Managing Investment and Fund Raising Resources
Having sufficient capital to start a new business can sometimes make the difference between success and failure. This module will outline the different ways to raise finance for your venture and when to do this, what documentation is required and how to ensure you are well prepared to negotiate effectively with a potential investor.
Types of Investment
Equity and loans are two of the primary sources of investment to bring capital into your business. Loans tend to be faster to arrange, whilst equity can take some time, especially if there is more than one investor.
New businesses do not normally generate income right form the start. Buy some time. Equity is an option where an Investor will provide a capital injection in return for shares in your business. Your company is now not 100% yours! You will need to steer your relationship via the appropriate legal documentation and that can take time. Once you give away shares in your company in return for investment you are unlikely to get them back.
Getting working capital for your business with a loan can be quick way to raise funds. Check your credit rating before you apply. Do your research and shop around. Find an interest rate (APR) and term of loan that suits you. Can you meet your repayments? Always read the small print and do not be caught out! Set up costs or late/early repayment penalties are common and hidden away in the terms and conditions.
Raising capital can be very time consuming. Start the process as early as possible so you can consider all your options and channels of investment open to you.
Exchanging shares in your business for money is a process that has been around for centuries. An investor will invest in your company and in return you will give them a stake in your company in the form of shares.
The key starting point when considering selling shares is the valuation of your company? The temptation is to value your business at a high level, but investors may apply a different valuation equation.
For early stage businesses, a valuation may have to be determined on the future potential of the firm and the owner / investor coming to an agreement from which the valuation will be based.
As the business grows, more traditional valuation based on revenue and growth rates can be applied.
Issuing shares has a definitive process and may include a shareholder agreement and will require an update to companies house
Taking a loan means that you borrow money and pay it back later at an agreed rate of interest, over an agreed time frame.
You can consider unsecured and secured loans.
There are two key types of loan:
When a loan is unsecured, the lender has no claim on your assets if you fail to repay. Although your credit rating is likely to suffer if you do not keep to the terms. The opportunity to negotiate terms is limited.
When a loan is secured, this means that an asset you own is used as collateral for the loan. If you fail to adhere to the payment terms, you may lose the asset. You should carefully consider when using an asset as collateral for a loan, negotiating with the lender – who is likely to place a lesser value on the asset.
Ensure you can repay loans. Use this calculator to determine the costs.
Traditional Sources of Financing
Traditional…what do we mean? Simply a loan or another line of credit.
Tried and tested source of finance for your business is your bank and the usual place to start, but what are these and other options you can consider to secure financing for your business;
- Banking Overdraft and other bank loan
- Business Angel
- Venture Capitalist
- Business Grant
If you need to secure finance, be prepared for your credit history, business plans and assets to be closely scrutinised.
Bank Overdraft & Loans
An overdraft is usually viewed as a short term fix for your business needs.
With an overdraft, you tend to borrow to an agreed limit known as a “facility” within your current business account.
Payments from account will be permitted, exceeding your account balance and up to the agreed limit.
Loans from your bank can also be quickly arranged, although the size of the loan and the length of repayments should be key considerations.
A bank may apply more scrutiny to your historical finances and could insist on some form of collateral
Investor angels, or business angels, are people who invest their money in the initial phase of start-ups, usually in exchange for shares.
Business Angels are private individuals who invest in start-ups (usually up to a maximum of £250,000, but more often in the region of £5,000 to £20,000) and early stage businesses with good growth prospects, in exchange for a share of the company’s equity.
Business Angels use their own money to invest in businesses they like the look of, either directly or through a business angel network. They can also carry out the role of a mentor and offer their experience to entrepreneurs.
Many contacts are made informally: personal friends and family, wealthy business contacts, major suppliers and clients of the business. Investors can also be found by approaching formal angel networking organisations. Many of the most active business angels use these networks to find out about interesting investment opportunities.
Early stage investment with an angel is typically made under the umbrella of investment tax relief (EIS/SEIS).
Can accelerate growth, but will want to follow stringent processes. A VC will want to play an active role and perhaps even sit on your Board. Restrictions on your decision making. You could lose control of the business if you take too much financing.
Venture Capitalists (VCs) are professional investment bodies, often regulated by government bodies.
VCs tend to offer capital in the range of £550k to £50 Million single investment. As such, the due diligence prior to an investment is likely to be intensive, be prepared for some heavy duty auditing.
