Sourcing new business finance and fundingPosted on: November 9, 2022
When starting a new business venture or forming a start-up, funding and financing are key to getting the business off the ground.
As most small businesses and start-ups aim to be lean, a whole microcosm of funding and financing opportunities have sprung up outside of the conventional route of business loans, which can be narrow in their eligibility criteria. These include competitions and awards such as The Mayor’s Entrepreneur Competition and The Great British Entrepreneur Awards, and accelerator programmes that offer mentorship and investment.
There are numerous other tried and tested sources of funding and financing for start-ups and SMEs (small and medium-sized enterprises), which don’t follow the usual business plan. But the first big question to answer is, are funding and financing the same thing?
What is the difference between funding and financing?
The words funding and financing are often used interchangeably, however there is a difference in their meanings. Financing is an amount of capital or a sum of money provided to an organisation on the understanding that it will be returned to the lenders along with any interest in repayment. Financing comes from bank loans primarily, but in the start-up world, it tends to come from investors such as venture capitalists, business angels, and shareholders.
Types of funding include grants, awards, or sponsorships. They are offered free of charge in that the money does not need to be repaid but the beneficiary will likely have some obligations to those who offer the funds. For example, they may need to mention the organisation that gave them the funding in any marketing or communications materials about the start-up business. Some other form of advertising may be requested by the providers of the funds.
Despite this differentiation, it’s common for start-ups to go through funding rounds which technically represent financing. Many of the most successful start-ups got where they are today thanks to their efforts in raising capital through rounds of external funding. These funding rounds provide angel investors the opportunity to put their cash into a growing company in exchange for equity, thereby becoming a shareholder or taking on partial ownership of the company. These funding rounds are referred to as Series A, Series B, and Series C and each follows a particular pattern helping potential investors to understand how their money will be used and the growth potential of the start-up. Early-stage funding is sometimes referred to as seed funding and happens before funding rounds. Start-ups can begin earning capital alongside funding, adding to their desirability as an investment option.
Crowdfunding is another form of funding that allows members of the public to help fund ideas they believe in. Crowdfunding platforms include Kickstarter and Indiegogo. There are also platforms that attract particular audiences such as Patreon for artists and musicians and Unbound for writers of books. Sites like Crowdcube open funding rounds to the public so that they too can become shareholders and investors in equity financing.
What are the five sources of financing?
When seeking finance, the five most common types are:
- Personal savings
Entrepreneurs are known for “bootstrapping”, which is pooling your own personal finances and finding ways to make your money go further when setting up a company. Using your own money rather than other sources of finance means that you don’t have to worry about business loans or interest rates but inevitably, it can only take you so far. Very few bootstrapped start-ups manage to do what GoPro did when it went public in 2014 with a $3 billion valuation from being totally self-financed and building working capital from its own business operations.
- Business loans
Business loans tend to come from banks and financial institutions and this form of financing is sometimes referred to as debt finance. Depending on the size of the business and the amount of money required, finance options could be in the form of a personal loan, a business loan, or a loan tailored to a particular kind of asset such as premises, vehicles, or equipment. Credit cards and overdrafts may also be options if interest rates are low and it’s guaranteed that the borrowed amount can be paid back in a certain period of time. Debt financing should only ever be a short-term solution and needs regular monitoring.
- Friends and family
Entrepreneurial ventures often have backing from friends and family. However, just because they’re friends and family, doesn’t mean it isn’t a business transaction. The funding they offer should be classed as debt financing (you have to pay it back), equity (you offer them shares), or a hybrid (for instance, royalties, which means that you pay them back an agreed percentage of your sales in perpetuity). The last option can be a gamble but shows faith that in time your investor will get their money back and hopefully some extra. As always, there is a risk that private investors may lose their money so formal paperwork should be completed to agree on what would happen in that scenario.
- Angel investors
Angel investors can be high net worth individuals and other successful business people and entrepreneurs who enjoy backing start-ups as part of their investment portfolio. Networking is a good way of becoming connected to investors and the start-up community is generally accommodating in linking up like-minded individuals. Melanie Perkins, co-founder of Canva, notoriously learnt how to kitesurf simply so she could attend investor Bill Tai’s MaiTai kitesurfing and entrepreneurship conference.
- Venture capital
Venture capitalists usually invest in companies that are beyond the start-up stage. A venture capitalist is essentially a professional investor. For example, founder of Social Chain, Stephen Bartlett, has invested in food replacement brand Huel, and is a non-executive director on the board. Bartlett joined in the wake of a year which saw sales over £100 million leading the company to consider an IPO (initial public offering). Venture capitalists tend to get more involved in the management of the business and offer their expertise in high-growth start-ups.
Become an expert in financing and funding options with an MBA Entrepreneurship
Understanding business funding and alternative finance options is integral to running a start-up beyond bootstrapping. The exciting and sociable networking culture of entrepreneurship and start-ups follows a different rhythm to regular business finance and is a world that an MBA Entrepreneurship can help you to unlock. Find out more about how you can study entirely online while you continue to work with the University of Wolverhampton’s specialist course.