By Jonathan Snade, Corporate Law Partner at Thomas Eggar LLP
The current investment environment
Traditionally, early stage businesses, especially start ups, have struggled to raise finance to support the launch and initial development of their product or service. Small business banks have been reluctant to lend funds to unproven businesses and venture capital funds have tended to avoid investing in early stage companies, focussing instead on investment opportunities in later stage companies and investing in ‘Series A’ rounds (being investment rounds in the £1m range). New businesses seeking their first £10,000, £50,000 or £200,000, have found it hard to access those amounts, unless obtainable from personal savings or those of supportive friends and family members.
However, the investment landscape for start ups and early stage businesses has been changing over more recent years.
Tax incentives available to investors
Tax incentive schemes such as the Seed Enterprise Investment Scheme (SEIS) have helped to encourage angel investment in earlier stage UK companies. The generous tax benefits offered under SEIS (which include a 50% rebate to an individual investor from HMRC on amounts invested by him/her into a qualifying company) have applied since April 2012 and have resulted in over £80 million being invested in early stage companies since then.
Alternative funding options available
Another trend in the early stage business landscape has been the rise in alternative funding options. For example, here we can think of:
• Grants: There are a myriad of government and other grant schemes (e.g. via Innovate UK, IC Tomorrow, Nominet). High demand and application levels often means they are run via a competition with strict eligibility criteria and application deadlines.
• Start-up loans: Start-up business loans are often backed by the Government, range in size, have low interest rates (approximately 5%-6%) and repayment terms of one to five years. Business founders may need to give personal guarantees to secure such loans.
• Incubators and accelerators: Accelerators tend to offer a limited investment (typically between £15,000 and £20,000) in exchange for shares in the company (often around 5-6%) and also provide mentorship and resource for a short period of time (3-6 months). Incubators generally tend to look for larger equity stakes (c.10-12%), bring in external management expertise and also provide office space, training and access to other investors.
• Crowd funding (debt/equity/reward-based): Crowd funding investment platforms (e.g. Seedrs) help companies raise funds from large numbers of individual investors, who each might invest anything from ten pounds to thousands of pounds.
There are different crowd-funding models based on equity investment, loans and ‘reward based’ (i.e. where start-ups provide products or services in return for investment).
How the profile of investors has evolved
With particular reference to crowd-funding, the profile of a business investor has changed significantly. As above, once the preserve of venture capital firms and serial non-executive directors, the new face of the modern business investment world is much more diverse, with more and more people pooling small amounts of disposable cash into start ups and early stage businesses.
Another current trend is the emergence of institutional investors targeting specifically much smaller investment opportunities in earlier stage businesses. Rather than focussing on ‘Series A’ rounds, some VC firms target ‘pre-series A’, ‘seed’ and even ‘pre-seed’ investment opportunities.