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Strategic funding with investors and lenders

To reach goals or turn a business idea into a reality, your business might need a funding injection. This is often a loan or money from investors.

Each type of funding type has its pros and cons. Here’s how to pick the best option for you — and how to prepare an investment pack to help you get the money.

Make a good funding match

The type of funding you go for depends on:

  • the stage your business is at
  • what you need the money for
  • how long you need it for.

It’s hard for new businesses to take out loans. Lenders usually want to secure the loan with assets, which you might not have yet. Some types of investors like to come on board early, but most new businesses start with their own money.

As businesses grow, they usually have a mix of loans and equity investment. Loans typically cover operating expenses, and investors usually fund growth:

  • Lenders look at your business’s past performance and rely on your assets for security if you can’t make repayments.
  • Investors are interested in your business’s potential to make money.

Be strategic about who you borrow from, or who invests in your business.

  • When choosing a bank for your business accounts, think about your long-term goals. What support and products are on offer for small businesses? If you want to go offshore, which banks have strong connections in your preferred country or region?
  • If seeking an investor, find someone with experience in your industry and region. They’ll be more interested in you if there’s a connection — and scope to put their skills and contacts to good use.

Your preferences come into it too. Investors are probably not the right choice if you:

  • want sole control — and ownership — of your business
  • are in business to have an easier lifestyle
  • have little appetite for risk.
Been in business before? Lenders and investors see this as valuable learning experience — even if that business failed.

Been in business before? Lenders and investors see this as valuable learning experience — even if that business failed.

baker with cakemixer

Case study

Dani's investor

Dani plans to build a new commercial kitchen so she can sell to more cafes and restaurants. She can’t afford to pay for the $500,000 kitchen fit-out herself. But she knows it makes financial sense to take this big step.

So Dani looks at whether it’s better to get a loan or seek an investor who’s interested in helping small but ambitious food businesses to grow.

Her bank is willing to lend her some of the money, using her current kitchen equipment to secure the loan. But she also decides to explore more options before making a final decision. The bakery has an established track record and years’ worth of financial statements, so she could be eligible for a cash flow loan or line of credit from a lender.

She talks to a growth advisor at her local Regional Business Partner Network about her plans and her financial model — for details, see Dani’s story on our financial model page.

The advisor puts her in touch with Chris, a local restaurant owner who likes to invest in small food businesses. This will mean giving up a stake in her business. But she’ll get money for the fit-out and new connections.

Chris is one of the bakery’s Facebook fans, having tried her cinnamon scrolls at a school fundraiser. He likes her plans, but wants a 20% return on his investment within 5 years. To see if that’s realistic, he asks for a financial model of expected costs and earnings.

Dani and her accountant add a 20% discount rate — also called desired return rate — to their financial model to calculate the total present value (also called net present value or NPV). It’s positive, which shows the bakery is expected to cover costs and earn profits.

Next, they adjust expected costs and earnings, as Chris will help bring in more business customers. The total present value rises, and the internal rate of return is now 35% — much higher than Chris’s required 20% return. These numbers mean Dani and her accountant feel confident it will work out for all involved.

It’s a done deal. Chris gives Dani money for a new kitchen. She signs a supply agreement to sell to Chris’s restaurants. He also introduces her to other potential business customers, including the regional manager of a supermarket chain who likes to stock local products.

How to appeal to funders

Potential lenders and investors will look for three things:

  1. Desirability — is there demand for your product or service?
  2. Viability — can your business be successful?
  3. Feasibility — are you capable of making it work?

You can show your business is desirable, viable and feasible in a business plan.

Lenders and investors want reassurance you’ve thought about how your business is going to work, and what kinds of things might trip you up.

Every lender or investor will have a different appetite for risk. This might depend on the industry you’re in and/or the products or services you offer.

Risks to consider

Investors and lenders are taking a risk when they team up with you. They need to be confident you have:

  • an achievable plan
  • the skills to manage your business and reach goals
  • a good grasp of your financial figures.

