Funding: Too Much, Too Little, Just Enough
Finding the Right Start-Up Funding
Ideas do not Fund Businesses
Starting a business takes more than a great idea and enthusiasm, it also takes cash. Funding a start-up is rarely straightforward, with options that are ever-changing and needs that are highly specific. This post isn’t a guide to venture capital or crowdfunding, those deserve deep dives of their own. Instead, this is a high-level look at small business funding, with a few personal lessons learned the hard way.
It may not be the most exciting topic but it is essential. I always get concerned when I hear founders say ‘I’m not really into the numbers’, personally I think until a business is big enough to have a great finance manager you have to be in the numbers.
Banks have a Reputation for a Reason
I founded my first proper business towards the end of 2007. We had a solid business plan and knew what funding we were looking for. Nothing too extreme, a mix of founder investment and a plan for some backing from a bank. We pitched to several banks, all of whom were keen to work with us.
As discussions progressed we selected one bank and got into the detail. Our plan included some investment in equipment, general start-up costs, and some working capital. It had head room built-in to see us through about 18-24 months but was quite reserved, leading to an external cash factor of around £100k.
The bank were prepared to offer this but soon started to advise that we would be better only taking what we really needed in the first 12 months and coming back for more if we needed it later. They said returning later for some additional support would be no issue. In fact they went further, saying it would be cheaper, as after 12 months of trading they would be able to offer a better interest rate on any loans.
We were a little unsure of this but they were insistent it was the much better approach, so in the end we agreed and settled on £50k to start with matching our own investment. We were now in the early part of 2008 and set about getting the company off the ground.
Everything was going fine until the second half of 2008 when the global financial crisis hit. Our business was primarily in the events industry and the scale of the financial crisis had wide-reaching implications. The first impact for us was that many sponsors of events pulled budgets and part of our business model relied on the sponsor income. In general event organisers became nervous and trimmed budgets.
Initially this was not a major concern, our business was growing well but we did realise our growth would be slowed for a period whilst we adjusted our model and the events market settled. We were heading towards twelve months in, growing revenue but with the normal start-up cash flow woes, knowing the financial crash was probably going to put us under additional pressure for the next 12 months. No problem we thought, let’s go back to the bank and release some further cash in the way they had suggested.
I remember the meeting very well, we gave the bank a nice update on our progress, they were impressed and then we explained we needed to get to the level of funding which we had originally set in our plan to facilitate growth and provide a little extra headroom given the current environment.
“That will not be possible. The rules are different now” was the cold, matter of fact response we received. Naively we hadn’t really thought that the global financial crisis would impact our small loan requirement, we had met all the criteria and expected the original promise to be honoured. The bank would not budge. We considered switching banks but the doors were firmly closed elsewhere too. The banking rule book was torn up in 2008 and we were in the wrong place at the wrong time.
Our eventual solution was to raise additional funding from the founders and some small known investors, however, this meant diluting the shareholdings to some degree, something we had not wanted to do. Crowdfunding hadn’t really moved to mainstream in 2008 and it felt like most of the finance sector had gone into hibernation.
Our experience with our bank at the time was no different to that of many other small businesses (and something that was repeated in 2020 during COVID until the Government stepped in). Banks are businesses not charities, they don’t like risk and have no interest in your business. It is just a financial transaction. You may be 100% invested in your business, banks do not care one bit provided your account is in credit and you are servicing any loans. Banks do not operate on pity.
When negotiating the original bank account, overdraft and loan we met our ‘Business Manager’ multiple times, we met him again several times when discussing the additional finance. We then did not meet or see him (or the subsequent business managers) for the next 12 years. The best we could get was calling a business centre and being given the standard script. Infuriatingly, we’d get endless calls from the bank trying to sell us services but we could never speak to someone about our actual needs!
Perhaps we were unlucky in our choice of bank and business managers, however, plenty of other small business owners have related similar stories to me, it certainly taught us some lessons.
A Bird in the Hand is Worth Two in the Bush
The old proverb rings true, if we had taken the full amount at the start we would not have required the additional investors and could have ridden out the financial crash comfortably. Of course we did not know there was a financial crash around the corner, and surely something like that was a one off, well it was until 2020 when COVID hit.
The lesson is to be very sure in your own planning on what you need and whether you can afford it. Yes listen to advice but always remember there may be motives behind that advice which could mean it is not in your best interest to follow it.
