You want to grow. You know you need an injection of cash to do so, but this is where the certainty ends. How do you decide where to get this money from?
Presuming you have already exhausted your own personal funds, you are left with two main choices. Equity vs Debt.
Equity financing means you are looking for an investor to give you money in exchange for a portion of your business (equity).
Debt financing means borrowing money that needs to be repaid, usually with interest.
There is a third option which I loosely group with debt but really sits in its own class of funding - Grants. Grants usually don’t need to be repaid but will often have conditions around how they are spent. You don’t need to give up any equity to get these, either.
Pros & Cons of Equity Funding
The obvious benefit of raising funds in exchange for equity is that it doesn’t need to be repaid. You have given away a chunk of your business for the pleasure, though…
It can be incredibly hard to successfully raise money this way.
Less than 1% of businesses that look to raise investment are successful in doing so!
You now have a partner in the business. How involved they are will vary hugely, but this could be a blessing or a curse. You might get access to valuable experience from your investors, or you could effectively report to someone who doesn’t get it or fit with your values, so choose carefully.
Most investment raises will cover your cash flow for at least 12 months. This peace of mind and security can give you the confidence to concentrate on growing the business.
Of course, I have seen the opposite true, too and some founders become lazy or wasteful with a 12-month+ runway of cash in the bank account.
Your exits need to be aligned. An investor coming on board will want to exit the company at a profit at some stage. This needs to be factored into your plans.
Is Now The Right Time?
The more your business is worth when you raise via equity funding, the less it “costs” you. By that, I mean the less of your business you need to give away.
Therefore it stands to reason that you should get your valuation as high as possible before considering this option. This is mostly true, but the reality is that it’s a relatively delicate balance that needs to be carefully weighed up.
I regularly see early-stage businesses going straight to equity before properly considering alternatives first.
Every business should consider exhausting two funding options first:
Grants
For the most part, grants are free money! The problem is that they may be few and far between or hard to get it.
What part of the country you are based in and the sector you operate within make a huge difference to what is available.
Speak to your accountant/CFO, and most will have access to what is available for you.
Two main problems with relying on grants:
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The easier-to-get grants are often for amounts too small to really make much of a difference
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The larger, more attractive grants can be incredibly time-consuming to apply for. Innovate UK grants, in particular, take a lot of time and attention and are notoriously hard to win, even with a grant application writer helping.
R&D Tax Credits
Most fast-growth businesses considering seeking investment are doing something reasonably innovative. Therefore, most will be able to benefit from R&D Tax Credits.
Partner with your accountant or specialist provider to determine how much of your expenditure is qualifying and how much credit/cash you could expect back.
These submissions are included with your Accounts and Corporation tax returns to HMRC once a year, so the timing might not be suitable to solve all of your problems.
Debt Financing
When discussing debt options, most people naturally think of an overdraft or a fixed-term loan from the bank. There is a vast world of options beyond this that will probably be a better fit. Let’s cover some of the more common options below:
Overdrafts and Fixed-Term Loans
Nice and straightforward. Easy to understand and usually relatively easy to access but shop the market for the best rates. Your bank is far from the only option.
Use these as they are intended. An overdraft should plug very short, temporary gaps in working capital, and a loan should be put to use in a planned manner.
Credit Cards
Again, it can be easy to access extra funds but usually carries a high interest rate, so be wary of this. These are usually a last resort.
Invoice Factoring
This involves selling your unpaid sales invoice to a third party, who will then collect the debt on your behalf from clients. They will pay you a % (80-90%) of the invoice upfront and then the remainder, minus their fee, once the client pays.
This can be fairly expensive but is extremely useful if you have a large outstanding invoice book with slow payers. We see many clients using this where they have big blue-chip clients who are notoriously slow payers.
Asset Financing
If you want to raise funds to purchase physical assets (Vehicles, equipment etc.), then raising finance tied to these assets is easy (the lender has something tangible to recover if you default).
An excellent strategy for asset-heavy businesses to consider is to refinance existing assets. For example, if you have £500k worth of assets (market value) and just £50k of financing left outstanding, then you could easily refinance the existing assets to pay off the old £50k debt and raise an additional £250k+ that you can then use in any way you like, not just more assets.
Merchant Cash Advances
Payment processors like Paypal, Stripe and other card terminal providers will lend you money based on the volume of transactions they regularly process on your behalf. They will deduct a portion of future card sales to cover the repayment before sending you the balance.
Credit Terms
Not thought of as traditional debt financing but try to negotiate longer payment terms with your key suppliers to free up additional working capital.
You must find a funding partner who really understands the products available to you and can shop around for the best rates. Just jumping into bed with the first person who offers you money is likely the most expensive option.
If anyone wants an introduction to my funding partner, feel free to message me.
When weighing up your options, it’s always best to look at all your options. Are any debt funding options going to be enough to get you that bit further on, hit a higher valuation and then raise via equity?
Balance this up with the fact that equity raising is complex and lengthy. Don’t exhaust all of your debt options and then start to look for equity and risk running out of cash!
Of course, all of this depends on your growth plans and how much cash that is likely to suck up. If all of the above generates £20k cash inflow and you need £2m then it isn’t going to make a dent! For most, though, exploring these options first, developing the product and business a bit more could bring a higher valuation, make it easier to raise, and make a lot of sense all around.
As is often the case, having a strong financial model and cash flow forecast is key to understanding what funding to take on and when.
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.