Currently there is a range of funding sources available to technology businesses, whatever their stage in the growth cycle and operational strategy.
Start-ups to early stage
Unproven tech start-ups will often struggle to raise funds from traditional sources, such as venture capital lenders. However, there are other options available:
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 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.
Friends and family
Friends and family members may invest or provide loans to start-ups. If friends or family invest, a proper suite of legal documentation (including a shareholders agreement) should, as with any investor, be entered into to avoid future disputes and uncertainties.
Early-stage to growth stage
High net worth individuals who, either individually or as a “club”, invest in early stage companies, typically between £10,000 and £100,000 each. They may be entitled to Seed Enterprise Investment Scheme (SEIS) relief too, which is a big attraction.
SEIS was introduced by the Government in 2012 to encourage investment in early stage businesses that would otherwise struggle to raise capital. Subject to certain conditions, it offers generous income tax and capital gains tax relief to investors.
Crowd funding (debt/equity/product)
Crowd funding investment platforms (e.g. Seedrs) help companies raise funds from large numbers of individual investors, who each might invest anything from £10 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).
A current trend is that more established businesses and SMEs are also using crowd-funding as a way to raise finance.
Larger angel rounds under the Enterprise Investment Scheme (EIS), the “big brother” of SEIS introduced in 1994 and offering similar tax benefits (subject to conditions and eligibility criteria).
Securing a “Series A” (first round of venture capital funding), which would ordinarily be in the range of £500,000 to £2,000,000 for a 20-25% stake in the business, can dramatically enhance a business’ prospects.
Start-ups must be confident of the added value the VC can bring in terms of market knowledge, contacts and experience. Legal advice should be sought early on in the process, even prior to term sheet stage, so that the terms and ramifications of the VC’s proposals are fully understood and negotiated, to achieve the best deal possible.
A VC backed company would then ordinarily undertake further rounds of venture capital funding, with each round being at a higher valuation and diluting the shareholdings of the incumbent shareholders (both management and investors).
Alternatively, some larger corporates with an interest in the underlying technology or talent/staff may themselves invest strategically – “corporate venturing” and is increasingly prevalent, for example Intel Capital and Juniper Networks (through its Junnos Innovation Fund).
Enter the lenders
As revenues grow business may attract traditional lenders and secure overdrafts, senior loans or mezzanine loans. HSBC announced in Spring 2014 that it is to make £6bn available to small and medium businesses in a new growth fund for companies with a turnover of up to £30m.
Exits and public fundraising
Ultimately, any investors, be they HNWs or VC investors, will want an exit in order to realise their investment. At this stage the options include:
Private equity buy outs
Private equity in the TMT sector is making a come-back with senior lending institutions keen to provide the debt finance required to leverage private equity-led transactions.
Eagle Eye Solutions Group, Xeros Technology Group and Rosslyn Data Technologies Group have all recently listed on AIM, showing evidence of a recovery in market confidence in AIM listed technology companies.
However the High Growth Segment (HGS) of the London Stock Exchange has been less active, with only two companies being listed as of January 2015.
Whatever a tech business’s size or funding requirements, directors and founders should not underestimate the time and effort needed to invest in the fund raising process, or the stress and distraction it will cause.
Investing in professional advisers will share the load, retain value in the business during the fund raising process and ensure that the transaction is executed on time while the risks to the stakeholders are reduced.
By Jonathan Snade, Corporate Partner, Thomas Eggar LLP