When it comes to starting and or running a business, fundraising is undeniably a primary concern for start-ups. It’s important to know that before you do anything concerning raising of funds, you need to have a clear understanding of how you plan to operate your business and a good business plan will surely increase your chances of securing funds and set you up for success. Here we will be discussing on the various options available to start-ups. We would also consider the advantages and disadvantages of these options.
There are basically two ways through which start-ups could fund their businesses;
- Equity financing
Equity funding means exchanging a portion of ownership of your business for a financial investment.
- Debt financing
Debt funding has to do with borrowing of money from creditors with the stipulation of repaying the borrowed money plus interest at a specific future time.
Most of the fund raising options we’ll be considering below would fall under this category.
FUNDRAISING OPTIONS FOR STARTUPS.
1. Bootstrapping / Self funding.
This options involves funding your business through personal savings or financial assistance from family and friends. This stage of self-funding is usually known as the pre-seed-stage funding. It’s largely advised that newly formed start ups rely on this option as much as possible as a result of the advantages below;
- It’s largely convenient as there will be no need trying to convince strangers to handover some cash to finance your business
- Eliminates complexity of giving up control by adding more partners or share holders
- All profits goes to the entrepreneur and his business only
- Founder bears all the risk alone
- Bootstrapping in most cases does not work for large businesses, but it works for small scale businesses.
- There is always a risk of jeopardizing relationships should the business fail and a close relative feel their money was ill used.
This is a process of gathering money for your business or a cause through a large number of persons online. Crowd funding platforms such as; GoFundMe, Pork Money, FarmCrowdy, Indiegogo, Malaik, CircleUp e.t.c, exists to enable business owners pitch their businesses to a crowd of individuals or prospective investors, who pledge publicly to finance the business, if they are willing to support such ideas.
There are basically four primary types of crowd funding namely;
- equity crowd funding
- reward-based crowd funding
- It essentially creates public interest for your business, thus running some free marketing and providing finance at the same time.
- Pitching your ideas on a platform could be a valuable form of marketing.
- Sharing your idea can get you feedback and expert guidance.
- It’s a good way to test the public’s reaction before product launch.
- Has potential to attract venture capital investment as the business progresses
- Ideas that may not appeal to conventional investors can often get financed more easily on such platforms.
- If your business pitch isn’t as solid as your competition, then there is a probability that you will be rejected.
- If you do not reach your funding target, any finance that has been pledged will usually be returned to your investor and you will receive nothing.
- Failed project risks damage to the reputation of your business and people who have pledged money to you.
- Due to likelihood of large exposure on such platforms, an unprotected business idea, faces high risk of being stolen.
3. Funding from angel investors or venture capitalists firms
There is a difference between an angel investor and a venture capitalist. An angel investor is a high net worth individual(s) who provide financial backing for start-ups or entrepreneurs in exchange for ownership equity in the company. In some cases, angel investors come together in groups to select businesses with better prospects of investing in.
A venture capitalist on the other hand, is a private equity investor that provides capital to companies that show a high growth potential in exchange for equity stake at the said company. Unlike angel investors who happen to be private individuals, venture capitalists are formed as institutions who take care of pooled money from investors, and invest them in a strategically managed fund.
- Alongside funds, selected businesses gain access to mentoring.
- Start up gains credibility from being associated with such investors.
- Because most angel investors are known to have a lot of business experience, start ups associated with such form of investors, stand a high chance of gaining access to meaningful networks and connections.
- Since venture capitalist firms are strictly regulated by agencies, they are reliable.
- Founder may give up part ownership of the business.
- Likelihood of pressure on founder to generate expected returns for investors.
- Founder stands a risk of losing control especially in cases were high amount of ownership was given up to angel investors.
4. Funding from business incubators and accelerators
Business incubators nurture businesses, while accelerators fast track businesses. With a clear difference in what they represent, their mode of operation varies.
Start up incubators work with early stage companies or individuals who have prospective business ideas. In most cases, they do not operate on a set schedule as they may be made to relocate to another geographical location to work with other startups. Entrepreneurs who enrol into incubator programmes should expect to have its idea refined, developed a business plan, work on a product – market fit, identify intellectual property issues and gain access to a network of fellow startups. Example of Start up incubators are; Idealab, Co Creation Hub, Afrilabs, etc.
Accelerators, create platforms for businesses to be exposed to mentors who ensure that such businesses do not encounter problems along the way. Their programs could take few weeks to months. Early stage start ups are also given seed investments and access to a large network of mentors in exchange for a small amount of equity. Examples of accelerators are Y Combinator, Techstars, MEST, Startup Bootcamp Afritech, etc.
- Reduced overhead cost for incubators as the latter are in most cases provided with free or low cost workspace.
- Provides networking opportunities with mentors and start-ups.
- Provides training opportunities on various areas of business.
- Being accepted into an incubator or accelerator programme helps build credibility for your business.
- Rigorous application process
- With lots of meetings and events, balancing one’s commitment to the programme alongside his or her business, could be demanding.
- Exposure to a high pressured environment as both programmes exist to make your business or idea work.
5. Bank loans
Bank loans are the most common source of debt funding for start-ups. A business owner may secure a loan from a bank for a period of time to be repaid alongside an interest rate.
- Business owner retains control of his or her business
- Interest on Bank loan is tax deductible
- Bank loans are difficult to obtain except a business has a substantial track record or valuable collateral, such as real estate.
- Interest rate proposals on loans are high in most cases and the amount which a business may qualify for may not be enough to meet the needs of such business.
- There is always a possibility of seizure of assets especially were a business is unable to satisfy the terms of such loan.
Whatever option a start up choses to rely on would largely depend on several factors such as; the current phase of the business, business ownership structure, the amount needed to be raised, the goal of the funds, etc . Each fund raising option could be adopted by businesses in a progressive order. However, as a business the primary source of your funds should be your paying customers. In other words, your business should generate enough revenue and profit to find growth and expansion.
Most importantly, start – ups must also understand, that carrying out due diligence is not the responsibility of investors or creditors alone. Deploying safety measures such as; ensuring that terms of investment are reduced into writing, understanding the terms of such investment, e.t.c are essential. Do not hesitate to seek legal counsel were a clause remains unclear.
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