The first level of financing for an innovative business is obtained according to the principle of the 3Fs (Founder, Family and Friends). Creating a business means taking risks: indeed, the initial equity capital usually consists of the entrepreneur's personal resources. This initial contribution is most important as it serves as a tangible indication to future investors that the entrepreneur believes in the project and is ready to stake his own resources. This capital may be increased by contributions from the family and friends of the business' founder, with the primary aim of helping to get the business up and running.
During the various phases of the business' development, the entrepreneur will probably need to call on different sources of financing, the most common of which are shown below:
It should be noted that any investment in a business start-up represents a risk for the investor, although this risk tends to diminish as the business develops. The higher the risk taken by the investor, the higher the return that this investor will require.
Private investors can help to increase the entrepreneur's equity capital. Unlike a bank loan, an investment consists of a sum of money injected into a company in order to obtain a shareholding in its capital. This investment is normally of a temporary nature, as the investor's objective is to obtain a capital gain by selling his or her shares. In general, this is carried out within a period of several years following the investment (on average 5 to 7 years in the case of venture capital funds).
Seed funds invest in innovative businesses when they have not yet completed the development of their product or have not yet embarked on the marketing thereof. These funds regularly collaborate on projects originating in public or university research laboratories.
Business angels (BAs) more often than not are natural persons who invest part of their personal wealth in new companies that they deem promising. BAs frequently invest in business sectors familiar to them and play an active part in the day-to-day management of the business, giving the entrepreneurs the benefit of their experience. In Luxembourg, the Luxembourg Business Angel Network (LBAN) was set up to bring together project initiators and BAs in the Greater Region.
The Seed4Start initiative, which was launched in October 2012, is a Cross-Border Venture Capital Forum in the Greater Region. Seed4Start aims to help innovative entrepreneurs in the Greater Region find the capital needed for their companies and to offer private investors (Business Angels, etc) a set of promising investment opportunities. Seed4Start facilitates the matching between the capital offer and demand for the start-up, buyout or development of innovative companies (start-ups which are younger than 5 years). The initiative also offers support, training and help to establish the right contacts through the organisation of numerous events and individual meetings.
Venture capital companies are funds managed by teams of professionals investing in innovative companies displaying high growth potential. These funds often support quite specific sectors, such as renewable energy, information and communication technologies, etc. Venture capital companies usually participate in transactions of more than €1 million involving businesses with high growth potential.
An adequate level of equity capital is necessary when applying for a bank loan. Unlike an investment, a bank loan does not entail a shareholding in the business. This method of financing consists of the provision of an amount of money to be used by the company to carry out a specific project, such as the purchase of production equipment. In return, the company undertakes to repay the amount received and to make interest payments.
Many innovative companies make use of bank debt to finance the business, from the purchase of fixed assets to the partial financing of working capital. A loan is a long-term debt that arises when a commercial bank lends a sum which is repayable over an agreed period. A credit is a short or medium-term borrowing.
Loans or credits are taken out by means of a commercial agreement between a bank and a legal entity. The agreement establishes an understanding with respect to the principal (the total sum borrowed), interest rate and repayment schedule. Generally speaking, banks do not wish to take part in the management of the business; rather, in return, they require guarantees to ensure the repayment of their debt. This method of financing is therefore most often granted to companies that are able to offer solid guarantees to the lending institution.