You have finally finished the beta test of your disruptive new app, you have an impressive business model and a “one-in-a-million type product” that you know will fly. Ready to launch, you find yourself at a roadblock – you need money!
In our previous article we touched on the essence of equity financing and the importance of keeping investors happy. Today we have a look at debt financing, the pros and cons and why so many start-ups choose this viable option.
Let’s take a closer look.
What is debt financing?
It’s the type of financing that most of us are already familiar with. When you take out a home loan, obtain a loan to buy a car, or purchase something using a credit card, you are using a form of debt financing.
Basically, debt financing means an individual or organisation is lending you money that you must pay back with interest at a future date.
Pros and cons
Pro: Probably the biggest pro of debt financing is that you retain full control and ownership of the business. You don’t need to give away shares. Once the loan is paid off, you are free and clear of any obligation and free to run the business on your own terms.
- Liquidity restrictions
Con: When you take on debt financing, you will immediately owe regular payments, the same as a monthly mortgage payment or a vehicle instalment. The repayment terms may differ depending on the type of loan. This will take away from the available capital you have to run your company, which is crucial for early stage businesses.
Pro: Debt financing is available in a wide variety of forms, including short and long-term loans, inventory and equipment loans, guaranteed loans and even personal loans.
- Personal risk
Con: If you fail to pay back the loan, or make late payments, it can hurt your business and/or personal credit rating, which will make it more difficult to get financing in the future. If you have put up security for the loan, you may lose your security.
How does it compare to equity financing?
Another way to make sure that debt financing is the route you should follow, is to compare it with equity financing and see which one would suit your current position best.
Here are three things to consider:
If you don’t have a problem sharing ownership of your business, reporting to investors and managing investor relationships at an early stage, then equity financing could be the better way to go. Investors can offer you a lot of business experience and advice.
- Financial projections
If there are still doubts around the size of the market or how the consumer might take up your product, the risk element may be too large to opt for debt financing. Bringing on an investor who is willing to take that risk in exchange for shares in the company, will therefore be the wiser move. However, if financial projections are sound and you are confident that you will be turning a profit sooner rather than later, debt financing is a very viable option.
Related: New Ways SMEs Can Find Funding
- Advice or guidance vs need for operating capital only
It is as simple as deciding whether you just need money or whether you want the possible guidance, connections and industry experience the investor puts on the table.
In closing, no matter how you choose to fund your start-up, make sure that you have taken your product for a test drive. You don’t want to risk investing your own money and even worse, someone else’s money, on something that has no chance of gaining any traction with customers. Many successful entrepreneurs decide to adopt a lean approach by starting out with a minimum viable product (MVP), bootstrapping and then committing to basic market testing prior to seeking out any investment.
Once you’ve raised your funding, be it by debt or equity financing, make sure to take a moment, reflect, raise the champagne glasses and then… go out, work hard and give it all you’ve got!
6 Signs Your Business Idea Is Ready For Funding
Potential investors need to be convinced that your idea is viable before they offer you cash.
Are you fundable?
For aspiring entrepreneurs, sometimes the hardest thing isn’t coming up with innovative ideas, it’s knowing which of those ideas are worthy of financing. Watch out for these six signs to know when you’re ready to seek the financing you need to turn that big idea into a reality.
It’s thrilling to hit on a great idea for a business and envision yourself at the helm of a lucrative new endeavour. Less thrilling, though, is the prospect of securing the necessary financing to get from idea to real-life CEO.
The truth is, finding the money to run a start-up requires a lot of preliminary planning, regardless of whether you’re going to pursue outside funding or choose to bootstrap your first few months. Most start-ups looking elsewhere to kickstart their cash flow will have the best luck securing funding through their personal networks. You can look to an angel investor, a loan from friends or family or even crowdfunding.
Regardless of which financing route you take, your potential investors need to see evidence that your idea is practically viable before they throw their hats into the ring. These six signs indicate that your business idea is ready for financing — and just might provide the evidence your potential investors need to be convinced.
1. Your idea serves a true, identified need
Your business isn’t going to work, let alone make money, if it doesn’t have a customer base. And, what’s more, if they don’t need whatever you’re creating. This may seem obvious, but many aspiring entrepreneurs get so caught up in the excitement of their big ideas that they fail to plan for how that idea will function in the real world.
Before you jump into the financing process, you need to identify your target customer segment and understand their behaviour. You should design your product or idea to deliver a solution to a problem that those customers are facing.
