Types of Financing and Sources of Funding

1. Introduction

Different types of financing provide access to different resources and require different pay-back schemes. Finding the right source of financing and mobilizing start up capital is a critical skill that an entrepreneur needs for her/his company to grow and succeed.

While reading through this session take notes where you feel a financing model could be suitable for your business idea and circumstances. Add questionmarks, where you need to do more research or foresee difficulties. Print out and use the note-taking template provided under "Assignments & Activities" to guide your note taking.

1.1. Forms of internal financing

If the business already exists and needs mobilization of funds for further investments e.g. several ways of internal funding are possible. These include:

• injection of equity

• personal or internal contributions in kind

• use of generated profits, reserves, unclaimed earnings

• diminuition of assets, value adjustments, depreciation

• Accruals

2. Bootstrapping

Bootstrapping is the practice of funding a business with your own resources. This can include cash on hand, credit cards, loans from family and friends, and liquidated assets. Bootstrapping is the most common source of funding for startups.

Bootstrapping allows entrepreneurs to have complete control over their business operations. Entrepreneurs tend to be successful more quickly when they bootstrap as founders can focus on their core business instead of worrying about repaying loans. On the other hand, cash flow management can be a major issue in bootstrapped companies. . 

The major disadvantage of bootstrapping is that usually only limited resources are available and it therefore can be difficult to expand or grow the business. This also means that it can be difficult to find investors as the startup company is usually still small and unattractive for investments, when more resources are needed to achieve the next step. Furthermore, a bootstrapped company has no track record of repaying loans and producing return on investment, which is often a pre-requisite to acquire loans later on.

3. Equity Financing

Equity financing is when a startup business raises money from investors in exchange for a stake in the company. This type of financing allows investors to become shareholders and gives them a claim on the company’s profits.

3.1. Process of Equity Financing

Business Plan:

The first step is to develop a strong business plan that outlines the goals and objectives of the business, as well as the strategies and tactics that will be used to achieve them. This plan should be presented to potential investors to demonstrate the growth potential of the business.

Pitch Deck:

The next step is to create a pitch deck that outlines the business, its objectives, and its growth potential. This pitch deck should be used to present the business to potential investors.

Investor Network:

It is important for startup businesses to build an investor network in order to seek out potential investors. This can be done through networking events, social media, and online platforms such as AngelList.

Negotiation:

Once potential investors have been identified, it is important to negotiate the terms of the investment. This includes the amount of money being invested, the ownership stake in the business, and the rights and responsibilities of the investors.

Closing:

Once the negotiations have been completed, the final step is to close the deal and receive the necessary funds. This can involve signing contracts, transferring funds, and issuing ownership shares.

3.2. Debt Financing

Debt financing is when a startup business borrows money from lenders, such as banks, and must pay it back with interest. This type of financing allows the business to keep ownership of the company and use the borrowed funds to grow the business.

3.3. Types of loans

3.4. Process of Dept Financing

Assess Your Financing Needs:

Before applying for debt financing, it's important to consider what you need and how much you need. Consider the purpose of the loan, the best terms and payment structure, and the impact on your business.

Understand Your Financing Options:

Analyze the different types of debt financing available to determine which type will best meet your needs. For long term loans the lender will assess the value of your total investment and existing capital, for medium term loans the lender will assess the value of your buildings. For short term loans the lender will look at your machinery and its depreciation rates. As much as possible make use of government programs that offer interest rate reductions and incentives for entrepreneurs. Then, research potential lenders to determine which one can offer the best terms and discounts.

Prepare Your Application:

A lender will want to see a detailed business plan and financial projections. Gather the necessary documents such as personal and business financial statements, tax returns, and supporting documents. Lenders will also determine your credit score. Factors to be considered and you should be able to provide proof for, are: status of checking account not constantly overdraft; timely payment of invoices; use of discounts, ability to build up reserves, investment from own capital of at least 30%, insurance cover, adequate state of buildings and machinery.

Submit Your Application:

Once you have all of your documents together, submit your application to the lender. Be sure to provide all requested information and answer any questions they may have.

Negotiate Terms:

Once you receive a loan offer, evaluate it to make sure it meets your needs. You need to consider the following details: capital amount you will receive, nominal and effective interest rate, type of interest and repayment modalities (billing periods, commitment periods, payment dates), residual debt, other loan conditions (interest-free period, repayment calculation, fixed interest rate, late payment fines, insurance costs, service and brokerage fees, etc.). If these do not fit your needs and capabilities, negotiate with the lender to get the best possible terms.

