External sources of financing your business
Barry Copeland
08 / March / 20
Visitors: 888
There are many reasons companies seek capital. These can be startups, companies that have already occupied their market niche, or simply business projects. These can be online companies, traditional enterprises or technology companies. They are united by one goal — the conquest of the market in which they operate. This is achieved through certain projects that are limited in time and require financial injections.
For example, the development and launch of a product is an independent project, which may require capital, which the business simply does not have. Therefore, the company has a choice: to wait until it has enough funds to develop and launch the product, or to attract financing in order to get down to business as soon as possible. Some projects may wait to be launched, while other projects simply need to be started as soon as possible before the opportunity disappears.
Entrepreneurs sometimes make the mistake of creating a company that requires regular financial injections to survive. The key to business success in the long run is profitability and self-sufficiency, which means that as soon as the project for which capital is raised is implemented, the business will be able to continue to flourish on its own.
There are many strategies to attract external sources of financing, and each of them is unique to your business and stages of its development. Some strategies involve sharing enough information with potential investors. To be able to use these sources of capital, you need to share your vision of why you think your business will be successful, which means that you will be required to provide detailed information about your idea or business strategy.
We tend to overestimate the risks we face when sharing our business ideas, but you should nonetheless appreciate how comfortable it is for you to share important information about your business. If you are not ready to do this, then you need to build your strategy using sources of capital that do not require a reliable analysis of your ideas and actions.
Another factor influencing the choice of financing strategy is your type of business. If you want to start an online business, your capital requirements will be significantly lower than a regular business. When it comes to opening a manufacturing enterprise, your capital requirements will be much higher. If you open a consulting firm that is largely related to your core competency, you may not need funding at all.
There are many external sources of financing, and depending on what kind of entrepreneur you are, what business you are in, and what stage of development your company is in, you already choose the most suitable source for you.
Ways to attract external sources of financing
To successfully raise funds, it is important to understand who the investors are and what is important to them in your business plan. Although each investor is a separate person, many of them have common features that every entrepreneur should take into account:
Most investors were or are successful entrepreneurs, or at least they have held high positions in large organizations;
they also started with some kind of projects, search for capital, and they know exactly what your path is;
they also had business projects that failed and were tired of business plans that were too optimistic or entrepreneurs who were too confident and not ready to hear their feedback;
they invest in your business to make money, so that they will look not only at your income forecast, but also at the distribution of funds received;
Each investor has their own unique goals, so do not forget to take into account their point of view when presenting them with your project or idea.
We have sorted out the common features of investors. Now we need to answer a very interesting question: is it better to attract the full amount of investment in our business or in small tranches? Many entrepreneurs believe that the whole amount is better.
Imagine that you have prepared your business plan and know that you need $ 100,000 to start your business. At first glance, the most logical option would be to find the whole amount at once. And if you get these funds now, then you can focus on your business, and not on the constant search for additional financing. As practice shows, investors are interested in investing step by step, and this, in fact, is better for you, in terms of cost savings.
Let's take a common example when a company attracts capital through the sale of its shares. The cost of shares depends on the effectiveness of the company’s business. In other words, the higher the price of your shares, the less shares the company must pay for the amount of capital that it wants to attract.
If your company is successful, what you should definitely plan, then its value will increase over time. Consequently, the value of your shares will also increase. Technically, the more you wait before attracting external sources of financing through equity, the more profitable the transaction will be for you. The only problem is that sometimes you may need all the money at once. Therefore, instead of asking for the entire amount that you need, perhaps you should ask for only part of it. This will allow you to give out fewer shares and give you time to raise the value of your company and sell a few more shares.
Thus, instead of collecting a million dollars with 40% of your shares, you could collect half a million dollars with 20%, and then another half million with only 10%. Or maybe even for five percent. In the end, you will receive the same million dollars for 25% of your shares instead of 40.