While we’re on the subject of product: You need to know what that product or service is, how it works and how you’re going to sell it. You’ve identified potential problems that may arise with your product, or barriers you may come up against in the market, and you have a game plan for troubleshooting those snags.
Then, you need to perform due diligence in your industry. Determine exactly how you’ll situate your business within the existing market, understand how your product can shift and grow along with it, and differentiate yourself from competitors. And make sure your customers can afford your product or service.
2. You’ve tested out your product, and it works
Pay attention, especially to that second part. Very few lenders will feel comfortable investing their money into just an idea, no matter how enticing it might be.
Your business idea is ready for financing when you have material evidence to bring to your investors’ table — whether it’s a prototype of a physical product or a beta version of a programme or website. Be ready to present any data, reviews or research you’ve acquired after testing out that product, too. And if that data isn’t favourable, you might need to go back to the drawing board.
3. You have a business model and plan
If your business model is the what, your business plan is the why.
Your business model indicates your business’s revenue streams, and your business plan lays out how you’re going to acquire those revenue streams. How is your business’s leadership team organised, and how is your business legally structured? What kind of equipment, staffing and marketing plan do you need to operate your business and generate income?
Both your business model and plan provide proof, both to yourself and to any potential lenders, that your business idea is practical and operable.
4. And you have a financial plan, too
Whether you’re pitching an investor or seeking a small business loan through a lender, your financier will want to see how you plan on using that potential money. You can’t just ask for money as an entrepreneur. You need to know exactly how much money you need, why you need it and how you’ll use it.
That’s especially true if you seek financing through an angel investor. Since these individuals lay their own money on the line to fund your start-up, they need to be sure your venture is sustainable, eventually lucrative and that you’ll use their resources wisely.
Poor financial planning, or no financial planning, certainly can’t convince potential lenders of your business acumen. So, draw up a financial road map that projects exactly how you’ll get from point A — where you and your resources are now — to point B, where you hope to be within the next one to five years.
Be sure to include a detailed plan of your projected business expenses, or how much capital it’ll take to get your business idea off the ground, and your operating expenses, or how much it’ll cost to keep that business going.
5. You’ve recruited a qualified team to execute on your vision
Even if you created your business idea on your own, in reality, every entrepreneur needs help kicking off, then operating, their start-ups.
Before you seek financing, recruit a capable and qualified management team to run your business, or have a hiring plan in place to do so ASAP. And if you don’t have enough relevant experience in the field yourself, you’ll need to gather a team of partners or mentors to fill the gaps in your knowledge. It’s crucial to acknowledge you can’t do and know everything yourself.
6. You can prove you spend money responsibly
Although you might not have a way to prove you’re responsible with business financing yet, you want to make sure you’re positioning yourself to create a track record so investors and lenders can trust you.
Even if you start with seed money from close friends, or crowdfunding from Kickstarter for your business idea, you may need to seek additional financing through a larger venture round or a small business lender.
That’s where the proof becomes necessary. For instance, if you’re working with a lender, they’ll want to know that your business is capable of repaying your debt before extending you a loan. And any other investor will want to know that any money they give you will be spent responsibly, especially if they’re expecting returns.
One of the best ways you can do that is to cultivate a healthy financial profile, and keep a high business credit score. Open a business credit card, and follow best practices to improve your credit score, like paying all your bills in full and on time and regularly checking your credit reports for errors.
Then, the proof will be in the numbers. Alongside a squeaky-clean track record and a strong personal credit score, a great financial history will position you for the financing your growing SME needs.
Pitching To Lenders – How To Get It Right, First Time
Gary Palmer, CEO of Paragon Lending Solutions, discusses what entrepreneurs should be aware of when preparing to pitch.
Earlier this year, US research firm, CB Insights surveyed over 100 start-ups to better understand reasons for early failures. The most obvious – no clear market need, not having the right team, and running out of cash – featured prominently. However, poor marketing was also a top contender as a reason for failure. This doesn’t only relate to difficulty in raising awareness of the product or service, but speaks to an inability to position the company in the eyes of potential lenders and investors.
Avoid fantasy financials
While various institutions have different mandates and place emphasis on different types of growth, all of them need to see evidence of your potential. When creating your financial projections make sure you can back up the assumptions behind the numbers. Developing financial projections is an art. Companies should certainly avoid over-inflating future earnings, but they should also be wary of being too conservative.
