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Investment options – The pros and cons

Written by James Lyons on Monday, 02 March 2020. Posted in Funding, Finance

As your business grows, it is almost inevitable that at some stage you will need outside investment to help it fulfil its potential.

Investment options – The pros and cons

As your business grows, it is almost inevitable that at some stage you will need outside investment to help it fulfil its potential.  Funding can come in many different forms but what is right for your business?

Bank or third-party loan

The most traditional form of finance is a loan, whether from a bank or a third-party lender. However, a loan can have a number of drawbacks.  Interest will need to be paid which can make the loan expensive whilst a bank or other institution would also seek security for the loan; this may require a charge being created over the company’s assets and/or personal guarantees being provided by the individual directors or founders.  So, whilst getting the money in is welcome, the debt may put a strain on a business in the early days.  Loans also require a good credit rating, so may not necessarily be an option for some businesses. The plus side is that you won’t be giving up any of the equity of your business. As a result, if you can fund the repayments in the short-term, you may end up better off in the longer run.

Family and friends

Start-up funding from family and friends can often be a useful source of investment in the early days, whether as a loan - typically on preferential terms - or as equity. Whilst this option can be considered hassle free, as you won’t have to deal with bankers, investors or lengthy documentation, it can come with other baggage. The main downfall of getting financial help from family or friends is that it could clearly affect your relationship with them if the business ultimately fails or does not provide the expected financial return. They say don’t mix business and pleasure for a reason.

Equity funding – Individual “Angel” investors and venture capital

For an immediate cash injection with no ongoing costs you could do worse than go for the equity funding option from private investors or venture capital funds.  Many businesses choose this form of funding in their early days as they are not serviced by repayments or interest charges, you are just giving up a percentage of your business. As a result, equity funding offers a much more efficient option in the short term, but in the longer term it could well cost you more as you are giving away a chunk of your business. Quantifying the cost of this is difficult as it all depends on how successful this is in the long run. It is a dichotomous situation in that the more successful your business is, the more you will ultimately give away - although with the benefit of the funding the more you also hope to make for yourself.

We have all seen Dragons’ Den where entrepreneurs walk away with a cash investment in return for a slice of equity after impressing one of the hosts.  The “angel” investor can also provide business support and create new opportunities for the business not just from their cash investment but also from their influence and own network.  Various tax reliefs, such as EIS, SEIS and VCT funding are also made available for individual investors thereby encouraging support for funding small businesses.

However, these professional investors and venture capital funds will also expect to have a degree of influence or control over how the business is run. This could mean a place on the board and certain veto rights on key strategic decisions. Whilst this may seem a huge intrusion for some, having been used to running their own business and making their own decisions, others will welcome the inclusion of a professional investor’s business acumen to the company as a worthwhile cost to pay.  But beware: successful investments arise where both investor and founder are aligned with the business strategy; a venture capital fund may typically seek an exit within a three to five year period, which may not necessarily align with the founders’ longer term strategy.

Crowdfunding

Various crowdfunding websites exist allowing businesses to procure investment from a collective pool of retail investors, whether as a loan or equity.  With this form of funding you are not necessarily going to be subject to the same level of scrutiny and controls as other forms of funding and will continue to retain a certain amount of independence as to how your business is run.  However, it can be quite unwieldy from an administration perspective, needing to manage a wide shareholder base as the business continues to scale up and in particular when you are looking to get investment the next time you need a cash injection. That said, there are examples out there, notably with companies like Brewdog, where your crowd of investors can very quickly become your ready-made customer base and brand ambassadors. As a result, if you have the right product and marketing campaign then this form of investment could allow you to benefit from the crowd not just through their financial investment but also as future customers.

What should you do?

That all depends on the nature of your business. If you are established, successful and can afford a loan then the traditional route may be the more suitable option as you are not giving up equity. But if your business is in its early days then you may have to give up some of your business to private equity or an angel investor. The main thing is that you shouldn’t be discouraged - there are plenty of options out there and perseverance will seek out the right option for you.

About the Author

James Lyons

James Lyons

James is a corporate lawyer with national law firm Devonshires. He has extensive experience advising on all aspects of corporate transactions and joint ventures, having acted for UK and international clients including start-ups, SMEs and listed PLCs together with clients in the public sector. His expertise also includes managing large corporate transactions and joint ventures in the real estate sector for PLCs, Registered Providers, private investors and international funds. James trained at magic circle law firm Allen & Overy before moving on to Olswang. More recently, James has been a corporate partner at both Trowers & Hamlins and in the London office of Ashfords prior to joining Devonshires in September 2016.

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