Contents:
Introduction
Finding financing for your start-up and attracting further investment to fuel your scale-up are necessary concerns for every entrepreneur, but they can prove to be a huge headache if you don’t know where to look.
We have created this guide to serve as a reference point. It includes the low down on every form of financing we could think of, with useful links wherever possible.
If you find any mistakes, or you think we’ve missed something relevant, please let us know at enquiries@webaxiscapital.co.uk
Before you start…
SEIS/EIS
An extremely important factor in the challenge of getting investment in the UK is a company’s SEIS/EIS eligibility.
The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) are two government programmes that have been created to incentivise investment into innovative start-ups through significant tax breaks.
SEIS covers very early-stage companies, as the acronym implies, mostly at the Seed stage. This scheme allows any single individual to invest up to £200,000 every tax year and receive a 50% tax break. Any single company can raise a maximum of £250,000 in SEIS funding.
EIS allows an individual to invest up to £1,000,000 per tax year and get a 30% tax break. The maximum EIS funding any single company can receive is £12,000,000.
At the same time, with both EIS and SEIS, there is the added advantage of not having to pay inheritance tax on shares owned for a minimum of two years. And if shares are at any point sold and a loss is registered, these losses can be offset against the investor’s capital gains tax burden.
Given that it offers an enormous advantage in the final ROI, SEIS/EIS status can make or break a deal for investors. Getting Advance Assurance from HMRC is essential and more information on which companies are eligible can be found here…
https://www.gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm3010
Applications for Advance Assurance are done here…
https://www.gov.uk/guidance/venture-capital-schemes-apply-for-advance-assurance
Investment Types
Friends & Family
This one is outside of the normal lines of financing and is exactly as it says in the heading – this is funding from your closest family members or friends. They are not professional investors and will be unable to run the necessary due diligence, but they will have expectations, sometimes wildly misinformed ones, about the potential success of the business.
The potential pitfalls of Friends & Family are many, but so is the advantage – this will probably be your easiest way to get any form of financing. It’s very unlikely that they’ll question your valuation, ask for securities or grill you on the most minute details of the business plan. At the same time, it’s a good way to show future investors that there are others with significant interest in your business.
The risk, of course, is painfully falling out with your family members or friends if things don’t go as promised, but there are ways to manage this risk, mostly through clear communication and setting transparent expectations from the start. The problem there is that often it’s hard to assess how much someone knows about investing when they aren’t a professional investor, so it’s very important to maintain lines of communication and keep them informed as the business develops.
If you do need to access this type of funding it could be a good idea to hire a lawyer with experience in venture deals. Also, getting everything in writing and explaining the risks in detail are the most basic prerequisites to your deal not turning into a huge drama two years down the line!
Equity Financing
Equity financing means raising capital through the sale of shares. Through an equity sale, the entrepreneur sells part ownership of their company in return for funding. Though often “equity” refers to companies traded publicly on stock exchanges, in the world of start-ups and scale-ups, equity is traded privately between the owners (usually the founders) and investors like VCs and Angels.
Equity deals can be very complex and include not only the sale of shares, but also many associated rights through mechanisms like preferred stock, convertible preferred stock, common shares and warrant rights.
How much equity should you give away?
There’s no hard and fast rule to this, however the amount you’re asking for must always equate to a percentage of the value of your company. A lot of advisors would argue that for those starting out, the general guiding principle is that you should think about giving away somewhere between 10-20% of equity. Giving up any more right off the bat could prove risky if your business grows as time goes on, as it’s possible you may face multiple funding rounds further down the line, which will dilute your share further and further.
This figure and how you got to it can position you anywhere from ultra-competent to ridiculous in the eyes of a potential investor. So, if you need to raise £200k and want to give away a maximum of 20% in equity, you’ll need to show that your company is realistically valued at £1m. If you want to give away less equity, say 10%, then you’ll need to increase the valuation to £2m.
