Growing a business brings a myriad of challenges, not the least of which is obtaining sufficient funds to invest in the growth of the business and provide adequate working capital for the specific lifecycle the business is in.
The common sources of funds for growth are:
- Family & friends
- Employees & suppliers
- Banks and non-bank lenders
- Angel investors and venture capitalists
- Equity financing
In this article, we focus on family and friends and also highlight often overlooked alternatives – employees and suppliers.
Family & friends
It is sometimes easy to dismiss this category, as there is a perception that this source of funds is inherently risky due to close personal relationships. Rightly so. Hence it is best to prepare for the worst and approach any financing proposition in a professional way and have any arrangements clearly documented with the assistance of your professional adviser.
Using family and friends as a source of funding is an age-old formula that works and makes sense if structured properly from the outset. The funds can be raised as:
- Traditional debt, with interest paid
- Equity or convertible notes (the latter being a particularly good option to provide for flexibility)
- Profit sharing arrangements.
As with any lender, security over funds provided and certainty of return on funds are the key to ensuring all parties remain comfortable with the arrangements, and happiness continues around the dinner table or BBQ.
Family and friends can often back you based on faith and goodwill, and often for nothing much more than to see you succeed and be happy. This is rare with most other sources of funding.
A few thoughts:
- If anything puts friendship or love to the test, it is asking for money
- Ensure you have done your homework on the business plan and ensure you have done more than just research before asking anyone to put their faith or financial future in you. Make sure you are clear on the business proposition you are presenting, including things such as:
- Amount being requested
- Use of the funds
- Proposed repayment timeline
- Interest rate applicable
- If debt, whether it be secured or unsecured
- If selling equity, the percentage of the company you will be selling.
- Be professional in your approach (e.g. prepare detailed forecasts and assumptions, review your strengths and weaknesses, determine how you will develop on-going communications) and document everything so there are no surprises
- We all hope for the best but you also must be mentally prepared to deal with a partial or complete loss and the implications on the relationship. Hence, always explain the risks as well as the opportunities involved upfront
- Don’t burden one, or a few, with the entire request for money – break it down in to bite-sized chunks that your potential backers can reasonably afford. You may not always get everything you asked for in one fell swoop this way, but treat this as your first entrepreneurial challenge
- Don’t ask everyone – approach those who are more entrepreneurially inclined and make an offer that is hard to refuse. The wrong backers can take up too much of your time and cause too much grief during the process
- Think about how you can share the upside and the downside – this doesn’t mean giving up equity
- Be clear on the terms of the funds, whether these are equity or debt. If equity, make sure you consider a shareholder agreement so the rights of all shareholders are clear. You will also generally want the right to control minority interests at certain times (i.e. a drag along clause so you can enter into a contract to sell the equity in the business if an attractive offer comes along)
- Seek financial advice.
Your suppliers will be loathe to become your banker especially when this is due to a lack of working capital. However, it may sometimes be in their best interest to stand by you, back you with your business ideas, and benefit from the additional growth in your business. They are interested in growing their business and your success is their success. This does not mean suppliers are ready to back any of your ideas and provide either an indefinite terms of trade or provide funds or goods as seed capital in your business.
A few thoughts:
- Create good working relationships with your suppliers by paying your bills on time
- If you can’t pay on time, communicate effectively and frequently and inform them how you intend to deal with a late payment. This helps retain their confidence and builds significant credibility and loyalty if you deliver on your word
- If you want a supplier to back you in your business, do your homework and present your idea on how it can be hugely beneficial to both your businesses. It doesn’t mean giving up equity in your business, as long as the return and risk mix is adequate
- Collaborating with a number of parties to fund a business idea reduces the risk for one person and, if done carefully, brings a wealth of experience and contacts to the business idea which can help increase chances of success.
The Australian Taxation Office (ATO) is often used by cash strapped business as a source of working capital by non-payment or lodgement of liabilities. The ATO can impose significant penalties and even make directors personally liable for debts of the business under certain circumstances. The ATO will not co-invest in your business, however, with proactive management, they may accommodate an extended payment plan for any outstanding debt as they want you and your business to succeed.
In the right kind of business, what better source of additional funds for growth than people who understand and are passionate about the business? Having your employees financially invested in the organisation might just help cement long term commitment and generate future interest in helping the business succeed.
It is well worth being cautious about obtaining finance from employees, however, as unmet expectations can create tension within your internal business environment.
A few thoughts:
- Don’t be fearful of losing control to the employee(s). It is not about employees becoming the boss – be absolutely clear on control and ensure everyone is aware that funding the business does not absolve them of obligations as an employee
- Ensure you have the ability to redeem employee shares in the instance where they need to have their employment terminated
- Document and professionalise the approach to raising the finance. Set out the risks, opportunities, expectations and obligations at the outset.
- Be selective of who you approach, but you might also be surprised at who really does wish to back the business with their own funds!
- It isn’t about giving up equity. You can still keep it all as long as you can structure the right funding mechanism to attract and reward your backers. Nevertheless, sharing the ups and downs through common ownership has been proven time and again to create a successful team, at least at the senior level.
Understand that most businesses struggle and fail from bad management decisions – so back yourself, surround yourself with good people and remain passionate about what you do.
If you would like to learn more about how to obtain finance for your business, please contact your local BDODrive adviser.