Then why do investors also prefer to invest gradually? First, and, as we will see later, some investors specialize in certain levels of company maturity. Other investors are investing in promising startups that are just starting their first steps. But there is a third type of investors who focus on those startups that have proven that they have a profitable and sustainable business model.
For example, some part of investors can invest when your business is just at the stage of product development and release and does not bring any profit yet. Another part may join you at the sales stage, when your business is engaged in attracting a certain number of customers and making a profit. And some investors will want to invest in developing a marketing strategy for the general recognition of your brand.
In the search for capital, there is a general sequence of events that you should consider. After you have estimated what capital you need, you should do everything possible to attract it as little as possible from investments, while observing the following sequence:
Self-financing or bootstrapping. Any own funds that you do not have to return.
Getting multiple loans. The good thing about loans is that you know from the start how much it will cost you and how long it will last. No one is going to interfere in your day-to-day management of the company. The disadvantage, of course, is the repayment of loans from the first months.
Once you have exhausted all the above, you can search for investors in the form of venture capital funds or business angels. In the amount of their investments, they will partially own your company, where you, in turn, will have to report to them and share profits.
The logic behind the sequence of events is that as an entrepreneur, you are interested in maintaining control and ownership of your company as much as possible. Like any entrepreneur in their right mind, when you have an amazing project and you know that you will succeed, you would prefer to share the profit with as few people as possible, which means you will want to explore all the possible ways to get the necessary capital, without sharing ownership of the company, if possible.
Determination of seed funding
The central element of the whole process of attracting external sources of financing is the business plan, which is presented to investors for consideration. We will not dwell on the preparation of a business plan, but simply list the key elements.
A business plan is a complete overview of your business, both internally and externally. The internal part of the business includes you and your team, your product and services, your strengths and weaknesses, your strategy and your ambitions. The external part of the business is the market in which you are located, what your customers need, what problems they have and what you are going to solve. In addition, who are your competitors that they offer to solve these problems.
An important part of your business plan is an executive resume. This is a two-page document that is correctly written and summarizes all the key elements of your business and, more importantly, arouses the investor’s desire to invest in your project. Investors usually review executive resumes first before requesting a complete business plan.
When raising capital, you will constantly be faced with the valuation of your company. This is a critical element of raising capital, especially when you raise funds through company shares.
A company valuation is needed so that you know how many shares you need to sell in order to get the amount you need. In this case, you agree with the investor or with the appraisal company about the value of your business, divide the cost by 100 to find out the price of one percent of the shares. After that, you already know how much percent of the shares you must give to the investor for the amount of money you need.
Use of own funds
Using your own funds is the most appropriate if you need for start-up capital is between 20-50 thousand dollars. Some self-financing options may seem counterintuitive to anyone opening their own company, while others are easily accessible but carry a high level of risk. We must say right away that investing part or all of your savings in your company is the right choice. But consider everything in order.
Using your own money, such as savings, to finance your company or project is the first and most important, simple and clear, the most logical way to start raising capital. You should like this option, because at first it will be a great way for you to get a much higher return on investment than any other investment. This is a great way to start a business without sharing control and ownership of the company.
You yourself can decide whether it is wise to invest all your savings in your project. You know that you risk losing it all. In this case, your liability is limited to the capital that you have invested in your company. For investors, this is a way to show that you believe in yourself and your company. If you start looking for investors without first investing your own funds, then they will rightly wonder why they should invest in your project, even if you do not want to do this.
An alternative to the more risky use of equity is to maximize the use of your credit cards to pay for everything you need to get your company started. Such loans have high interest rates, and the repayment time can be extended for many months, if things go wrong as planned or your customers require a serious deferral of payment for your goods or services. In addition to this, you will spend your time looking for funds to repay the loan, and not looking for new customers or directions to optimize your business. You can also expose your credit rating to risk with all the ensuing consequences.
Another way to attract part of the material resources to your business is a commercial mortgage. The essence of such a loan is obtaining commercial premises in the form of warehouses, offices, etc. Most often, such loans are issued against 20-25% security.