Banks and other finance institutions are all too happy to make promises to win you as a customer, the tune rapidly changes if you do not meet their requirements, and those requirements can change. The crash of 2008 and the financial regulations which followed changed the way banks operate when it comes to lending. The days of a people orientated local bank manager with whom you could discuss things are long gone.
How Much is Too Much?
In the early days after founding our business we often crossed paths with new start ups and frequently discussed funding, seeing a wide range of funding options that businesses had gone after. We saw some who had very little funding, almost nothing, and at the other end of the scale there were a few who had a million or more from investors. What was interesting is that the level of funding did not correlate to the future success of the business.
There were a few with very limited funding who had to throw in the towel very quickly as they had underestimated how long it would be before they would become cash positive. Others with a bit more funding and careful management went on to thrive. Another company I knew one of the founders of was very open about how they had secured over a million in initial funding. They went off hiring staff, renting premises and operating like they were a well established business. In less than two years they had spent all the cash and folded.
In the early 2000s I was running an engineering department working on large scale hosting supporting dotcom start-ups. I would sit in meetings with customers who had secured large amounts of funding but often with somewhat vague business plans. They were convinced they would be successful because they had financial backing. Few of those companies survived very long.
Too much investment can be a bad thing, perhaps being backed by an investor with a significant sum creates a false sense of security which distracts you from the basics.
At the low end, fighting cash flow day-to-day is a real chore and can quickly drive a business over the edge. The problem with too much capital is that it tends to encourage poor behaviours and control, leading to money flowing out of the company at an alarming rate. Any downturn in the business environment, such as the financial crash, is likely to drag down a business which is careless with cash far faster than those that treat every penny spent very carefully.
I have often related a story that if we had started our business a year or so earlier then we would have probably got into real problems during the financial crash, luckily we had only been going around a year and were being very careful on our finances, we were growing but very conservative on spend so this put us in a good position to ride out the crash. I think if we had had another year of growth we would have been investing more heavily on further rapid growth and the impact from the crash would have been far more significant for us.
On the flip side if we hadn’t started the business when we did then the chances are it would never have happened as it is highly unlikely we would have taken the risk of trying to start-up during the 2008-2009 recession period, and probably for longer afterwards.
Consider Your Options Carefully
Spending time examining the options for raising finance is a key part of start-up planning with a range of options which are ever changing. Alongside standard bank options of loans and overdrafts the UK Government typically promotes one or more start-up schemes which change on a regular basis. It is always worth checking what schemes are available, however, these schemes typically have requirements which are difficult to satisfy, often requiring heavy guarantees and investment from the founders, leading to low application success rates. We looked at several and in the end the basic offers from the banks were better, easier to apply for and had less onus on the founders.
Beyond loans there is the territory of investment based on equity in the business. It is often tempting to persuade friends and family to invest in your business but it is important to be conscious of the fact there is a high risk they may lose their investment which can lead to tensions!
Most options for finance are likely to require personal security from the founders, expecting the founders to take their share of risk. This security is often defined as ‘joint and several liability’ which means any one of the individuals signing the security deed can be held liable for the full amount.
For example a bank may match the investment from the founders in the form of a loan and if there are four founders each putting in £20k, the bank would advance a further £80k. With joint and several liability, if the company folds or defaults on the loan then any individual founder would be liable for the full £80k loan if the other founders do not meet their liability.
Beyond Start-Up
Your start-up funds will only go so far and as you will be told relentlessly - cash flow is the life blood of a business. Lack of cash kills businesses and it can happen quickly if you are not totally on top of cash flow forecasting.
Ongoing cash flow management deserves a separate post as it is such an important topic and needs to cover options such as factoring and invoice discounting.
Final Thoughts
Understanding what your start-up funding requirements are is critical to the success of the business. Too little will starve the business, too much may load the business with a debt which isn’t serviceable, or create a culture that I snot razor sharp on spending.
Loans are much harder to get than they used to be and will come with required security guarantees. They are often still the best option but take time to check the terms and ensure the payback is manageable. Remember it is just a financial transaction and the banks will aim to minimise their risk.
External investment may look attractive but in general is something you may want to hold back from until the business is established otherwise you could be giving away far too much equity at an early stage.
Getting the cash is only the first part, how you manage it in those earlier days is just as important. When I started the business I probably did not appreciate how much of my time would be spent managing finances. Personally I think a founder must understand the core elements of finance. They do not need to be an accountant but they should be able to understand the profit and loss, balance sheet and cash flow to a level which enables them to run the business effectively and know where all spend is going.