Our outsourced Finance Directors (FDs) and other Finance professionals are often approached to provide advice and insight around investment funding – and it’s hardly surprising. It comes in many forms and can be complex for small business owners and managers to navigate.
But it can also propel the business to success and generate a healthy return for you as founder and for any investors who join you on your journey – if you can secure the right investment type and make use of it effectively.
So, whether you’re looking to expand your premises, increase your headcount, strengthen your research and development activities, buy more plant and machinery, or whatever else growth looks like to you, investment funding could be the financial springboard your business needs.
Here’s what you need to know, distilled from our many years’ experience of helping small businesses secure the best investment funding methods to fuel their growth and innovation ambitions.
What are the different types of investment funding?
In the very early stages of start-up funding, founders are expected to invest at least some of their own money (and often that of their personal contacts, including friends, family, and former colleagues) in the business.
But outside these initial informal channels, investment funding for small and medium enterprises (SMEs), broadly speaking, breaks down into four types of funding provider.
Venture capital –
These firms (or funds) pool many individual and institutional investors’ capital together and put it into early-stage businesses to help them grow and generate a return on the investment. You can potentially access funding rounds of increasing value over a period of between five and seven years, and Venture Capital firms also often advise on the business’s strategy, technology, and management.
Venture Capitalists will have to return the money invested to their investors so are unlikely to support you for your full business life and may need their money back earlier than you are ready to part with it!
Angel investors –
These are individuals or small groups (syndicates) with, typically, an entrepreneurial background and/or extensive experience in the business world. They invest their own money in a small business in exchange for a minority stake (usually between 10% and 25%). Angel investors tend to be very “hands-on”, spending much time and effort advising the business, and enabling it to benefit from their knowledge, skills, and contacts. A good angel investor will add value and not interfere.
Private equity firms –
Combining their own money with capital raised from other investors, these firms consist typically of a group of investors from a variety of backgrounds that buy stakes in both startups and more established businesses. Private Equity firms tend to do larger deals and rarely invest in smaller companies.
In contrast to all the other investment funding sources mentioned above, grants are cash awards from Government or industry organisations that don’t require a stake in the business or aim to generate a return back to an investor, and, unlike a loan, don’t need to be repaid. They may or may not come with conditions such as matched funding, however, and are often subject to a great degree of scrutiny and reporting.
Customer/supplier funding: a fifth option?
It’s worth mentioning, outside the four conventions listed above, that funding may also come from sources that would not primarily regard themselves as funders.
Technically, funding can also be secured, for example, through customers paying deposits or advance instalments, or by getting suppliers to give extended terms or even by their accepting payment by way of shares instead of cash (something we see quite often with app/technology developers).
Large corporates may also use their own funds to back a business venture-style, or incubate it, perhaps with a view to acquiring it later.
Equity versus debt – what’s the difference?
With the exception of grants, and putting aside the less typical customer and supplier funding option, the methods above come under the umbrella of equity funding – that is, a means of you securing capital from investors in exchange for their obtaining a percentage of ownership in your business.
It’s quite different from debt funding, which involves securing funding through a loan from a bank or other lender, but there is an important similarity: namely that, in both cases, someone is going to want their money back (and then some).
In debt funding, this is simply about repaying the loan back to the lender from the growing business’s cashflow over time, plus interest. Hence it is unusual to consider applying for debt if you are pre-revenue or not cash generative.
In equity funding, it’s about investors selling their share in the business, and (hopefully) seeing a healthy return on their original investment.
But there’s a critical point to understand here: with equity funding of any kind, you are most likely setting your business on an exit path, as there is no easy way to return equity to the investors without selling the business. This is therefore not a source of funding to consider if you have no plans or desires to sell your business.
And as part of the equity funding process, your existing shareholdings may also have to be diluted – but it’s important to understand that you’re taking investment to “grow the cake”, and that a thinner slice of a large cake is usually a lot more valuable than the entire ownership of a single cupcake!
Preparing your business for investment funding
Securing investment funding is necessarily a highly competitive process, so you need to make sure your business is properly prepared – and much of that preparation depends on the work of an FD and a Finance team. (If you haven’t got these in-house, you should look to outsource it to specialists like EFM, who can provide the necessary expertise without the full-time salary bill.)
Critical for funding success are, amongst others, a clear business plan, an accurate valuation of the business, due diligence on potential investors, legal and regulatory compliance, and clear projections of how investors will realise a return on their investment. (Remember, ultimately, they’re in it for the money, not the experience.)
It’s also worth bearing in mind that, depending on the funding route secured, there can be quite a lot of tax considerations and reliefs in play (for example, your Research and Development (R&D) tax credit refund can form part of your funding strategy), so you’ll need to seek specialist advice on these fronts too.
In short, investment funding is a potential goldmine of opportunity – but the onus is on you to persuade the funders that you are a viable investment proposition.
And that’s exactly where we come in.
For more information on how EFM can help you secure investment funding to propel your business’s growth, get in touch today.