Creating a funding strategy is a challenging, yet crucial step for any business. Most experts agree that the key to a successful financing plan is understanding the different sources of funding, and pursuing those that are applicable to the company’s stage of growth.
The diagram above sets out the different sources of funding at each stage of growth.
There is no doubt that government funding is a critical source of funding for many organizations and should be included in any business financing plan. It is an important source of financing in its own right and can often be used to leverage additional private funds.
In particular, government funding is important for two reasons:
- It is often designed to fill the gap when private sources of financing aren’t available, and can in fact fill that gap; and
- It can often be leveraged to attract private funding—investors will often respond more favourably to an investment pitch from a company that has a government funding commitment from a prestigious government sector funding agency. Wouldn’t you?
Using personal resources is often the first step in starting a business and it shows investors that you are committed to your business. Entrepreneurs can invest some of their own money through cash or collateral assets, or get loans or use personal credit. Entrepreneurs can also devote non-cash or “in-kind” resources to their business, such as time, expertise, services or a car, credit facility or home office.
Friends and Family
Friends and family may be willing to provide funding, and will often be patient in terms of repayment. In exchange for funding they may seek equity in the company, but it’s wiser to consider the funding a loan. Often friends and family are a great resource for in-kind services, such as helping to write a business or financial plan, building a website and marketing. These services can save your business thousands of dollars.
For early-stage companies, government funding will tend to be a pre-condition or path to private and commercial financing. For mature companies, government funding will tend to supplement revenues and corporate resources to finance a specific project that has strong public benefits, such as market-leading R&D, job creation or regional economic development. There are many types of government funding, including grants, repayable contributions, tax incentives, vouchers, and job creation programs. Searching for government funding is facilitated by ordering a custom report on your top sources of funding.
Equity or Debt Crowdfunding
Crowdfunding is the process by which a business raises capital or debt from individuals using online crowdfunding platforms. Each platform has its own variation of crowdfunding, so it is important to verify that the terms provided by the operator are suitable for your purposes and are in line with the regulations put in place by your regional securities authority.
Accelerators and Incubators
A business incubator is a centre that encourages early-stage businesses to accelerate their development by providing an array of support services. Accelerators provide debt or equity financing in addition to support services, such as office space, guidance and shared administrative services.
Angels are often wealthy individuals, entrepreneurs and business people or groups of investors who provide capital to early-stage businesses for ownership equity or convertible debt. Traditionally, this funding ranges from between $25,000 and $100,000 on a per angel investor basis. Along with providing funding, angels often offer knowledge and guidance to businesses, and may ask for or be willing to take a seat on the company’s board. Angels often focus on sectors in which they have previously worked and can bring experience and networks, as well as cash, to the table. Because angels expect a return on their investment – something more than they could get in the market or in the bank – they look for companies that have compelling prospects for capital growth and returns. Angels often have a relationship with the company they are investing in, usually through both industry and business networks and geographic proximity. Because angels do not want to be inundated with requests for capital, angels often work below the radar and can be difficult to identify.
Strategic Corporate Partners and Investors
Considering partnerships is an important part of developing a financing strategy as the right partners can accelerate product commercialization and create market leadership. Traditionally, a strategic partner is a large company or association that has a commercial interest in the project’s outcome. In their heyday, Nortel and BNR were strategic partners for a generation of venture companies within the telecom sector, often providing them with access to labs, office space, capital and knowledge in return for an ownership stake. Very little is achieved in business without strategic partnerships. When searching for a strategic partner, consider which complimentary businesses or associations could increase the value of your product or service. Will your partner increase your credibility? Help customize your technology? Introduce you to a new market? Then, think about how the partner will benefit from its relationship with you in order to create a proposal of mutual value to both parties. In doing so, be a bit wary. Often there is a clear inequality in bargaining power and many companies that are desperate for financing make deals-giving up enormous ownership or control in return for relatively small sums of cash-and come to regret them years later. This is why government funding can be so attractive, providing seed or R&D financing without having to take on debt, or give up ownership of the company or its IP.
Venture capital firms (VCs) provide significant financing to companies in return for significant ownership stakes. Most will not take on the costs of due diligence unless the investment range or “deal size” is $5M+ and many start at $50M+. The VC space or “sweet spot” is companies that present high risk-and high reward. Generally, VCs seek an exit-a way to liquidate their shares through a strategic sale or initial public offering (IPO) within five to 10 years. Venture capital is only applicable to a tiny percentage of companies with business plans that suggest capital returns well in excess of the public market returns. The VC portfolio is designed to complement yields from more reliable sources such as bond markets. VCs tend to favour proprietary technology companies that almost uniquely have the potential to generate these stratospheric returns. VCs generally invest in early-stage companies to open themselves up to the longest possible growth run. VCs get intensely involved in their portfolio companies — wouldn’t you if you had millions on the line? – and only entrepreneurs who are willing to share and perhaps relinquish decision-making control over key decisions should consider going “the VC route.” The positive side of that coin is that VCs bring extraordinary knowledge in areas that tend to complement in-house expertise and their thirst for high returns can be of great financial benefit to the company and its shareholders.
Banks and Commercial Lenders
Banks and commercial lenders should be the last stop on the funding continuum because they usually deal in debt. Bankers look for companies with a strong business plan, a good track record and good credit. Each bank presents its own advantages to customers, so businesses should review their options to find the best fit.