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Raising Finance Scenarios

Introduction

One of the biggest challenges facing a new business is making the leap from fledgling start-up to marketable product. To do this effectively, the vast majority need to raise finance to get to market. Here, Scott Haughton of Envestors examines two scenarios of new businesses and how they could go about raising funds.

Question

Our company, which commenced trading in early 2007, provides innovative software solutions to leisure operators. The business founder, who has already injected £200,000 to seed the business, is a proven entrepreneur, having previously started-up a technology company which went on to achieve a full market listing and achieve a market capitalisation of £80m. The business is formally registered and based in the UK, but is currently generating sales solely in the United States. We are currently seeking £800,000 of funding from UK based angel investors to expand. Is this a viable option?

Answer

The company certainly appears to tick a lot of the critical angel investment criteria “boxes”. Firstly, the business founder appears to have a very credible track record, not only in a similar industry, but perhaps more importantly having built a company from scratch which then successfully went on to achieve a full market listing and deliver excellent investment returns; Secondly, investors would require and indeed expect the founder and management team to have put enough “skin in the game” i.e. to have personally invested also; Thirdly, it is great to see that the business has proved its technology and is indeed currently generating sales revenue, therefore considerably “de-risking” the investment for potential investors; Finally, angel investors like software and are aware of the growth in the leisure market, so it would appear that the business does offer a highly scalable and profitable investment opportunity.

The only potential concerns for UK based business angels are firstly whether the business would qualify for all-important tax advantages which most angel investors require under the Enterprise Investment Scheme (EIS). Under this scheme, investors can receive a number of tax benefits, including initially off-setting 20% of their investment against personal income tax, then in the event of the company failing offsetting a further 32%, so that the investor only stands to lose a 48% of his investment. If the company succeeds, the investment is inheritance tax free and capital gains tax free. So as you can see, it is essential that the business does secure EIS. For the business to be eligible, the business can generate sales abroad, but must be operating from the UK.

Secondly, despite having what appears to be a very attractive investment offer, you must also offer the investors a reasonable slice of equity in return. The market rate for early-stage businesses generating sales under £300,000 annually would be a pre-money valuation in region of £500,000 to £1m.

Question

My London based company has spent 18 months and £20,000 founders investment, researching and developing the architecture for a new mobile phone data security application. The product concept is at pre-prototype concept stage. I am seeking to raise up to £1m to develop and fully test a beta prototype and then to fully launch the product. Beta development is estimated to take up to six months, and if successful we expect to be able to bring the product to market within a further twelve months. We are ideally seeking angel investors to help us succeed. Is this a viable option? If not what are my options?

Answer

At the current moment what you have is a good idea, but a wholly unproven concept. It is highly unlikely that you will attract any angel investors at this stage of your company development, because the risks are far too high: you do not yet have a working, proven product; you would need a highly experienced, well balanced management team; you do not have a solid sales pipeline and you are at least 18 months from generating revenue.

Furthermore it is highly unrealistic that you will be able to raise £1m for a pre-revenue start-up. Assuming that you do not want to relinquish control of your company, raising £1m in return for say 50% equity, implies a pre-money valuation of £1m and a post-money value of £2m. This is way outside what the market will bear. Normally pre-revenue start-up’s command pre-money valuations in the range of £350,000 - £750,000.

You also state that you require £1m total funding to develop the product, test it and then launch it. Whilst it is highly commendable for you to raise all your funding requirements in one tranche, this is highly unrealistic. It would be more sensible to raise finance in stages, starting with securing research & development funding and incubator support. This is more achievable and in the long run will ensure that you can command a higher market valuation in the future.

We would suggest that your best option would be to seek to secure a grant to assist you fund the required R&D. As a London based technology company, you may be eligible to apply for R&D grants, ranging in size from £2,500 to £500,000 from the London Development Agency (see www.lda.gov.uk ).

More pages

Page 1: Introduction
Page 2: © Envestors Ltd

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