Reasonable, defendable assumptions that you are confident can be achieved, is the goal. These are also important as they will set the parameters for measurement going forward and need to be realistic if you are going to live up to them.
Avoid information overload
Pitching to lenders is a process and the leadership team should have a specific, shorter pitch for the first meeting. The top level detail should be included with an emphasis on ensuring the lender understands what it is you do, which market problem you are solving, the future potential of your company and how you aim to achieve success.
I have been in pitches where the presentation looks fantastic, but runs into 30 or more slides. Once you have piqued their genuine interest, you can delve into the finer detail. Death by PowerPoint never closes deals.
Know your audience
Each lender will be looking for specifics according to their mandate. A bank may be interested only in the numbers and the underlying security of the deal. Certain asset managers, meanwhile, may be looking for local job creation, while others will pay close attention to your ESG (Environmental, Social and Governance) report if sustainability is high on their agenda. You should understand the motivators for each lender and remember that this is not a one-size-fits all exercise.
Tell a story
Humans are hardwired to respond to storytelling. From our days sitting around fires in caves we have used stories as mechanisms to teach and retain information. Entrepreneurs should weave their company’s past and future into an interesting story to grab attention. Using different mediums, like a company video, can make a significant difference. Three minutes of screen time with compelling visuals will help get the message across as well as give a flavour of the business that a written document can never achieve.
Keep it clean
Once lenders are interested they will be doing more than kicking tyres. They will be doing a thorough search under the bonnet and your financials should hold no hidden surprises. Up to date management accounts and audited financials are imperative While we all know how difficult it is to run a start-up, having personal loans run through the business accounts will not do.
You don’t have to go it alone
Pitching to lenders is a skill, and not everyone is a born salesperson. You only have a few minutes to catch an investor’s eye. It makes sense to work with a partner who knows the lending environment and all its players. Insight and experience is the secret sauce when it comes to securing lending. Find an independent lending specialist at the beginning of the fund raising exercise who can help you craft your pitch and, most importantly, help you negotiate the best possible deal.
What Elon Musk Can Teach You About Getting Funding for Your Start-up
Elon Musk has made some very smart start-up moves — but he’s also made mistakes. We can learn from both his successes and his failures.
If there’s one person who embodies the idea of ‘entrepreneur,’ it’s Elon Musk.
He has been responsible for the development of a large number of high-profile technology companies, which include Zip2, X.com (later merged with Confinity to form PayPal), SpaceX, SolarCity, Tesla and many others.
What’s remarkable about Musk is the way he funded his start-ups, especially SpaceX and Tesla. While he has relied on external funding, he nonetheless had to face many setbacks that almost brought his companies to an early end.
As an entrepreneur, Musk can teach you a great deal about how to get funding for your start-up. Here are the three most important learnings you can get from his experience.
Convince investors with your commitment
The mid-nineties remind us of an era of unprecedented economic growth and a feeling of prosperity toward the country’s future, something that stands in sharp contrast with our present.
The context in which Musk raised venture capital to fund his first start-up represents another drastic difference compared to the present. In 1995, there was slightly over $8 billion available in the global VC market, a small piece of the current $155 billion that was raised last year.
In that same year, Musk launched his first start-up, Global Link Information Network (which eventually got rebranded as Zip2), a company that provided directions across the San Francisco Bay Area. According to Ashlee Vance, author of Musk’s biography Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future, his beginnings were humble. Musk, his brother Kimbal, and a small sales team initially pitched the new company door to door.
For the first few months of operations, Musk couldn’t rely on the large pool of available VC funding, or the experience or connections he has today. The only strategic advantages that set him apart were his passion and commitment.
Due to their lack of funding, Musk and his brother had to live on the little money they had, sleeping on futons at their office and using the showers of the YMCA that was located a few blocks away. To convince their investors, Musk and his brother relied on a creative trick: They built an elaborate casement around the computer that worked as Zip2’s server and put it on a large, wheeled base that made it look like “a mini-supercomputer.”
This trick, together with the frugality in which the Musk brothers lived, helped them become profitable soon. Their early profitability helped them raise money from a small group of angel investors, which would eventually lead to a $3 million investment from Mohr Davidow Ventures, and finally, a $307 million acquisition by Compaq.
Due to their lack of funding, Elon Musk and his brother had to live on the little money they had, sleeping on futons at their office and using the showers of the YMCA that was located a few blocks away.
