Q&A - Should a start-up raise investment from outside investors?

You will have seen entrepreneurs making their pitches to the Dragons on Dragon’s Den – this is a good example of how a start-up or small business tries to raise capital by encouraging people other than the entrepreneur to invest in the business idea. But is this a good idea, and who should be asked?

Friends and family

For a start-up, the main source of outside (external) investor in the share capital of a company is likely to be friends and family of the entrepreneur.

Opinions differ on whether friends and family should be encouraged to invest in a start-up company. They may be prepared to invest substantial amounts for a longer period of time; they may not want to get too involved in the day-to-day operation of the business. Both of these are positives for the entrepreneur. However, there are pitfalls. Almost inevitably, tensions develop with family and friends as fellow shareholders.

Business angels
Business angels are the other main kind of external investor in a start-up company. Business angels are professional investors who typically invest £10k - £750k. They prefer to invest in businesses with high growth prospects. Angels tend to have made their money by setting up and selling their own business – in other words they have proven entrepreneurial expertise.

In addition to their money, Angels often make their own skills, experience and contacts available to the company. Getting the backing of an Angel can be a significant advantage to a start-up, although the entrepreneur needs to accept a loss of control over the business. The entrepreneurs on Dragon’s Den are examples of business angels.

Venture capital
You will also see Venture Capital mentioned as a source of finance for start-ups. You need to be careful here. Venture capital is a specific kind of share investment that is made by funds managed by professional investors. Venture capitalists rarely invest in genuine start-ups or small businesses (their minimum investment is usually over £1m, often much more). They prefer to invest in businesses which have established themselves. Another term you may here is “private equity” – this is just another term for venture capital.

It is important to remember that a start-up is much more likely to receive investment from a business angel than a venture capitalist.