SOURCES OF FUNDING

NOVEMBER 25,2019
ROOTS IVY
LO2

Asses the various methods through which organization access funding and when to use
different types of funding

When starting a new business, or growing the business the first concern that must be
addressed is how to properly fund it. Funding a business is never easy and never cheap. You
should explore all possible options in order to find the most suitable means. By doing your
homework and choosing the best funding option, you can save money in the long run.
Some of them;

1. Bank Loans

Having good credit history is very important in obtaining a bank loan as a means to fund a
business. Your credit history provides the financial lenders with an idea of your ability to pay
off debts. Most banks require you to provide a business plan that should reflect the
products and services of your business as well as your company mission. The plan also
should include financial predictions to allow lenders to see how your company will be able
to come up with sufficient income in order to settle loan payments.

2. Government Grants

The government can provide capital for a business in the form of a grant. A grant usually is
designed to promote economic growth or to instigate research for a particular industry.
Options will vary depending on the industry. The Houston Small Business Administration
may be able to help you find a list of grants that apply to your industry.

3. Government loans

Another funding method is through micro loans from local government agencies. As its
name suggests, micro loans are small loans to help you get your business going. Non-profit
organizations provide services aimed at helping entrepreneurs and boosting the growth of
the local economy.
4. Venture Capitalists

Venture capitalists can provide funding for small business. Venture capitalists are groups of
people who pool their funds together to invest in new technology. They are often hands-on
with the management of the business and provide ideas and guidance on running the
business.

5. Angel Investors

Angel investors generally offer large amounts of money, so the entrepreneur must be
prepared to provide them with a percentage in ownership, stock options and a return on
investment when working out the deal. If you don't want to give up complete business
ownership, angel capital may not be a suitable funding method for you.

Advantages and Disadvantages of bank loan

Advantages

Bank loans are available to finance the purchase of inventory and equipment as well as to
obtain operating capital and funds for business expansion. These loans are a time-honored
and reliable method of financing a small business, but banks often only finance firms with
substantial collateral and a long track record, and the terms they offer are often very strict.
Business owners should weigh the advantages and disadvantages of bank loans against
other means of finance.

Keep Control of the Company

A bank loans money to a business based on the value of the business and its perceived
ability to service the loan by making payments on time and in full. Unlike with equity finance
where the business issues shares, banks do not take any ownership position in businesses.
Bank personnel also do not get involved in any aspect of running a business to which a bank
grants a loan. This means you ghet to retain full management and control of your business
with no external interference.

Bank Loan is Temporary

Once a business borrower has paid off a loan, there is no more obligation to or involvement
with the bank lender unless the borrower wishes to take out a subsequent loan. Compare
this with equity finance, where the company may be paying out dividends to shareholders
for as along as the business exists.

Interest is Tax Deductible

The interest on business bank loans is tax-deductible. In addition, especially with fixed-rate
loans, in which the interest rate does not change during the course of a loan, loan servicing
payments remain the same throughout the life of the loan. This makes it easy for businesses
to budget and plan for monthly loan payments. Even if the loan is an adjustable-rate loan,
business owners can use a simple spreadsheet to compute future payments in the event of
a change in rates.
Disadvantage:
Tough to Qualify

One of the greatest disadvantages to bank loans is that they are very difficult to obtain
unless a small business has a substantial track record or valuable collateral such as real
estate. Banks are careful to lend only to businesses that can clearly repay their loans, and
they also make sure that they are able to cover losses in the event of default. Business
borrowers can be required to provide personal guarantees, which means the borrower's
personal assets can be seized in the event the business fails and is unable to repay all or part
of a loan.

High Interest Rates

Interest rates for small-business loans from banks can be quite high, and the amount of
bank funding for which a business qualifies is often not sufficient to completely meet its
needs. The high interest rate for the funding a business does receive often stunts its
expansion, because the business needs to not only service the loan but also deal with
additional funding to cover funds not provided by the bank. Loans guaranteed by the U.S.
Small Business Administration offer better terms than other loans, but the requirements to
qualify for these subsidized bank loans are very strict.

