Traditional Funding Sources

Tool: Traditional Funding Sources

An overview on the role of grant funding, loans and equity.

TOOLS

Traditional Funding Sources

Family and Friends

Family and friends are often the first people approached when starting a business. They know you and may well have had input into the project or business’s concept and ideation phase.

When borrowing from this group it is important treat their money with the same importance as any other any avenue. Establish whether it’s a loan, or if they will take shares in the company. Are they partners, funders or owners? Make an agreement, set an interest rate and most importantly ensure a regular payment schedule Is established and followed.

Finally, consider in what form this funding will take place – will it be a loan or are you willing to give shares to these initial funders? Both considerations have an impact on your enterprise. A loan is repayable and you will also need to pay interest, so it can affect your cash flow. An equity investment is only possible if you have a company with shares. The early investors may have their equity holding diluted by future investment or they may want

Suited forUnsuitable for
Strong network of people willing to lendA small or unstable network of family/friends
Small investment requiredLarge investment required
Risk is relatively low, i.e. a clear productHigh Risk with inconsistent cashflow forecasts 
  

 

Small Business Loans

You’ve done your business planning, with a clear vision and purpose. You have articulated the business model and have run the numbers with a financial model. With this information you have drawn up your business case (See Ohu Finance, Business Planning).

Borrowing from a bank often initially comes in the form of an overdraft – a short-term funding mechanism to meet the start-up’s working capital needs, i.e. a bridge to cover any shortfall between expenses going out and income being received.

Banks are renowned for being low risk takers. They will require a lot of due diligence and they will assess you on the degree of risk you represent to them. If successful loans will enable you to get your business or project off the ground, and can provide a valuable source of bridging finance for times when cashflow ebbs and flows.

These loans often come at high interest rate. If you are starting out you are high risk, as you have fewer “knowns” as you do not have a credit rating. There is a significant power imbalance with lending from a bank.

Social banks are a growing market. They typically understand social enterprise and are more supportive than the high street banks. This market is in its infancy here in New Zealand, and progressing.

Suited forUnsuitable for
People with good creditPoor or no credit history
Track record of running a successful businessThose who need flexibility in repayment terms
A strong product offering, that meets a need and demandA risky or untested business model
  

 

Grant Funding

There are many grant funders in New Zealand, and this is often the go-to form of funding a social enterprises will default to. Funders traditionally support not-for-profits, but are increasingly supporting social enterprises and initiatives with a clear purpose, and service to the beneficiaries. This donation is a one-way flow of economic capital, with an intended social or environmental return.

Grant funders will set criteria that must be met to be eligible for this funding. Conditions are often set with regular reporting required on the outcomes achieved. Governance is closely scrutinised. This can be at odds with a company limited by shares, which gets the heart of the legal status of for purpose organisations (see Ohu Legal).

You’ll need to show a clear need, demand and wide reach of your clear vision and purpose. Grant funders will expect to see a sustainable business model, with a financial model to support this (See Ohu Finance, Business Planning).

Suited forUnsuitable for
Not-for-profits / For purpose organisationsIndividuals
A sustainable business modelHigh risk low social return
One year of trading historyStart-up funding can be a challenge
 Project specific funding requests Funding salaries or overheads

 

Early Investors

Early investors are individuals who are attracted to sound business models, and are accustomed to investing in high risk ventures, providing much needed funding to get the project off the ground. The investor will be assessing not only the business plan, but also the people involved. This high-risk investment opportunity will have no track record, so it’s important the passion, commitment and maturity of those involved shines through.

The right Investor will be a great asset giving you essential commercial insights with a broad view of the holistic ecosystem required to establish a successful venture. They will have connections and will help open doors for you.

Investors receive equity (shares) in your business and often have a five year investment approach. It’s important to be clear on their objectives from the outset. Do they want to be bought out when someone else invests? Be clear on your investors’ motivations and repayment / exit strategies.

Suited forUnsuitable for
A proven business planThose who have not done thorough business planning and forecasting
Those who need doors openedA weak business model
Those who recognise their gaps in knowledge and are willing to listen and learn.Those who are fixed firmly to their path to market.
 Willing to give a share of the business to others Low returns offered

 

Crowdfunding

Crowdfunding is now a popular and accessible form of funding. Platforms such as PledgeMe enable funding to be secured through donations, loans or equity campaigns.

Crowdfunding can be extremely successful if you have a strong offer that will appeal to the public, along with a strong marketing and communications campaign.

Crowdfunding has been successful in raising funds to enable collective ownership of community assets in New Zealand, such as the Mt Hutt Bike Park campaign. However, for every successful campaign, there are many that do not secure their fundraising targets.

Suited forUnsuitable for
Strong online social media presenceWeak online presence
Clear purpose resonating with a wide sector of the publicA very niche purpose, that is not widely understood by the public
People who are comfortable with a wide variety of funders, backers.Those who need advice and guidance from their investors
  

 

Equity Investment

If your company is limited by shares you can bring in equity investors. Shares are sold to the investor. The investor will look for a financial return on their investment – a share of future profits. Social impact investors also look for social and environmental returns in the company, and are often prepared to accept a lower financial return.

It is important to understand the motivation of your equity investors, along with their desired exit strategy.

EQUITY SALES
Once your business is a successful venture, you may need to raise additional capital. You can sell part of your business to release capital.

A seed round is often the fund you raise from friends and family or from investors. This is the money that gets you off the ground given in exchange for capital.

After a seed round, businesses can go through Series A, Series B, etc. to raise more cash in exchange for equity.

At each new round, you’ll be able to revalue your business, which means you’ll be building hype for an eventual sale to a private company or for a public offering.

Equity is the tried and tested method for companies to scale, but to do so part of the control and ownership is given up.

Suited forUnsuitable for
Company structureCharitable Trusts and Foundations
Those willing to give a share of the company to others.Minimal financial, social returns
Profits clearly defined in the financial model.Those short on time, it's important to get the right equity partner.