The passion and commitment Musk showed goes beyond the funny tricks and futon nights. Musk didn’t waste the $22 million he got from Zip2’s sale on expensive cars and luxurious mansions. He reinvested — and risked — everything to build his second company, X.com, which would lead to PayPal. The sale of PayPal to eBay netted Musk $180 million, which he then used to fund SpaceX, Tesla and SolarCity.
If there’s one thing the beginnings of Musk’s journey show, it’s that he’s the kind of entrepreneur who works for the long run. When he’s involved with a company, he goes all in. He invests everything he has, putting all his energies into building them.
It’s hard for a venture capitalist to reject an entrepreneur with such a hard-working spirit. You don’t need to shower in a YMCA to show the sacrifice you are willing to make for your company (unless you are truly broke, like the Musk brothers were back then). Rather, you need to show you live and breathe your company, and that you are willing to do anything to make your vision happen.
Don’t give up control too soon
A hard fact about the tech world is that few start-ups get to grow to billions of dollars in valuation without any VC funding. This leads to dilution of equity and loss of control of the company.
Most start-up founders need to live with that situation, and many get to keep control, thanks to the high trust VCs have for the founder and executive team. The case of Mark Zuckerberg, who owned 28.4% of Facebook‘s shares at the time of its IPO, is a good example of this.
Yet, in some other cases, founders lose excessive control too soon, leaving them powerless against the more professional and experienced VCs. This is something Musk learnt early in his career.
Musk’s career in Zip2 had an abrupt and sad ending: The first funding round deeply diluted his equity, which left him powerless after his board of directors decided to bring on a new CEO and make Musk the CTO. While Musk was still on the executive team, he couldn’t tolerate the lack of control and the way the new CEO, Rich Sorkin, ran the company.
Musk met a similar fate with his second start-up, X.com. After Musk merged X.com with one of its competitors, Confinity, he ended up being the CEO of the new company, PayPal. Unfortunately, he was ousted from the CEO position after a rather trivial fight over the technology platform PayPal used.
The lack of control he had over his two companies had a significant impact on his future ventures. Nowadays, Musk prefers to start by investing as much money as he can, making sure he always has the upper hand in his company’s decisions. His obsession over equity control explains why, while he was going through Tesla’s funding, he maintained his ownership percentage.
The lessons are clear: Before you focus on raising as much money as you can, remember to keep some equity of your own (particularly if you are an inexperienced CEO). If you care about your company’s vision, you need to make sure you can carry it out. It’s hard to achieve such a feat if you hold little voting control over your company. Becoming profitable as early as possible can help you overcome this issue, especially if you get creative.
Elon Musk didn’t waste the $22 million he got from Zip2’s sale on expensive cars and luxurious mansions. He reinvested — and risked — everything to build his second company, X.com, which would lead to PayPal.
Lack of resources isn’t something that sits well with Musk. He has been willing to do whatever he has to do to have his companies prosper. What’s remarkable about Musk is that whenever he’s got all the odds against him, he turns the situation around by being resourceful.
To help you understand what I mean by this, let’s take a look at what he did with his latest venture, The Boring Company. Despite the fact he funded the company with his own money (as usual), the mission to build underground tunnels seems like an expensive task, making the company strapped for cash.
To raise money for the company, Musk decided to sell expensive flamethrowers at $500 each, which helped him raise over $10 million in just a few days. Instead of spending a long time raising money with the help of VCs (which would have diluted his ownership), he took one of his most significant advantages — his personal brand — and used it to make money for his start-up.
Being resourceful is an attitude shared by almost all successful tech entrepreneurs, as in the case of the founders of Airbnb. According to Leigh Gallagher, author of the book The Airbnb Story, when the founders were on the verge of bankruptcy, they decided to sell cereal prior to 2008’s Presidential election. Thanks to their PR-fueled campaign, not only were they able to extend the life of the company (which today is worth $31 billion), they were able to get accepted into Y Combinator, the famous tech accelerator, which would lead to their first funding round and the growth of the company. As Paul Graham, the co-founder of Y Combinator said, “If you can convince people to pay $40 for a $4 box of cereal, you can probably convince people to sleep in other people’s airbeds.”
The lesson you can learn from Musk is that if you lack funding (or any other thing that is essential to the existence of your company), it’s your job to do whatever it takes to get it. Life isn’t fair for risk-averse entrepreneurs, yet Musk has been able to make his companies work by getting creative, thinking on his feet and showing commitment right from the start.
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