What is an advice for funding a startup
Current start-up dates
If nothing comes of this, the European Central Bank will raise interest rates towards the end of the year. For start-ups, this means higher costs of capital and more difficult access to bank credit, which is already limited. So it is high time to think about alternative financing options, such as factoring, leasing or finetrading. The following article shows what options young companies have to reduce their dependency on their house bank.
The key interest rate of the European Central Bank has remained unchanged at zero percent since March 2016. At that time, the European economy was firmly in the grip of the euro crisis. The inflation rate in the euro zone was just below zero percent. The ECB feared a spiral of deflation. In the meantime, however, the tide has turned. Last year, inflation exceeded the target of two percent for several months.
Interest rate turnaround from autumn 2019 likely
Meanwhile, the negative sides of low interest rates are becoming more and more apparent. Dangerous price bubbles have formed in the real estate, bond and stock markets. Conservative investors such as pension funds are suffering from an investment crisis and are increasingly getting into trouble. The banks, which earn a large part of their income in the interest rate differential business, are also under pressure. Some financial institutions are currently not even generating the cost of capital. The ECB also knows that the current situation is not sustainable. Since June 2018, it has therefore been preparing the market for a possible interest rate hike from autumn 2019.
Difficult access to bank credit
For start-ups, the interest rate turnaround means not only higher costs of capital but also problems with access to credit. With the higher interest rates, the risk of bad debts increases, which is why the banks will limit their lending to companies with poor credit ratings. A quarter of the start-up companies already rate access to credit as difficult. A major reason for this assessment are excessive security requirements.
It is therefore all the more important for company founders to prepare for the interest rate turnaround today. In particular, this includes them
- take advantage of the currently still favorable interest rate environment and when negotiating new loans on a long-term fixed interest rate respect, think highly of.
- Avoid over-securing and reduce existing over-insurance. Because values that serve as security for existing loans are no longer available for future financing.
- the Financing portfolio the company distribute it on different legsto avoid becoming dependent on the house bank.
Equity plays a key role in diversifying the financing portfolio. Equity does not require interest and is therefore not directly affected by the turnaround in interest rates. Apart from that, a higher equity ratio ensures a higher creditworthiness, which in turn leads to better conditions for borrowing.
Company founders secure the greatest independence from external investors by financing their start-up exclusively from their own resources. So-called bootstrapping is usually an emergency solution because there is no access to other sources of finance. Nevertheless, this path can be successful. Research shows that over 80 percent of the 500 fastest growing US companies initially relied only on the savings of their founders. However, the mostly tight budget does not allow for a long dry spell. The start-up needs to generate positive cash flow quickly.
Family, Friends and Fools
If the founder's own fortune is insufficient to finance the company, it makes sense to look for equity among the "three Fs": Family, Friends and Fools - family, friends and enthusiastic private investors. If the investors are not to have a say, the following financing options can be considered:
- (profit participation) loans
- Profit participation rights
- silent partnerships
In view of the foreseeable turnaround in interest rates, it makes sense to limit the amount of any promised interest in favor of a profit or revenue sharing.
Crowdinvesting is a relatively new variant of financing through "fools". Crowd finance is not just a substitute in case the bank refuses to accept the loan. Depending on the target audience, it is also suitable as a marketing tool that helps to bind future customers to the company. Incidentally, a successful equity crowdfunding campaign attracts the attention of potential venture capitalists.
Risk capital mostly comes from special investment companies, the venture capital funds. These are active investors who demand significantly more say and control rights than family, friends or private investors. Your goal is to sell the investment profitably after a certain period of time. One of the most important players on the German market is the High-Tech Gründerfonds, a cooperation between the Federal Ministry of Economics, the Reconstruction Loan Corporation (KfW) and the private sector. Unfortunately, it can be assumed that the availability of venture capital will decrease if interest rates rise. Because as soon as higher returns can be achieved on the less risky bond market, institutional investors will withdraw part of their capital from the venture capital funds.
A rate hike has less of an impact on the engagement of business angels, who make their investments primarily from their own assets. Business angels are experienced entrepreneurs who support the founders with advice and action. You are primarily involved in the early phase of a start-up and contribute an average of 100,000 euros. As compensation for the high risk, they expect an above-average return - either in the form of high exit proceeds or a profit sharing.
Apply for funding
If you can do without the know-how of an angel investor, you can travel more cheaply with state subsidies. Apart from private savings, according to the German Startup Monitor 2018, it is the most important source of funding for young companies. Funding includes:
- low-interest promotional loans
- Equity investments
- Guarantees for promotional or house bank loans
Grants do not have to be repaid, but are earmarked. Among other things, there is a start-up grant for the unemployed, grants for start-up advice and grants for university founders. With the INVEST grant, the federal government is promoting financing through private venture capital. When it comes to development loans, the focus is on start-up loans from KfW and the state development banks. Some of them do not require any collateral or contain a guarantee to the credit intermediary. Otherwise, it is worthwhile to apply for a deficiency guarantee from the responsible state guarantee bank. Some of the development banks also offer equity and mezzanine investments. You can read more about funding and how you can use it for your project here.
In addition to various variants for increasing economic equity and subsidies, asset-based financing is particularly suitable for times of rising interest rates. The existence of an equivalent value means that the interest rates are often lower than with a classic loan. However, a start-up usually has few assets that it could borrow or sell to a financier.
An exception are - if the company is already operational - the invoice receivables. It is therefore advisable to make use of factoring. The sale of outstanding receivables not only creates the necessary liquidity. It also helps to smooth out cash flow and protects against payment defaults as the factor typically takes on the del credere risk. This is a key benefit in the event of a future recession.
In addition, it makes sense to finance equipment such as IT infrastructure, office equipment, vehicles or machines not through an investment loan, but through leasing. The leasing rates are usually fixed in advance so that the lessee is not exposed to the risk of changes in interest rates. In addition, the leasing rates can be staggered so that the leasing costs develop in parallel with the income from the leased objects (pay-as-you-earn principle).
Another option is the pre-financing of goods purchases through finetrading. In finetrading, the financier acts as a middleman. He purchases goods such as raw materials, semi-finished products or finished products and sells them to the customer with an extended payment term of up to 120 days. Unlike factoring, however, finetrading requires a credit check. That is why it is less suitable for low-capital start-ups.
Keep track of financing options
The interest rate turnaround is coming. Young companies have to adjust to higher interest rates and additional difficulties in accessing credit. For this reason, it is even more important for them than in the past to diversify their financing mix. The range of alternative financing solutions is diverse - so diverse that it is sometimes difficult to keep track of things. Therefore: Entrepreneurs should sound out their financing options at an early stage in order to be able to consistently face changes in the financial markets.
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