Financing your business

1.Equity Finance

Equity finance is a way of raising share capital from external investors in return for handing over a share of the business. This may take many forms including a share of future profits, but is most frequently associated with sharing the ownership of the business to some degree.

The two main providers of equity finance for private businesses are venture capitalists - also known as private equity firms - and business angels.

Equity finance can sometimes be more appropriate than other sources of finance, eg bank loans, but it can place different demands on you and your business.

The main advantages of equity finance are:

The funding is committed to your business and your intended projects. Investors only realise their investment if the business is doing well, eg through flotation or a sale to new investors.
Resources for your business. The right business angels and venture capitalists can bring valuable skills, contacts and experience to your business and can assist with strategy and key decision making.
In common with you, investors have a vested interest in the business' success, ie its growth, profitability and increase in value.
Investors are often prepared to provide follow-up funding as the business grows.
The principal disadvantages of equity finance are:
Raising equity finance is demanding, costly and time-consuming. Your business may suffer as you devote time to the deal. Potential investors will seek background information on you and your business - they will closely scrutinise past results and forecasts and will probe the management team. However, many businesses find this discipline useful regardless of any funding.
Depending on the investor, you will be subject to varying degrees of influence over the management of your business and making of major decisions.
You will have to invest management time to provide regular information for the investor to monitor.
Your share in the business will be diluted. However, your share may be of a much larger business because of the funding.
There can be legal and regulatory issues to comply with when raising finance, eg when promoting investments.

2.Floating on a stock market

Introduction

A stock market flotation involves selling a percentage of your business in the form of shares on one of the stock markets. Floating on the stock exchange can be time-consuming and costly so is not suitable for all businesses. You might consider it if you want to raise capital, or have private investors or an owner-manager that wants to cash in on their investment. It can also help you increase your business' profile and motivate your employees by issuing them with shares.

Subjects you should study about this option are:

Is your business suitable for listing?
Do you choose the right market?
How to Price your business listing?

Advantages and disadvantages of flotation
Even if your business is suited to flotation, it may not be the right choice for you. There are a number of key advantages and disadvantages to weigh up.

Advantages:
You get access to new capital to develop the business.
A float makes it easier for you and other investors - including venture capitalists - to realise their investment.
You can offer employees extra incentives by granting share options.
Being a publicly quoted company can provide customers and suppliers with added reassurance.
Your company may gain a higher public profile.
Having your own traded shares gives you greater potential for acquiring other businesses, because you can offer shares as well as cash.

Disadvantages:
Your business may become vulnerable to market fluctuations beyond your control.
The costs of flotation can be substantial and there are also on going costs such as higher professional fees.
You will have to consider shareholders' interests when running the company- which may differ from your own objectives.
You may have to give up some management control of the business and ultimately there's a risk the company could be taken over.
Public companies have to comply with a wide range of additional regulatory requirements and meet accepted standards of corporate governance.
Managers could be distracted from running the business by the flotation process, and by dealing with investors afterwards.
Employees may become demotivated. If shares are only offered to selected employees, those without shares may resent those who have them if the flotation is successful. In addition, shareholding employees could feel that there is little left to work for if they are sitting on valuable shares.

3.Financing from friends and family

There are clear benefits to approaching family or friends for a loan or investment rather than conventional sources. Generally, they will be flexible. On a practical level, they may offer loans without security or accept lower security than banks. They may also lend funds interest-free or at a low rate.

For both loans and investments, friends and family may allow you a longer period than formal lenders to repay the loan or start making returns on their investment. They may also seek a lower rate of initial return than commercial backers.

On a personal level, they already know your character and circumstances and so are less likely to need a detailed business plan.

However, transactions of this nature can be complex. Any misunderstandings about the terms of the arrangement can damage relationships. There is a risk that your investors may offer you more than they can afford to lose, or that they will demand their money back at a time which suits them but not your business. They may also want to get involved in running the business, which may not be appropriate.

It's a good idea to approach borrowing or investment from friends and family in the same way you would a formal lender:

Be crystal clear about your own expectations - make sure that you communicate how long you need the money for.
For loans, make clear what repayment level you can afford.
For investments, be clear about how much of the shares or profit the investor will receive - and when any returns will be paid.
Clarify whether an investor will have any financial liabilities for your business activity.
Don't rely on a verbal agreement - draw up a formal written agreement.
Think twice about approaching a friend or family member for a loan or investment if other sources of finance have turned you down. You may need to analyse the reasons for this and review your business proposition. Remember that if your business fails, lenders and investors may lose their money.
Pass on the reasons that other prospective sources of finance gave for turning you down.

4.Bank Loans

A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.
Loans are generally most suitable for paying for assets, like vehicles and computers, for start-up capital and in other instances where the amount of money you need is not going to change.
The terms and price of loans vary by provider and may be negotiable.

Advantages

You are guaranteed the money for a certain period - generally three to ten years - unless you breach the loan conditions.
Loans can be tied to the lifetime of the equipment or other asset you're borrowing the money to pay for.
At the beginning of the term of the loan you may be able to negotiate a repayment holiday, meaning that you only pay interest for a certain amount of time whilst repayments on the capital are frozen.
While you are obliged to pay interest on your loan, you do not have to give the lender a percentage of your profits or a share in your company.
Interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan.
There may be an arrangement fee that is only paid at the start of the loan but not throughout its life, though this may not necessarily be the case if it is an on-demand loan - an annual renewal fee may be payable.

Disadvantages

Most loans have strict terms and conditions.
They're not very flexible - you could be paying interest on funds you're not using.
You could have trouble making monthly repayments if your customers don't pay promptly, causing cash flow problems.
In some cases, loans are secured against the assets of the business or your personal possessions, including your home. The interest rates for secured loans may be lower than for unsecured ones, but your assets or home could be at risk if you can not make the repayments.
There may be a charge if you want to repay the loan before the end of the loan term particularly if the interest rate on the loan is fixed.
It is not a good idea to take out a loan for on going expenses. Expenses are best funded from the cash received from sales, possibly with an over draft as back up.