Funding Options for Start-Ups

All businesses must start from somewhere, but what happens when entrepreneurs struggle to raise the finances needed? There are many options, and many alternative routes…

 

The Sussex start-ups scene is positively booming, especially in the tech sector. Brighton in particular has grown into one of the UK’s most vibrant tech business hubs, with a focus on creative digital and gaming. Recent statistics from the Centre for Cities 2015 Outlook found that Brighton has the highest number of start-ups per capita outside of London.

Start-ups have often struggled to raise finance from traditional sources of business funding. However, the investment landscape for early stage businesses has been changing over recent years, driven by a combination of factors, including Government-led tax policy and incentives, technology innovation and a recognition by larger commercial enterprises that supporting smaller businesses makes good business sense. Against this backdrop, entrepreneurs are now able to access a wide variety of different funding sources to launch and grow their businesses, including:

Grants – Grants are typically in the thousands of pounds to tens of thousands of pounds range and are available from public bodies, principally at local, national and European level. They are usually awarded for a specific purpose or project. There is a very high demand for grants that are available, and application levels often means that grants are run via a competition with strict eligibility criteria and tight deadlines. Another feature worth noting is that, while these are not loans (strictly speaking), grants may nevertheless become repayable if certain conditions are not met or deliverables/targets are not achieved.

Start-up loans – These are personal loans, again typically in the thousands of pounds to tens of thousands of pounds range, and are funded by the public purse. They have relatively low interest rates and favourable repayment terms. However, while no security would normally be required over the assets of your business or personal assets, they are not without legal risk or consequence if repayments are not able to be made when due.

Incubators and Accelerators – These offer a limited investment (c.£10,000-£20,000) for a small equity stake and also provide mentorship and resource e.g. technical expertise, office space, PR and marketing services. Legal documentation is often in “standard” form with little room for negotiation, but it is always recommended to ask a lawyer to check for onerous obligations and restrictions.

Friends and Family – Friends and family members may invest or provide loans to start-ups. As with any investor, such investments should be documented in legal agreements to avoid disputes and uncertainties.

Business Angels – Angels may typically invest between £10,000 and £100,000 each. Angels may be entitled to Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) relief, which offer generous income tax and capital gains tax reliefs to private investors. Both SEIS and EIS are subject to a raft of conditions and eligibility criteria and so it is very easy to fall outside of the rules and lose the tax advantages.

Crowdfunding Platforms – These facilitate fundraising from large numbers of individual investors, each investing relatively small amounts of cash. There are different crowd-funding models, based on equity investment, loans and ‘rewards’ (i.e. where a company provides products or services in return for investment). Several other innovative tech businesses are facilitating peer-to-peer fundraising, such as ‘crowd’ invoice discounting and debt factoring platforms.

Venture Capital – A number of early-stage VCs focus on smaller deals (‘pre-Series A’, ‘seed’ and even ‘pre-seed’ rounds). The proposed deal terms need to be negotiated, understood by all parties and implemented – having a robust legal document in place will ensure there are no misunderstandings. According to a recent study by London & Partners, VC funding of UK tech startups reached £2.46bn last year, an increase of more than 70% on 2014.

Banks – Banks, particularly the so-called ‘challenger banks’, are becoming more innovative in terms of developing products and services aimed specifically at earlier stage businesses and SMEs.

Corporate Venturing – Larger corporates often invest strategically in smaller, early stage tech companies. The drivers for this include larger corporates seeking access to innovative and disruptive technologies with synergies to their own business and strategies, which would take too long to develop in house, and/or gaining access to talent – again, which would take too long to hire or develop/up-skill internally.

Founders Agreement – It is important to have a simple shareholders agreement in place between co-founders from the outset of the business formation. This will ensure that a number of key issues are agreed and documented, in particular relating to how the business is to be run, how decisions are to be made and, crucially, what happens to the shares held by a co-founder if he/she leaves the venture. Companies who have not invested in such an agreement run the risk of being ‘held hostage’ by a co-founder who leaves with a significant proportion of the shares, with no legal way to require those shares to be returned to remaining founders. This is potentially a deal-breaker in terms of being able to subsequently raise external investment, and the costs of negotiating a settlement without any legal documentation in place can far exceed the costs of putting a founders agreement into place in the first instance.

Web Terms and Conditions/Privacy Policy – These are particularly key for businesses with an online presence, in order to minimise liability and reputational damage in respect of customers and users. The requirements will vary from business to business, so there is no ‘one size fits all’ approach.

Trademark Registration – Another key step for early stage businesses is to invest time in protecting their brand and developing an intellectual property strategy. Trade mark registrations advice should be sought, in order to avoid potentially costly litigation and/or re-branding exercises at a later stage.

Hiring – There is often confusion around hiring employees versus interns versus contractors. Companies should understand the differences between the terminology and ensure that advice is taken to ensure the most appropriate contracts are in place.

Fundraising – Founders preparing for an investment round from angels or VC investor should familiarise themselves with example term sheets (that is, short summaries of the key investment terms which investors propose). This will put founders in a much better position of understanding of the legal terminology and commercial provisions involved when term sheets are received and need to be negotiated. While the majority of provisions in term sheets are not legally binding, it is very difficult to subsequently seek to amend the investment terms once they have been signed, so a detailed understanding is a must.

Jonathan Snade is a Corporate Law Partner at Thomas Eggar, a trading style of Irwin Mitchell LLP. Jon advises on a broad range of UK and cross-border private company transactions, including angel and venture capital fundraisings, private equity investments, management buy outs, mergers and acquisitions, disposals, joint ventures and reorganisations. Jon has a particular focus on the technology sector and advises both large international players as well as early stage, high growth digital businesses.

 

www.thomaseggar.com