Advantages and Disadvantages of Venture Capital

There are various deciding factors which contribute to the decision of whether a company
should go ahead with venture funding or not.

ADVANTAGES OF VENTURE CAPITAL

OPPORTUNITY FOR EXPANSION OF THE COMPANY

Venture Capital provides the company with an opportunity to expand. This would not have
been possible through other methods like bank loans. Bank loans require collateral and
there is an obligation to repay the loan. However, in venture capital, the investors
themselves are ready to take the risk as they believe in the company’s long-term success.
Therefore, venture capital financing is beneficial for start-ups with high initial cost and
limited operating history.

VALUABLE GUIDANCE AND EXPERTISE

Besides capital financing, venture capital is also a source of valuable guidance, expertise,
and consultation. A member from the venture capital firm is usually appointed to the board
of the start-up company. This allows the active involvement of the venture capitalist in the
company’s decisions. As venture capitalists have experience in building and expanding start-
ups, their expertise and guidance can prove to be beneficial. They can help with building
strategies, technical assistance, resources, etc. in order to make a business successful.

HELPFUL IN BUILDING NETWORKS AND CONNECTIONS

Venture capitalists have a huge network of connections in the business community. These
connections could be advantageous for the start-ups to grow and become successful. They
can help the start-up to enter into alliances with potential customers or business houses.

NO OBLIGATION FOR REPAYMENT

There is no obligation to repay the venture capitalist investors if the start-up fails or shuts
down. Hence, venture funding is essential for start-ups. It does not leave the start-up with
the burden to pay back as is the case with bank loans.

VENTURE CAPITALISTS ARE TRUSTWORTHY

VC’s are strictly regulated by regulatory bodies. For instance, In USA, VC’s are regulated by
U.S Securities and Exchange Commission. They are subject to similar regulations as any
other form of private securities investments. Also, know-your-customer (KYC) and anti-
money laundering regulations may apply since a large number of venture capital funds are
provided by depository institutions and banks. It’s a rarity to see a VC perform an
unscrupulous activity.

EASY TO LOCATE

It is very easy to find and locate VC within minutes, investors, as they are documented in
various directories. This reduces the time, efforts and money involved in searching venture
funding. One can find a VC quickly and efficiently. For instance, you can get a huge list of
venture capital firms by typing on any search engine.

DISADVANTAGES OF VENTURE CAPITAL

DILUTION OF OWNERSHIP AND CONTROL

Venture capitalist provides huge capital to the start-ups in return for a stake in the equity of
the company. If the start-up succeeds, then it helps them earn tremendous amounts of
profit. VC’s usually become a part of the Board. They actively participate in the company’s
decision-making. VC’s will want to protect their investments. If there is a difference of
opinion between the VC and the start-up founder, then things can get chaotic. Any major
decision requires the consent of investors.

EARLY REDEMPTION BY VC’S

A VC may decide to redeem the investment within 3 to 5 years. Their primary focus is to
earn capital gains. Venture capital may not be suitable for an entrepreneur whose business
plan will take a longer time to provide liquidity.

LONG AND COMPLICATED PROCESS

The start-up company’s owner should first present a detailed business plan. Thereafter, the
VC analyses the business plan in detail. Then, a one-on-one meeting is conducted to discuss
the business plan in detail. Later, if the VC agrees to go ahead with the funding then due
diligence is done to verify the details. If the due diligence is found satisfactory then only the
VC will offer a term sheet. Therefore, venture capital funding is often found to be a lengthy
process.

VC’S TAKE A LONG TIME TO DECIDE

Venture Capital funding involves a huge amount of risk. So, VC’s usually takes lots of time to
decide whether they want to undertake investment or not. Venture funding may be a great
source of availing funds for the start-ups. However, the long wait before receiving the funds
is a huge drawback.

APPROACHING A VC CAN BE TEDIOUS

A lot of investment opportunities through uninvited emails overburden the VC’s. Due to this
a lot of business proposals go unnoticed. One of the ways to approach the VC is through a
mutual connection.
MAY REQUIRE HIGH RETURN ON ORIGINAL INVESTMENT

Some VC’s require high ROI within the next three to five years of investment. If your start-up
will need more time to generate high ROI, then opting for VC may not be the right choice. As
expectation of higher ROI may cause a high level of stress.

