A Guide to Fundraising

Do you really need to raise finance for your business? If you can, avoid raising finance in the start-up stage, but if you do need an injection of cash, here is a brief guide to the fundamentals of fundraising.

Equity?

The objectives you set for the business will dictate the type of finance you should raise: the two key options being equity (selling shares in your company) and debt (borrowing from a bank or financial institution). There are two types of business:

(a) a “lifestyle” business that you want to develop but have no real expectation of selling

(b) a “growth” business, that you are looking to grow and scale and then sell in the foreseeable future (eg the next five years).

If growth and sale are not part of your plan, then an equity raise is not the right choice for you.

Other sources

There are myriad investment sources ranging from seed funds, incubators, business angel networks, family offices, regional funds, corporate venturing funds, international investors (individuals and companies) and enterprise capital funds (ECFs).

For early-stage companies it is especially important to develop a network of industry contacts as it is these connections (individuals that understand your sector or know you personally) who, directly or indirectly, are the most likely source of investment.

Right amount from the right people

If raising equity finance, you should make sure you are raising the right amount at the right time at the right valuation from the right source. A mismatch here will decrease the chances of successfully raising capital.

Legal structure

There are a number of business structures in the UK:  sole trader, partnership, limited liability partnership (LLP), unincorporated association, community interest company (CIC) and company limited by guarantee. In order to raise equity finance you need to set up a limited company that is registered on Companies House.  This makes the buying and selling of shares in your business more practical.

Enterprise Investment Scheme (S/EIS)

Private investors paying tax in the UK can benefit significantly from tax relief of up to 72.5% of the funds they invest into UK limited companies under the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).

Approximately 70% of private investors in the UK prefer to invest in companies that provide them with tax relief under the S/EIS([1]). In fact, the majority will not even look at an investment opportunity unless the eligibility of tax relief is explicitly stated upfront.

There is also 100+ S/EIS investment funds which pool private investors’ funds and look to invest into early-stage ventures to obtain tax relief on their behalf.

Obligations

One of the biggest complaints from private investors is the fact they get ignored the day after they invest their cash into a business. If you are asking private investors for money you need to keep them on board with regular reporting: quarterly updates, and an annual Shareholder Meeting sharing annual accounts and the budget for the following year.

Financial projections

Entrepreneurs need to strike a balance between explosive hockey-stick shaped financial projections which they believe investors will want to see and credible numbers that have a realistic chance of being achieved.

Typically, you will need to show financial projections for five years: the first two years broken down by month and the following years in quarters. It can be helpful to prepare target and realistic (and even worst-case) scenarios.

Financial projections should include the following:

• Cashflow forecast outlining the cash needs of the company. This will include capital expenditure, exclude depreciation, and allow for delays in receiving payments from clients/customers as well as building in payment terms to suppliers.
• Profit and loss account forecast outlining the profitability of the company. A company can be profitable and yet still require cash for capital projects.
• Balance sheet forecast outlining the financial position of the company at each year end in terms of assets and liabilities.

Do keep it simple. Massively over-complicated and detailed excel models that can only be understood by the author will put off investors. It is important to show the key revenue drivers to enable investors to understand the business model.

Simple structure

When raising investment from private investors (business angels) it is best to avoid complicated investment structures that are difficult to understand. If raising equity finance in the UK, ensure the proposition is eligible for tax relief under the (Seed) Enterprise Investment Scheme (S/EIS).

Increasingly companies are looking to offer different investment structures such as Convertible Loan Notes (CLN) and Advanced Subscription Agreements (ASA). Some private investors are not comfortable with such structures as they are seen as more complex with regards to the treatment of their rights and the treatment of S/EIS tax.

Full disclosures

A pet peeve of investors is business plans that only tell you the good bits. Investors need to see the whole truth to make a decision – that means the good, the bad and the ugly.

If raising money from experienced investors and funds, you will be expected to provide disclosures on a range of matters, including:

• Do you employ your spouse, son or daughter, or any other family member?
• Has any member of the team been involved in insolvency or been disqualified from being a company director?
• Are any of the management team members involved in another business? Ideally, they are wholly and exclusively working for the company without any potential conflicts of interest
• Have you disclosed all financial liabilities, including taxes due?

Valuation

Arguably, one of the biggest challenges in the early-stage investment market is setting the pre-money valuation for the investment round.  A key complaint by investors, especially when viewing propositions on crowdfunding platforms, is that entrepreneurs tend to base valuations upon expected future earnings without taking account the associated risks.

This has led to businesses that have successfully raised investment having to go through a “down-round” later to attract follow-on investment from sophisticated or professional investors.

Know your worth. Many companies mistakenly believe it is better to let the investor decide. That can be fine if you’re dealing with a single potential investor, such as a fund or VC, but if asking private investors, it is quicker and better to present the investment offer in full, including the share price.

Exit routes

A clear exit strategy should be part of your investment proposition. The business exit is where investors will get their money back – hopefully with a return.

Business angels research conducted by UKBAA and British Business Bank shows the most common way in which businesses exit are:

• Trade sale 55%
• Sale to other shareholders (including management buy-outs) 10%
• Sale to a third party through a secondary sale process 10%
• Listing on a stock market 10%
• Other 15%

It is good practice to provide examples of businesses that are similar to yours who have exited.

Finally, remember that raising equity finance is a marathon not a sprint.  It can be as short as six weeks to close investment but typically it takes six or more months. You need to balance the demands of fundraising with continuing to grow the business as you can’t afford to take your eye off the ball.

[1] Source:  Research conducted by Envestors Private Investor Club (EPIC) on investor references of its 4,000 private investor members, July 2021

ABOUT THE AUTHOR

Oliver Woolley is CEO and co-founder of Envestors. Envestors’ digital investment platform brings together entrepreneurs and investors across geographies, communities and sectors – creating the single marketplace for early stage investment in the UK.

https://www.envestors.co.uk/