Funding and investment can be the lifeblood of a start up, or indeed any business that is looking to expand. The risks associated with funding change and evolve depending on what the investment landscape looks like at any given point.
Following the global financial crisis, squeezing any sort of loan or investment out of traditional sources has become much more difficult, which may have led desperate entrepreneurs to take too many risks with their funding. One could, however, argue that because of increased due diligence on the behalf of lenders, funding risks are simply harder to fall into than they used to be.
People are often caught out taking risks with their personal finances but businesses have very different funding options open to them. This has changed in recent years and extends outside of the traditional banking model. Each funding option comes with its own type of risk. Here they are:
1. Bank loans
Banks can offer straight-forward debt financing for small businesses where a lump sum is handed out and then paid back with interest over time. The risks here are obvious: you can’t pay back what you owe, traditional debt collection procedures start to be followed, and you can find yourself losing your company and being blacklisted from starting future endeavours. Bank loans are currently a lot less popular than they used to be for the simple fact that banks are more reluctant to hand out funding. Following the 2013 Budget, this might begin to reverse for plans to set up a business lending fund to encourage more growth in the small business sector.
2. Venture capital funding
Taking the form of an equity loan, venture capital funding is normally only available to companies that expect to grow to ten times their size in the next three or four years. Apparently you?ll normally know if you qualify for this sort of investment and it should be obvious whether you reasonably expect to grow as quickly as these investors expect you to.
The risks attached with this form of funding come in the form of you losing chunks of your company, having less of a say in what you’re doing and generally being funnelled into creating a revenue generating monster at the expense of other parts of the business. Although this might work very well in communications, technology and media based companies, many industries will simply not be an appropriate fit for venture capital funding. The nature of the risk companies take with this also very much depends on who they end up securing backing from.
3. Angel investors
Sometimes described as mini venture capitalists, angel investors will rarely sink any less than a million into a company. The same risks that apply to venture capital funding apply here as well with the same issues relating to equity financing and a risk that is particularly dependent on the individual investors.
4. Private investors
Private investment sits somewhere between angel investment and a traditional bank loan and is sometimes sought out if the latter is refused. Private investors will carry out similar due diligence to that of a bank but will often request equity of your company in return for the loan.
5. Family and friends
This is a common and much recommended form of financing, but also carries some significant risks. These are less legally troubling but can have significant impact on your life all the same. It is recommended that you approach borrowing money from friends and family as you would a private investor, draw up the same form of contracts and treat it as professionally as possible. With running a small business, you will at some point need the support of those close to you and if you’re losing their money, you could clearly go a long way towards alienating them.
Many will proclaim that this is the most risk free form of lending available to businesses, but I would argue that it can have the most impact on your life outside of your entrepreneurial world.
This won’t be appropriate for all industries, but a new form of funding has started to become popular that calls on the general public to offer up small amounts of money to contribute to your funding goal.
Working especially well for media, entertainment and technology companies, crowdfunding can get smaller projects off the ground if you market your campaign properly, and carries very little risk. In fact, pretty much all of the risk is carried by the crowd that is funding you. Beyond possibly alienating a market by failing to deliver on your promises, there is very little that can happen to you if you take the money and subsequently fail to make any form of return.
7. General risks
Aggressively chasing funding can put you in a highly disadvantageous situation. You could find yourself tied to unfavourable terms by your investors. Taking out multiple streams of funding could pull you in conflicting directions and you could simply need to pay back large sums of money that eat in to your business’s profitability. Once the dust settles, you might even find that you’ve had to surrender too much of your company to secure the funds.
The intentions of your investors can also be a problem. There is the risk that your investors could be in it for a short term cash gain while you might be in for setting up a long term sustainable business. If this is the case, you and your investors are likely to clash, as business practises that support one of those goals are not really compatible with those that support the other.
Today’s businesses are not necessarily taking too many funding risks. But inadequate or badly timed financing is often cited as the second biggest reason for businesses failing, right behind poor management and planning and this is not a new thing brought about by our current financial climate.
You can’t avoid risk when running a small business, and if you need funding you must court further risk. So long as you are informed of what you are getting into and you research what is most appropriate for you, you mitigate this and give yourself a much better chance for survival.
David Hing works for small business insurance broker YOUR Insurance.