Financing my idea: Must I lose control?
It’s not enough to have a great idea: you need resources to flesh that idea out. That means financing, a business plan and a bank loan, right?
Well, maybe. Being in a position to raise a lot of money isn’t always the best thing. Often, a cash pile can lead to a rise in expenses as you hire staff and take on additional costs such as things like offices. Profitability can suffer and it only gets worse as you potentially become accustomed to the new lifestyle. Add in the temptation to seek more funding as your costs continue to grow and you can see it can lead to a vicious cycle.
In life, though, we rarely get a free lunch and you’re going to have to give something for that money and that something is more than likely going to be control of your business.
How much control you give and how you give it is up to you depending on what road you decide to travel down. The money you raise in the infancy of your business will likely be the most expensive thing you ever get.
“Never buy new what can be bought second-hand
Never buy what can be rented
Never rent what can be borrowed
Never borrow what can be begged
Never beg what can be salvaged”
-The Miser’s Maxim-
The questions you must ask yourself
- Do I actually need the money?
- How much money do I need?
- What will I do with the money?
- How long will the money last?
- Where will I get it from and what am I willing to give up to get it?
- How and when do I plan to pay it back?
If you don’t know the answers to the above questions, then forget about raising money from outsiders because you don’t have any idea of what you’re doing. It’s an important exercise to go through because being vague will not help you when decisions have to be made.
When it comes to raising finance the type of business you are will affect the type of finance you will want to access as well as your bargaining power relative to the providers of capital.
Lean, mean and in control
We could write the cliche stuff on raising money from friends and family and that’s not bad advice. The fundamental advantage of this type of money is that it overcomes the ‘information asymmetry’ problem.
Information asymmetry is where one party in an economic exchange has more information than the other. Your friends and family know you and trust you. The bank doesn’t, so it will not give you the same generous repayment terms but more than that they’re unlikely to take a chunk out of your equity.
Just being repaid would be enough and therefore your long-term potential returns from the business are undiluted. Importantly, you also maintain control of your business and can steer the ship in the direction you please.
All well and good, but can you do it? For example, if you’re a consultancy firm your start up costs are not going to be as great as a wholesalers’. Going down this route may not just be feasible but actually preferable.
It’ll require discipline, though; you’re not going to be spending money on a lavish office. Alternative facts may not exist but there are alternative ways of running your business, and a home office is still an office.
Besides, discipline is not a bad thing. It is through trial that we learn and improve. In fact, another way to raise money is to continue working. There’s no reason you can’t in the very beginning keep a part time gig to bring in some cash as you begin to build your business if you can do it.
The advantage of this is you lower the risk and you give nothing away. For instance, you start a website and sell football kits, with enough time you build a customer base and have a healthy cash flow, then you can let go of the part time job and go full time into the business maybe even eventually move to a physical premise with a shopfront.
If you can get to where you want to go by bootstrapping and relying on your personal network then do so. It’s a lot less risky to go down this path than to finance your business with debt, especially when you don’t have any sales. Again, fundamentally this boils down to whether it’s right for you and only you can decide that when weighing the advantages and disadvantages against your goals.
Part of the crowd
If you don’t have a large personal network from which to draw from then don’t worry - the world is a big village. If you have a vision and you can articulate it, then through the magic of language you can persuade many others to come on board. Crowdfunding is a prime example of raising money from a large number of people who each contribute a relatively small amount, typically via the Internet to fund a project or venture.
We’ve seen it with our own eyes. Not far from where we’re based is a company called Frontier Developments, who had a vision of exploring the galaxy which they shared on Kickstarter and raised over £1 million from over 25,000 people to bring Elite: Dangerous, a space exploration and combat imulation video game into existence.
It can be a very fast to raise the money you need with little to no upfront fees. In addition, as you’re raising funds through this method you can get feedback on your idea as well as test the public’s reaction to it.
It can also provide much needed publicity if you do really well as in the case of Elite: Dangerous. Banks, by contrast are quite a conventional bunch, so if you have an unconventional idea the crowdfunding audience may be more open minded.
If you don’t reach your finance goal then you won’t even get the money that’s already been pledged to you. It can also be very difficult to get the attention you need in the first place plus if you haven’t properly protected yourself it leaves you open to someone else pinching your idea.
Angels in suits
Angel investors provide financial backing for startups in exchange for an ownership stake in the businesses they invest in. They typically invest around £20,000-£250,000.
If things go well they will reap the financial rewards and if things don’t go well they won’t expect their initial investment back. But not everything is money: in addition to funds they’ll inject into your business they can also provide time and expertise into making your business a success, it’s likely not their first rodeo and since they’ll be on your team it would be foolish to waste them as advisers and mentors.
They can also provide access to a vast network of businesses and other relevant contacts who can help your business grow and develop. If you’re not looking to do it all alone and want help this can be a route to take
But it comes at a price as you will be selling equity now, which means you’re letting go of potential future earnings, and as your equity dilutes so does your control. You have to justify to yourself whether what they bring to the table outweighs the equity stake they take.
Venture capital (VC) is a form of financing that is provided by firms or funds to small emerging companies that are deemed to have high growth potential.
The typical investment sums we’re talking about here are over £2 million. That should give you an indication of what to expect.
A lot of money. If you really really need it then VC is pretty much the only road big enough. Like angel investors they can provide advice and access to a huge network of businesses and opportunities and listen if you raise a lot of money this way you’re going to get your name in the papers.
They’re going to want a seat on your board. Yes, you’re going to have a formal board. In addition you’ll have to give up a significant amount of equity and some control. As this is more impersonal than the sources of funding we’ve mentioned before they’re unlikely to care as much about your dreams as you do, they want a significant profit and that is their ultimate goal as professional investors. Anything that gets in the way of that (including, potentially, you) will be in for a world of hurt.
Also any agreements made will be very complicated and therefore expensive, you’re going to want a lot of legal advice before agreeing to anything as terms and structures can vary widely. Plus it can take up to 12-18 months to raise the money.
There are many grants out there, including for very small startups, if you’re not looking for huge sums, the Prince’s Trust grants are a great way to go. Not only do they offer financial help they offer mentoring too.
Here in Cambridge we have a great reputation for nurturing and growing technology-based companies, in fact the Cambridge Enterprise’s Seed Funds are an example of just that. They allow staff, students and researchers at the University to turn their ideas that have commercial potential into a living, breathing business through advice, access to the right networks and actual seed funding too. Many companies in our locale got their start this way, you should ideally look for similar opportunities like this in your region to see if they might be the way to go.
A word on convertible debt vs equity financing
Equity financing is not the only game in town. Increasingly many startups take the convertible debt route as financing rounds are usually quicker and you’ll be more likely to retain more shares in your company.
The last word
Whether you need money or you find that you don’t, we hope there are questions raised in this article that will help you on your path to building a successful business. Merely having money to throw around is not sufficient to build a success, and in fact it can breed a false sense of complacency.
What is more important is knowing where you want to go and having some idea of how to get there. The financing is a tool in achieving that goal, you should not look at it as end in itself that will solve all problems. Really what it comes down to is what will the money change?