In most cases – from Angel Investment to Venture Capital – asking for too little is worse than asking for too much. Asking for 5%, for example, may not be enough money to assist you, and it’s not enough money for the investor either because it’s not enough of a commitment for them to decide they should spend their time introducing you to people you don’t know, giving you the benefit of their experience etc.
There are longer term relationship implications here too. “Pitch high and you can always be scaled back – because if you end up going back and asking for more it annoys people and looks like you don’t know what you’re doing”, suggests Tim Hames, Director General of the BVCA.
The Fundamentals of Equity funding rounds
Pre-seed
This is often an unofficial round of funding and in most cases no outside investment is taken in. Pre-seed is usually the term given to the founder’s initial out-of-pocket start-up funding. Sometimes this includes some F&F (friends & family) money, but professional investors are usually not involved at this point. I say usually because pre-seed VC is starting to become much more common.
VCs like Forward Partners (https://forwardpartners.com/) now have pre-seed funds and if your company qualifies, they offer a lot of support until your idea becomes reality. Also, Seedcamp (https://seedcamp.com/) offers a standard £100,000 at 7.5% target ownership in pre-seed.
Seed
The Seed round commonly refers to a series of investments in which a group of investors, often up to 15, put up to £2 million into a new company. The seed stage is usually dedicated to building the foundations of the new company and is ideally based on the company having a viable product and showing at least a little bit of traction with clients. Convertible notes (debt investment which can convert to equity investment at a later date), preferred stock or straight equity are all typical ways of rewarding investors at this stage.
The Seed round is a great opportunity to get the core competency of the company right. Finding and refining product-market fit is the most important step an early-stage company needs to take to set themselves up for later success. At Seed stage, having the option to access the wisdom and network of a variety of seasoned investors is an amazing advantage, so it pays to not rush through seed straight into Series A.
An important source of seed funding is Accelerators (fixed-term, group-based programs that include seed investments, mentorship, access to industry connections and educational components to accelerate a start-up’s growth), Angels and specialised VCs. At the same time, major banks and tech corporations have an assortment of seed VC branches to be able to capitalise on the next big thing.
A helpful guide on seed funding can be found here:
https://www.ycombinator.com/library/4A-a-guide-to-seed-fundraising
Series A
Series A funding usually comes from a smaller number of VCs and Angels who will invest £2-10 million, in most cases for equity. The series is named after the type of shares the participating investors will eventually receive – Series A Preferred. This is usually the first round of preferred shares.
If the seed round is dedicated to laying healthy foundations for the company and not speeding up before finding product-market fit, Series A could demand high growth. That’s why the main question investors will ask before going in for a Series A is: Does it scale? Is the company’s main growth constraint cash, or is it that ideal product-market fit isn’t quite there yet? VCs will want to see that you know ‘exactly’ what you’re doing and have the right foundations before submitting their term sheet (a non-binding agreement that shows the basic Ts & Cs of an investment). That usually means a proven track record with clients and a very credible plan on how to scale up the revenue 2-5 times in the next 18 months.
Series B
While in Series A the goal is usually to support a business model that works, scales and proves that the company can reach well-defined goals, Series B is there to pour fuel on that initial fire. The companies that can access a Series B are usually already starting to turn a profit and their major challenge is scaling fast on the cash they have now. At the same time, a company in Series B may be targeting international expansion or developing related product ranges.
Compared to Series A, where a lot of the investment still rests on the “promise” of the new company, in Series B, the investment is based on cold hard realities, like market share, revenue, profits, assets, etc. That’s why compared to Seed and Series A, a Series B round is usually much harder to access.
While in a Series B you might still have a few Super Angels populating the ranks of investors, most of the money will come from established VC funds and the transactions are rigorous and structured. The amount invested in this round is between £10 – 30 Million.
Series C and beyond
A Series C round is usually raised to prepare the company for a buyout, to make one or more acquisitions itself or for an IPO. Series C is definitely in the big leagues, and the first of the “later stage” rounds, reserved for companies with huge traction and massive potential. A series C can lead to a D, E, F if the company is interesting enough.
