During the heydays of the dot com era, many rock star entrepreneurs became rich simply from investment funds. However, as fast as they reach the pinnacle set up by the notoriety from the investment they acquired, the drop by themselves was as spectacular as their rise. Read on and decide whether you too should look for funding to start a business.
- Pets.com – the entity was set up as a supplier of pet food and pet supplies. Julie Waiwright founded the company and managed to get Amazon.com and a few other investors to invest $ 10.5 Million into it in 1999. Pets.com made a revenue of $ 619,000 during its first fiscal year despite spending in excess of $ 11 million for advertising. Their IPO was impressive. The stock debut hit a peak of $14 before going all the way south to $1.
- Webvan.com – the online grocery store boasted state of the art logistic system and managed to scale their service to eight cities in less than two years. Their modus operandi lies in scaling as fast as possible. At the same time, Webvan raised more than $ 800 million from powerful VCs like Goldman Sachs, Sequoia Capital, and Yahoo, making them the poster boy of capital funding during the peak of the dot com craze. The IPO itself made $ 350 million. However, the house of cards tumbled just as fast. They quickly made a loss of $ 800 million and became insolvent all within a few months of fairy tale run.
There is no free lunch in business. I could continue for more than 3000 words on cases of business failures that raked in millions and billions of dollars. To be fair, there are also many companies that thrive due to lifeline extension from investors.
Basically, there are two main concepts of business funding. They are either the selling of shares or in taking up loans. You will also come across some funding vehicles that come in the form creative mixture of the two concepts. Let us look at the list:
- Private Equity
This kind of funding is usually done at the initial stage. You sell your shares to investors, groups or individuals who believe in your business model. Your company appeals to them either because they are your parents or these people believe that the ROI will be worth the trouble by investing in your startup.
- Most investors will stick with your goals at a longer time frame.
- Capitals from investors can fund rapid growth.
- Equity investors who receive common shares do not have legal claim to both tangible and non-tangible assets.
- External investors who control a large chunk of your startup equity command stronger voting rights thus able to exert a large influence on decision making.
- You as the founder will have your share diluted. Your return diminishes upon the sale of your company due to your diluted shares in the company.
- Financial institutions are fair weather friends. Companies resort to debt financing when the company is stable and when you are sure that you won’t default in repayment.
- These debt holders hold your tangible or non-tangible assets as collateral / ransom when you borrow from them.
- Terms are rigid as compared to funds from private equity investors.
- You need to give up your company’s shares if you default in servicing the debt.
- These debtors may disrupt your long term decision if your strategy threatens your payment to them.
This is an example of a company finding a private equity firm that is willing to grow the business conservatively.
2. Debt Funding
A form of straight forward borrowing from financial institutions or specialized investment banks. Bear in mind, debtors are concern about getting back their return of debt principal. As a result, they are less interested to lend you money during the earlier round of financing especially when your company’s cash flow is weak. Debt providers need collateral in the form of your tangible or non-tangible assets, unlike private equity.
3. Equity Warrants
Equity warrant gives the holder the right to purchase a specified number of shares at a specific price. The company that issue the warrants may or may not specify a term for exercising the warrants. Equity warrants have all the characteristic of shares except for the voting rights that shareholders have. After the warrants exercise date, the warrants convert to ordinary shares.
4. Convertible Debt
A hybrid of both private equity and debt. The debtor is allowed to convert his debt principal into equity at any time during the note term. Convertible debt favors the debtor but not good to the entrepreneur. If the company does well, the debtor has the option to become a shareholder of the business without the initial risk undertaken by earlier investors. On the other hand, if the company goes south and liquidate, the holder of convertible debt gets the protection of a debtor.
Factoring is a short to intermediate term loan that accepts an account payable as collateral. Not many people know about this business financing tool but it is an attractive option for entrepreneurs. For factoring financing to work, you will need at least a 6 to 12-month clean payment history with a client with a strong credit rating.
6. Licensing Sharing
An investor in a licensing sharing agreement is granted the right to use one or more IP assets of the company. However, before entering into such an agreement, the entrepreneur must be aware of who the right is given to. It is a disaster if you accidentally give the right to a competitor who is waiting for the right time to slit your jugular.
7. Revenue Sharing
The concept of a revenue-sharing contract is similar to licensing sharing contract. Instead of having a share in the use of the IP properties, the company shares a portion of its current or future revenue stream with the investor.
A grant is a dream of any business entrepreneur. This is practically free money without any payback obligation. The only offside is your time to prepare a business plan and many periodic reporting on your business progress and the use of the fund.
As an entrepreneur, the possibilities for funding is enormous. Be prudent in selecting the right vehicle for your business financing because, at the end of the day, you have to pay back what you owed. I would talk more about an easier way of running a business. A Bootstrap Business.