Getting Finance – Part 2
In this, the second part of looking at the different forms of finance available to a startup, I look specifically at the different types of equity finance and try to summarise the benefits and drawbacks of each. The March edition of the magazine looks at the question of finance in full detail.
The essence of raising equity finance is simple – you sell part of your company in exchange for an investment into the company. Remember though that to attract any investor you will need a real business and not just dreams, and that business must have a real and supportable valuation. Your business plan and investment deck must be clear, compelling and detailed but concise, and you must be able to demonstrate that you or your team know all aspects of the business and can defend the assumptions that you have made.
So, having gone through all the stages I mentioned last time and above, what are the different options for raising equity investment?
An Individual or HNW
This can be the easiest but only of course if you know some wealthy people or can get some warm introductions! Maybe your mentor or other contacts can help. If an individual already knows the sector or can instantly see the potential of your product or service then they will often make a quicker decision than obtaining funding in other ways. Having just one investor that is not a professional investor though can easily lead to a lot of wasted time and effort in answering too many questions from a potentially ill-informed large minority shareholder. The very big benefit though can be if this is ‘smart money’ – that is an investor that knows the sector and brings much more than just money.
This is typically a group of small serial investors that look to invest directly into early stage businesses. Often, each individual would invest between £10,000 and, say, £50,000 and the network would secure the whole funding round in a sindicate. The network provides the opportunity for a group of separate companies to do ‘Dragon’s Den’ style pitches to the investors at an event and would charge a fee in the region of seven percent of monies raised although this can vary considerably depending on the total amount raised and the level of services offered. The benefits of this option is that you are put in front of a range of serious individual investors but the downside is that you will end up with a number of small investors that you must then manage going forward and this might actually be even more time consuming than dealing with one lager investor.
This type of funding is relatively new but now represents a large part of the market for early stage fundraising. In theory this can be for either debt or equity but as mentioned earlier to raise debt requires three years’ worth of trading accounts and clearly, to be successful, these should show a good business and not one that is still loss making. This type of funding is what is known as peer to peer funding and anybody can invest as little or as much in any project that they wish to having looked at your presentation on the crowdfunding platform.
The presentation will consist of a short video, business explanation / plan, projected accounts, and of course the amount that you seek to raise and on what terms. You may end up with a small number or really quite a large number of shareholders and this has the potential to be complicated and time consuming for you so I would suggest that you use one that acts as a single nominee for all the shareholders as this would seem to be by far the best structure. Typically amounts raised are up to £1m but can be higher and before they are launched on the public sites the platform provider will want to see about on third sold to your existing contacts and wider network.
Preparation can take up to a month and it would be normal to allow one month to obtain the target investment – if the target is not achieved then normally the fundraiser gets nothing. Fees are again broadly seven percent of monies raised and only on success. The benefits are that this is quite quick and easy and uses the power of the internet to reach a wide audience without you having to do individual pitches. Depending upon your product or service it can also act as a very good marketing tool as investors would also become buyers.
Venture Capital Firm
This is a professional firm of investors that will do detailed analysis and due diligence and will often push much harder for a bigger percentage of the company. They are more typically seen in second or third round funding or larger amounts although some do specialise at the smaller end of the market (although would normally then charge higher fees). The process can be much longer and more painful for a startup due to the level of information required but once a VC is on board the fact that they are professionals means that they can be a very good business partner and would often look to invest in subsequent, larger rounds.
Raising finance can be a complex business and how it is done and exactly what structure is used can greatly affect both your own tax and that of the investors so all of this must also be taken into consideration. Again, seek advice and guidance and work with somebody that you trust.
Remember that the earlier in your venture that you raise funding the more expensive it will be – that is the value of the company will be lower so for each pound raised the greater the percentage of the company you will need to give away. Later rounds would sell a lower percentage of the business and raise larger amounts of investment.
Which of the above is right for you and your company will clearly depend on many things including: the amount required; whether you seek seed funding, or second or third round.
Next time we will look at one of the biggest but most underused tax benefits available to an innovative company: R&D tax credits.