At this stage, even the VC funds are thinning out and private equity companies, hedge funds and banks start to become much more common. At Series C and beyond, companies can raise anywhere from £15 Million to multiple hundreds of millions.
Crowdfunding
What is Crowdfunding?
Crowdfunding is the practice of raising money from a large number of individuals for the purposes of financing a project, venture, business or cause. Traditionally, crowdfunding has been carried out via subscriptions, benefit events and door-to-door fundraising. However, today the term is typically associated with raising money through website platforms, which allows crowdfunding to reach a larger pool of potential funders.
Different types of crowdfunding
Crowdfunding can be split into four main categories:
- Loan-based: also known as peer-to-peer lending (P2P), this involves individuals lending to businesses or other individuals in return for interest payments and a repayment of capital over time.
- Equity-based: individuals invest directly or indirectly in new or established businesses by buying investments such as shares, debt securities or units in an investment scheme.
- Donation-based: people give money to individuals, organisations or enterprises they want to support, with no expectation of any return on their investment.
- Rewards-based: individuals give money to receive a reward, product or service (for example, concert tickets, artwork, a new product etc.).
Equity-based Crowdfunding
Equity crowdfunding means raising funds from many individual investors by selling securities like shares (or convertible notes) in a company that isn’t listed on a stock exchange. Investors stand to make a profit if the company is successful, but can also lose their investment if it fails.
For companies, equity crowdfunding is a great opportunity to not only gain investors, but also comments, feedback, and essentially a small army of incentivised advocates that will strive to make the venture successful. This adds exposure and credibility to the company, and often the initial investors will follow up their investments in further rounds.
The main equity crowdfunding platforms are:
- Seedrs https://www.seedrs.com/
- Crowdcube https://www.crowdcube.com/
- Crowdfunder https://www.crowdfunder.co.uk/
- Syndicate Room https://www.syndicateroom.com/
Rewards-based crowdfunding
In rewards-based crowdfunding, individuals or companies create a pitch to raise small amounts of capital from many participants in return for specific rewards if the company meets its funding goal. The rewards are usually small and proportional to the funded amount. In most cases, the reward is the final version of the funded product.
The main advantage of rewards-based crowdfunding is the fact that the company does not need to lose equity. It’s also an ideal way to test market demand for a B2C product, especially if it’s visually demonstrable. The challenge is that for a campaign to succeed, you need to create a strong and convincing brand first. Your video pitch is the most important asset in this campaign, as is how and where you distribute it. If you’re a strong marketer and have a consumer-oriented product idea, rewards-based crowdfunding might be the best choice.
The key features of a rewards-based crowdfunding campaign are:
- Funds given don’t have to be repaid; you just deliver the service or the goods promised.
- Orders are secured before the launch of a new product, and the crowdfunding campaign allows you to build your customer base as you raise funds.
- You are obliged to deliver on your promises on schedule.
- It is a popular option for start-ups and entrepreneurs as it provides a way to fund the launch of new companies or products.
- It is particularly suitable for products and services that are either innovative or garner high levels of consumer attention.
- Complicated concepts or products are less suitable for rewards crowdfunding.
The main rewards crowdfunding platforms are:
- Indiegogo https://www.indiegogo.com/
- Kickstarter https://www.kickstarter.com/
Angel Investment
Angel investors are usually high net worth individuals who invest in start-ups in exchange for equity or convertible debt. The Angel could be from any background, but they are usually either former entrepreneurs or professionals who are retired, or high net worth individuals interested in innovation and the start-up world.
