What to Consider When Choosing a Funding Option for Your Startup

The Entrepreneur’s Launch-Out Guide

As an entrepreneur, you have probably done your background checks, developed a concept for your startup, and may also have gained a reasonable customer base to attest to the solutions your startup provides.

You are probably also raking in some revenue already. One thing is certain, at one point or the other, you would want to expand your startup or take some other financial steps and seeking external funding would become inevitable.

Threading a path of success as an entrepreneur is largely dependent on the business idea and strategy you have got up your sleeves, and the kind of funding model you deem comfortable.

However, majority of entrepreneurs lack the legal and financial know-how required when choosing which funding option suits them more.

The overarching consideration is how to choose the best funding option.

Financing Methods and Best Approach

Startup funding is basically in two folds: Alternatives and Traditional financing. Traditional financing includes Venture Capitals (VCs), Equity, Incubators and convertible debt funding.

Alternative financing on the other hand include venture debt, loans, and revenue-based funding. Narrowing down on any of these financing methods will be determined by the nature of your startup and the stage it has attained.

The best approach to finding a suitable funding model is drafting a road map and providing genuine answers to the questions below:

Your decisions should also be framed around the nature, valuation and culture of your company, equity and of course, how much control over key decisions you wish to retain.

Why has funding become necessary at the moment?
What are the funds needed for?
How much capital cost is required?
How do you intend to secure startup capital?

Key Factors to Consider

Before choosing a funding option for your startup, there are some key factors that will aid your decision. Some of which are available funding options, startup goals, control retention, legal advice etc.

These factors will guide you as to how, where, why, when and what; in terms of external funding models.

Here is an overview of some of the important factors you should consider before adopting that financing method.

Set Goals and Milestones

One of the first point of attraction for investors is Vision. How far do you intend to drive your startup?

Articulating your vision, creating excitement about your company and exhibiting positive energy; these are the things that excites and interests a potential investor. You must also consider the following:

What are the non-monetary and monetary goals for your startup over a period of time?

Achieving these set goals will require how much capital?
What do you intend to do with the capital?
Can a particular funding option aid your startup goals?
What milestones can you achieve in the short run that will be a game changer and what can an investor expect in the long run?

These are the key points that you must be able to put together provided you are open to investors. Nobody wants to invest in a business without a future and of course no business owner wants to run into debts.

Equity Financing and Control

Equity financing has proven to be a sound and attractive option for startups because all the cash is splashed by investors. In most cases, startup owners do not have to bother about repayment plans; investors take all the risk with the hope of profitable returns.

Having decided to externally sought funds for your business, you must be aware that you also cease to retain the larger share of profits and sole control over that business even if you still remain the majority shareholder.

Some people would rather lord it over a small firm than be part of a bigger company that can make much impact.

It is, however, important to meticulously negotiate and document equity investments to ensure that the interests of all and sundry are adequately protected.

Rushing into an equity investment deal just because you are desperately in need of quick infusion of capital could put you at a huge disadvantage.

Ability to service loans/ venture debts

Provided you are already raking in a stable cash and from all indications, you can pay up debts, a business loan or venture debt may just be what you need rather than equity investments.

With business loans, you still retain absolute control over your startup. Lenders in this case will most times request exorbitant interest rates on repayments and will also demand that debts are fully paid within a set time.

This type of financing may require guarantor(s) who are also responsible for loan repayments. Venture debts are often the quickest means to financing a startup because its negotiation proceeding is often straightforward compared to other means.

A business owner must weigh up the benefits of ownership retention plus high rates on loan repayments. This ties up with several business and personal risks should the startup fail to rake in funds sufficient to repays loans when making financing decisions.

If you are able to service loans within stipulated periods, ceteris paribus, this funding option may just be good enough for you.

Unique Selling Proposition

The best way to describe this is – What value do you provide to your customers? What customer related problems does your business solve? Is business value enough to attract investors or secure a loan?

Before going out in search of funding for your business, it is important that there exists a satisfactory customer feedback and interaction base.

Your customers must have validated your value either via testimonials or other means. Ensure that you document these testimonials because at a stage, certain investors or lenders might want to put a reference call through to your key customers before splashing the cash.

Understanding Market Share, Growth and Size of Target Market

Majority of investors abide by a particular investment policy; some only invest in the tech market while other invest in vertical markets.

The ability to clearly articulate your market growth, forecast share, and market size is key to securing a credible financial model. Having a holistic idea about market factors will be of great help when seeking out the best funding method from a pool of options.

Convertible Debt Financing

This is very much the same as venture debt because periodic paybacks apply, and debts must be settled in full within a set period (52-76 weeks).

Also, ownership rights do not depreciate immediately. Supposing debts are not repaid after set date, the lender becomes a shareholder in the company by converting debt to equity under certain predefined terms.

This financing model is very predictable in the sense that businesses are aware of loan repayment or renewal timeline.

Convertible debt can however, become a threat to the owner if he/she has no interest in sharing business ownership rights. This takes a long time to obtain because conversion, repayment and equity structure (lender) will have to be negotiated

Flexible Financing

This is often referred to as convertible equity. In other words, Startups don’t spend the cash, investors do, with no guarantee of recouping capital. This financing model is quite different from equity financing.

In this case, investors do not get to immediately exercise any sort of control over the business neither do they get a share of the profits immediately – all of this only happens at a later date and it is dependent on the occurrence of predetermined events.

This is often the case for publicly traded companies; investors can convert their shares into equity, therefore, acquiring all the privileges and rights as it were with the initial owner(s) of such companies.

Securing flexible financing can be overly slow because of its terms and conditions associated with conversion. On the other hand, discussions about repayment structures or interest rates do not take place, hence, can be quicker than convertible debt.

Last Lines

A successful startup requires careful and solid planning right from very start either with traditional financing or alternatives. However, hastened financial decisions without adequate understanding of the associated terms and conditions could be detrimental to the success of a business.

It is therefore important to seek legal advice before choosing any funding model for your startup as this will help juxtapose the risks and benefits involved and to choose the best option for your business venture.