It should come as no surprise that starting a business is hard work; it takes innovation, commitment and a splash of good luck. One of the main obstacles faced by would-be startup businesses is obtaining sufficient funding to get the initial idea off the ground. You may be in a position to self-fund initially, but as the business grows, so too does the need for further funding and investment. There are a number of funding options available, each with its own advantages and disadvantages, to be carefully considered. This article will set out some key considerations for startups, in relation to both equity and debt financing.
Equity Financing
Equity financing involves an investor supplying financial backing in exchange for equity in the business. This is achieved through granting shares to the investor, giving partial ownership in the company, in exchange for capital. There are various forms of equity financing, such as investment from a venture capital firm or angel investment, where individual investors offer expertise and mentoring alongside funding.
Some Key Advantages of Equity Finance –
- It may be easier to pitch your business idea to equity investors, compared with more traditional sources of funding, as they are less likely to be risk averse and are already on the hunt for investment opportunities.
- Fledgling startups often lack the collateral to secure business loans, or the cash flow to take on large repayments. Unlike other forms of funding, equity financing does not usually require interest payments or repayment should the business fail, as the investor has taken equity in the business, rather than provided a loan.
- Angel investors and venture capitalists often have expert insights and guidance to offer that could be invaluable to a new business. They may also provide credibility, leading to further growth opportunities.
Some Key Considerations for Startups looking at Equity Finance –
- You will lose an element of control of your business when you give the investor equity in your company. The investor may also want a say in the day to day running of the company.
- Legal clarity is essential – you will need to ensure you get legal advice throughout the process and consider putting formal investment agreements in place that clearly set out the terms of the investment and the rights the investor may have as a result.
Debt Financing
Your business could take out a loan, which will then be paid back, with interest. An agreement will be reached with a financial institution meaning that you’ll get the money you need upfront and agree to a fixed time period and interest rate at which you’ll pay back the money.
Some Key Advantages of Debt Finance –
- There are numerous forms of debt financing available – for example bank loans and government-backed start up loans.
- Debt financing allows you to raise capital quickly, without giving away any ownership in the company.
Some Key Considerations for Startups Raising Debt –
- There is no guarantee that the business will be profitable within the necessary timeframe for repayment. Interest rates could also be high and you could face costly late payment fees or legal action if you are unable to make repayments on time.
- Having outstanding debt may make the business less attractive to other forms of investment.
Key Takeaways
Whether you are at the initial stages of starting your business or are looking to grow your startup company, it may be time to consider funding options. This can be a complex and intimidating process, but seeking expert legal advice at an early stage can help you assess the best options available for your business. It is also essential that any investment or funding arrangements are documented carefully to protect your business.
The Transactional Business Services Team at Berry Smith can provide specialist legal advice on funding and investment, as well as general commercial and business legal advice.
Please contact us if you would like more information about the issue raised in this article or any other aspect of Business law at 029 2034 5511.