Pimp your start-upHow to use crowdlending to finance your start-up without giving up control
As a (social) enterprise, there are a handful of basic financing options for funding your expansion, and none of them are perfect. One of the most recent trends is crowdlending, which could be very promising for start ups without getting an investor involved. Read More
As a (social) enterprise, there are a handful of basic financing options for funding your expansion, and none of them are perfect. You can bring investors on board who trade their capital for a share in the company (venture capital). You can take out a loan from a bank, invest your own money, or attract the money you need from “friends, family and fools” (FFF).
As a social enterprise, impact investment is also an option. Impact investors are primarily interesting in putting their capital to good use promoting positive social change and the financial gain is secondary. There may also be subsidies and grants available if you meet the criteria. And then there are the almost overwhelming number of crowdfunding and crowdinvesting platforms, from Kickstarter and Startnext, to Seedmatch, Companisto, and Funding Circle.
If you’re really lucky or a very disciplined company, you can also try to expand with no external funds at all, using your own cash flow alone to drive growth.
Each of these options has advantages and disadvantages, and each has an inherent cost, whether in interest paid for loans (and sometimes personal liability on top), additional work in applying for grants or a loss of control. If your hope is to use cash flow to grow, this tends to severely limit your ability to scale – depending on your business model.
Since we founded soulbottles four years ago, we have grown to 22 employees, our revenues run to seven digits, and we have donated a total of 150 thousand euros to water projects. During this time, we have run the gamut of pretty much every type of financing, and would like to explain why we now focus exclusively on three forms: bank loans, crowdfunding and crowdlending.
We define crowdlending as a direct loan from customers directly to our public limited company that is paid back with interest. Since this is the least well known of the three types of financing, we’d like to explain in detail how you can employ it for your (social) enterprise, what situations it can be useful in, and the legal framework in Germany. Especially since in the last six months, we raised 150 thousand euros this way with just a minimal investment of around 1 hour per person per week.
We raised 150 thousand euros this way with just a minimal investment of around 1 hour per person per week.
How does crowdlending work?
It is quite simple really: a private person gives a company a private loan and is paid back with interest. There are no middlemen, so there are no extra fees or additional costs for you. You set the conditions or negotiate them with your lender. We offered our investors a basic interest rate of 4% that would increase to up to 10% percent, depending on how high are profits are at the end of each year. Since we are not a bank, we were legally obligated to include a “subordination clause” that says if soulproducts GmbH declares bankruptcy, these loans can only be paid back after all other creditors have received their money. To put it more bluntly, this means that investors would in all likelihood lose their money if the company goes bankrupt (this is based on the German legal situation, but is probably similar in other countries).
So we offered our investors a – beware, here comes a bit of legalese – “profit-participating (= return depends on success) subordinated loan” and found 20 people who invested a total of 150 thousand euros.
Why 20 people? This was based on the crowdfunding law that took effect in Germany in July 2015. It set limits under which companies are allowed to directly collect money from private investors. These exemption limits are a maximum of 100 thousand euros in total investment or 20 investors. So if you successfully find 20 investors who each invest more than 5,000 euros, you can ultimately collect more than 100 thousand euros. If you want to exceed these limits, you need to file a detailed business plan with the Federal Financial Supervisory Agency (BaFin) that has to be updated every year and which the agency also audits. (This is known in the business as a “securities prospectus requirement”.)
You can also use an online crowdlending platform like Companisto or Seedmatch to source your funding. There the upper limit is 2.5 million euros, given out also as profit-participating subordinated loans. The disadvantage here is the horrendous commissions the platforms take. Companisto, for example, charges 10% of the total amount borrowed.
"Trust is the key"
How do you inspire people to invest this way?
It is really no different from other types of investment. You have to convince potential investors that your business model will work, and that your team is capable of realizing the business model.
Like with any investment negotiation, trust is the key, the question :“Do I trust them to handle my money responsibly?”
This means that you need a business plan too, of course, that lays out your (social) business model in detail. Even if it is not necessarily relevant for your day-to-day work because you have to shift concrete strategies too quickly, it is very helpful when communicating with investors. You also need a financial plan that makes sense and is easy to understand. You need to identify what will drive sales and the costs factors involved so you can explain any irregularities. Nothing destroys trust as quickly as your inability to answer the question “exactly how do you plan to achieve these sales figures?”
How detailed does the financial plan need to be?
