Business Funding Options: Crowdfunding

Hello and welcome to FYI.

In the last four posts, we covered business funding options and delved into the worlds of bootstrapping, debt financing, and equity financing. This week brings the concluding installment of our five-part series. It’s about Crowdfunding as an innovative source that focuses on the customer.

So what is crowdfunding?

Simply put, crowdfunding is the process of raising money through small contributions from a large number of people during the startup process. In the past decade, it has been successful in funding sectors as diverse as music, politics, IT, scientific research, and journalism. And while platforms like Kickstarter and Indiegogo are leading the online revolution, innovations in real estate finance have promoted a rapid shift in the industry offline.

How does it work?

The entrepreneur sells his idea or project to the public via a neutral platform (usually a website) to prospective customers (the crowd) and receives donations towards meeting a funding target. Depending on the cause or project, the entrepreneur will also set contributory terms such as reward, debt, or equity and offer commensurate returns accordingly. It is this particular capability of being set up as debt or equity financing or even providing an avenue to escape the drawbacks of both that has made crowdfunding a game changer. Additional flexibility allows the entrepreneur to offer to return individual contributions if the funding target is not met and the project doesn’t go forward.

And how do you decide on a crowdfunding campaign?

The best campaigns offer donors the right incentives to attract investments. It is therefore your target donors and their interests that will determine how you design yours.

For innovations, reward-based campaigns will generally offer free products, discounts, or first-purchase options to contributors. Credit-based campaigns are used to finance projects that will generate enough money to pay back debt and remain sustainable, while equity-based campaigns are used to finance projects that will generate enough profits to be shared with donors. An additional charity-based campaign may be used to finance philanthropic causes where the donors do not even except anything personal in return. Such projects may include potable water supply in rural areas, disaster relief, or local drug research for epidemics.

Fundamentally, a decision on crowdfunding should be based on an understanding that it is fuelled by innovations in marketing and competition. Donors will only contribute to causes or projects that offer innovation or rewards, solve problems, or promise social identification. These qualities allow each donor to view himself as a customer, individually drive awareness, and help mobilize the funds needed for the project to succeed. As such, crowdfunding campaigns must be set up to trigger the right donor emotions. This usually means a touching storyline delivered with the right words and captivating visuals.

And here’s the good news for African entrepreneurs. An African crowdfunding solution called Funda Solva was launched this year. And according to its website, it has successfully raised close to twice the initial funding target for Solar Nigeria; a project that intends to source solar cells and wiring materials from Nigeria and build solar panels.

So what are you waiting for? With several options through bootstrapping, debt or equity finance and now crowdfunding, the last thing that should hold back your business is funding.

Editor’s Note: A version of this article first appeared in The Business Hub on 20th August 2014.

Business Funding Options: Equity Financing

Hello and welcome to FYI.

This week, we bring you the fourth installment of a five-part series on business finance. It’s about equity financing as an external source of funding and continues from previous posts on bootstrapping and debt finance.

So what is equity financing?

Simply put, equity is a stake in a business; a claim to both profits and losses. Equity financing therefore translates to raising money by trading a slice of the business in exchange for financial investment. These investors agree to a permanent partnership that can only be liquidated by the sale of their stake to the original owners or other new investors. As such, equity funds are not repayable and do not attract interest payments.

What are the sources of equity financing?

During the start-up process, family and friends in some instances would want a share of ownership as opposed to granting a loan. The fund received under these terms is classified as equity finance because they inevitably become shareholders in the business. It is important to note though, that once again the absence of drawn agreements and shareholding structure has led to lots of problems with equity investments from family, especially during future refinancing stages of the business.

The second source of equity financing is Angel Investors. These are usually business-savvy, wealthy individuals who bring networking opportunities in addition to interest-free leverage in exchange for a part of the business. They are the most sought-after type of investors and can come in during the early stages of the business life cycle. They not only share risk but also increase the probability of success through their personal experiences and relationships. They are however difficult to find and demand considerably higher stakes than family and friends.

A third source of equity financing is Venture Capitalists. These are the big-money investors that fund high-growth businesses in a bid to sell off or go public. They also bring networking opportunities, interest-free leverage, and a wealth of industry knowledge in exchange for a part of the business. They base their decisions on the competitiveness of the management team and sometimes insist on installing theirs. They also usually require an exit strategy that is achievable in not more than 5 years.

Another source of equity finance is Government Grants. These are highly competitive funds that are sponsored by Federal or State Governments in exchange for small stakes in the business. They usually carry single obligor limits and are directed towards growing small and medium enterprises in strategic sectors of the economy. A typical example of an equity grant is the type available to entrepreneurs under the YOUWIN program in Nigeria.

For businesses that become highly successful brands with established profitability, stable management, and growing public demand for goods and services, Initial Public Offerings (IPOs) provide further equity financing opportunities. These are however guided by Government regulations and are in most cases very expensive. It is also an important part of the exit strategy for other private equity financiers such as Venture Capitalists and Angel Investors.

And how do you decide on equity financing or the source to pick?

