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A Guide to ‘Alternative Finance’ – the new funding options for startups and small businesses

August 22, 2016

Young businesses and start-ups that are looking to raise funding have a dizzying array of choices nowadays. In fact, there has probably never been a bigger range of places to go for early-stage finance, from crowdfunding and angel investors through to government-backed start-up loans and P2P lenders.

But before we take a look at the options in more detail, it’s important to think about what sort of funding you’re after for your business, and what you’re prepared to offer in return. The basic division here is between equity and debt.

Equity or debt funding?

Raising equity funding means selling shares in your company to an outside investor in return for cash. This obviously involves giving up some control of the company because you will be bringing in an outsider who will become a shareholder – or co-owner – of the business.

Some people are reluctant to sell equity in their business but bringing in new investors can provide valuable expertise as well as money. Another attraction of equity funding is that it does not have to be repaid. The investor puts their money at risk in the hope of selling their shares later on at a profit, but also accepts that the business could fail and they could lose their money.

The other major way to raise external finance is to borrow. This avoids giving up legal control of the company by selling shares, but it places an obligation on the business and usually on its owners personally to repay any debt within a pre-set deadline.

Most lenders regard small, early-stage companies as being particularly risky and so they are often reluctant to lend to them at all and when they do charge high rates of interest.

First things first

Before you start hunting around to raise money from other people, the first thing to consider is how far you can fund your business yourself.

Many entrepreneurs start off by drawing on whatever sources of funding they can access personally before they start looking for outside money. This could involve putting their own savings into their company, using credit card borrowing to get the business off the ground, remortgaging their home to raise seed capital and asking family and friends to back them.

There are several advantages to raising money from these sources. First, you can thoroughly test your idea and make sure it is viable before you start looking for outside funding. If your business is already up and running, it will be worth more when you come to raise outside funding, meaning you can expect more money in return for fewer shares than if you chose to raise equity.

Second, outside investors will expect you to demonstrate your own commitment to the business, which is easier if you have done everything you can to fund it yourself before you turn to them.

For more ideas on funding your business without raising finance, make sure you read;

Rewards-Based Crowdfunding (Donations)

Rewards-based crowd funding has become a very popular way for start up businesses to not only fund their business, but also raise awareness for their product or service that they offer.

Kickstarter is perhaps the most recognisable online platform for rewards-based crowd funding, allowing entrepreneurs to pitch their idea to people over the Internet, and giving people the opportunity to fund projects and start-up businesses.

In order to incentivise people to fund these ventures, the promoters usually offer a reward based on the quantity of the funding offered. For example, a T-shirt design business could offer funders one T-shirt if £10 is offered, or two t-shirts if £20 is offered, and so on.

Games designers, fashion designers, product developers and many other businesses have started this way.

Equity Crowdfunding (Equity)

Equity Crowdfunding enables the founders of a business to raise money by selling shares in it to the public, normally via an online platform. In many cases, investors can put in small sums and, because legal costs and due diligence are minimal, this can be a quick and relatively easy way to raise start-up funding.

While you do have to relinquish some control of your business, you can receive input from your investors and also raise awareness for your idea. For help on raising money for your business through crowdfunding, read; 10 Top tips to ensure your crowdfunding efforts are rewarded

Business Angels (Equity)

Business Angels tend to be wealthy individuals, some of whom have set up successful businesses themselves, who are looking to invest money in early-stage companies in return for a stake in the business. Like crowdfunding, you must be willing to sell shares and therefore some control.

A Business Angel will often insist on joining the board of the companies they invest in and as such can bring experience and knowledge to your business. Therefore, investments from Business Angels can provide both funds and vital knowledge in areas of management that your start-up team lacks.

Business Angels often operate in groups, known as syndicates, and many will carry out extensive due diligence on the start-up team and their business idea. Be prepared to be grilled!

These guides will help you understand more;

P2P Lending (Debt)

Peer to Peer, or P2P lending, involves raising a loan from a group of individuals or institutions and is a very flexible source of borrowing, with the minimum loan amount ranging from £5000 to £50,000 and terms ranging from 6 months to 5 years.

Much of this lending is unsecured, so the borrowers do not have to commit personal or business assets as security. However, most P2P lenders will not deal with start-ups and very young companies, so this source of funding is suited to companies with at least a couple of years’ trading that are looking for capital to expand.

P2P loans do not involve surrendering any control of the business but they usually involve signing a Personal Guarantee, which commits the directors of the company to guarantee the loan if the business fails to repay. For more details, read;

Start-Up Loans

Another good source of early funding is Start-Up Loans. These are unsecured personal loans for up for terms of 1-5 years that charge a relatively low 6% rate of interest. Each individual can borrow up to £25,000, meaning that two founders of a business could in theory borrow £50,000 between them.

They also come with access to mentoring for new entrepreneurs and business advice. Although they are called Start-Up Loans they are in fact available to established businesses, providing you haven’t been trading for more than two years.

Before you think about applying for a bank loan, make sure you read;

Summary

As you can see, there is a big variety of ways to secure funding for new and young companies – so it’s critical that anyone that wants to raise money for their business researches the options thoroughly and takes the time to understand the ins and outs of each one so that they don’t waste time pitching for an unsuitable type of finance.

About the author

This guide has been written for ByteStart by Informed Funding, an impartial and free platform designed to help businesses understand their funding options and connect them directly to finance providers. If you are looking to finance your business or just want more information, register for free today at www.InformedFunding.com.

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