I recommend planning out the next 6-12 months in fairly extensive detail based on the KPIs (key performance indicators) measured over the past months. You will need to invest some time in creating the necessary Excel table and a reporting structure. But this is time well spent and in the long run, it can make the difference between being able to respond quickly when the numbers threaten to get out of hand and a “surprise” bankruptcy because you ran out of money without realizing it. You can then draft a rough five-year prognosis on a year by year basis.
An example: We broke down how many retailers offer soulbottles in their stores, and how many soulbottles they sold on average over the past twelve months. We then used this as a basis to predict how many new stores we could acquire per sales person per month, and how that could change the order volume over the course of the year. This provided us with a fairly solid basis for predicting sales over the next 6-12 months – and for deciding how many sales people to hire. The more key performance indicators you have from the past allows for better and more accurate planning for the future.
These numbers also play an important role in our day-to-day business, since we are a production company and have to have enough goods on hand. Some parts need to be ordered up to four months ahead of time. It is incredibly frustrating to discover you have ordered too little and cannot meet your quotas, but ordering too much though severely curtails your liquidity. The better our plan, the smarter our ordering can be. And when investors see how well-founded our planning for the future is, their trust that we have the day-to-day running of the company well in hand increases.
For our five-year outlook, I very roughly outlined on a percentage basis how sales should increase compared to the previous year (i.e. 20% revenue growth compared to last year), and realistically how high the percentage of profit from sales could be. For a well-established trading company a profit margin of 8-15% is realistic. Though probably not in the first few years.
How do you draw people’s attention to your company?
We are lucky because our product has been on the market for 3 years now and already achieved a certain level of recognition. It was therefore enough to publicize the investment options on our blog and via our newsletter. People could download a 3-page PDF that detailed the investment options available. We then sent our business and financial plan to those who expressed a real interest.
This is the best example of how important it is to encourage people to subscribe to your newsletter and provide exciting updates about your work right from the very start. Creating a community of interested people around your project or company is an investment that will ultimately pay a variety of dividends.
Why we decided against venture capital investment
There were two major reasons. The first is that we did not want to give up any control of our business decisions. This was very important because we focus on a holacracy and non-violent communication, two perhaps unusual approaches to business management. We don’t have bosses who bang on the table or raise their voices. This makes us a much better and more efficient company, but many classic investors see “self-organization” as the equivalent of “chaos”, even if our experience has been the exact opposite. A venture capitalist who wants to get involved and exert control could do a lot of damage.
We also wanted to retain the right to make business decisions that might limit profit, but improve our social or ecological impact. Like manufacturing our product completely in Germany, even if that is more considerably more expensive.
The second reason is that having shareholders means you have to expand. Venture capital funds invest in a company because they expect to be able to sell their shares for considerably more in a few years – for at least twice to as much as ten-times as much as they originally paid. The anticipated price increase is always based on how much profit you are likely to be making and sharing in the future. You have to grow a lot in a very limited time for the value of your shares to increase that much. Plus venture capitalists generally want to secure fairly comprehensive control rights, even if their involvement is rather limited, to reduce their risk. Even though of course this depends on the investor and the rights you negotiate.
We make a physical product that is not as easy to scale exponentially as a digital product would be, so we simply could not realistically portray the projected growth required to achieve the desired price increase for shares in the company. Having to finance preproduction up to four months in advance in order to support your planned growth severely limits the rate at which you can expand. Unicorns are not made this way. Which is completely fine, by the way. You don’t need to build a unicorn company to feel like you did something meaningful. It just means that VC investment is not your go-to financing source.
Impact investment does not involve this expansion requirement, but here too the investment funds tend to want to secure considerable control rights.
It can be helpful to have external investors who can act as experienced sparring partners and okay large decisions, especially if this is your first start-up. But for us crowdlending was the more attractive option.
We might look into impact investment for the next expansion phase – we certainly don’t want to reject this type of financing across the board. But it does have some clear disadvantages you have to be aware of.
What are the risks of crowdlending?
For you as a company, the risks are relatively small. You are not liable for the money (assuming the legal structure of your company has limited liability), nor do you have to surrender control. This is why the crowdfunding law was passed to strictly regulate this type of financing. This does not, of course, mean you have the freedom to handle the money invested irresponsibly. Our private investors have placed their trust in us, and their generosity makes us feel even more responsible to do everything we can to make sure they get the promised return on their investment. We also made sure they understood that their money would be gone if we went bankrupt before they agreed to invest in us, and that they should only invest if they could afford to lose their money if that happened.
Once these fronts have been clarified though, crowdlending is one of the nicest kinds of financing. Your community, the people who know your products, and value your work and the mission behind it, trust you enough to invest a large sum of their hard earned money in your success.
What could possibly be better?