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.
The type of funding you go for depends on:
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:
Be strategic about who you borrow from, or who invests in your business.
Your preferences come into it too. Investors are probably not the right choice if you:
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.
Potential lenders and investors will look for three things:
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.
Investors and lenders are taking a risk when they team up with you. They need to be confident you have:
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?
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
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.
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.
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.
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:
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.
It’s common to have funding from a variety of sources. Which ones you use will depend on factors like:
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.
The different funding types are:
This is when you use your own money to start a business.
This is a loan to pay for a particular asset like a delivery van
Make sure you understand the terms before signing anything.
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 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.
Reward-based crowdfunding is through websites like Kickstarter or Pledgeme.
Websites like Lending Crowd or Harmoney connect borrowers with people willing to lend small and large amounts.
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.
These are successful entrepreneurs who put money into innovative new businesses.
Typically from a bank, these require you to have an asset the lender can take if you can’t keep up repayments.
A set amount of credit — either time to pay a bill, or a dollar amount — from a supplier or lender.
This type of crowdfunding involves offering part-ownership of your business, rather than rewards.
This means reinvesting any profits in your business.
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.
Venture capitalists are interested in investing in startups and small businesses that have the potential for strong and rapid growth.
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.
This is for businesses that trade overseas only — it’s common among importers and exporters.
New Zealand’s Credit Export Office helps small businesses by offering financial guarantees.
NZCEO in two minutes(external link) — Credit Export Office (NZCEO)