The main difference between an Angel and a Friend or Family member is that an Angel is a sophisticated, savvy investor who will do comprehensive due diligence and understands what they are getting themselves into. Angels usually invest their own money, in contrast to VCs who are essentially fund managers. That gives them a more personal stake in the transactions and often allows for more flexibility in how the deals are constructed. Venture capitalists are usually bound by stricter operating procedures and formalities, so Angels have more free rein to negotiate customised arrangements. This might mean more flexible terms, but it might also mean more equity, as the exposure and involvement for any one deal is likely to be higher for an Angel than a VC.
The risk born by Angel investors is very high, so their target return on investment is usually 10 times or higher – sometimes even 20-30 times. Their investments are very early in the company’s life cycle and the threat of losing the investment or dilution is a constant worry. This makes Angel investment quite an expensive form of capital, as all these risks need to be mitigated and reflected in the cost of financing.
Have a look at this link for an example of Angel investor connections… https://www.angelinvestmentnetwork.co.uk/find-investors
The trade body for Angel & Early-Stage investment is here… https://www.ukbaa.org.uk/
Angel Networks and Syndicates
Slightly more unstructured and informal than Venture Capital funds, Angel networks are groups of semi-independent angels, usually headed by a few industry specialists. Given the added structure, angel syndicates tend to be more risk-averse than single investors, but they also represent a bigger pool of money. These networks fill a needed space between the often quite loose world of solitary investors and the normally quite rigid universe of VC funds.
Angel syndicates are like VC funds in that they often specialise in certain sectors. It’s not uncommon to have MedTech, FinTech or cleantech (green) Angel syndicates that only invest in businesses with that profile.
Because Angels are often people with deep experience and passion for their industry, working with an Angel investor can mean introductions to the right people. Compared to a VC fund, Angels and Angel syndicates are usually more hands-off, preferring to not get involved in the day to day running of the business, but can still be a huge asset. The value of an investment, in this case, can’t always be measured in simple monetary terms, it’s also a function of the investor’s connections and the quality of their wisdom.
Some examples of angel networks and syndicates:
- Startup Funding Club https://www.sfccapital.com/
- 24 Haymarket https://24haymarket.com/
- Enterprise 100 @ LBS https://enterprise100.co.uk/
- Angels Den https://www.angelsden.com/en-gb/
Alternative P2P Lenders
While a bank may be the first thing that comes to mind when thinking of loans, some of the most active lenders in the SME space are something else entirely. Alternative lenders have sprung up to cover the whole lending market, offering secured and unsecured loans from a few thousand to several million pounds. This new breed of lenders is leveraging machine learning and various API integrations to get data straight from the source and profile their clients with a greater degree of precision than the old school banks.
Companies like Spotcap (https://www.spotcap.co.uk/) and Iwoca (https://www.iwoca.co.uk/) can lend up to £350,000 and £750,000 respectively with rates ranging from 1-3%/month.
Peer-to-Peer lending or debt crowdfunding is another spin on the more well-trodden equity crowdfunding. For start-ups that are already generating some revenue, P2P lending could be a great source of low cost finance. With rates from 5-12% APR, P2P lending is on the lower end as far as the cost of capital is concerned.
The main P2P lending platforms are:
- Funding Circle https://www.fundingcircle.com/uk/
- Growth Street https://www.growthstreet.co.uk/
- Lending Crowd https://www.lendingcrowd.com/
- Archover https://www.archover.com/
VC Funds
VC Funds are usually what people imagine when they speak about investment. These are managed pools of funds that are invested in start-up and scale-up companies with high growth potential. Funds come in all shapes and sizes, but the main ways each VC differentiates themselves is in three dimensions: Geography (ex. UK, European, Global), Stage (Seed, Series A, Late Stage), and Sector (MedTech, IoT, cleantech). This is important to keep in mind if you were planning a scattergun approach with a mailing list of VCs in hand.
It pays to do a bit of research on the specifics of each fund and their current investments before you start approaching them. You’ll save time and energy in the long run and your future investor will actually take you seriously if you do your homework.
The best way to start a conversation with a VC is through a warm introduction, so it pays to do some serious networking if you’re planning on raising funding.
