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Explaining Business Funding Stages

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This article is part of Institute of Entrepreneurship’s content partnership with Morgan Capital. Find more of their articles here.

 

How You Can Acquire Funds to Start up and Leverage Your Venture, at the Right Time to Do It.

Starting a business is not exactly a walk in the park. There are many challenges that entrepreneurs and small business owners have to consider. One of the biggest challenges is conducting business funding to grow their business venture.

Stages of Business Funding

To grow a business, a business owner can consider either to take on two options of business funding: either debt or equity financing, though latter is most frequently used method. Equity financing is essentially the process whereby the company issues shares of the company in exchange for funds from investors.

Equity financing is often the choice for businesses as it is less expensive than taking on a debt from the bank and it is also fairly straightforward compared to the many procedures when taking a loan.

Investors are keen on equity investments as the returns for these equity investment can be exponential. Due to this, investors are willing to take a higher risk for a higher earning potential.

There are four stages (as illustrated in the figure below) of equity funding i.e. seed, early-stage, expansion and late stage financing.

stages of business funding

Image Credit: QFinance

Informal Investments

In the earliest stage of funding, acquiring funds might be a bit limited for businesses. This type of funding is often referred as “The Seed Stage”. Funding during the seed stage may often come from the founder’s personal savings or from friends and family members of the founder.

During the seed stage, businesses can tap into Angel Investor funding. The founder can reach out to wealthy individuals outside the circle of friends and family and convince them the business that he/she is trying to run is going to be profitable. These wealthy individuals are often referred to as “Angels”.

These angel investors tend to have entrepreneurship or managerial experience, or previous startup founders who have had exits, and decided to invest in other startups.

Both Friends and Family as well as angel investors are very important for the Seed Stage. The seed stage is viewed as a very high-risk stage of a startup because of the possibility of the company never taking off and reaching its potential. However, if the startup does succeed, these early stage investors will earn the highest returns as the investors entered the investments earlier and often at a much cheaper price.

Seed stage businesses can utilise crowdfunding platforms which are available online, such as Kickstarter and Indiegogo. There are four types of crowdfunding which are rewards-based crowdfunding, donations-based crowdfunding, equity crowdfunding and peer-to-peer lending.

Crowdfunding is a preferable choice for seed stage businesses as they would be able to gain not just funds but also loyal supporters and brand awareness from being placed on a crowdfunding platform.

Formal Investments

Formal form of investments usually come in the early stage of growth. At this stage, businesses have usually figured out their products, the size of target markets, and has started to earn revenue but not necessarily generate profits. Businesses at this stage are prime candidates for external investments often from professional investors.

Early Stage Business Funding

Venture capital (VC) is the typical form of external investment that company in early stage would use. A venture capital firm usually are established to invest funds in early stage companies.

Usually, venture capitalists would expect a company to come with a business plan with a detailed description of the business model, marketing plans, and forecast for the next 3-5 years.

Early stage business funding could be raised in a few series or rounds. Each funding round would reflect different valuations. Typically, the valuation and size of funds raised would be higher than each of the previous fundraising rounds. The latter the investment round, the more expensive the cost for investors to invest in the company.

Late Stage Business Funding

In the expansion and late stages of business growth, the business might want to consider different forms of funding to support the ever expanding growth.

The funds for expansion during this late stage would come from the method of mezzanine financing and bridge loans.

Bridge loan is a loan that ‘bridges’ the business owner’s working capital needs until he or she obtains newer funds. Bridge loan is simply an interim source of fund until the next round of financing can be obtained.

Mezzanine financing, on the other hand, would be  a hybrid of debt and equity financing that gives thelender the rights to convert their debt to equity interest in the company. Mezzanine financing usually starts 6 to 9 months prior to IPO. Businesses prefer to use mezzanine debt because it is usually tax deductible.

Initial Public Offering

Initial Public Offering or also known by its acronym, IPO is when the firm starts to open their shares to be traded publicly.

IPO is a popular method of raising money from the public via the stock exchange. IPOs are traditionally the way to go for businesses who have been established for a very long time, and has a profitable record.

However, this is no longer the case as regulators in the world has open up secondary boards for startups and small medium enterprises (SME) to do their IPO listing. One of the top secondary boards in the world is the US OTC Markets. The US OTC Markets is viewed as the stepping stone to main board listing in NASDAQ or NYSE.

 

 

This article was first published on Morgan Capital.

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