You’ll be expected to talk about your revenue, gross profit and net profit off the top of your head. Not knowing these basics is a warning sign you don’t understand the financial side of your business.

Be honest about your long-term plans. Relationships sour when it turns out everyone has a different idea about where the business is going — especially if it puts the investor’s or lender’s money at risk.

Investors will expect you to stick around, as they’re investing in you as much as the business itself. Talk about their plans too. Make sure you have the same idea about where the business is going. Most investors want to become board members, get involved in decision-making and exit after a few years. Exiting can mean selling the business. Do their plans match yours?

Get advice

It’s worth getting professional advice from the beginning, and it’s vital the more your business grows. Start with your bank’s business advisors. Using your bank’s services helps build a relationship — they’ll get to know your business from the start.

The Regional Business Partner Network has a local office in each region of New Zealand. Their advisors can connect you with business networks and other advisors to help in different areas of your business.

How we can help (external link) — Regional Business Partner Network

Always compare funding options to bank interest rates — these set the benchmark.

Always compare funding options to bank interest rates — these set the benchmark.

Don’t accept offers of fast or unsecured loans without carefully checking the terms.

Don’t accept offers of fast or unsecured loans without carefully checking the terms.

This type of financing tends to come with higher interest rates.

Borrowing money

Stress test the options

Before pitching for a loan or investment, work out how your business will fare in good and bad times. What will happen to your financial figures if interest rates change, or your sales don’t go as well as expected? Will you be able to afford loan repayments, or meet the demands of investors?

Financial modelling is a way to explore how your finances might fare in good times and bad. It’s also useful to compare funding types, eg interest rates from different lenders.

See the step-by-step guide on our financial modelling page— there’s also a modelling workbook so you can test good, bad and in-between scenarios.

designer with dresses

Case study

Anika's crowdfunding appeal

Clothing designer Anika needs money for a bulk order of her new fastenings. It’s a quiet time of the year for sales of her dresses, so she needs another source of capital.

She’s got a lot of social media followers, including many loyal customers. If she can come up with a good crowdfunding pitch, they will help spread the word — and some will pledge money.

Anika isn’t keen on equity crowdfunding, as a stake in her business won’t appeal to many of her followers. But they love discount offers and styling tips, so she decides to try reward-based crowdfunding.

She first asks her Instagram followers what type of rewards might interest them. She uses this to put together a list of rewards and how much to contribute for each. As well as discounts and free limited edition buttons, she offers three personal styling sessions to those who contribute the most money.

She then makes a video showing off the buttons and the styling sessions.

Once she posts the video with a link to her crowdfunding appeal, the interest is instant. The smallest rewards go first. By the end of the first week, two people have pledged money for personal styling sessions. She hits her fundraising target, and is able to pay upfront for a bulk order of fastenings.

Sell your business story

Investors want to know you’ll be able to make money, and lenders want to be confident you’ll pay them back — even if your business fails. They’ll both want to know personal information as well as financial details. Be prepared for difficult questions about what you’ll do if things don’t go to plan.

Be ready to tell the story of your business, where it’s headed and why you need the money. You’ll have to back up your story with hard data too.

You’ll need to explain exactly what the money is for and how much you need. It’s easy to underestimate, so it’s worth talking to a financial advisor.

Investment packs

If you’re pitching to potential investors in person, prepare a presentation and an investment pack. If you opt for crowdfunding, either equity or reward-based, check your chosen website for advice.

Make sure you can talk about, or show:

  • what your business does, or will do
  • the problem you will solve for potential customers
  • why people will choose your solution
  • details about your market and industry, eg size, competitors
  • a business plan setting out your goals, and how you’ll achieve them
  • financial forecast or model showing how much money you need
  • financial performance information, eg income statements and cash flow statements for the past few years
  • who's involved, eg shareholders, key employees, long-term suppliers or clients.

Case study

Sam's asset finance loan

Sam is about to buy a van for his house-painting business. He’s got a 20% deposit but needs to borrow the rest.

Sam is trying to decide between paying by credit card, or getting a loan. A secured loan will be tricky to get — his current vehicle isn’t worth enough. Nor can he use his home as security as he lives in a rental property.

