Each start-up has its own unique funding requirements. For example, a young software development company might only need $25,000 to cover the salaries of a few employees until its product is market-ready. A transport company, on the other hand, could require $400,000 to buy vehicles before it can start operating. For the software company, bringing an angel investor on board could be the preferable option as it doesn’t yet generate any revenue to pay off a bank loan. However, for the transport company, approaching a bank for vehicle financing is likely to be the best option.
Below we take a closer look at some popular sources of funding.
1. Bank loan
Bank loans typically need to be repaid according to a fixed repayment schedule. To receive a loan, entrepreneurs have to provide a comprehensive business plan with future financial projections. There are a variety of bank finance options available to businesses, including overdrafts, bridging finance, invoice finance, property and vehicle finance, and medium-term loans.
- Bank loans are paid off in relatively small instalments over a long period of time. However, entrepreneurs need to ensure their cash flow can support the monthly repayments.
- Start-ups don’t have to give away a stake in their business or share profits with the bank.
- Without collateral it is difficult for young companies to receive funding from banks.
- Banks charge interest on loans, which means the total amount that has to be repaid is more than the original amount borrowed. It is therefore important not to borrow more than is required as interest will have to be paid on money not actually used in the business.
- Banks normally don’t provide additional operational support or mentorship.
“Entrepreneurs need to know that a great idea on its own is not sufficient. They should show a road map that demonstrates that the combination of their idea and the investors’ money will lead to wealth creation.” – James Mwangi, CEO, Equity Bank Group
2. Equity investment
Equity investment involves providing funding in exchange for shares of a company. Essentially an equity investor becomes an entrepreneur’s new business partner. Angel investment and venture capital (VC) are two types of equity investment. Angel investors are typically wealthy individuals who invest their own money, while VC firms invest other people’s funds. Whereas angel investors invest relatively small amounts into young companies with little more than an idea, VCs look for bigger investments in start-ups with a proven business model. Equity investors aim to one day sell their shareholding for a higher price than what they initially paid for it. They have a long-term outlook and stay invested in companies for many years.
- No monthly repayments
- Long-term partnership
• Equity investors normally provide operational support and access to their network of business contacts.
- Entrepreneurs need to give away shareholding in their start-ups
- Equity investors whose goals are not aligned to that of the start-up founder can cause significant friction in a business
“Startups are very risky… entrepreneurs are not perfect but we want to take them from where they are to a place where they are going to be stars.” – Mbwana Alliy, managing partner, Savannah Fund (sub-Saharan Africa-focused equity investment fund)
Crowdfunding is the process of raising funding from multiple investors. Popular online crowdfunding platforms include Kickstarter, Indiegogo and RocketHub. Entrepreneurs submit a detailed description of their project, stating the amount required as well as the rewards on offer to investors. Depending on the platform, rewards can be in the form of equity, interest on loans or more creative incentives such as an invitation to the project’s launch event.
- Access to a large number of potential funders
- Investors don’t have to contribute large amounts
- Crowdfunding platforms can be used to create awareness about your business before it is launched. They can also be a source of valuable feedback on a project or be used to iron out any issues.
- With thousands of projects featured on popular crowdfunding platforms, it is difficult to stand out. Many crowdfunding campaigns never receive funding.
- Creating an attractive profile page with regular updates can be time consuming
- Business ideas can easily be copied from crowdfunding platforms. Start-ups therefore need to ensure their ideas are adequately protected before submitting them.
“To date, we have financed our company through a variety of channels, including a traditional round of angel investment, prize money from competitions, crowdfunding (using Kickstarter) and our own founders’ capital. Given the fact that Tomato Jos is a social enterprise, we are also exploring other funding avenues such as grants, fellowships, and a social bond. With any outside investment (whether debt or equity), we make sure that the investor is very clear on both the financial and the social goals of our mission.” – Mira Mehta, co-founder, Tomato Jos (Nigeria-based tomato paste producer)
4. Additional funding sources
Grants: Grants are non-repayable funding provided by governments or non-profit organisations. Entrepreneurs usually need to account for how they spend a grant.
Entrepreneurship competitions: Throughout Africa there are numerous entrepreneurship competitions through which winners can receive a cash investment into their businesses as well as mentorship.
Development finance institutions: These government-backed organisations support entrepreneurship and economic development through high-risk loans with favourable repayment terms.