Seedlegals has set up a list of the best places to contact people that could help you out on your funding journey: The 11 best events to meet investors in London. Also, their blog is really helpful for anyone starting a business in the UK, so it doesn’t hurt to check it out.
Venture Debt
Around 10% of the global venture cake is not comprised of equity, but debt. As part of an equity deal, VCs will often offer a company additional funding as venture debt. This helps to reduce the dilution of the founding members (or postpone it until a Series B+ round) and can still offer investors significant returns, as the average cost of venture debt is around 20% of the loan value over a typical 2 year period.
In general, the better the company is doing, the less attractive it is to give away more equity, so venture debt can be a more attractive proposition.
R&D Finance
R&D finance or R&D tax credit loans are a completely new type of debt where companies who are eligible to receive R&D tax credit loans can access them earlier in the form of a secured loan. R&D tax credit factoring is very similar to invoice factoring. The difference is that the “invoices” that are discounted are based on predicted payments from HMRC, not clients.
This type of finance works best for technology heavy companies who are either pre-revenue or pre-profit and wouldn’t be attractive for banks or other alternative lenders because they lack profitability, large receivables or assets like equipment and land. What these companies do have is significant investment in research and development, and now they can use that as an asset.
Because the R&D tax credit is a predictable source of cash for many UK companies, but very slow to materialise, lending against it makes sense. For a pre-revenue company, it can seem like selling equity is the only viable funding option. R&D tax credit finance can be a great alternative, as it leverages an asset that will materialise in the future to fund the cash needs of the present. This can be a good way of protecting the current position of shareholders and shielding them against dilution.
The best resource on the how, what and why of R&D tax credit finance is: The Complete Guide to R&D Tax Credit Loans.
Government Funding
Though most of the start-up and scaleup funding in the UK is done through private means, there is quite a big slice of government funding that goes to funding innovation and regional development projects.
Though the money on offer can often sound quite enticing, the downside is that the application process is laborious, the competition is stiff and the money comes with many strings attached. Actually, it’s like VC funding, venture debt or anything else outside of your family or friends investments.
Government funding can take many forms…
R&D Tax Credits
This is often the easiest and most accessible form of government funding for start-ups, especially those with a tech bias. Companies can access up to 33% of what they’ve spent on eligible R&D activities as a repayment from HMRC after the yearly accounts are filed. This includes salaries, contractor invoices, consumables, software, in fact almost anything that a high tech company would spend on development.
An excellent guide on this is available here:
https://granttree.co.uk/r-d-tax-credits-guide/
https://www.gov.uk/guidance/corporation-tax-research-and-development-rd-relief
Innovation Grants
Innovation Grants are available for many emerging areas of science and technology and most grants are sector specific. At the same time, there are open competitions with significant “prize money”, but because of their openness they also tend to be the most competitive. The caveat here is that for a technological advance to be eligible for innovation grant funding, there must be innovation present in the core aspect of the technology, not just in the fact that the new product or service is an innovation in a specific market.
The main body that handles innovation grants is Innovate UK:
https://www.gov.uk/government/organisations/innovate-uk
Regional Growth Funds
There are quite a few local growth initiatives across the UK. For companies looking for funding of less than £1m, it’s well worth contacting your local RGF programme manager: (https://www.gov.uk/guidance/understanding-the-regional-growth-fund)
SBRI Grants
The Small Business Research Initiative (SBRI) runs a series of competitions which are set up with the purpose of allowing the UK public sector to have access to the most cutting edge technology. Essentially, an SBRI is a government contract with an innovative company for a solution, similar to a tender offer.
Information on SBRI can be found here:
https://www.gov.uk/government/collections/sbri-the-small-business-research-initiative
Patent Box
Under Patent Box, a company that owns a patent from either the UK or an EU based patent office can apply for a reduced level of Corporation Tax (10%). This is a significant tax break that also applies to companies that own certain medicinal or botanic innovation rights.
