Securing the right funding at the right time can be the difference between the success and failure of a new venture. What many entrepreneurs may not realise is that there is a great variation of types of funding available according to the size and timing of a new business’ financial needs, as well as the milestones it has achieved.
Learning as much as you can about entrepreneurial finance is crucial if you want to understand which type of investor is suitable for your company. Typically, entrepreneurial finance involves mainly private funding, as opposed to public funding, although it can be the case that very successful ventures might end up reaching the stock market, as a way of harvesting and giving liquidity to its investors.
Entrepreneurial finance begins with the challenge of acquiring the funding to test whether an idea can be turned into a business – a viable one, that has the potential to become financially sustainable. As the business grows and its financial situation changes, it is imperative to secure the right funding for growth and support, and to research which resources might be available. Here is a guide to financing each stage of development.
The seed stage
The seed stage begins as an idea for developing a new product or service hatches. In most cases, the venture will not yet have been established but its founders are enthusiastic about the idea and willing to devote time to producing a prototype and getting it to the market. The time this takes varies wildly between sectors. Where some will take a week or two to complete this stage, others, for example in the biotechnology field where the processes of testing and approval are lengthy, will take years.
The founders will require funding to finance this period of time to pay salaries, invest in tangible or intangible assets and other expenses. Usually, the first port of call will be the founders’ own savings, with perhaps some support from the ‘3Fs’ – or family, friends and fools. The support of the 3Fs is the typical first resort of entrepreneurs, but hardly qualifies the venture. In some cases, there are also research grants and public funding available if the business meets certain criteria. Others launch crowdfunding campaigns or approach an incubator or accelerator.
The start-up stage
By this time, the company is already selling its products or services but is not yet able to cover its own costs or ‘break even’. Having the first customers is a milestone for a start-up as it is proof that there is initial demand. However, many of the first patrons are often friends or people close to the entrepreneur, which may not give an accurate reflection of the company’s potential customer base.
At this stage of the company’s life cycle, when it is still consuming cash, the most suitable source of financing is often through business angels or, if a larger sum is needed, venture capital. Besides providing capital, both sources add their network and experience which are key in growing the venture early-on and preventing typical pitfalls.
The growth stage
The growth stage occurs when a company has broken even and is now becoming profitable. Although it may not be generating a huge amount of profit, crucially, it is no longer operating at a loss. Most of this money will be reinvested into the continued growth of the company, at the same time the founders secure larger investments and might occasionally turn to banks for additional funding as now, most likely, they will meet the credit control requirements of these more traditional financial institutions.
The maturity stage
This final stage is characterised by the growth of the company stabilising at normal rates. Normally, the directors will not make large investments and will maintain the current market share. Typically financing a more mature company can involve commercial bank loans, high yield bonds and private equity.
Some ventures opt to partner with established businesses to build their own credibility and facilitate access to a broader corporate network. This allows not only for funding and distribution support, but can often also offer other benefits to branding and PR. For bigger corporations, there are mutual advantages of these types of alliances. For example, by partnering with a young and innovative venture, directors are able to build understanding of new trends and develop a new supplier or buyer relation.
In my book, Entrepreneurial Finance: The art and science of growing ventures, I and other European experts discuss best practices in sourcing and obtaining funds as well as financial tools for growing and managing the challenges and opportunities of any start-up. What is clear is that in order to be successful, entrepreneurs and early-stage investors must be armed with the knowledge to make sound financial decisions at every stage of a business’ life.
Job Andreoli is leader of the Start-up Incubator at Nyenrode Business Universiteit in Amsterdam, senior lecturer in the University’s Centre of Finance and venture capital advisory board member.
