The correct funding channel is perhaps the key determinative factor in allowing your company to achieve serious growth. The choice between employing investors versus lenders is an essential one in business financing, and each category, of debt and equity financing, has its benefits and disadvantages. This decision will impact the structure of your company, how you operate, and the course of its growth. Below, we’ve summarised the main channels of financing early-stage companies have at their disposal.
Bank loans and overdrafts remain a very relevant source of financing for businesses, with loans to small and medium-size enterprises (SMEs) occupying a significant part of banks’ dealings. Banks tend to offer attractive interest rates on debt and usually come with a trusted and stable reputation.
As with any form of debt, a significant advantage is that there is no dilution of ownership or control compared to selling a stake in equity. Furthermore, debt incurs a tax advantage in many jurisdictions, as interest payments on loans are deducted prior to calculating a company’s tax bill, thus reducing it. On the other hand, dividends paid to shareholders are deducted from after-tax earnings and therefore miss out on what is termed an “interest tax shield”.
Although banks continue to actively engage in business lending, startups are being left behind. Banks have lower risk thresholds to the other finance channels we will discuss. They remain focused on SMEs with established track-records – and of course the large players - and tend to avoid early-stage companies that lack strong balance sheets and a history of trading.
Another concern with bank lending is that its benefits are limited to the provision of funds alone - it comes with none of the expertise of venture capitalists, nor the public exposure of a crowdfunding campaign.
Is significant capital required to grow the market share of your company? The larger amounts of capital typically offered by venture capitalists (VCs), together with their hands-on approach, may be the most suitable route. The prestige, advice and forward thinking typified by VCs may spin your company into the direction you’re aiming, and achieve its funding goals, in one stroke.
The above consideration must be weighed against how much of your company you are willing to exchange for venture capital investment. The dilution of your stake for the sake of their investment is off-putting for some, as is the diminution of control that results from VC management. Both can be disheartening for entrepreneurs, especially those who are not solely concentrated on an exit strategy. Similarly, if you are an entrepreneurial figure with minimal history in capital raising, VCs will be difficult to attain, as they tend to target more established figures. Similarly, VCs prefer companies in the latest stages of development
Equity and debt crowdfunding, alongside the alternative finance industry as a whole, has seen a marked rise in popularity, as companies harness the investment power of the crowd to break down existing barriers to investment. This inclusive model allows for a broad range of investors, offering new opportunities to the public and allowing early-stage companies to swiftly fill gaps in funding, often with business angels in tow.
In certain circumstances, companies can ‘overfund’, going beyond their projected targets as the momentum of a crowdfunding campaign sweeps up eager investors. As such, attaining investment through crowdfunding platforms has the dual purpose of funding and marketing your company simultaneously. Debt-based crowdfunding has the advantage of retaining ownership and control, and in some cases provides aforementioned tax advantages.
The proliferation of crowdfunding platforms poses a surplus of choice for companies, and although the process itself is cost and time efficient, significant research should be conducted into the appropriate platform to choose. Similarly, companies must be cautious of platform fraud, and ensure every measure has been taken to safeguard their privacy. While crowdfunding campaigns can be effective marketing, companies must remain conscious that targets are not always met – your funding could be back at square one after attempting a raise.
By teaming with experienced Angels, companies are afforded expertise and a network of industry players. Angels’ involvement also encourages investment from those within their network. Following the Angels’ lead makes sense – their investment credentials and background allow investors to hijack this experience for their own portfolio’s benefit, with a common interest. Angels can work as ambassadors for your brand, arranging future funding and continuing to lend their vital business acumen.
Be wary – the upsides of securing funding through angels must be carefully weighed against the strings and compromises attached to it. This is no charitable deposit on their behalf – each action demands a return, and they are often in a position of bargaining and institutional power to exert influence and demands over entrepreneurs. Ensure you are well educated when it comes to the funding process and the necessity of this kind of investment, and be aware that angel investors are not created equally.
Ultimately, the expansion beyond traditional bank financing has afforded companies a new host of possibilities when it comes to early-stage investment. As with any form of alternative finance, it’s important to seek advice, know your business and realise that there is no “one-size-fits-all” approach to funding channels – extensive research will allow you to secure the kind that’s right for your business.
Richard Andrée Wiltens is a commentator within the fintech sector, who has written for an array of international investment platforms. His career has spanned from investment banking to financial technology firms, backed by an education in economics and finance.