1 Funding strategies

How business start-ups are financed is one of the most important questions in entrepreneurship. The first thing that you will learn as a start-up entrepreneur is that not all money is the same. As Burns (2016, p. 359) puts it, ‘Different sorts of money ought to be used for different purposes and not all types of money are available to all new ventures.’

Table 1 depicts the main types of financial capital and how they should be used. Generally, the term duration of the source of finance should fit with the term duration of the use to which the money is put. That means that fixed or permanent assets should be financed by long- or medium-term sources of finance. Short-term finance, such as an overdraft, serves the purpose of mitigating fluctuations in working capital.

Table 1 Sources and uses of finance

Duration of finance Source of finance Use of finance
Long- and medium-term
  • Equity

    • Personal, family and friends investment

    • Angel finance

    • Venture finance

  • Long- and medium-term loans

    • Personal, family and friends

    • Bank

  • Lease and hire purchase

  • Crowdfunding (equity or loan)

  • Fixed assets: land, buildings, machinery, plant, equipment, vehicles, furniture etc.

  • Permanent working capital: stock, debtors (net creditors)

Short-term
  • Bank overdraft

  • Short-term loans

    • Personal, family and friends

    • Bank

Seasonal fluctuations in working capital: stock, debtors (net creditors)
Source: Burns, 2016, p. 359

In practice, start-up entrepreneurs rely on a combination of various inflows of money. These are broadly classified by source (formal or informal) and by type (debt or equity).

As it is easily available at short notice, start-up entrepreneurs often try to fund their new business with their own money, typically coming from savings and borrowing, secure on a property or unsecure on a personal guarantee. Credit cards are an easily accessible and flexible source of funding, albeit an expensive one.

Having exhausted their personal capital, many entrepreneurs borrow money from friends and family members – i.e. bootstrapping. These informal investors often require lower returns than formal investors such as venture capitalists and business angels. Relatives and friends are even approached before founders ask banks for loans.

However, informal sources of funding are not unlimited. For sustainable growth, entrepreneurs need to turn to more formal sources of funding, either by borrowing money from banks, i.e. loans, or by raising equity from formal investors (Blundel et al., 2017).

The purchase of fixed assets can also be financed by lease. Having a lease allows the firm to use an asset without owning it. They can make regular lease or hire purchase payments, which allows the firm to purchase the asset over a period of time, and the asset can be used as security in the event of default (Burns, 2016).

Crowdfunding is a novel source of funding. It allows individual investors to support new ventures with relatively small contributions and is typically via online platforms. Crowdfunding can take the form of equity investment and loan capital, debt finance or peer-to-peer lending (Blundel et al., 2017).

Most start-up entrepreneurs find it challenging to conceive of an appropriate funding strategy and to decide on sources and types of funding. The flowchart in Figure 1 guides you through the process of deciding what type and source of funding is most appropriate and available to you.

Figure 1 Designing a funding strategy (Source: Burns, 2016, p. 361)

Activity 1 Designing your personal funding strategy

Timing: Allow approximately 30 minutes to complete this activity

Use the flowchart depicted in Figure 1 to help you plan a funding strategy for your new venture.

Reflect on the constraints and obstacles in getting access to the financial capital that you identify in the process. What opportunities do you see to overcome them?

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Discussion

Everyone’s circumstances are different but you might have thought of the following constraints and obstacles:

  • Lack of awareness of opportunities to apply for a grant

  • No money available from family or friends

  • Lack of personal savings

  • Difficulties in attracting co-founders

  • Personal circumstances, such as age, health and family situations, family and work commitments

  • Lack of knowledge in business and management.

Opportunities to overcome obstacles include, but are not limited to, seeking advice from experts in finance and/or entrepreneurship, applying for support from a business incubator or an accelerator, and joining networks of like-minded start-up entrepreneurs.

2 Cash flow management