From the financial model created by his partner Alex, Sam is confident he can afford loan repayments with interest up to 13%. Rates for vehicle loans vary, so it’s good he knows an upper limit. For details, see Sam’s story on our forecasting page:

Using his credit card feels risky. It’s 0% interest for the first year, but then rises to 20%.

An unsecured loan from his bank is an option, but again the interest rate is higher than Sam would like.

Then there’s asset finance, offered by his bank and others, to buy equipment, machinery or vehicles. The bank will buy the van for Sam, then he’ll make monthly repayments. Lenders set interest rates case by case.

Sam also looks into a range of credit lenders, as assets aren’t always required for security. Instead, they look for good financial performance, based on financial statements for the past 18 months. Because Sam’s cash flow has only just started to improve, he’s not eligible.

Alex does several versions of the financial model, forecasting repayments for:

  • asset finance, using his bank’s interest rate
  • credit card only
  • credit card in the first year, then switching to an unsecured loan.

Asset finance works out best. Sam fills out online applications with several banks and talks it over with their advisors.

Soon he’s loading his gear into a new van, owned — for now — by his chosen bank.

Funding is unique to each situation and what fits best will vary from business to business.

Funding is unique to each situation and what fits best will vary from business to business.

To pick the right funding type — or mix of types — think about your business’s needs and growth potential. Make sure you approach funders whose appetite for risk and return match your own.

Here’s an overview of how funding types typically fit with stages in a business’s lifecycle. If you’re on to your second or third business, you’ll likely have more options than someone new to business.

It’s common to have funding from a variety of sources. Which ones you use will depend on factors like:

  • your stage of business, eg starting out, growing fast
  • your industry
  • how appealing you and your business — or your business idea — are to funders.

Each section includes pros and cons of key funding types for that stage of business. It’s worth exploring all sections to find funding options to suit your goals and your finances.

Idea for a business

Good fit for: Bootstrapping, asset finance.

When you’ve got a great idea but not much else, you’ll need to rely on your own money or investment from friends and family. Most new businesses need $50k-$100k to get off the ground.

It’s difficult for those new to business to get a loan. If you do, you’ll be asked to use personal assets as security, eg your house. Even unsecured loans are hard to get because lenders will be looking at your cash flow, which might be non-existent.

Bootstrapping

This means using your own money to start a business.

Check out the introduction to bootstrapping — and borrowing from family and friends — on our funding page.

Asset finance

Asset finance is a loan to pay for a particular asset, eg a delivery van. The lender buys the asset for you, then you pay them back in monthly instalments. The loan is secured against the new asset, or existing assets as well. They’re usually shorter-term loans, from six months to five years.

Make sure you understand the terms before signing anything.

Upsides include:

  • Interest rates can be good if you go through a major bank.
  • You won’t have to pay a big lump sum.
  • Depending on the terms of your loan, you may be able to own the asset outright at the end of the loan period, upgrade it, or return it.

Downsides include:

  • It can be more expensive overall to use asset finance rather than pay in one go.
  • The whole asset isn’t tax deductible while you’re paying for it — only payments in the liabilities column on your balance sheet.

Early days - testing the market

Good fit for: Reward-based crowdfunding, peer-to-peer lending.

Secured loans will still be hard to come by due to your short track record and lack of business assets. Lenders who look at cash flow for security won’t be interested either, as you’re likely to still be burning through cash and earning little income.

Crowdfunding

Reward-based crowdfunding is through websites like Kickstarter or Pledgeme.

Upsides include:

  • Appeals can be launched with just a prototype product.
  • Feedback can cast light on ways to tweak your product or service.
  • Useful for market validation, as it shows people are interested in your product or service.

Downsides include:

  • You might not hit your fundraising target.
  • It’ll take time to put together a compelling offering.
  • Going public means someone else might use your idea — make sure you protect your intellectual property, eg with a patent or registered design.

Peer-to-peer lending

Websites like Lending Crowd or Harmoney connect borrowers with people willing to lend small and large amounts.

