth company with excellent potential, for example one with valuable intellectual property, may be well-suited to venture capital. This can work well if your aim is to increase value in a short time, for example, if you’re aiming to sell the business in three years.’
While this level of funding can have a huge impact on your business, venture capitalists can also take a long time to decide whether to invest, so this method may not be a good choice if you need funding quickly.
Businesses also have the option of selling their intellectual property – the ideas behind their product or service – often in the form of a patent or copyright that they have already secured.
It may sound counter-intuitive, but small companies can sometimes attract funding from more established firms in the same industry. For example, in the 2000s, McDonald’s took a 33 per cent stake in upmarket sandwich chain Pret a Manger and Google invested $1billion in fellow search engine AOL, as part of a strategic alliance.
Sharma says says: ‘If you have a disruptive product, consider speaking with the companies you are looking to shake-up – they might be keen to buy a stake in the business as a defensive measure.
‘Just make sure a corporate investor is keen to share in your success, rather than simply neutralise the competition.’
What makes a winning pitch?
Once you’ve worked out which form of investment is right for you, the next step is to make sure you nail your funding pitch.
The best way of doing this will depend on your audience. For example, crowdfunding investors are unlikely to be experts in your field, so you need to be clear in your pitch about what your business has set out to achieve and why this represents an exciting opportunity for them.
Meanwhile, venture capitalists or angel investors are likely to ask probing questions about the inner workings of your business – so you need to be prepared for that and make sure you know all your facts and figures.
However, there are a few tips all small businesses would do well to bear in mind, regardless of who they are pitching to.
Sharma says: ‘You should be able to explain your business in one or two simple sentences. Being able to succinctly describe your product or service, and the problem it solves, is critical to securing investment.
‘For certain sectors, such as technology, it can be helpful to give a demonstration, or talk through a prototype, which will help potential funders to visualise a complex idea.’
While backers may think your idea is good, they will also want to know pretty early on what’s in it for them financially.
Sharma says: ‘One of the most important things to get across is how you plan on generating revenue. The bottom line is that backers look for a financial return, so you need to prove that your idea is a promising investment.
‘Lastly, excite investors! Enthusiasm for a venture, plus expression of your own expertise and tenacity can be a great asset.’
By ELEANOR LAWRIE for www.thisismoney.co.uk