Financing your business: Things to keep in mind

February 4, 2015

Financing your business: Things to keep in mind

Most small businesses and entrepreneurs will at some point seek funding for their business. Whether this process is to help grow the business or is designed to provide an exit strategy for the founders, there are a number of considerations to keep in mind when seeking funding for your business.

#1: What is the source of the money?

There are a number of different sources that businesses typically get funding from. One of the most common sources, especially for early stage businesses, is family and friends. For larger amounts, businesses will typically go to an institutional financer, whether this is a bank or an investment fund. Another option for larger-scale financing is crowd-funding sources, which are becoming increasingly popular.

Finally, there is always the option of receiving monies in the form of grants or loans from the government or other organizations whose mandate it is to help fund entrepreneurs and small businesses. Where you get your money from will change the way the funding process will work and the things you need to keep in mind during this process. For instance, institutional lenders will likely require a greater degree of due diligence before advancing money.

#2: Debt or equity?

There are typically two ways of conducting financing for your business – through debt or through equity. Debt financing is relatively straightforward – you will borrow a certain amount of money on the agreement that you will pay that money back over a certain period of time, often with some interest attached. Sometimes, the lender will want to have this debt “secured” against your assets – in other words, if you default on your payments, they can seize your assets. Equity financing involves the person advancing the money taking an ownership interest in your company. Financing can also be done with a combination of the two.

#3: The value of incorporation

If you wish to engage in an equity financing transaction, your business must be incorporated. Indeed, even if you are looking at debt financing, many institutional lenders will still require you to be incorporated. The benefits of incorporation are numerous. With respect to financing, having an incorporated entity allows for equity financing – in other words, for people to give you money in exchange for “shares” in the company. This will give the lender the certainty that they have assurance of getting their money back at some point.

#4: The value of shareholder’s agreement

Many investors, especially sophisticated institution investors, will not advance equity-based financing unless there is a shareholder agreement in place that will protect their interests. Essentially, a shareholder’s agreement is an agreement between all of the owners of a corporation that sets out what rights and responsibilities each party has. Some institutional investors will insist on certain provisions being included in a shareholder agreement so that they can feel confident that their interests are protected.

#5: Have your house in order

Many investors expect you to have certain issues taken care of. As I mentioned earlier, many institutional investors will want to ensure that your business is incorporated. Investors will also want to make sure that your business doesn’t have an excess of debt or potential claims against it. This will involve ensuring that all of your employment relationships are solidified and that there are no disputes that may come out of these relationships. Ensure that any intellectual property your business makes use of (software, logos, designs, etc.) is actually owned by the company and not by the founders individually.

This is just a brief run-down on issues to think about when seeking funding for your business. Each business and each investor will have its own preferences and procedures. The key to a successful investment relationship is ensuring that both the business and the investor see eye to eye. It is always important to consult a lawyer prior to signing any agreements that will affect the ownership of your business.

Image credit: by Tax Credit, via flickr.com.

Author

Jonathan MacKenzie

Jonathan MacKenzie is an Associate with Aluvion Law, a law firm providing innovative solutions for entrepreneurs and small businesses. Jonathan has an entrepreneurial background, having started a company to help pay his way through law school. After graduating from the University of Leicester in the UK, Jonathan joined Aluvion Law so that he could leverage both his entrepreneurial streak and his legal acumen.