Startup funding involves a comprehensive process of raising capital to start a new business or scale things up. It requires developing a strategic framework wherein budding entrepreneurs identify, analyze and prioritize startup funding sources.

In the previous post, we looked at the different stages of financing in the startup cycle and how it works to help you make a well-informed decision.

This article addresses the following questions to enable emerging entrepreneurs to manage their ventures with the right financial wisdom and insights.

• How much funding will you require to get your startup off the ground?
• How to do financial projections?
• What influence the choice of sources of finance?
• Which financing method is suitable for your business?

How Much Capital Will You Need?

It is essential to come up with realistic estimates to know exactly how much a new business will need to start. Aspiring entrepreneurs can calculate the capital requirements of a new venture through financial forecasting.

Your financial projections will help you determine your financial needs and the type of startup funding you require. It will help you get funded and determine whether or not your business is on the right financial trajectory.

To make financial projections for your new business, you would require a set of financial statements, including:

• Balance Sheet
• Cash-Flow Statement
• Income Statement

1. Balance Sheet

It’s a financial statement that provides the basis for computing rates of return for investors and evaluating a company’s capital structure.

The most common equation that represents the balance sheet is:

Assets = Liabilities + Shareholders’ Equity

As evident from the equation, it’s represented by three key elements:

Assets – resources owned by a company that can be converted into cash (e.g., cash, accounts receivables, equipment, and property).

Liabilities are debts or obligations you owe others (e.g., bank overdrafts, payments to your suppliers, sales taxes, etc.)

Equity – Also referred to as net worth or capital and shareholder’s equity. It is equal to total assets minus its total liabilities. E.g., common stock, preferred stock, and treasury stock.

Equity = Assets – Liabilities

2. Cash-Flow Statement

The statement of cash flows tells you how money moved in and out of business.

It will provide insights to investors into different areas a business used or received cash during a specific period. As a result, it’s a critical financial statement regarding valuing a company and understanding how it operates.

You can create a cash flow statement for a startup as follows:

• Determine the starting balance
• Estimate cash flows from investing activities, operating activities, and financing activities.
• Estimate cash going out
• Subtract outlays from Income

3. Income Statement

The statement of revenue and expense identifies the costs a startup incurs to earn income and profit.

Startup founders can calculate the net Income is calculated based on the following:

Net Income = (Revenue + Gains) – (Expenses + Losses)

The income statement with balance sheet and cash flow statement helps budding entrepreneurs understand their business’s financial health.

How to Build Financial Projection for Your Startup?

There are two main approaches to financial projections: top-down and bottom-up. Each system is generally used at a different stage in a business’s growth.

The top-down approach holds- an optimistic view of the market and offers companies a broader picture of revenue potential to help them identify sales patterns.

The bottom-up approach forecasts production capacity, department-specific expenses, and addressable markets to create a more accurate sales projection.

‍As early-stage startups lack data points to build projections, it’s pivotal for them to understand their potential market and know their competition.

Moreover, young company executives often use top-down strategic planning in their businesses, whereas bottom-up strategic planning is typically implemented in established companies.

Factors affecting the Choice of Financing

Different businesses have different types of financial needs determining the source of funding. As a result, the strategic choice of startup funding significantly impacts a firm’s financial performance, business growth, and overall profitability.

Essential factors to consider when selecting startup funding methods are:

• Purpose of Finance
• Cost
• Financing Period
• Business Control
• Risk Involved
• Tax Benefits

1. Purpose of Finance

Here a company needs to consider how much it should raise the capital. The choice of source of finance depends on the purpose of money intended. As a result, business firms resort to different sources for raising funds.

Therefore, Startup owners should match the sources of finance to the need for it.

You might require capital for:

1. For the daily running of the business
2. To grow your business
3. To fund a new project
4. For investments in fixed assets
5. International Market Expansion
6. For Survival

2. Cost

When deciding on the investor, young company executives should consider the cost of the fund. It is a significant input cost for a financial institution because a lower price would produce higher returns as borrowers use the funding for short-term and long-term loans.

