06 Sep How to raise capital to start a business
Starting a new business is both exciting and challenging. As a new business owner, you probably dream about running a successful and thriving business. You are most likely focused on the immediate concerns, like getting your first customer, or starting the production of your product. However, we know that making the right decisions for your business early on, highly improves the chances of your business succeeding. To make sure you avoid common pitfalls that often see the death of UK businesses, it’s crucial that you know how to raise capital initially, and how to avoid bad deals.
In this article we go through some of the common ways of raising capital to start a new business. We also advise you on how you can choose which options to best fit your business.
What does business capital mean?
Business capital is the collection of the assets and people in a business. We usually use the term when we talk about the money, equipment, products, property, employees and owners, skills and knowledge within a business. To simplify, business capital is all the pieces of a business that holds value.
Where do you start to find funding for a new business?
Before you start looking for funding for a new business, you need to have a business plan. You need to know how much money your business is expected to make, how you will operate, and exactly what you need to get started.
You’re not looking for any capital, you need to know what kind of capital you need, and how much you’re looking for. Will you need any equipment? If so, exactly what, and what will the cost be? Will your business require an office, a warehouse or a store front? Do you need to hire employees? How will you cover their salaries? What about a website, a car or a manufacturer for your product idea? Do you have any potential customers, or will you have to start marketing from scratch? If so, will you do your own marketing, and how? What is your long term plan? How much do you expect the business to grow in the first five years? When do you expect to start making a profit?
It’s also worth noting that new businesses rely on much more than just money. You might need to find someone to help you with certain tasks where you don’t have the skills required, like marketing, bookkeeping, or designing a logo. You also want to build a network of potential customers or introducers early on.
From this, you can start working out a plan. This will help you identify exactly what type of capital you need, and how to raise it.
Start a business from nothing
A startup or early stage business wants to create capital quickly. You often need employees, money, skills, a place of operation and equipment before you can start making sales. Naturally, you want to move your business from just starting up to thriving as soon as possible.
Unfortunately, it’s not a straightforward process, and with an abundance of alternatives it can be hard to know which methods suit your business’ needs. To make matters worse, many capital providers want to see proof that your business will succeed before offering any capital. But you need capital before you can provide any proof. Your detailed business plan might therefore be the only way to convince lenders or investors that your business idea will work.
Ways to raise capital to start a business
Here are six ways you can get funding for a new business.
Bootstrapping means starting a business on a small budget with no investor involvement. If you are starting a small business in an industry or trade you know well, you might be able to get started without the need for a business loan or investors. This typically involves using private funds, your credit card or personal loans. Bootstrapping usually only works for very small businesses or sole traders where the initial need for capital is very small.
2. Loan capital
A common way to raise some initial capital, is to reach out to banks and other loan providers. In some cases they might be willing to give your business a loan. However, many banks will automatically refuse to finance a business that is less than two years old. Banking decisions are often made by automated systems, and if your application is denied, there is nothing you can do to sway the vote. Some finance houses have proven to be more acceptant to helping out new startups than banks. A detailed business plan and financial forecast with physical assets such as equipment or property is usually enough for them to accept a loan.
Taking a loan can be a good alternative, however as a new business it’s very hard to be accepted for one. It might require a few applications, and you must have certified projections that your business will succeed.
Alternatively, you could take a private loan from friends or family. These can be with or without interest, and a suitable agreement should be made.
If you’re looking for loans to start a business, we always recommend to be cautious. Read the terms, and make sure you understand them. If you’re not comfortable with making loan decisions on your own, seek advice from a professional that’s not tied to the bank or loan provider you received the offer from. We have seen examples of people going into serious debt, or even losing their houses because of poor loan decisions and unfavorable terms.
A key principle with loans is to match the length of the loan to the remaining useful lifetime of the asset you wish to acquire. The right loan at the right time can be the perfect choice in some cases, you just have to make sure that your business can support the down payments.
Grants are great, as you don’t have to pay it back. It is simply money that the government gives you. They are only available for certain business under certain circumstances, so you might not quality for any. However, it’s well worth looking into, as it’s essentially free capital. Your local council will typically be the best point of contact, as they administer most grants. It might also be worth searching online and see if you can find any.
Most grants typically offer to match a certain percentage of your spend as a grant. Sometimes they only match against any spend after the grant has been agreed, so make sure to apply for your grant before you do any large spending.
4. Equity capital
If you have a great business idea, but struggle to get a loan, you might want to look into equity capital. If you have ever watched Dragon’s Den, this is what the Dragons are offering. In essence they offer a business cash for a share of ownership of the business. If your business succeeds, the investors will then have valuable stock, and can get a return down the line. You will need a solid business plan or an excellent idea to convince anyone to invest in you. As you are trading ownership of your business for capital, equity capital might cost you more money in the long run than a simple bank loan. Many new businesses will however not be eligible for loans, and equity capital could therefore be a good option to get started.
Angel investors are influential people that invest capital in a business, typically for a share of ownership. We typically use the term to describe individuals that invest a substantial amount, and receive a large portion of shares in return. The number of angel investors have increased in recent years, and more people are looking to invest in profitable business ideas.
