Often, a new company has limited resources available. For this reason, it is necessary to resort to an external financial aid. In this chapter, we want to show you the best chances to fund your business just before or after the foundation of your company.
Equity is the most traditional financing option with regard to the establishment of companies. If a company decide to finance themselves with equity, often those who give money are investors (in the role of shareholders or partners). In turn, the investor will receive shares of the company and become a co-owner. The effects on the capital and the company are as follows:
- Decision right of the investor but also liability
- Possible payment of dividends for the financier of equity
- The more equity, the more solid is the basis of the capital: the possible losses do not unbalance the company very quickly
The borrowed capital is often provided by banks. However, it is also possible that individuals of a company are willing to grant a loan. These lenders have a credit for the amount of funds allocated to the start-up. The effects on the capital, and on the company that receives the loan are as follows:
No decision right of the capital lender but interest payment for the capital provided
The more borrowed capital is available, the thinner the base of the capital: possible losses exert greater negative influence on the equity ratio
Business Angels and Venture Capitalists
Business Angels and Venture Capitalists are people / institutions that provide capital for companies in the early stages of their activity. Therefore, it comes to investors with obligations and rights. However, Business Angels / Venture Capitalists do not only make capital available, but they also offer valiant know-how and constant advice to founders. The effects on the capital, and on the company that obtains the loan are as follows:
- Business Angels provide the know-how, but their volume of funding is limited
- The Venture Capitalists usually can contribute to more cycles of funding, however, they offer less know-how to the company and are mainly motivated by economic interests
Participation in competitions
Participation in competitions for entrepreneurs is another way to raise capital. Often, the winners of these contests receive awards in the form of relatively substantial initial capital by the sponsors. Generally, these awards are not subject to special conditions. The effects on the capital, and on the company that raises the capital are as follows:
- Usually the capital must not be returned
- In most contests, prizes are not tied to a stake / shares in a company and do not imply the payment of interest on capital
- Partial publication of the business idea
- The know-how provided by the organizers is limited
Here you can find more information about the different forms of financing listed above.
A common way to finance your venture is with equity. In this case, an investor (a shareholder or proprietor) provides your start-up with assets, receiving a share of your company in return. The investor hereby becomes a co-proprietor in your start-up and gains certain rights to information and codetermination. However, he is not entitled to any company secrets.
Equity investments provide an investor with two kinds of advantages. He not only benefits from the distribution of dividends, but also from a rise in equity value. Whereas dividends lead to a direct cash flow, an increase in equity leads to a higher value of the share in the company. If the investor decides to sell his shares he will then make a profit.
The amount of an investment determines the liability of the investor as a “liability ceiling”. In case of bankruptcy, the investors can only access their investments after all other creditors have been disbursed. This can lead to a total loss of an investor’s equity.
For start-ups, the most common source for investments are the 3 F’s: Friends, Family and Fools. In most cases, friends and family are the first investors of young start-ups. They have the advantage of knowing the capability of the young entrepreneur and assessing the risks of their investment.
Another way to finance your start-up is with liabilities. These are mostly provided by banks, but also by private individuals. These outside creditors have a claim against your company amounting to the sum of their loan, but do not have the same rights as an equity investor. However, a loan agreement can include certain securities that provide the creditor with leverage in case of payment difficulties. The agreement can also include duties to provide information to the creditor.
The outside creditor is entitled to an interest on his loan. Furthermore, the redemption can occur over the term of the loan or at the end.
Start-ups tend to have trouble getting loans from banks. This is mainly because the future development of the start-up is unsure and banks assume illiquidity, but also because barely any assets can be posted as collateral.
Business Angels and Venture Capitalists
Business Angels and Venture Capitalists help start-ups in their early stages to raise equity. As mentioned before, their equity comes in exchange for a share in the company. But in most cases it is more than financial assistance that they offer, as Business Angels and Venture Capitalists offer valuable know-how and consultation.
In most cases, Business Angels are successful entrepreneurs that have sold their company and are looking to invest in new start-ups. They therefore tend to take an active role in the development and assistance of the start-ups they invest in.
Venture Capitalists are very similar to Business Angels. The main difference is that VCs are firms or fund companies, rather that individuals. They offer intensive coaching in the following phases after their investment. Venture Capitalists look for their investments in a certain pattern, focusing mainly on tech and web-based start-ups.
Prize money at startups Competitions
Another way of raising capital is by attending start-up competitions. In most competitions you can win seed capital without having to give away a share of your company. This prize money can amount to a very large sum at big competitions. Your start-up is mostly assessed by a panel of experts and compared with the competitors. Hereby your success depends on a thorough presentation and a good business idea.