MAY RELEASE THE FUNDS FROM TIME TO TIME

Because venture funding involves a huge amount of capital, the VC may not release all the
funds at the same time. Most of the contracts require the start-up company to reach certain
milestones in order to receive the funding, which they originally requested. This creates
undue pressure on the start-up company.

MAY LEAD TO UNDER-VALUATION

Venture Capitalists are in a hurry to sell off their equity stake. Therefore, they may
pressurize the owner of the company to list the company. This untimely listing of the
company could result in under-valuation of the company’s shares. This could prove to be a
disadvantage for the company’s owner.
Angel Investors
Using their own money, angel investors specialize in providing financial backing for small-
business owners and entrepreneurs during the startup phase and beyond. These investors
can sometimes mean the difference between an idea becoming an empire or never getting
off the ground. You know how real estate investors purchase up tons of land? Angel
investors are very similar, only they deal in ideas and businesses.
Advantages and Disadvantages of Angel Investors
All funding comes with risks, however. For example, seed investors can result in you having
to report to numerous stakeholders. Unlike seed investors, a sizable loan from the bank
means you’re only held accountable by the bank. But a bank loan often translates into hefty
interest rates and in many cases, less money than you’d get from an investor.
Like other forms of financing, angel investors have their own pros and cons. Let’s take a
look.
Advantages
Angel investors are willing to take risks
Angel investors are often established entrepreneurs who understand the degree of risk
involved with establishing a small business. Unlike banks, angel investors aren’t afraid to
 throw investment capital at an idea that seems like it has potential. This is generally the
result of several things:
 They have an investor network and can get multiple people to invest.
 They’re well-versed in business development and have the foresight a bank lacks.
 Because of their entrepreneurial background, they know a good investment opportunity
when they see one.
 They have private equity to spare and don’t have the same concerns as a bank.

The money isn’t a loan

When you take out a small-business loan, the bank expects you to pay it back, regardless of
whether your venture actually succeeds. Angel investors operate under a different set of
rules. They provide you with the money you need to get going and, in exchange, they get an
ownership stake in the business. If your startup takes off, then you both reap the financial
rewards. If the business fails, the angel investor doesn’t expect you to pay them back.
Note: This does mean the angel investor might have an exit strategy in place if things aren’t
looking good. The wrong decisions can doom early-stage companies very early on. In which
case, the remainder of the angel investment might be pulled.

: Your odds of success increase

Typically, angel investors bring years of experience to the table, and they already know the
ropes when it comes to starting a company. (Remember, these are often people with
numerous business ventures under their belt.)
If you’re seeking advice and guidance in addition to funding, an angel investor may offer a
wealth of valuable knowledge. With the right angel investor and mentor, you could end up a
part of the next generation of angel investors

Disadvantages

Angel investors may set the bar higher

An angel investor’s higher risk tolerance may come with the expectation of a high return.
They’re in business to make money, and when there’s a substantial amount of capital on the
line, they’re going to want to see a payoff. It’s not unheard of for angel investors to expect a
rate of return equaling 10 times their initial investment within the first five to seven years.
An unhappy angel investor could mean no more funding from them in the future.
Again, with a bank you’d be paying interest every month on your loan. This is simply the
tradeoff you make by going with an angel investor. There’s no interest now, but the angel
investor comes with the expectation that their angel capital will grow into something larger.
In short, the pressure to deliver can be intense.
(Hey, angel investors became wealthy individuals with large net worths by being smart and
aggressive.)

There are strings attached

Even though you’re not technically obligated to repay the investor the money they chip in,
there’s a catch. When you hand over equity in your company as part of the deal, you’re
essentially giving away part of your future net earnings. The percentage of ownership an
angel investor asks for typically depends on how much they’re investing.
If you expect your business to be wildly successful, it could add up to a lot of money you
won’t be able to claim. When you’ve got an offer on the table, review the terms carefully to
make sure the amount of ownership the investor is requesting doesn’t infringe on your own
ability to make a profit.

