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WAYS OF FINANCING STARTUPS
By Vivek Risal
The Nepali economy is on a growth trajectory. Numerous small and medium enterprises have been established with the ultimate motive of profit in the recent days. Some are prospering while others have faltered. However, a harsh reality still exists: many startups have yet to shape their innovative ideas due to lack of financial resources. With the development of a great idea and likewise a great business plan, an entrepreneur feels almost entitled to receive the required funding. Reality, though, is that most entrepreneurs must prove the concept first before convincing anyone to inject that kind of money. Sometimes, it also comes down to simple cash flow i.e. the outflow of money in comparison to the inflow of money.
There are some factors to consider before exploring your funding options.
Are your requirements short term or long term? What is the forecasted payback period i.e. how quick will you be able to return the investment amount in quantitative terms?
Is the investment for operating expenses i.e. daily expenses or for capital expenditure i.e. purchasing fixed assets including real estate and machinery equipment?
Do you require all the investment upfront or in specified amounts in pre-defined time intervals?
Are you willing to assume all the risk or do you have a partner?
Gauging the above questions will prioritise your funding options which are as follows. In hindsight, there are generally two types of start up financing:
Equity Financing: It is a method in which you sell part ownership of your company in exchange for cash. The investors assume all the risk i.e. if the company fails to perform as per the expectations, the investors lose their investments. However, on the other hand, if the company does succeed, then the investors generate a greater return. In simple words, equity financing is far more expensive if your company is successful and less expensive if it isn’t.
Debt Financing: It is a method whereby you borrow the money from a bank or financial institution on agreed terms and pay it back on particular time frames at a set interest rate. An entrepreneur has to return the money irrespective of the fact that the venture succeeds or not.
In the above methods, the investors will typically play an involved role in the decision making process. This can be a mixed blessing. On one hand, the investor will offer you advice and help you grow your connections with the business world to foster your business. But on the other hand, if their plan is to exit the company in 2-3 years with a quick and substantial return on their investment, you may find yourself at odds as the organisation grows. It is imperative to not to give up too much control of your company in their hands.
Here are other innovative ways to finance your startup.
Personal Financing: The idea is simple and straight forward. If you have conceived a brilliant idea for a startup, it’s better to save money before you actually start the implementation process. Saving huge amounts of money for a new idea may be grueling but the process will reap rich dividends at the end.
Family and Friends: For most entrepreneurs, financing startups begins from home and also from a close circle of friends. The terms are less stringent regarding credit and also the expected return on investments. One caution, structure the deal with the same legal documentation or it may create problems down the road if the business plan flops. Prepare the business plan and formal documentation along legal terms and you will leave no scope for misunderstanding with you near and dear ones.
Peer-to-peer lending: Been around for many centuries, it is a method in which a group of people converges to lend money to each other. The practice is rampant in small communities or ethnic groups where support of such business efforts helps in building the community in general.
Angel Investors: This type of investor invests in the early stage in exchange for a 20 to 25 percent return. Angel investors have helped to start up many prominent companies including Google and Costco to realise their potential. Angel investors have strategic experience in such capacities and therefore provide tactical benefit to the company they are investing in.
Venture Capitalists: As the name suggests, venture capitalists are entities who lend money to help entrepreneurs build new startups that are considered to have both high growth and high risk potential. Fast growth companies with an exit strategy in place can generate profits that can be used to invest, network and grow their company frequently. Since venture capitalists focus on specific industries, they can generally offer invaluable advice to entrepreneurs on whether the product will be successful or not. However, on the flip side, they have a short leash when it comes to loyalty to the company and often look to recover their investment within a 3-5 year time window.
Crowdfunding: The power of the internet cannot be understated. Likewise, an entrepreneur can use the internet to identify likeminded people with small amount of investments to back the business idea. Websites such as Kickstarter and Indiegogo provide the boost to finance small businesses. It allows businesses to pool small investments from numerous investors rather than having to search for a single investor. However, an entrepreneur is advised to read the fine print of different crowdfunding sites before enrolling into the idea.
All of the above approaches require careful analysis on part of the entrepreneur since all have numerous variations. Generate a solid business plan and talk to a financial adviser for recommendations. Someone will eventually agree and utter the magical word YES!