There is no business without finance. The required level of funding might be small, but there must be some level of funding.
Since funding is of critical importance to the development of an idea into a business, there is definitely a need to look at the possibilities. In the Nigerian business environment, it is very uncommon to get a bank loan to start-up a business. Yes, I know that we all dream of a NGN1 billion bank loan being granted for our different start-up businesses. Yes, that can only happen in Nollywood movies. Wake up!
So, lets take a look at some non-banking sources of funding for our start-up businesses.
Personal investment will come in handy at the launch stage of a business, as sales are low but steadily increasing. Start-up entrepreneurs convert their existing assets (buildings, cars, shares, etc.) into cash for investments in their start-up businesses. Profits usually lag behind sales due to the initial start-up costs already incurred. There is no urgency to repay the investments because it is the seed money from the Entrepreneur. This is one of the reasons why people with day jobs are able to better survive the initial cash flow crunch in the early tears of a new start-up business, as they have a fallback position to draw form. Any start-up that is deprived of cash inflows whenever it is critically necessary will face an early death. In fact, many start-ups will sacrifice extra profitability in favour of immediate cash flow when faced with such do-or-die positions.
Personal investments in a business tend to give an indication of the entrepreneur’s long-term commitment and believe in the business opportunity. Apart from the fact that there is a limitation as to the level of cash that the entrepreneur can invest in the business, there is usually a risk that such funds might not be efficiently utilized as a result of the 1-man syndrome — the entrepreneur spends as he wishes since he is not accountable to anyone.
Due to our ego-centric nature as Nigerians, personal investments is sometimes the only source of investments as it is an automatic ticket to the Chairman/Managing Director or the MD/CEO titles, which we covet so much. The other sources of funding, however, will require that the start-up entrepreneur should relinquish some level of control and share of profit (or loss) to the other financiers. The $1 Million question is that “do you prefer to be a big fish in a small river, or an averaged size fish in a large ocean”?
Family, Friends and Networks
Once a start-up entrepreneur is willing to consider external sources of funds, their immediate community — family, friends and networks — are the immediate targets for consideration. It is important to note that a business relationship with friends or family members should not be taken lightly and may also involve relinquishing some equity in your company. At the launch stage of a start-up business, it is easier to source funds from family and friends rather than debt finance due to its unproven business model and uncertain ability to repay debt. However, as the business begins to show signs of growth, the entrepreneur can begin to expand the scope to his or her networks of colleagues and business associates.
The funding at this stage could be either equity or debt. The entrepreneur must be clear as to his or her expectations, and must ensure that there is a clear communication of his or her preferences and intentions to these potential investors. Once agreements are reached, there must be a detailed agreement that clearly spell out the terms of the relationship — such as type of funding being provided, tenor and interest rate for the loan (where applicable) and loan payment schedule, share of equity being purchased, profit sharing ratio, process for raising additional funding, transfer of equity ownership, responsibilities of all the parties in the business, in addition to the exit clause. The agreement doesn’t need to be fanciful — it must just be workable. The absence of such a signed agreement will lead to disagreements, sorrows, tears and maybe, not blood. The agreements could be made to reflect the informal nature of the transaction, but it must be documented.
Venture & Private capital
This involves giving up some ownership or equity in your business to an external party — sometimes experienced individual investors or investor groups or institutional investors. Usually, the start-up entrepreneur might not necessarily have any prior relationship with such venture capitalists. They are in it primarily for the money! There are focused on the dough! No permanent friends, just permanent mutual (but sometimes exclusive) interest. Venture capitalists take an equity position, and at times a hybrid of equity and debt, in your company to help it carry out a promising but higher risk project and of course expect a healthy return on their investment. It is important to state here that venture capital is not necessarily for all entrepreneurs.
Due to the structured decision making process of the venture capitalists, they may require the entrepreneur to engage a firm like Roedl & Partner to perform an independent evaluation of the legal, accounting, and operational position of the targeted business, at the discretion of the venture capitalist. This is one of the reasons why it takes a while for venture capitalists to decide whether to invest or not. In this type of arrangements, there is usually a loss of control and diminished ownership. The venture capitalist might also demand special rights in the business and could bring in a member of their team to join the management team.
It must be noted that venture capitalists usually have a wealth of experience and network which could assist the business on its journey to growth. However, each venture capitalist might have preferences as to the types of business they support. RSG Funding Program is an example of a SME-focused financing group, backed by young professionals in oil and gas, telecom and professional services sector. The Lagos State Employment Trust Fund (LSETF) also provides cheap loans to entrepreneurs in Lagos. There are several others as well.
Banks and venture capitalists will look for you when you have demonstrated that your business truly has a valid and real business case. Individual private investors might also not be willing to risk their investments until they are certain that there will be returns on their investments. It is always easier to get funding for growth and expansion. But until then, lets continue to focus on the non-banking sources of funding. Whatever source you opt for, you need to source for finance from sources that work for you. Aluta continua, victoria ascerta!
Wole Oluyemi is a chartered accountant and business advisor, with special interests in SME businesses, strategy, finance and tax. He is also a doctoral researcher at Cranfield University (UK) with research focus on corporate political strategy. He can be reached at @WoleOluyemiCo on Instagram, Twitter and Facebook.
Sandra Ejikonye is an Associate at the Lagos office of Roedl & Partner.