Patent Box guidelines can be found here:
https://www.gov.uk/guidance/corporation-tax-the-patent-box
Start-up Loans
Start-Up Loans are a government-backed financing scheme that aims to help entrepreneurs just starting out. The interest rate is 6% and companies can borrow up to £25,000. While it’s no multi-million-pound Series A, it might be a useful addition to a company that’s just taking off without having to sell equity in the first instance. Applicants who are successful also have access to some mentoring options with successful entrepreneurs.
Information here: https://www.startuploans.co.uk/
Scottish Enterprise
Scottish Enterprise have recently changed the way they support businesses with a new funding model that’s simpler and more inclusive. Their new funds are aimed at helping businesses create jobs and contribute to a greener economy.
SMART: Scotland Grant
The SMART:SCOTLAND grant is a research and development (R&D) grants that aims to support high risk, highly ambitious projects.
It covers conducting feasibility studies. It’s only available to small and medium enterprises (SMEs) based in Scotland and supports activities that have a commercial endpoint. It supports feasibility studies that help to show your idea could work in the real world. Your project will need to generate intellectual property (IP) that your business will own.
You may be eligible if:
- You’re a small or medium sized business, university spin-out or an individual
- You’re based, or planning to set up, in Scotland
- Your project represents an advance in technological innovation for the UK industry or sector concerned
- There are technical risks and challenges associated with defining and developing the technology
- You own, or have rights to use, the intellectual property required to undertake the project
- You’ll own all intellectual property developed throughout the project
- You have the necessary management and technical expertise and resources (either in-house or brought-in) to make the project a success
- Both the project and the business are financially viable
- Financial assistance from SMART:Scotland is essential for the project to go ahead
All companies which are awarded a SMART: SCOTLAND grant over £100,000 will have the opportunity to work with our specialist teams to review their approach to Fair Work.
This will include:
- Appropriate channels for effective voice and employee engagement, such as trade union recognition
- Investment in workforce development
- Action to tackle the gender pay gap and create a more diverse and inclusive workplace
- No inappropriate use of zero-hours contracts
- Payment of the Real Living Wage
What level of funding is available for feasibility studies?
Scottish Enterprise can support up to 70% of the eligible costs for a small enterprise and up to 60% of the eligible costs for a medium enterprise.
Studies must last between 6 and 18 months, and the maximum grant is £100,000. Feasibility is paid with a third of the grant in an upfront instalment and the rest is quarterly in arrears, with proof of expenditure.
More information: https://www.scottish-enterprise.com/support-for-businesses/funding-and-grants/business-grants/smart-scotland-grant
Digital Development Loan
Funding to improve digital capability
Does your company need funding to improve its digital capability?
If you want to improve your digital capabilities and processes in areas such as cyber security, data analytics, software engineering and digital skills development, the Scottish Government provides interest free loans to help small to medium enterprises:
- Loans from £5,000 and £100,000
- Interest free payments
- 3 months to 5 years terms
Is it for me?
- Your business must be located in Scotland
- Must be trading a minimum of 6 months
- The purpose of the loan must be to improve digital capacity and or capability of the business
- Applicants must be over the age of 18
- Applicants must be a UK resident with the right to work in the UK
All industry sectors are eligible for consideration. The assessment will focus more on the contribution of the project to the fund objectives. Your business must meet the European Commission’s definition of an SME in relation to employees, balance sheet and turnover.
SME Definition link: https://ec.europa.eu/growth/smes/sme-definition_en
Lending terms
Summary terms of the Digital Development Loan for existing SME’s including sole traders, partnerships and social enterprises:
- Minimum loan is £5,000
- Maximum loan is £100,000
- Minimum repayment term is 3 months
- Maximum repayment term is 60 months
- Interest rate is fixed at 0%
- No administration fee
- No penalties for early settlement
More information: https://www.scottish-enterprise.com/support-for-businesses/funding-and-grants/business-grants/digital-development-loan