Venture capital firms or funds are actively looking to invest in risky start ups in hopes that they will become successful. These are attractive for new businesses that are too small or have too little operating history to secure a bank loan or get investors on the public market. Venture capital often offers good business networking opportunities. As they want the business to succeed, they often help out with finance, mentoring, expertise and business advice.
As a result of TV shows like Dragon’s Den, a number of online markets have grown up to help new and existing businesses raise funds. You can use websites such as Crowdcube, Kickstarter and AngelInvestmentNetwork to appeal for cash. These online forums are a great way to reach out to potential investors. Done correctly it can both give you the capital you need, and some publicity to drive early sales.
There are many versions of crowdfunding. It can be done on a donation basis where people can donate money if they like your idea. Sometimes investors can be offered shares, pre-orders or symbolic gifts in return for their investments. In 2013, Rob Thomas created a Kickstarter campaign to fund a new Veronica Mars movie. Fans of the TV show pledged cash simply because they wanted to see the movie, and it became the fastest project to reach $2 million in Kickstarter history. In 2012, the virtual reality headset Oculus Rift raised $2.5 million on Kickstarter within months of forming a company. Two years later they were sold to Facebook for $2 billion. If your idea is good enough, there are many opportunities on these platforms.
6. Enterprise Investment Scheme
The UK Government has created some very valuable tax incentives for investors that want to invest in startups. Higher rate taxpayers can obtain high tax credits against their tax due. This is an incentive to encourage high earners to invest in new businesses. By giving this tax credit, the UK government is investing heavily in small business.
This incentive is called the Seed Enterprise Investment Scheme (SEIS), or Enterprise Investment Scheme (EIS) for larger investments. Many businesses qualify for the incentive, but it is unfortunately not open to all. For Social Enterprises, there is a very similar tax incentive called Social Investment Tax relief (SITR)
With these schemes, a higher rate taxpayer can invest £10,000 in a startup company and obtain a £5,000 tax credit against their tax due. In addition if the investment doesn’t work, the investor could obtain a further £2,000 tax relief later on. If however the business does well and subsequently sells for a large gain, then there could be zero further UK tax. So a business can raise £10,000, for a cost of £3,000 from the right kind of investor.
The difference between SEIS and EIS
Both EIS or SEIS are available to new businesses. To qualify for SEIS, your company must be less than two years old, have no more than £200,000 in gross assets, less than 25 employees and not previously carried out a different trade. To quality for EIS, the business must have less than 250 employees and no more than £15 million in gross assets. Companies can raise up to £150,000 with SEIS, and up to £5 million with EIS.
How to get approved for EIS, SEIS or SITR
To take advantage of these schemes, businesses should first obtain something called Advance Assurance. This is essential an approval from HMRC that you qualify and will be able to use the scheme as long as you follow their conditions. In order to obtain Advance Assurance you will need to outline your plans for the future business in broad detail to enable HMRC to make a decision on whether your proposal will fulfill the EIS, SEIS or SITR eligibility criteria.
Once approved, you can let prospective investors know that their investment will include a refund from HMRC against tax paid in the year they make the investment to the company. If SEIS is used, investors could receive £5,000 back from HMRC for every £10,000 invested under SEIS. Of course as it’s a tax refund, your investors need to have had tax bills in excess of the refund. For EIS and SITR, investors could receive £3,000 back for every £10,000 invested. This fundamentally changes the investment decision for many people, and is a great way to convince investors.
Before you get started, you need to make sure that you are in a qualifying industry. A list of non qualifying trades can be found on the Government website here.
Applying for EIS, SEIS and SITR
Although you can apply for EIS on your own, it is usually a good investment to pay an experienced professional to help you with your application. As your investors typically make their investment decision assuming they will get tax credit, you definitely want to make sure your application gets approved. If not, you will have to explain that there is no tax credit to be obtained.
After that you need to decide if you are seeking SEIS or EIS, or a combination of both. It’s common to raise the first £150,000 (the SEIS maximum amount) using SEIS and any further amounts using EIS.
Choosing how you raise capital for your business
There is no right or wrong way to raise capital. It all depends on the individual business. A service business might not need much funding at all, other than some hard work. A few sales early on, and you might have all the capital you need to get properly set up.
If you have a capital intensive business and it’s brand new, you might want to use a number of the options above. Perhaps you’re able to put some of your own money into the company. Further, you might want to give some equity away to raise additional funds. You might even have to top that up with some loans. The more capital you need to raise, the more complex the equation gets, and you’ll either need to do a lot of research independently, or seek help from a professional.
Before you start looking for funding options, or reaching out to investors or banks, make sure you make a plan. Find out exactly what you need, and go from there.
Alan Davidson is a Chartered Accountant, director and founder of Pentins Business Advisers, entrepreneur and author of the Amazon best-seller “Achieve Your Business Vision”. With over 25 years of helping businesses succeed, Alan knows how to build a business with real value, while avoiding costly mistakes.