Stages of funding – a brief guide for entrepreneurs

1. Seed finance (friends/family, angel investment, crowd funding) – Seed finance is useful when requiring external funding to boost your business. This tends to come via informal networks such as friends and family, angel investment and crowd funding.
2. Early stage investment (family offices, business angels, accelerators, crowd funding) – Early stage investment is typically sought for a fast-growing product. Family offices, business angels, accelerators or crowd funding would be relevant options to pursue at this stage of a business’ lifecycle.
3. Scale-up (first round venture capital, family office investment) – As the product or service gains traction and more investment is required, the need to scale-up becomes critical. At this stage, a first round of venture capital or family office investment is recommended.
4. Equity vs. debt, or mezzanine financing – At the next stage, the options become wider. Clear business objectives will dictate whether further equity investment, a mezzanine finance (debt and equity) product, or straight debt is required to support the business better. There are positives and negatives to equity versus debt financing; it comes down to a number of variables and these do tend to differ from business to business.

The reason for pursuing a debt-only investment is that raising debt is less complicated:

• it does not dilute the owners’ interest in the company
• the lender has no direct claim on the future profits of the business
• there is a fixed amount to re-pay which is relatively easy to budget for
• it is a tax-efficient investment as interest on loans is tax deductible.

But, there are negatives:

• debt has to be repaid – interest rates increase the risk of insolvency
• highly-leveraged companies find it difficult to grow as there is a high cost of servicing debt
• there is a restrictive pressure on cash flow.

Debt is usually secured on the assets of the company and/or by personal guarantees from the founders. The legal advice around taking on debt normally focuses on the covenants in the debt instruments, the effect of breaching these covenants and the nature of the security required by the lenders.

The advantages of pursuing further equity investment include:

• bringing in a strategic trade or financial partner that can help the business grow
• equity investment can be more creative and flexible, offering options for the business
• if the business fails, there is no money to pay back.

However, with equity investment, the loss of control can feel significant. The trade-off between financial gains versus the loss of control is often a big consideration for founders. That said, the reality is that investors will generally only interfere with management decisions if the business is not progressing in accordance with its plans.

The best piece of advice I can give is to have defined business objectives. A clear sense of the type of exit strategy you wish to pursue will, to some extent, dictate the best funding option to fulfil your objectives.