In Part 1 of this article, we looked at the sources of funding that could be considered. The next step is to understand how to match that to your needs and situation and develop a funding plan.
First then you need to understand where you are in the development of the business and therefore the most appropriate sources of funding. The chart below shows the funding cycle:
Chart 1: The “Funding Cycle”
There are two things to take from this, first you need to determine where you are in terms of the business development as this will determine the funding options available to you. So, are you Seed stage, Early/Growth, Expansion or Pre-Sale? Secondly the risk/return nature of the funding cycle. The more to the left you are the greater the risk and therefore the higher the expected return, the more to the right the less the risk and consequently the lower the expected return. This is because in the Seed stage the business is not making profit, it is still trying to prove its business model, whereas in the later stages you have some customer validation. Someone, at least, has been prepared to pay for what you do. You have demand. Consequently, Seed stage investors are taking a big risk so will expect a 5 to 10 times return on their investment, whereas in the later stages, where risk is lower, that might only be two times. The sums invested at each stage are also quite different though. In the Seed stage investments are typically £150k-£250k, whereas in the later stages it’s more likely millions!
Whichever stage you are at, you have to consider first if you are investable in your current position for that stage. In other words, have you done enough, proven enough for an investor to be interested to invest? Is it compelling? If the answer to that is yes, you can look at which of the investment options we discussed in Part 1 are open to you at your stage of the funding cycle. The possibilities are shown in the table below:
The Seed stage has the most options, but as mentioned the sums here are relatively small. As the business develops the sums required are larger and so the options narrow to commercial and institutional investors. So far, we have only considered equity investment (shares) but at later stages debt is also a possibility. Why is this? Well, in the Seed stage the business has no profits and so doesn’t have the financial resources to service (pay interest) on its debt but, as the company grows and has profits, it can. Keep this in mind as equity is the most expensive way to raise money and debt maybe a more attractive option.
The Funding Plan
Having considered all of this and with refence to your Strategic Plan you need to draw up an Investment Plan. This plan should consider the following:
- How much funding do you need?
- When do you need it?
- What will be the source of the funding?
- Do they invest at your stage?
- Do they invest in your market sector?
- How much do they typically invest?
- Have they invested recently and if so to whom?
Having a plan will save you lots of time and energy as it will provide you with a shortlist of investors that are a good fit for you, rather than just pitching to anyone who will listen. But beware, this will take time. Raising investment typically takes 6-9 months so you need to start early, don’t wait until you really need the money.
So far in Parts 1 and 2 we have covered the different types of investor, where they sit in the funding cycle and how to create a funding plan. In Part 3, next month, we will discuss the actual money raising process.