You’re not in total control

Because angel investing comes with so many risks, some angel investors may want partial
control over your company as well. Seasoned venture capitalists may see a great
opportunity in your business but may also want more say in how things are operated.
Even if they leave the reins in your hands, you may have to explain the reasons behind your
choices.

Government Grant

As an entrepreneur, you can reap the benefits of government grants and grow your
business. These funds are awarded to organizations, artists, students and just about anyone
who has an interesting idea or project that serves the greater good. Unlike loans, they are
not expected to be repaid and don't include technical or financial assistance. For example,
SEngine Precision Medicine, a startup involved in cancer research, got a $3.1 million grant
from the National Institutes of Health.

Think of government grants as free money for your business. As long as you have a plan and
a clear purpose, it may be worth applying for one. Just beware that eligibility requirements
are quite strict.

Make sure you understand the advantages and disadvantages of social grants. Seeking them
out, submitting your application and following up isn't easy. It can take months to receive
the money you need.

Advantages Government Grants

Government grants are widely available. All you need to do is check out Grants.gov,
SBIR.gov and other similar websites. Even the USDA awards grants to businesses that use
renewable energy systems. No matter your industry, you can find grants that meet your
needs. Qualifying for one is the hard part.

One of the primary benefits of government grants is that you don't have to pay anything
back. It's free money for your business. This can take some pressure off your shoulders so
you can focus on other aspects, such as improving your products. Many times, government
agencies are willing to take a risk that an investor or a bank wouldn't, especially when your
business is just getting off the ground.

Additionally, funding is available in a wide range of categories, from health and wellness to
science, commerce and education. You can use this money to expand your business and
generate more revenue. Furthermore, there is no limit to the number of grants for which
you can apply.

Before sending your application, take the time to learn about government grants
advantages and disadvantages. Check the eligibility requirements, create a detailed business
plan and come up with a grant proposal. You're competing again thousands of other
businesses, so make sure your project is grant-worthy and has a significant impact on the
community.

Disadvantages

The most challenging aspect of a grant application is crafting the proposal. No matter how
innovative your project is, it's worth nothing without a convincing proposal and a solid plan.
Government agencies usually have very strict criteria. Therefore, the completion of a
successful proposal takes a lot of research and know-how.

Another drawback is that government grants often come with strings attached. Even if you
qualify for one, you cannot use the money however you want. It's imperative that you stick
to the initial plan and comply with the rules. Plus, you need to track your progress and
submit regular reports to the agency that gave you the grant. If you break the rules, you
may be asked to repay the money.

Beware that most government grants are short term. When you run out of money, you have
to find new funding sources. That's why it's important to use the money wisely and make
the most out of your grant.

At the end of the day, the benefits of government grants outweigh the drawbacks. If you’re
willing to invest the time and effort needed to secure funding, go for it. Just make sure
you're prepared to be rejected more than once. Keep trying until you find a grant that suits
your specific project and aligns with your goals
Conclusion

The choice of selecting a single or a multiple sources of funding mainly depends upon the
financial condition and sustainability of the organisation. It is the decision to be taken by the
senior management that how much they need and on which terms. They also have to
decide that weather they want equity financing or debt financing because both sources of
funding have different terms and conditions. Both have different pros and cons as we have
discussed above. The organisation has to decide that weather they have to select one or
two sources of funding keeping in mind their financial need, keeping in mind the conditions
to be agreed upon.
If the company decides to take option of bank loan it has to keep in mind that upon which
terms bank is granting loan like the payback period, rate of interest, collateral.
And on the other hand if company decides to take the option of equity financing like angel
investors or venture capitalists, the main thing they should be of their concern is the
dilution of control, and the other terms of the contract.
As per from the above discussion we can choose multilple sources of funding. Here we can
choose funding through a bank loan (debt financing) and funding through a venture
capitalist which is equity financing. It will help the organisation to consider and
accommodate the terms and conditions of both sources of funding.