Finalize the Loan:

Once the lender has approved your loan, sign the agreement and begin making payments as agreed.

3.5. What to prepare before applying for a small business loan

3.6. Grants

Grants are funds provided by the government or private organizations for specific projects or businesses in order to help small businesses start and grow. These grants are typically offered to businesses that meet specific criteria, such as being located in a certain area or industry.

3.7. Process of Government Grant Financing

Research Government Grants:

Research the various types of Government Grants that may be available to you and your startup business. Make sure to review the eligibility criteria for each grant to ensure that you meet all of the requirements.

Prepare a Business Plan:

Develop a comprehensive business plan that outlines the purpose of the business, the services to be provided, the target market, and the expected financial projections.

Apply for the Grants:

Once you have identified the appropriate grants, complete the application process and submit it to the appropriate agency. Make sure to include all required documents and be sure to follow-up with the agency to ensure that all paperwork is received.

Review and Negotiate Terms:

Once the Government Grants have been approved, review and negotiate the terms of the grant to ensure that the agreement meets all of your business needs.

Execute the Agreement:

Once all of the terms have been agreed upon, execute the agreement and begin using the Government Grants to start and grow your business.

3.8. Angel Investment

Angel investing is when a wealthy individual investor provides capital to a startup business. This type of financing is usually provided in exchange for a share of ownership in the business. This can be a great source of funding for startups because they usually provide more capital than family or friends and typically don’t require the same level of involvement as venture capital firms.

For this kind of financing to be accessible for an entrepreneur it is usually necessary to build and maintain strong networks and to invest into relationships and the public persona of the entrepreneur. Being visible through public engagements and social media activities can help finding an angel investor.

3.9. Process of Angel Investment Financing

Prepare:

Before approaching angel investors, you must have a well-researched business plan, financials, and a clear understanding of your target market.

Research:

Research the angel investor market to find the right investors for your business. Look for investors who are familiar with your industry and have an interest in your product or service.

Pitch:

Develop a professional pitch to make your case to the angel investor. Explain why your business is a good investment opportunity and why the investor should believe in you.

Negotiate:

Negotiate the terms of the investment with the angel investor. Consider the amount of money being invested, the percentage of ownership, and how the investor will be involved in the business.

Close the deal:

Once an agreement has been reached, complete the legal paperwork necessary to close the deal. This includes a term sheet, a shareholders agreement, and any other documents required by the investor or your business.

3.10. Crowd Funding

Crowdfunding is a form of fundraising that involves a large community of people who contribute to a project or business. This is usually done through an online platform and usually involves rewards or incentives for contributors. Other options are lending-based crowdfunding, equity-based crowdfunding or donation-based crowdfunding. Crowdfunding is a great way for startups to raise funds without having to go through traditional venture capital firms. Through crowdfunding, entrepreneurs can reach a larger group of investors, often at a lower cost than venture capital firms. Funds raised through crowdfunding can be used to finance product development, marketing, hiring, and other business needs.

3.11. Process of Crowd Funding

Crowdfunding typically involves a business or individual creating a campaign page on a crowdfunding website, such as Kickstarter, Indiegogo, GoFundMe, or Crowdfunder. The campaign page will describe the business and its goals, and provide an overview of the investment opportunity. Potential investors can then review the campaign and decide if they want to contribute. Contributions can be made in the form of money, goods, services, or equity. In exchange for the investment, businesses often offer rewards like discounts on products or services, or special access to content or events.

Research potential crowdfunding platforms:

Before launching a crowdfunding campaign, entrepreneurs should research the various crowdfunding platforms available to them. Each platform has different rules, fees and resources to consider, so it's important to find one that best suits the business’s needs.

Develop a marketing strategy:

To make the crowdfunding campaign successful, it’s important to have a well-thought-out marketing plan. This should include details about how the business will reach out to potential donors, advertise the campaign and keep supporters updated throughout the process.

Create a compelling pitch:

To attract potential backers, the business must create a compelling pitch. This should include information about the business’s mission, why it needs

Promote the campaign:

After the crowdfunding campaign is launched, it’s important to promote it to potential backers. This can be done through social media, email campaigns, press releases, etc.

Monitor the campaign:

During the campaign, it’s essential to monitor the progress to ensure that it’s on track to meet its funding goal. If the campaign isn’t meeting its goals, entrepreneurs can adjust

3.12. Venture Capital

Venture Capital is a type of funding provided by venture capital firms. This type of funding is usually for high-growth startups that have already achieved some level of success. Venture capital firms provide capital in exchange for equity and often require a high level of involvement in the business.