Any decision on equity finance must be based on the understanding that while traded equity provides leverage that doesn’t carry the weight of interests nor needs to be repaid, it slows down the decision-making process, and reduces your control of the business and share of profits in the long run. It is for this reason that equity finance is considered by some to be more expensive than debt in the long run. However, entrepreneurs in fast-growth industries, where economies of scale are crucial, understand that total ownership of a small business will not compare to a smaller slice of a larger one. For example, a 100% stake of N1million compared to a 25% stake of N100million.

For investors, the high risk of incurring losses means investments will only be tempting if the possibility of high returns exists. Businesses seeking equity finance must therefore prepare comprehensive business plans that show rapid profitability and feasible exit strategies. These strategies can range from buyouts from existing shareholders of the company to mergers and acquisitions that target other businesses, IPOs that target the general public, and even liquidation. Venture capitalists and Angel Investors particularly pay close attention to this aspect of the business.

If you haven’t considered these exit scenarios and the other funding options discussed are not favorable for your business, we still have one last part of the series to go. So just follow our social media page(s) and get notified.

In what other ways have you used equity to finance your business so far?

Editor’s Note: A version of this article first appeared in The Business Hub on 13th August 2014.

Business Funding Options

Hello and welcome to FYI.

This week, we look at funding options available to businesses. It’s the first installment of a five-part series focusing on business finance.

While business finance has always been a tricky affair, the list of options is growing. These options depend on the nature of your business, its current stage in the growth process, the availability of collateral, and the willingness to relinquish some control or share of the business. They can be classified into internal and external options.

Internal options include bootstrapping during the start-up process, and reinvestment of profits during the latter stages. Although external options were traditionally classified into two broad areas (debt and equity finance), innovations are bringing customers into the funding process earlier than ever before.

Bootstrapping is the process of using personal savings to run a business. In some cases, it is extended to include funds from loans against personal assets. While being the fastest and easiest way to start a business, it eliminates leverage or the ability to share business risk.

Debt financing can be accessible at different stages of the business life cycle. However, the source of funding depends on the availability of collateral and the current stage of the business. For small businesses in the start-up phase, the major external source of finance is family and friends. While being a one-time source, it is the cheapest form of leverage and requires no collateral and minimum agreements if any. And because of the personal relationship with the funding source, the appraisal is not always based on a convincing business plan or market realities. Rather, it is an investment in the business owner.

The second source of debt financing is Financial Institutions. This is considered expensive due to the requirement for payment of interest. It is difficult to access, slow, and cumbersome during the start-up phase but gets progressively easier as the business grows. Minimum requirements generally include a defined repayment plan, justified cash flow projections or business history, alternative sources of repayment through the provision of collateral, and reasonable asset liquidity. It is however an inexhaustible financing source as long as these basic requirements are met at every stage of the business life cycle.

Equity Financing is a rapidly growing source of funding for owners who are willing to give up ownership of part of the business. These sources also depend on the stage of the business. During the start-up process, family and friends in some instances would want a share of the ownership as opposed to granting a loan. The fund received under these terms is classified as equity finance because they inevitably become shareholders in the business. While providing leverage without the weight of interests, traded equity may sometimes reduce control of the business and slow down the decision-making process.

The second source of equity financing is Angel Investors. These are usually business-savvy, wealthy individuals who bring networking opportunities in addition to interest-free leverage in exchange for a part of the business. They are the most sought-after type of investor and can come in at different stages of the business life cycle. They not only share business risks but also increase the probability of success through their personal experiences and relationships. They are however some of the most difficult types of investors to find and demand considerably higher stakes in the business than family and friends.

A third source of equity financing is Venture Capitalists. These are the big-money investors that fund extremely rapid growth businesses in a bid to sell off or go public. They also bring networking opportunities, interest-free leverage, and a wealth of industry knowledge in exchange for a part of the business. They however rarely invest during the start-up stage, base their decisions on the competitiveness of the management team, and sometimes insist on installing theirs. They also usually require that the business be sold within five years or less.

This brings us to the latest trend in external business financing. The Customer. It is growing thanks to innovations in marketing and an all-time high in competition. Ever heard of Crowdfunding? It’s a process of raising funds through customers during the start-up phase. This can be as a pre-sale on a defined item or a promise of a discount on an innovative product. It is usually a cheap source of non-equity-based leverage; sort of like family and friends. While platforms like Kickstarter are leading the online revolution, innovations in real estate finance have promoted a rapid shift in the industry offline.

The second source of customer financing is Strategic Investors. These are businesses that combine elements of classic equity financing models to provide interest-free leverage in exchange for part of a business they buy from. They are usually driven by a potential for lower long-term costs, and the need to enjoy significant advantages over competitors. They could however end the relationship at any point in time while usually also restricting your ability to sell to their competitors.

It’s a lot of words, but we’re just getting started. Over the next four posts, we’ll help make sense of it all by matching business types to funding options. Follow our social media page(s) and get notified of the next installments.

For now, how have you funded different stages of your business so far? And what other funding options did we miss?

Editor’s Note: This post first appeared on The Business Hub on 23rd July 2014.