Capital is fundamental to the survival and growth of any business, with such pressures amplified in the start-up arena. However, against this backdrop start-ups should always consider whether such capital needs to be solely from investment and, more importantly, when is the best time to seek investment.
During the early stages of a start-up’s lifecycle its funding will likely be through bootstrapping. This is essentially the process whereby a business is funded from its own money and that of the founder(s), and whilst the positives are flexibility and control (amongst others), the negatives are the financial exposure associated with using personal funds and their limited supply.
Short term measures can include issuing share options to key members of staff in lieu of a payment of salary and claiming R&D tax credits, however this can only take the business so far. Share options require confidence from the employees that any shares will have value at some point in the future but also require staff to be able to afford the reduced salary. We have discussed the availability of R&D tax credits at length in previous articles, but for innovative start-ups R&D tax credit claims are often available and can result in reduced corporation tax payments or a cash payment which can be reinvested to grow the business.
Whilst there have been many notable successes achieved without external capital, there will likely be a crossroads when it is required and the options are many, with the most common being:
- Friends and family
- Venture capital and angel investors
For the focus of this article we will solely look at investments. Therefore, how can you seek to maximise the chances of a successful investment?
- Consider the key criteria looked for by investors and whether you meet them:
a. Team: a strong founder team with technical and commercial expertise with previous industry experience.
b. Product: is there an identifiable market for the product?
c. Size of the market
2. Know who you would you like investment from. Are you looking for a partner with valuable expertise and experience as well as capital or solely the best price?
3. Organisation - ensure that the legal structure of your product and company are secure, such as any IP being registered in the name of the company.
- Business plan - ultimately any investor is trying to understand the potential for the product, therefore a clear and justifiable business plan is essential. Consideration should also be given to a future exit plan; how will all parties seek a return from their investment in the future?
When seeking investment, the two key questions are:
- how much is the business seeking to raise; and
- by how much are the founder(s) prepared to dilute their shareholding?
Fundamentally, this comes down to a valuation that both investor(s) and founder(s) need to agree. As is often the case, the investors valuation may be lower than that of the founder(s) and therefore in order to secure investment, a higher proportion of equity is sought. Thankfully, there are various ways to structure investments in order to bridge this gap and align the ambitions of both parties – which is key for future success.
These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.