Upsides include:

  • Applying can be less time consuming than arranging a bank loan.
  • Interest rates can be lower than banks.
  • Loans are unsecured so you won’t need to use an asset for collateral.
  • You usually won’t be asked to give up equity in your business — but make sure you understand the terms you agree to.

Downsides include:

  • Missed payments affect your credit score, just like a bank loan.
  • If you have a low credit rating, interest rates can be high.

Types of intellectual property

Launching your business

Good fit for: Cash flow loans, angel investors, asset funding (see business idea, above).

Which is the best fit partly depends on your industry. Banks are reluctant to lend to businesses without plenty of assets, so it’s hard for those in hospitality or tech to get secured loans. Some lenders look at cash flow — useful for businesses not yet making a profit but with high turnover.

Cash flow loans

These are backed by your expected cash flow, not your assets. They’re usually used to help a business cover operating costs for up to a year.

Upsides include:

  • No need to offer assets as collateral.
  • As your cash flow improves, you can borrow more.
  • Even those with lower credit ratings may be eligible — if cash flow is good.

Downsides include:

  • Higher interest rates and fees compared to bank loans.
  • You may be asked to personally secure the loan, eg against your house or car. If your business can’t pay it back, you’ll have to pay it back yourself.
  • Payments are taken straight out of your bank account — tricky if your cash flow has peaks and troughs.
  • It may automatically renew if not paid back in time. This means more interest, and a renewal fee.
  • Some online lenders are actually brokers who charge a fee to connect you to a lender.

Angel investors

Successful entrepreneurs who put money into innovative new businesses. They typically pick businesses in their field of expertise, so their knowledge and experience can help it succeed. Angels want to have influence in your business. For some, this will mean a seat on the board. This might suit you or be a big turn-off.

Check out the introduction to angel investors on our funding page.

Angel investors

18 months or more in business

Good fit for: Secured loans, lines of credit, equity crowdfunding, funding from profits.

It’s easier to raise capital as you’ll now have:

  • a proven business model
  • income
  • financial statements showing your performance over time.

Even if your statements are in the red, investors and lenders will be interested if you can show how your business will make money. It’s worth also thinking about asset loans — for details, see the business idea section above.

Secured loans

Typically from a bank, these require you to have an asset the lender can take if you can’t keep up repayments. The size of the loan depends on the value of your assets, including invoices, accounts receivables and stock. Banks use LVR — loan to value ratio — to work out how much to lend, eg if your assets are worth $2,000 and the LVR is 60%, you can borrow $1,200.

Upsides include:

  • Interest rates are lower than for unsecured loans.
  • For loans longer than 12 months, terms can usually be structured to minimise monthly repayments.
  • It builds a relationship with your bank — a good repayment history means future funding requests are more likely to be approved.

Downsides include:

  • If you don’t keep up repayments, you could lose the asset used to secure the loan.
  • A personal asset might still be used as security. Businesses of this age are still seen as new, and therefore risky.
  • Longer loans might have lower interest rates than short-term loans, but the overall interest paid might work out to be higher. Compare total repayments.

Lines of credit

A set amount of credit — either time to pay a bill, or a dollar amount — from a supplier or lender. You don’t have to use it all. It’s like an overdraft managed in a separate account, or a revolving mortgage. Your credit limit depends on your business, but it’s typically between 10% and 50% of the value of your cash flow.

Line of credit lenders like Spotcap prefer to fund those with experience — even if a business venture has failed, you learn from mistakes.

Upsides include:

  • You’ll only be charged interest on the credit you use.
  • There’s often no need to offer personal guarantees.
  • It’ll help build your credit rating.

Downsides include:

  • There can be high fees.
  • If arranged through a bank, you may have to use a personal asset or director’s guarantee as security.

Equity crowdfunding

This type of crowdfunding involves offering part-ownership of your business, rather than rewards. Equity crowdfunding websites like Seed Invest and Snowball Effect connect business owners to potential investors. Pledgeme offers this as well as reward-based crowdfunding.

