The Secrets of a successful financing campaign (Part 4) – Understanding the different Investments

In our previous post (Understanding the Financing Ecosystem), we have seen that funding happens in cycles at defining moments of the company’s life.

Since it is critical to be familiar with the sequence and the vocabulary, you will find, here-below, a quick summary of the common Company’s life cycles and the related funding rounds:

Understanding where you stand is very important as the Investors tend to specialize in a specific Funding round. For instance, while Business Angels (BAs) will be interested in Seed Funding rounds, there are extremely little chance (although everything is always possible) for Investment Funds to consider any Seed Funding rounds… Similarly, BAs will likely not consider Series B or C Funding Rounds…

Understand where you are is necessary to determine who you should reach out for… and thus, optimise your chances of success!

The other key point to master is the different types of funding, as, again, each type of Investor tend to prefer one over another.

To summarize, funding can come as:

• Equity

• Grants

• Sponsorships

• Senior Debt

• Junior Debt

• Mezzanine Debt

• Convertible Loans (also called Convertible Debt, Notes or Bounds)

• Secondary market Financing

Each type of financing has it’s ups and downs so it is important to understand them.

A short classification from a strict “financial benefit“ for the Entrepreneur (from the cheapest to the most expensive) would be the following:

• Grants (nothing is asked in return)

• Sponsorships (funds are given only in exchange for some “exposure“, i.e. marketing and communication benefit for the “sponsor“)

• Equity (paid back through dividends, i.e. only when the company makes enough profit to distribute dividends – on the other hand, it will give rights over the company’s assets, management, etc… the Entrepreneur will lose some control as he will gain a “partner“)

• Senior Debt (lenders is atop the creditor’s list if things go wrong so as it is less risky, the interest rates are the lowest on the market, yet the qualifying requirement are the most stringents)

• Convertible Debt (or Notes or Bonds) (A convertible bond offers investors a type of hybrid security that has features of a bond, such as interest payments, while also having the option to own the underlying stock. Convertible debt tends to have lower interest payments but higher equity dilution than a structure with warrant- see Mezzanine Debt below. Because the payment of Mezzanine debt is subordinated to the payment of the senior debt, it is more risky and therefore benefits of a higher interest rate than the Senior Debt).

• Mezzanine Debt (usually associated with acquisitions and buyouts, for which it may be used to prioritize new owners ahead of existing owners in case of bankruptcy. In practice, Mezzanine financing usually includes equity participation, in the form of “warrants“.

A convertible structure through Convertible Debt or Mezzanine allows the lender to convert all or a portion of the principal into equity of the borrower.

• Junior Debt (actually the terms includes all Debt which payment is subordinated to other Debts. It includes Convertible Debt and Mezzanine Debt are specific forms of Junior Debts. Because they are subordinated, the interest rates are the highest)

The secondary market financing consists in bringing, generally a portion of, the equity, to the Stock Market Exchange, in order to offer it to the public.

This is done though an operation called an Initial Public Offering (IPO). Extremely regulated (for good reasons), this is reserved for well-established companies, which is not the subject of these posts, so we won’t discuss it any further.

There is MUCH more to say about each type of Debt and our next post will specifically cover the ups and downs of the two main funding options, i.e. Debt Funding vs Equity Funding.

Another type of funding, which shall not be overlooked as it is not only a possibly significant one, but also because it’s often the easiest to get, is Supplier’s Loans!

Indeed, if rather than raising money to pay your suppliers you can manage to have them give you loans over whatever you are buying (which practically means offering you significantly favorable terms of payments), it’s just as good… if not better!

Indeed, if they can afford it, suppliers will be more likely interested to finance you for at least two reasons:

• First because it will be much more profitable for them than it would be from strict financial players. Indeed, they will be financing the full cost of whatever they will provide, while it will only cost them a fraction of the amount (they will finance the “selling price“, while it will only cost them the “cost price“). To illustrate it, let’s imagine you wish to finance the purchase of a 100k€ product. The “systematic“ option would be to borrow 100k at, for the sake of the argument, a 8% facial interest rate, to a financial lender. This will require the lender to give you the 100k “out of his pocket“ for a 8% ROI for him, right? Now, if you borrow the same 100k at the same 8% facial interest rate, but this time to the supplier, in fact the lender (which is the supplier) will only give you 50k (assuming he has a theoretical 100% profit margin) because it is its cost price. This means that the same 8% theoretical ROI will turn into … 16% for the lender!

• The second reason, is simply because suppliers have an interest in “selling“ you, even with delayed payment terms, as it allows them to use their production facility, gain a client, etc…

For those reasons, suppliers have every interest, if they can afford and are ready to “take the risk“, to finance their clients... It's potentially a win-win operation for them!

And we are just scratching the surface of the general notions and related vocabulary, that must be mastered before taking a fund raising journey.

So, stay tuned for more tips, or contact Fred by mail, write a comment here-below, or just click on the Chat button to further discuss this topic... or any other 😉