Funding is so important when it comes to running a business. Raising funds for a start-up or a SME may feel like a daunting task, this article aims to provide you with different ways you can go about seeking funds and what legal documentations are needed respectively.
After reading this, you will also find out the advantages and disadvantages of different forms of funding so you can choose the most suitable one for your business!
1. Friends and Family
Friends and family are usually the first source of financing for many young businesses. This type of funding can come as a gift, a loan or in exchange for shares of the company.
| Pros | Cons |
| Usually interest-free The process is not as complicated as other forms for fundraising | This may pose an adverse effect on one’s personal relationships |
2. Small Business Loans
A Small Business Loan, also known as a SBA Loan, is a fixed amount of funding given to a small business in exchange for repayment of the loan principal amount plus interest. A small business or a start-up can get a small business loan from an investor, a bank or any qualified money lender.
Like regular loans, the amount of funding available and the interest rate are dependent upon the credibility of the company. With more solid financials, a company can expect to obtain a bigger loan with a lower interest rate.
In Hong Kong, a loan can be given by an authorized money lender or a bank. A company if wishes to borrow money should enter into a Loan Agreement with a lender. A loan agreement operates as a contract between the borrower and the lender and will stipulate the followings:
- Whether this is a secured or unsecured loan
- Principal amount
- Interest rate
- Any conditions to be fulfilled before the loan becomes available to the company
- Dates for repayment
- Obligation of borrowers and lenders
- Governing law of the contract
For more information, check out our Commercial Loan Agreement template, please be reminded that in case of a secured loan, additional security documents are required.
Borrowing money from a financial institution which is not a bank is governed by the Money Lending Ordinance, whereas a bank loan is governed by the Code of Banking Practice. Both regulations set out how money lenders should conduct their business.
| Pros | Cons |
| Low interest rates Flexible repayment terms Lower down payments No collateral is generally needed | Smaller amounts compared to regular bank loan Longer approval process Decent credit score often required |
Instead of a lump sum of cash, a company can seek rounds of funding and raise more capital as it grows. Each round of capital is provided so that the business can get to the next stage. There are usually 4 rounds of funding (Pre-seed, Series A, Series B and Series C), representing different stages of business. This concept can be applied in Venture Capital Investment.
3. Venture Capitalists
Venture Capital is a form of private equity financing that is provided by venture capitalists who are interested in start-ups and early-stage companies. Venture capitalists (VCs) are often members of a larger venture capital firm who has a board that votes on which companies they will invest in. A VC provides capital to promising companies by buying equity in a company.
Since most VC investments involve buying shares in a company, a Share Sale Agreement is always needed and usually drafted by the investors. A Share Sale Agreement is a legal contract for sale of shares in a company and will usually include the following:
- Details of the investment: amount and nature of the investment
- Completion procedure: payment, settlement and completion mechanisms of the sale of shares
- Conditions precedents: conditions that must be fulfilled before the completion of the sale of shares, for example director’s approval should be provided to the lender.
- Representations, warranties and indemnities and undertakings: Statements regarding the conditions and aspects of the company such as the financials and underlying assets of the company.
- Governing Law: Set out the law of which jurisdiction will govern the agreement if legal issues arise.
For more information, please check out our Share Sale Agreement and Investment Agreement templates. Besides, parties also need to prepare all the related documents (contract notes, resolutions, management accounts and instruments of transfer etc.) for stamping by the Hong Kong Government. The transfer of share is only considered completed upon successful stamping of the documents.
| Pros | Cons |
| Large amounts of capital can be raised Venture capitalists can provide the company with valuable guidance, expertise and consultation. Venture capitalists have a huge network of connections in the business community that could be advantageous for the start-up There is no general obligation to repay the VC if the start-up goes under. | Dilution of ownership and control of the existing shareholders as VC provides huge capital in return for a stake in the equity of the company. The funding process can be slow and long as VCs take a lots of time to screen the companies Most VC requires high return on original investment Companies are often required to set up a more rigid internal structure which could limit flexibility. |
4. Angel Investors
Angel investors, also known as business angels, are high-net-worth individuals who provide funding for a business in exchange for debt or ownership equity in the business. A small one-time investment is usually provided by the angel investor to help the start-up grow. The best way to be introduced to an angel investor is through the referral, thus the angel investors will have more confidence in investing in the company.
