Funding is the provision of capital. For startups it’s the provision of capital that allows you to realize your business plan. To cover the whole funding of your idea you will most likely need several financing sources. In general those sources are divided into equity- and external capital.
Traditionally equity capital is what funds you and the other entrepreneurs invest into the company. Depending on the concept, equity can also be funds that you acquired through selling shares of the business. Later when the company is up and running those funds, provided you keep the profit inside the company, will increase your capital further. In short: Equity capital is defined by being at the company’s disposal for an extended period of time, without being in immediate need of paying it back. Furthermore it’s the first asset that is liable in case of a problem. Contrary to that is the external capital, which is a classic bank loan. You are aware, that this involves a strict plan for repayment. If problems arise, your own funds are the first to be liable.
The importance of the optimal financing mix are outlined in the following chapter.
Importance for your Business Plan
The higher your net assets, the more likely banks and investors are going to invest into your idea. A higher rate of personal capital makes the startup safer. No regular interest has to be paid and starting losses can be compensated by using your own resources. Furthermore investing personal capital shows commitment to the project. Due to those facts, external investors usually want to see about 20% non-external vestment.
Generating external equity capital, e.g. by selling shares, is difficult. Only companies with a high chance of success usually get that form of funding. Since the risk of losing all of the investment is relatively high, shareholders usually demand a lot of shares for little money. In case of an economic success of your company, you would have to share the profit.
You can compensate by contracting a counter-guarantee bank. These banks are usually supported by their respective government and act as a guarantor for external capital. A fee has to be played for this service.
In reality, if your company goes bankrupt only being liable with your personal assets is highly unlikely. Sole proprietors and shareholders are usually liable with both their professional and private capital. Even using the legal form of a corporation (e.g. limited liability Company) you will be contractually obligated by the bank to bear liability with your private savings. Counter-guarantee banks also hold your private resources liable. This is often misunderstood.
Last but not least an important fact that you should know for planning external investment. The complete bank investment usually consists of several financial products. This mix has to fit your investment plan. The keyword is matching maturity:
- long running, low interest and committed loans should cover your capital need for investments
- medium-term, higher interest but flexibly usable bank loans are used to cover foundation cost and startup investments
- the expensive but highly flexible overdraft loan is used only to compensate for short-term liquidity peaks
Good founding and bank consultants know these things and will secure advantageous and governmentally sponsored entrepreneur loans for you.
- If you bring your own equipment into the company register them as non-cash contribution in your equity. This raises your equity capital quota. Attention: Banks and investors see those non-cash contributions critically. Their intrinsic value is unclear and on the other hand, they are not flexible enough to compensate for losses in the startup phase. Non-cash contributions are not sufficient without being combined with cash contributions.
- The best kind of financing is the one you don’t have to pay back. The chambers of commerce usually have consulting programs for new entrepreneurs. Get informed! There are special funding programs for a technological venture.
- Subventions you applied for, but that were not granted yet, should be listed in a small part of your business plan. However you don’t need to list them in your financial planning yet. It is better to explain why there is a gap in your financial plan, than to assume approval.