VCs are professional investors and will be looking for:
- Evidence of growth in the business’s trading history
- Experienced management team
- Distinctive value proposition with big market potential
- Clear plan for using funds, e.g. technology, people, marketing etc.
The more your company grows then the greater their return on investment, so expect them to be heavily involved. A high profile investment gives credibility to the business.
A business grant is money awarded to businesses in need.
Unlike a loan, grants don’t have to be paid off. The money is not being borrowed, so there is no interest attached.
Business grants are often offered by government bodies and schemes to fuel new businesses and advances in technology.
Grants often seek to serve areas that commonly find traditional investment hard to secure, for example;
- Areas of the country in economic depression
- Sectors of the population needing support, e.g. handicapped
Grants can also be used to accelerate business activity, for example;
- Emerging technologies
- Overseas trading
Alternative Sources of Funding
Areas of investment you may not have thought of can include:
- Friends &Family
Allowing you to approach your wider network of personal and professional investors. You can market your business to a target audience or community of interested investors. The Crowdfunding platform will take a percentage of the raise, but will actively help you design the right pitch and documents.
Friends & Family
One of the biggest ways that business start ups get off the ground. Taking investment from your close circle who want to support you and your business. Be open with them on the risks.
Stretch your own resources. Use your own savings to fund a new business venture…opposite to exchanging shares for investment.
Crowdfunding has become a legitimate way to get early funding, but also growth capital.
There are a number of established networks. Crowdcube, Seedrs and GoFundMe being chief amongst them.
Terminology and Key Documents
As you prepare for an investment or raising funds, you are likely to face completing more documentation and structured data.
In particular, what information you have to disclose and the degree of due diligence that is undertaken by the investor.
Financial disclosure is a term given to describe the giving of your financial information, usually supported by documentary evidence. An potential investors will be looking for historical accounts and forecasts.
Due diligence is an investigation, audit, or review performed to confirm the facts of a matter under consideration. Due diligence requires examination of financial records before entering into a proposed transaction. The due diligence process will become more onerous the further down the investment route you get. Expect stringent processes from investors at Series Investing Rounds A and beyond.
There is a special language around financing, so understanding the terms used by investors and other stakeholders is important.
There is standard documentation that most investment activity generates:
- Term Sheet
- Investment Agreement
- Share Subscription & Shareholder
Get the ball rolling with a Term Sheet. Lay down the basic terms and conditions of the investment of this non-binding agreement. It could take the form of a letter of intent or memorandum and have the basics of the deal in bullet points.
You will contract with your Investor via an Investment Agreement. In this, you will state the definitive terms of the agreement and any warranties. Warranties can encourage an Investor to commit based on assurances. If the warranty is not met, you are in breach of contract, liable to damages.
The Investment Agreement outlines the terms on which an investment is made and shares are acquired. The Shareholders Agreement states the relationship between the shareholders, management, ownership and protection of shares. You can see these two different agreements tied together in what we call a Share Subscription & Shareholder Agreement.
Resolutions. It is not enough to just sign an Investment Agreement. You must have agreement from your other existing shareholders to go ahead. You may need to adopt new articles and all will need to be evidenced by company resolutions.
Start-ups raise capital through rounds – this could be several phases as the Company grows and sees results.
If goals are met, your previous investors may invest more in later rounds.
The first official funding stage…think of the analogy of planting a tree. The beginning or idea stage…what can you grow?
2. Seed investment
Contribution is usually small as the business idea or product may need development beyond your simple proof of concept or prototype.
3. Angel investment (may be part of Seed Investment)
Injects capital in at an early stage. The company has no track record so the risk is high and therefore they may feed capital through in small chunks.
Series A-E (larger Angels may participate in A/B rounds)
More significant rounds of investment. Series A-E usually refers to a class of share/stock your investor will take for investment your company. It helps investors understand where you are in your journey.
Use the term sheet and subsequent investment documentation to outline under what situation they would be willing to invest more in the business at a later stage.
A-E Funding Rounds
Each funding round A, B, C or beyond is a steppingstone to a bigger business with expanding capital growth.
Series A investors tend to lead the process and call the shots. They will lay out a more stringent process that was used in previous rounds. They see potential in you but they want a return on their investment. You may feel a loss of control as they now own part of your company.
Series B goes beyond development to growth in every area., such as business development, sales, advertising, technology and employees. You are growing fast and are well established. New investors may join in.
