Start-ups tend to have limited financial resources. Accordingly, external financing options are important in developing a start-up’s business. Below are some of the financing options that are available.
State agencies such as Enterprise Ireland and Local Enterprise Offices often make finance supports available to start-ups. Those supports can range from grants (which can have performance conditions or objectives attaching to them) to investments for shares with specific rights attaching to those shares.
Dealing with State agencies can be attractive for start-ups. Their remits often focus broadly on growing businesses and increasing employment. However, accessing funding can be a lengthy process and there is often limited scope for negotiation in respect of the terms attaching to the investment. Nonetheless, Ireland has a strong reputation in terms of State agencies supporting investment when compared to other jurisdictions. In addition, where a State agency has invested in a start-up it lends a certain weight which may encourage other early stage funds to invest.
Investors can provide start-ups with assets or cash, but they usually receive an interest in the business in return. For start-ups the most common source of equity investment is from the founder’s family and friends. They have the advantage of knowing the capability of the founder and being more familiar with the risks associated with their investment. The investors’ returns are dependent on the growth and profitability of the business. Unlike bank loans, investments allow for a degree of flexibility as they are unsecured, fully at risk and usually do not have a defined repayment plan.
Angel investors and seed capital/venture debt firms can also help start-ups in their early stages to raise finance. They are accessible to start-up companies who cannot offer tangible security to traditional lending institutions or predictable cash flows to service loans. Their investments are typically made in exchange for shares. However, investments can also be made in return for debt, which may or may not be convertible into shares.
When an investor provides cash or assets, it typically gains certain rights in respect of the business, such as rights to company information, directorship rights and consent rights over certain aspects of the business. This often has the effect of encouraging discipline in the regulatory compliance and financial reporting of developing companies.
It is important in the context of any angel investment or seed capital or venture debt financing arrangement that the investor’s rights are clearly set out in an investment or shareholders’ agreement. It is essential that that agreement provides the start-up with the protections that it needs. In the absence of a document setting out the investor’s and the business’s rights and obligations, uncertainty can give rise to conflict at a later stage when the value of the business begins to grow.
Aside from cash, business angels and seed capital/venture debt firms can offer the advantage of “softer” business benefits, such as guidance, know-how and providing the start-up with contacts and access to business partners. Non-executive and executive directors introduced to the company through investors can provide invaluable knowledge and experience to developing companies. Research has shown that venture capital backed companies grow faster than other types of companies, employ more people and are more profitable when benchmarked against their peers.
Seed capital/venture debt firms differ from angel investors in that they typically fund companies, rather than individuals. The type of venture capital/venture debt firm that will be interested in investing in a business usually depends on the industry sector in which the business operates and the stage the business is at.
Click here to see the standard Terms & Conditions for a seed or venture capital investment.
There are a range of credit options available from banks and non-banks. The type of credit that a start-up needs will depend on the stage of its development, its trading history, its financial status and how the business will use the funds.
Credit can range from short term options such as overdraft facilities and credit cards to more medium and long-term options such as term loans, hire purchase, fixed asset loans and business mortgages. However, for developing knowledge based companies, traditional forms of borrowing such as bank finance may be unavailable as start-ups typically have insufficient assets to provide security for loans and are unlikely to be generating significant revenue.
While banks have been the traditional source of credit in Ireland, there are increasing numbers of non-bank lenders entering the market. These non-bank lenders usually have an industry-specific focus. Crowd-funding is also a novel way for start-ups to gain access to credit, although its popularity in Ireland has been slow to gain traction.
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