3. Financing Period

Your business plan should clearly define the time duration you require the capital, i.e., for short-term or long-term.

For Short-term purposes, sources such as overdrafts, trade credit, commercial papers, etc., can be used. However, sources such as debentures, long-term loans, and shares are preferred for the long term.

Businesses can eliminate inappropriate funding sources by determining the duration and choosing more appropriate ones by selecting the time.

4. Business Control

Emerging startup companies tend to hold on to shares, the ownership of the company, and property, to effectively retain control over the business while also allowing the investors to buy in at a fair market price.

Successful businessmen suggested that aspiring entrepreneurs should address these four areas of control to run their businesses the way they want:

– ownership control

– voting control

– board control

– financial control

This way, you can avoid the risk of dilution of the control in the business.

 5. Risk Involved

Aspiring entrepreneurs can face bankruptcy, financial, competitive, environmental, reputational, political, and economic risks. Therefore, there is often a probability that the growing company will not make sufficient profits to repay the loans.

Young, developing companies seek capital from outside sources depending upon their business intention. This funding requirement creates a financial risk for the companies seeking an amount and the stakeholder investing in the company’s business.

The potential default in paying interest and capital may lead to the liquidation of business enterprises besides damaging the reputation of the business concern in the business world.

Hence, the entrepreneur needs to be aware of the risk a company can encounter in their business and prioritize them appropriately since some risk is inherent in every industry.

 6. Tax benefits

A firm’s tax status has predictable, material effects on its debt policy. According to financial experts, deductions and credits lower the average tax rate. Also, they reduce the marginal rate if they cause the firm to have no taxable income and thus face a zero marginal rate on interest deductions.

As corporation taxes are taken from the company’s net profit, it affects investment decisions. As a result, it could be invested in the business to generate more profits, thus increasing the shareholders’ value.

Therefore taxes make debt a more attractive financing option for certain businesses than equity.

Figure Out Your Financing Methods

Once you have determined the amount of capital you require to finance your startup and determine the factors influencing your choice of funding, the last step would be to choose the best method to fund your business.

There are two main types of financing available for startup organizations:

• Debt financing
• Equity financing

Debt financing

In debt financing, startup organizations raise capital by selling debt instruments to individuals or institutional investors.

It is further classified into two categories based on the type of loan entrepreneurs are seeking, i.e., long-term or short-term.

Here, the startup organizations retain ownership as the lender has no say in how you manage your company.

Your business relationship ends once you have repaid the loan and the interest cost.

However, the amount you pay in interest is tax deductible, significantly reducing your net obligation.

Examples:

• Mortgages
• Credit cards
• Bank loans
• lines of credit;
• government-backed loans
• loans from family and friends

 Equity financing:

In Equity Financing, the young developing companies raise capital by selling shares.

In exchange for capital, you will share your profits with investors and consult them on crucial decision-making processes which affect the company.

Startup organizations prefer this method of financing as you don’t have to make the monthly payment, and you’re free from the worry of lack of credit worthiness.

Here, the entrepreneurs can leverage the expertise of investors in the form of business contacts, management experience, and access to other sources of capital.

Example:

1. Angel investors
2. Crowdfunding platforms
3. Venture capital firms
4. Corporate investors
5. Initial public offerings (IPOs)

Final Thoughts

There are many aspects for young companies to consider regarding setting their business up for financial success.  It is in their best interest to understand the investment ecosystem comprising how investors think, which phase they are in, how much capital they need, and what market they want to dominate.

An in-depth understanding of the market and process is paramount to the success of your startup business, enabling you to raise startup finance.

At Numberly, we are committed to helping young entrepreneurs and founders with best-in-class financial advice and solutions. Let our experts guide you if you aren’t sure about the feasibility of your next business move or aim to build a new economic model.

Schedule a consultation session as per your convenience and availability – and we will talk business during the chat.