Series C sees a successful business looking for additional funding. Perhaps the business has grown to encompass a new product, or you may be at a stage where you incorporate an overseas subsidiary.
Most typically companies utilise their Series C-E towards boosting the value of their company and looking towards going public or a trade sale.
At each stage, you ned to have a financial and business strategy mapped over time, with milestones that will be met.
Investor Tax Relief
The UK Government has a number of initiatives available in the form of tax reliefs to encourage innovation in start ups – EIS and SEIS in particular. Shares issues under both schemes must be ordinary shares only.
How to structure a deal so are can offer tax relief to your investor…the golden ticket is to acquire “Advanced Assurance” before you approach investors.
Qualification and Exclusion of Schemes
Check you can participate. Government guidelines help determine if a business falls under a blanket exclusion. VCM3010 – Venture Capital Schemes Manual – HMRC internal manual – GOV.UK (www.gov.uk)
There are rules around investment as a percentage of trading volume and exclusion of specific sectors, e.g. banking, insurance + others.
Qualifying Business Activity
Your investment must only be used in a certain way, such as developing your business concept or product, hiring a team etc. Use the Enterprise Investment Scheme (EIS) to raise money for your company – GOV.UK (www.gov.uk)
Assurance that your company is eligible for SEIS or EIS relief. Get an application out to HMRC before you approach your investors. Preparation is key. HMRC will want details for at least one proposed investor along with their intentions for at least 30% of the amount of SEIS/EIS you are applying for. If you do not include these details, your application is likely to be rejected as a “speculative” investment. Once rejected an “Advance Assurance” application can be difficult to reinstate, so take advice.
EIS and SEIS Advance Assurance can can take anything between 2 – 6 weeks
SEIS / EIS Process
- Draft a covering letter to support the application form and reference all information and documentation being supplied, as well as to include all relevant details and arguments that will help HMRC grant you advance assurance.
- Valid company Unique Tax Reference (UTR) (otherwise known as the ‘corporation tax reference’) and Company Reference Number (CRN);
- Copy of latest accounts where available;
- The company’s business plan / pitch deck (or even a short executive summary) including 3 year financial forecasts;
- Details of all trading or other activities to be carried on by the company;
- Schedule of all other tax-advantaged investments received by the company, including the amount, date and scheme under which each investment was received;
- Details of the amount the company hopes to raise, and a schedule of the activities, and amounts, on which it intends to use the money (the amount does not need to be precise but should be close to the actual amount needed;
- Up-to-date copy of the Memorandum and Articles of Association of the company;
- Copy of the register of members (a list of your current shareholders) at the date of submission of the advance assurance application;
- Subscription agreement/Investment Agreement or other side agreement to be entered into by the shareholders;
- Latest draft of any prospectus, information memorandum, brochure or similar document relating to the relevant fund raising or offer to be issued to potential investors;
- Confirmation that the company expects to be able to complete the declaration on a compliance statement in due course; and
- The information cited above about one potential investor…do not let your application fail at the first hurdle!
- From 10th October 2019 HMRC introduced SEIS and EIS checklists which must now be completed and submitted with any SEIS and / or EIS advance assurance application requests.
Make sure you issue the share certificates.
Send a SEIS1 and/or EIS1 “Compliance Statement” to HMRC. You must do this before HMRC will grant tax reliefs to your investor.
If successful HMRC will send your investors a SEIS3/EIS3 certificate to your investors enabling them to move on and claim relief.
Issue your investor with their shares only AFTER you have received their investment and it has hit your account. It is possible to raise investment under both schemes BUT do not issue shares under both schemes on the same day.
Investors can take no more than a 30% stake in shares in your company in order to qualify for either tax relief. Your investor must not be connected to your company in a director or employment capacity. Only AFTER the shares have been issued can you appoint your investor as a director!
Be clear on what “trading” means and seek guidance…distinction between “preparing to trade” and “trading”…You pay for software developers to work on your app and they raise an invoice. You are “preparing to trade”. The beta-version of your app is ready to go out to your paying customers…you are “trading”.
Additional ResourcesBusiness support and funding https://www.gov.uk/business-finance-support
Small Business Finance https://smallbusiness.co.uk/small-business-finance-list-grant-funding-options-2536394/
UK Crowdfunding Association https://www.ukcfa.org.uk/about-us/members/
UK Business Angels Association https://www.syndicateroom.com/angel-investors/networks