Authored by Áslaug Magnúsdóttir and can also be found here: http://is.gd/zyWvt6
This is the third in a series of articles on the Business of Fashion basics, and is taken from the business of fashion website. Originally published in 2007, this series is used to educate those interested in going into the business of the fashion industry. NosaFashions claims no copyright to this material and is used strictly for educational purposes.
Taking on financing is one of the most important decisions an emerging fashion company will make. This step is absolutely essential because the early stages of growth often requires significant amounts of working capital that cannot be generated by the business alone. So, unless you are independently wealthy and sitting on a pile of cash, financing decisions will be part of your critical path, early on.
What is the difference between equity and debt?
Financing can come in many forms, but it basically comes down to equity versus debt.
Equity investors (in this case, venture capitalists or angels) provide cash to invest in your company and therefore end up sharing ownership of the company with you. They invest in the hopes that your business will grow and that they will have some positive return through shared profits and upside. They may offer you resources and expertise to help drive the business further. In fact, this is much preferred to someone just giving you cash and leaving you to fend for yourself. If, however, you disagree fundamentally with your investor on where you want to take the company and how you will do it, then you may find their “help” a nuisance. Thus, when evaluating equity investors, choose someone who is aligned with your strategy and who has the industry and/or functional experience that your business needs to grow.
Debt financing, on the other hand, usually comes in the form of loans, where you are required to pay back the money you have borrowed, plus interest, using a fixed schedule of payments that can be spread out over many years. While debt providers won’t be actively involved in your day to day business, taking on debt will mean you will have an additional cash outflow that your business will have to be able to support each month to stay on good terms with your bank. If payments aren’t made regularly, you may quickly find yourself dealing with irate calls from your bank manager. In the worst case, taking on too much debt could drive your business into bankruptcy. Debtors are always paid back before profits are shared amonst the shareholders of your company.
The good news is that with your business plan in hand, you are in a good position to share your vision with potential financiers to sift through the various options and make the best decision for your company. Financiers may have advice to offer, and you should take this under consideration. But, keep in mind the need to stay true to what you originally set out to create. It is important that you believe in the strategy you pursue.
What legal precautions do you need to take?
Before sharing the nitty-gritty details of your company with anyone, you should request that they sign an NDA, or non-disclosure agreement, which legally restricts the other party from sharing your confidential company information with anyone else. Of course, you can’t control what they actually tell other people, but this is a good way of sending a message that you take your business seriously, and that there is value that needs to be protected. Often, NDA’s are reciprocal, so both parties are protected. Your lawyer will very likely have a template that you can use, with some small adjustments so that it is fit for purpose. It is customary to offer two copies for the other party to sign, so that they can also keep a copy for their files. Eventually, you may also need legal advice to ensure your interests are being protected in any subsequent financing arrangement that arises.
What are the equity and debt options available to you?
1) Venture capital – VC funds look for high-potential businesses with strong prospects for growth, often based on a core new technology or brand.
Many VC companies don’t even consider fashion as a core industry for investment, as it is a notoriously fickle place with all sorts of “fashion” risk. However, as the world has been awash investment capital lately and as the competition for traditional investment opportunities has increased, more people seem to seeing a gap in the market for investing in fashion. Initially, the money was targeted at larger investments that have seen the likes of Jil Sander, Helmut Lang, Jimmy Choo and most recently, Valentino, take on private equity. But now, new funds are being raised in London, New York and Paris to focus on earlier stage businesses:
2) Angel investors - If you’re looking to raise capital for a pure start-up businesses, Angel investors could be your best bet. “Angels” are independently wealthy individuals, often with backgrounds in entrepreneurship and business themselves. While the name might make them seem truly heavenly, angel investors can sometimes be anything but divine and this route needs to pursued with caution. Just finding angel investors (let alone convincing them to invest) can be tough.
The best thing to do is ask friends and family if they know people who might be looking to invest some cash. This will not only help you find angels, it also comes with a built-in personal reference from the person who puts you in touch. There are also networks of angel investors, like Pi Capital, The Go Big Network and The Angel Investor Network, which help to bring angels and entrepreneurs together.
When dealing with angels, it is mportant to ensure that there are clear roles defined before any investment has taken place. It is not rare to see angel investors, with the best of intentions, wreak havoc because they think they are fashion experts and end up interfering in the business. Make sure you agree what they will and will not be involved with based on a clear assessment of their skill set. Make sure you are confident you can jointly make business decisions with them. Test their response to pushback. It is better to know exactly what you are getting in advance, than taking the money and having to struggle later on.
Guy Kawasaki has some great lessons on raising angel capital on his blog, How to Change the World.
3) Banks - Bank loans are possibly the most readily available source of funding for young start-ups. a bank loan usually comes down to:
Since you won’t have much in the form of collateral to offer the bank in return for your loan, the amount the bank can give you may be relatively small compared to your overall funding need. Therefore, a bank loan strategy may not be sustainable over the longer term as it requires constantly going back to your bank and offers no guarantees that future loans will come through.
Finally, keep in mind that loans also add another cash outflow to your business. To reflect this in your plans, use your cash flow statement to establish your funding gap for the next 1-2 years, and add in the loan payments that you will have to make each month to learn how taking on the loan will impact your monthly inflows and outflows of cash.
4) Factors – Factors provide capital to businesses based on the actual orders they have received on a season by season basis. This is very useful in the fashion business as it can help to finance production for sales orders that have just been completed. Once you hand over your order book to the factors, they will take a cut of the total value themselves, and in return provide you with the cash up front while they take on the risk of collecting payments later when the goods are delivered. Factors may choose not to underwrite certain stockists which are too small or have bad credit records. One of the leading factors in the US is Hildun. Working with factors means giving away part of your revenues to the factor right from the start.
Where else can you look for more information
For more information on financing your fashion start-up, some general lessons can be learned from the US Small Business Administration website and from this case study.
Next time: How do I decide where to allocate my capital?
Once you have successfully raised your capital, you will need to think carefully about how to allocate this capital across various business needs that you have identified in your plan. You may not have raised all the money you need, so carefully prioritising key areas is important.
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