Question: I am planning to expand my startup next year and I will be needing some extra cash to finance it. There are investors interested to help but I don’t know how to handle this properly. I want to raise funds without getting eaten alive. Can you advise? – Sophia
Answer: Raising money from investors can be challenging especially if your business is just starting. Investors normally put a lot of premium on their expected payback from investments when a business has no solid financial track record. Such premium can mean higher interest rate if you are borrowing money, or higher equity share in your company by way of lowering the value of your business if you are selling your shares.
There are always costs involved when you seek funding from external sources. The costs vary on how risky your business is perceived to be in the eyes of your investors. Some investors may like your business idea so much that they are willing to give you the money you need in exchange for a small equity share in your company. Some may not be that excited about your business model and may demand a bigger piece of your business.
Paying higher costs for funding is not necessarily bad. Sometimes you have to pay the price to get the funding you need for as long as the additional income that you will get from expansion will more than compensate your costs. The challenge is this: how do you get the funding you need without losing your control and flexibility in managing your business?
Here are the five funding tips that every startup founder must know when raising funds:
1. Identify your potential investor.
Family and close friends are the most common source of funding for startup businesses. You can get financial help from this group not because they really understand your business but because they trust and believe in what you are doing. This is the easiest and cheapest way to raise funds because they will not require so much due diligence about your business. Sometimes, they can lend you money interest-free, too.
Unless you have a wide network of wealthy friends and relatives who are willing to support you all the way, funding from this group can only be so much. When there are growth opportunities present and you want to grow your business fast, you will need serious money to finance your expansion. Potential funding sources can be from a bank loan or outside investors.
2. Identify the win-win deal.
Banks and investors will always try to get the most out of your business. You don’t want to overpay for interest charges and sell your shares at an undervalued price. Try to negotiate and arrive at the best terms that will satisfy both parties.
For example, if your investor is willing to invest Php 10 million in your business in exchange for a 30 percent share your in business, you can negotiate to just borrow the money and repay the loan in two years. You can offer to grant your investor a free equity share of 10 percent in your business for agreeing to lend you money, and if you fail to pay in two years, you can offer your investor to get the remaining 20 percent.
In this way, you get to buy time and work hard to pay your investor so that you will only give up 10 percent, while your investor will be happy to get 10 percent free equity in your company aside from getting paid back in two years with interests.
3. Identify the right pitch to sell your business.
Raising funds is more than just asking for money and paying the price for it. It is about selling the business. What is your business model? How do you create value for your investors and customers? What makes your business unique in the competition? How attractive is your business as an investment?
When you pitch for your business, you must have a bulletproof business concept. You must be able to demonstrate to your investors that the business has the potential to grow in the future. It will also help if you can convince your investors that the business can generate immediate cash flows to help them recover their investments as soon as possible.
4. Identify strategic partnership with investors.
There are investors that you will never want to work with no matter how much money they pour into your business. You want to get an investor who will not only help you financially, but also advise and mentor you from time to time on important business matters.
An ideal investor is someone who can help add value to your business besides funding. For example, your investor can help you find new customers and expand your network by referral. Or your investor may introduce you to suppliers that can give you special arrangement to lower costs.
5. Identify opportunities to eliminate the need for funding,
As your business expands and grows, there will always be the need for additional funding at some point in the future. Try to avoid the temptation to always raise money from outside investors. Find creative ways to finance your operations and grow using internal cash flows.
Efficient cash flow management may help eliminate the need for short-term financing. For example, negotiating hard with suppliers for longer payment terms can help relieve cash flow constraints. Managing your inventory well to less than six months turnover can boost your cash flow significantly if you are in the retail business. Monitoring your credit and collection by limiting aging of receivables to less than two months can also help a lot.
Henry Ong, CMC, is president of Business Sense Financial Advisors. Email Henry for business advice firstname.lastname@example.org or follow him on Twitter, @henryong888.