Upsides include:

  • You can sell shares without being listed on a public stock exchange.
  • As it’s an offering to the general public — with a low minimum investment, eg $250 — you might have a lot of shareholders.
  • Good PR for potential customers and other investors.

Downsides include:

  • There can be administration fees.
  • It will take time to put together a compelling offering.
  • You’ll give up part-ownership of your business.
  • Lots of shareholders means more admin.
  • These aren’t strategic investors — they give you money, but not expertise or contacts.

Funding from profits

This means reinvesting any profits in your business. Make sure you forecast future costs and income, and model if it makes financial sense to spend your profits on the business.

Upsides include:

  • No interest or dividend payments to third parties.
  • Your money can earn interest until you spend it.
  • It can be easier to quit a project when you don’t owe money.

Downsides include:

  • Unexpected costs may eat into your profits, leaving you short of funds.
  • You must set time aside to create a realistic forecast, and keep track of progress.
  • It can take a long time to build up enough money to achieve your goal.
  • Growing too fast can choke cash flow and stall growth.

Three to five years in — settled and/or primed to grow

Good fit for: Venture capitalists, convertible notes, trade finance, secured loans, funding from profits.

If you’ve got loans secured with personal assets, eg your house, switch to using business assets as security. See 18 months or more for details about secured loans and funding from profits.

Venture capitalists and private equity firms

Venture capitalists are interested in commercialised growth businesses at this stage, especially those with annual turnover of at least $10m and still growing. Private equity firms look for businesses with annual turnover of at least $20m, with proven business and cash flow models.

These investors often put in large sums, are more hands-on, and expect more control and ownership in return.

Check out the introduction to venture capitalists on our funding page.

Venture capitalists

Convertible notes

Loans that turn into equity later on — usually at a later funding round. Investors loan money with the understanding they’ll get equity in the company at a cheaper rate than later investors.

Upsides include:

  • It’s cheaper to issue convertible notes than equity.
  • Because it’s a loan, the valuation of your business is delayed until you decide to issue equity.
  • You won’t have to give up control to investors.
  • You’re less likely to have a deadlock where investors wait to see who else will invest.

Downsides include:

  • Some investors don’t like convertible notes because of the lack of control over the business, eg voting rights.
  • It can be difficult for investors to work out if they’re getting a fair deal.

Trade finance and letters of credit

This is for businesses that trade overseas only — it’s common among importers and exporters. Trade finance is when a bank guarantees a supplier you’ll pay for their product. The guarantee is called a letter of credit.

Upsides include:

  • The risk a supplier takes is covered by a bank, so suppliers will be more willing to work with you.
  • It’s secure — the transaction goes through a bank.

Downsides include:

  • There can be high fees.
  • It’s only for international trading.

New Zealand’s Credit Export Office helps small businesses by offering financial guarantees.

NZCEO in two minutes (external link) — Credit Export Office (NZCEO)

tech company owners

Case study

Merryn and Leni's profits

Siblings Merryn and Leni want to expand into Australia. They know there’s demand for their digital point-of-sale system — and they know it’ll cost about $200,000 to get established in Sydney.

They talk to potential investors at a pitch event hosted in their co-working space, but each wants a big stake in the company in return for the money. Is it worth it? Or can they fund it through a loan or their own profits?

A loan isn’t a realistic option for such a large amount of money. Tech companies tend to have few assets other than their employees, and people can’t be used as loan security.

One investor seems like a good match, but she wants a 40% return each year. To see what this will do to their future financial figures, Merryn goes back to her model — for details, see her story on our modelling page:

She looks at each year’s expected free cash flow, from which they would have to pay 40% to the investor.

The result is tight. The investor might get her desired dividend payments, but there would be little left over to reinvest in the business. The investor suggests she instead gets 40% when Merryn and Leni sell the business.

The siblings are reluctant to commit to selling the business. So Merryn reruns the model to see if they can earn enough to cover expansion costs themselves. If they save their free cash flow, their expansion into Sydney can be funded through organic growth within three years.

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