There are some common challenges I’ve noticed when talking to hundreds of entrepreneurs who are looking for funding. These entrepreneurs range from those who have an idea and are trying to raise seed capital to start their business, to owners of high growth businesses who need expansion finance, and everyone in between. Irrespective of whether they are looking for a loan or for someone to invest in their business, they generally have the same thing in common – they are uncertain how to go about securing the funding they need.
Challenges facing entrepreneurs seeking to raise finance
Small business funding is not something that is taught at universities or even offered as a training course for entrepreneurs. This means that most entrepreneurs don’t know where to start when it comes to applying for finance. Without a basic understanding of small business funding, learning to navigate it can be a challenge, and this leads entrepreneurs to feel that the odds are stacked against them before they even start. Most believe that only a large, well established business is likely to get funding.
Finding the right funder can be like looking for a needle in a haystack, particularly if you don’t know who all the funders are (besides the banks of course). The reality is that most startups and small businesses that approach banks for funding are unlikely to meet the stringent loan assessment criteria. For banks, small businesses represent a high risk, and banks find it difficult to accurately assess the risk of lending to them. Fortunately, there is a variety of different funders that are able to assist. However, it is critical to understand how each type of funder works, as you’ll be expected to meet their specific lending criteria.
Whilst entrepreneurs know that Government funding is available, they feel that this is very difficult to secure. Even when funding approval has been received, it takes a long time for the funds to be released, and this often occurs after the opportunity (which required funding) has been lost.
A further complication for entrepreneurs is knowing what type of funding to apply for. People know that there are several different funding options, but few have the knowledge to identify which ones match their particular business and their funding need, or what the best terms and rates are. The way funding information is presented also makes it very difficult to compare funding offerings, so entrepreneurs tend to settle for whatever is available, rather than what is the best option for the business. That said, there are some general guidelines to help with the different types of funding.
How funders view funding applications
The reality is that businesses that lend money are measured on the return they get for the capital they provide. In other words, like any business, they need to make a profit and minimise the risk of losses caused by businesses defaulting on their loan repayments. This means that all loan applications are vetted through the lens of risk. Funders must assess the risk of loaning or investing the money they are entrusted with, and the only way to do this is to thoroughly investigate the applicant’s ability to repay the loan, or produce the promised return on investment. Therefore, funders collect information from the entrepreneur to do a detailed assessment, and this is often when the gap between the finance provider and seeker is most evident.
The funder’s aim is to gather the information necessary to assess the viability of approving the finance. If the entrepreneur understood how the funder used this information, they would be better able to respond to the funder’s questions in a more reassuring way. It is important that entrepreneurs seeking finance are well prepared when they want to apply for funding, especially as far as business and financial forecasting and recordkeeping is concerned. The aim is to be able to provide the information funders need to back up the application for finance, and assure the funder that lending money to their business is not a high-risk decision.
How venture capitalists view funding applications
Venture capital represents high risk lending, since this is money that an investor puts in (in exchange for shares in the business), in the belief that the business will rapidly grow and make sufficient profits to yield a good return on the investment. There is very little, if any, financial history in the start-up or early stages of a business. Since risk cannot be assessed by looking at historical trading history, venture capitalists ask for information that will help them assess the future prospects of the business.
The information most venture capitalist require:
- The entrepreneur and the team: they want to be sure that the business has an excellent founder and driver, often referred to as ‘the jockey’. Growing a startup is not easy, they need to know that the leader and the team have the knowledge and expertise to make a success of the business.
- Market size: they want assurance that the business is addressing a pressing need for a large market i.e. are there many people who will want to buy what the business is selling?
- Product differentiation: they want to know how the product/service offered by the business is different to what is already available in the marketplace.
- Competitor information: they want to ensure the entrepreneur has done their homework i.e. details on who/what is already available in the market.
- The business model: this document is critical as it provides a snapshot of how the business is going to make money i.e. does it have annuity income options (e.g. monthly subscriptions), does it sell directly or make use of partners etc.
- Market plan: VCs will want to know how the business intends to acquire its customers and how quickly this can be achieved.
- Traction is key: few people are prepared to invest in an idea, they want to know that the business has at least reached the stage of testing the product/service in the marketplace, and that there are some customers will to pay for the product or service.
- Financials: VCs will require a summary of the next 3 to 5 years’ projected income and expenses in the business. They expect a very detailed account of income and expenses for the next 12 months and will use this to gauge the viability of the business.
The information above will be used to perform an initial assessment and, more importantly, will be used to make a decision to pursue the investment opportunity further. If the information you have provided is sufficiently compelling, then the VCs will now want to do an in-depth analysis of the business to verify your projections. This is called a ‘due diligence’. If they are satisfied with the results of due diligence, they will then start discussions on the terms of the investment.
What documentation do you need to apply for funding?
In general, historical trading history documentation is key to securing funding, but as has been shown, future projections are critical for VCs. It pays to have the following documents updated regularly, so that when the need arises to raise finance, the business is ideally situated to quickly conclude the funding.
Banks and other private lenders usually require the following information in order to assess a loan application:
- Basic business plan.
- Cash flow projections.
- Outstanding debtors (i.e. customers who owe you money).
- Up-to-date management accounts (i.e. income statement, balance sheet and cash flow statement).
- Latest annual financial statements.
- Latest VAT statement.
- Last three/six months’ bank statements.
- Tax clearance certificate.
Besides these documents, they will ask for the following supporting documents to confirm statutory compliance, and to validate the information on funding applications:
- ID documents of owners.
- Marriage certificates of owners (where applicable).
- Company registration documents.
- Office lease or mortgage agreement.
- Shareholder agreements.
- Share register.
- Proof of business address.
- Relevant business licences, accreditations or registrations.