Many entrepreneurs starting a business will face a funding challenge and some will need investment. But where does the entrepreneur go? What are the options? Which is the right path? Is crowdfunding a fad? Are venture capitalists old hat? Do the banks still lend to small businesses?
Here is our quick guide to the routes available to entrepreneurs starting a business with growth potential. Which path is suitable for you will largely depend on your requirements and how you personally balance the advantages and disadvantages of each option.
Small business bank loan
A small business bank loan provides limited investment, which is repaid with interest over an agreed period of time.
- Interest rates are low at the moment
- Most banks are on the high street so easily accessible
- Banks don’t want an equity stake in the business, their primary concern is getting the loan, with interest, repaid
- The amount you can borrow is unlikely to be more than £25K
- Lengthy application process and a long list of loan pre-requisites
- May require collateral
- The whole loan request is not always approved/granted
- No hands-on support with running the business
Small Business Grant
This is a sum of money given for a specific project (e.g. InnovateUK which supports the development of innovative technologies and products). Grants vary from as little as £2K to hundreds of thousands of pounds.
- The prestige of receiving a grant and consequential marketing opportunity
- Once granted the money doesn’t need to be paid back provided you meet the criteria
- You won’t lose any control of your business
- Highly sought after and consequently difficult to attain
- The entrepreneur may be expected to match some of the funds they are awarded
- The process can be time-consuming
- Unlikely to be hands-on support or guidance with running the business
Seed Enterprise Investment Scheme
SEIS is an HMRC scheme that offers startups, and business entrepreneurs access to early-stage funding in the startup phase when they are just beginning to trade. The aim is for the entrepreneur is to sell some shares in the business to the investor in return for a cash investment.
SEIS also encourages investors by giving them tax-efficient benefits in return for their investment in early-stage and startup businesses in the UK.
- No banks to deal with and no high-interest payments.
- New skills from a mentor/investor.
- The investor has no preferential terms and faces the same financial risks as other shareholders.
- There is an additional scheme, EIS, which is intended for when the business is more established and looking to raise money to help them to grow (with a higher cap of £5,000,000)
- Limited to £150,000 of total investment.
- The founder will hold less shares giving a lower return on their idea.
- There are strict qualification criteria so not all tech companies are eligible.
- There is government red tape so it’s prudent to obtain ‘advanced assurance’ from HMRC before approaching investors.
Crowdfunding is raising money through the collective efforts of a large pool of individuals – primarily online via social media and crowdfunding platforms, e.g. Seedrs, Crowdcube and Kickstarter. Crowdfunding has moved on significantly in the last few years and is becoming an increasingly popular source of business funding.
There are three different types of funding:
- Donation funding – usually used by charities and disaster relief funds.
- Rewards-based funding – individuals contributing to your business in exchange for a ‘reward’, typically in the form of the product or service your company offers.
- Equity funding – allows contributors to become part-owners of your company by trading capital for equity shares.
For the purposes of this blog, we will consider rewards and equity only.
- Raising <£50K
- Offer custom product/service incentive
- Anyone can back you
- No equity dilution
- Raising £50K to £10M
- Offer equity stake
- Available to accredited investors only
- Must issue stock in the company
- Access to hundreds, maybe thousands, of potential investors
- A good way to test public reaction to a product or idea, if people are keen to invest it’s an indication that your product will work
- Can be fast
- Can be an alternative source of funding if the more traditional routes have failed
- Access to a vast array of business support services, help and mentoring
- It may potentially be faster but may not be easier – significant resources, time and money, will be required to build up interest before the project launches
- Failed funding projects risk damage to your business
- It’s all or nothing – if you don’t make your target, money already pledged must be returned to the investors
- An equity investor will expect to realise a profit by selling their shares to another investor or through a buyout by the entrepreneur
- Loss of privacy and potentially confidentiality
Business angels (popularised by the BBC2 television programme Dragon’s Den) are wealthy individuals, typically successful business people, who invest their personal capital in return for an equity stake.
The UK Business Angels Association estimates there are 18,000 business angels who privately invest around £850m each year (more than two and a half times the amount of venture capital invested in a typical year).
Typical investments between £10K and £500K.
- The business angel can make quick investment decisions
- Access to the angel’s sector knowledge and contacts
- Access to mentoring and management skills
- No need for collateral
- No repayments or interest, although depends on the mode of investment
- Takes a while to find a suitable business angel
- They will want a significant equity stake
- Their involvement is less structured than a VC
- They will be looking to realise a return and may push hard for an exit
- Future investment decisions may be affected by the size of the business angel’s pockets and can be restrictive
Venture Capital Funding
A form of private equity investment, where a business with high growth potential obtains significant, long-term funding in exchange for a share of its equity.
VC investments are typically over £250K and can be up to tens of millions of pounds.
- Access to significant levels of investment
- Committed and long-term investment
- An invaluable source of information, resources and contacts
- Active support and mentoring
- Raising venture capital is demanding, costly and time-consuming
- A VC will want a significant equity stake
- They usually want a member of their team on the company board – though intended to ensure the success of the business, this can be problematic
- They exercise significant influence sometimes above that of their shareholding
- VC funders will want a defined exit strategy to realise their profits – generally the sale of the business within 3-5 years
- They are professional investors who know how to maximise their position
Research your options
Take your time and research all your options and be sure on the right source of investment for your business.
Here is some additional information:
- 10 venture capital funds UK tech start-ups should be aware of provides a valuable insight into which types of companies VCs are looking to invest in at the moment and how they operate.
- The UK Business Angels Association’s Introduction to Angel Investing
- What you need to know about Investment Crowd Funding 20 questions to ask yourself if you think Crowd Funding is the right form of investment for your business
Please Note: This blog should not be considered as advice from Isosceles. Always seek professional advice specific to your circumstances.