Funding can traditionally be separated into two main categories; debt or equity finance.
Debt finance involves borrowing a fixed amount from a lender, which is usually repayable with interest. Equity finance involves giving investors shares in the company. In the last few years, crowdfunding has become a popular source of funding for startups or 'young' companies and this can take a number of forms.
Each funding option has its advantages and disadvantages.
Debt
Debt funding can be obtained relatively quickly and simply. If all goes well, you will only need to repay the agreed loan amount plus interest. A lender may require security from the company, often in the form of valuable assets of the company (e.g a freehold property). It is important to make repayments on time. In an event of default the lender can demand repayment in full and enforce their security.
Debt funding can be obtained in various forms including term loans, overdraft facilities and invoice discounting facilities. The rate of interest charged and repayment terms differ, depending on the type of debt funding and the debt provider.
Equity
Equity finance is an attractive funding option for tech companies because no interest is payable on the investment and the investment itself does not need to be repaid (except on an exit). However, it does involve giving up a share of the business, which will mean less of a return for the owners on an exit and may also mean giving up control of the business.
A 'private equity house' will generally invest within a sector in which it has specialist knowledge. They generally aim to exit the business within 3 to 5 years, having assisted with business growth by sharing expertise.
Individual investors such as friends, family or 'business angels', might be the first port of call for some tech businesses (particularly those looking for initial funding).
These investors may be able to contribute useful know-how and introduce contacts to the business, or may not have any real connection to the business or sector. In offering shares to such investors, you need to ensure that you adhere to financial services legislation intended to protect investors. Breach of such legislation can lead to criminal sanctions.
Crowdfunding
Crowdfunding is essentially peer to peer funding which allows companies to pitch their idea, product or business to the market and numerous individuals (or entities) to make an investment in those companies. There are four main types of crowdfunding:
- Debt – the company will receive low-interest loans from a number of individuals.
- Equity – investors take small portions of equity in the company in return for their investment.
- Reward-based – the company will give pledgers an item (free trial, gift or sample product) in exchange for donated funds.
- Donation – individuals interested in the product or service may invest with no expectation of a return (usually in relation to social enterprise or charitable projects).
Whilst some of the crowdfunding platforms are regulated by the FCA, not all of them are. The FCA is in the process of implementing additional regulation in this area, which may affect the availability of funds.
When considering funding, it is important to consider the short, medium and long term goals of the company and the way in which the type of funding chosen now may impact the flexibility and development of the business in the future.
- Janine Esbrand is an Associate Solicitor in the Corporate Department at Stevens & Bolton LLP.