Since angel investment can take the form of debt or equity, corresponding documents will be needed. If an angel investor intends to invest by buying shares of the company, a Share Sale Agreement or an Investment Agreement will be needed like in a VC investment (see above). On the other hand, if an angel investor lends money to the company, a Commercial Loan Agreement should be used.
| Pros | Cons |
| More flexible as angel investors invest from their own pockets No repayment or interest are generally required. Angel investors can provide the company with tremendous insight and resources. | Dilution of ownership and control of the existing shareholders Usually in a smaller size compared to other forms of funding Follow-up investments are not common |
5. Crowdfunding
Crowdfunding is the collective measure for SMEs and start-ups to raise funds. Crowdfunding can be accomplished by holding local or digital events, but it’s more commonly accomplished through crowdfunding platforms, like Kickstarter or Indiegogo.
Crowdfunding is legal in Hong Kong and is subject to regulatory limitations set out by the Securities and Futures Commission (SFC) under the Securities and Futures Ordinance (SFO). As crowdfunding is considered an “Offers of investments in securities/collective investment scheme”, the SFC has enlisted certain limitations of crowdfunding mechanisms.
- Crowdfunding is subject to the licensing obligation under the SFO and the SFC’s Code of Conduct.
- Crowdfunding platform needs to be a Type 1 licensed person under the SFO and is subject to the relevant regulations under the SFO.
- It is an offence for a crowdfunding platform to issue any advertisement and invitation to the public for entering into an agreement to acquire securities unless it is authorized by the SFC.
Crowdfunding platforms are also subject to content requirements and prospectus registration requirements under the Companies (Winding Up and Miscellaneous Provisions) Ordinance. If a crowdfunding platform has an ordinary business primarily or mainly involves the lending of money, then it must also obtain a license under the Money Lenders Ordinance.
| Pros | Cons |
| Fast way to raise funds with no upfront fees Pitching a project in the online platform can be a valuable form of marketing Public reactions to the products and ideas can be tested | There is a set of regulations that companies have to follow Risk of leaking valuable information about your company Competition is very high as crowdfunding platforms are so accessible and have countless projects going on. |
6. Hong Kong Government Fund/Grants
Apart from getting funds from banks or investors, start-ups and small businesses can check out the funding schemes or grants set up by the Hong Kong government. Both funding schemes and grants are sums of money given to a business in order to help them further their business, promote innovation and/or support different industries. Companies are usually not obliged to at a later stage pay back the money so long as they meet the requirements and conditions set out under the grant.
For more information, check out our Q&A on types of government funding and grants that are available to small businesses in Hong Kong.
| Pros | Cons |
| Obtaining funds without diluting existing shareholders’ ownership in the company No general obligation to pay back the money | Competition is fierce and a lot of work needs to be put into preparing the application The amount given under the funding schemes/grants may also be insufficient to fully finance the company |
7. Incubators
Business incubators, also known as accelerators, are tailored to provide young businesses with a full-scale range of services such as management training, administrative support and/or mentorship. Here are some Incubation & Acceleration Programmes in place in Hong Kong.
- Cyberport Incubation Programme
- Hong Kong Design Incubation Programme (DIP)
- The Fashion Incubation Programme (FIP)
- Hong Kong Science and Technology Park’s incubation programmes
| Pros | Cons |
| Free or low-cost workspace Incubator may also offer business development programming | The application process can be rigorous and competitive Not exactly a fundraising exercise |
Key takeaways:
- There are mainly 7 forms of funding for a start-up or a SME including Friends and Family, Small Business Loans, Venture Capitalists, Angel Investors, Crowdfunding, Hong Kong Government Fund/Grants and incubators.
- There are pros and cons of all forms of funding, a company should choose the most suitable one(s) accordingly.
- A Loan Agreement is needed when a company tries to raise funds by taking out a loan, whereas an Investment Agreement/Share Sale Agreement should be used if a company wants to raise funds by selling its shares.
- A binding and legally enforceable written agreement should include the terms of the loan or investment and specify what rights are given to the lenders or investors in exchange for the fund raised.
Bibliography:
- Hong Kong Government, “Government Funding Schemes at a Glance”
https://www.success.tid.gov.hk/success_enews/govfundscheme/eng.pdf
- Money Lending Ordinance
https://www.elegislation.gov.hk/hk/cap163
- Code of Banking Practice
https://www.hkma.gov.hk/media/eng/doc/code_eng.pdf
- Securities and Futures Ordinance (SFO)
https://www.elegislation.gov.hk/hk/cap571
- Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission
- Companies (Winding Up and Miscellaneous Provisions) Ordinance