Business Leader campaign: The fundamentals of fundraising
As part of Business Leader’s campaign to support entrepreneurs this year, our next article sets out all you need to know about raising capital for your business. Oliver Woolley is the CEO and co-founder of Envestors, a digital investment platform that brings together entrepreneurs and investors across geographies, communities and sectors and creates a single marketplace for early-stage investment in the UK. He spoke to Business Leader about the key information and best practices for fundraising as an entrepreneur.
The objectives you set for your 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.
Here are a few more questions you should be asking before setting out to fundraise:
Have you considered all sources of funding?
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.
Are you raising the right amount from the right people at the right time at the right valuation?
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.
|Stage||Amount raised||Ave. pre-money Valuation||Source|
|Pre-seed, start-up, pre-revenue||£150,000-£500,000||£500,000||Crowd, business angels, SEIS funds, incubators|
|Seed, early stage||£250,000-£750,000||£1m||Business angels, EIS funds, accelerators,|
|Pre-Series A, post revenue, pre-profit||£500,000 – £2m||£2m||Strategic investors, corporate partners, funds|
|Series A, growth (profitable)||£1m-£5m||£5m||Corporate partners, VCs, Family Offices, growth funds|
Have you got the right 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.
Are you eligible for UK tax relief under the 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. 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.
Do you have enough cash to raise cash?
Raising capital requires assistance in a number of areas from the legal documentation to the S/EIS application to marketing.
As a rough guide, it is recommended you have a ‘war chest’ of around £10,000 to £20,000 plus fees. In total, the cost of raising finance can be around 8% to 10% of the funds raised.
Are you aware of the obligations of having external investors?
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.
Have you got, or will you work towards getting, an independent board?
Many early-stage companies will not have a formal board in place, but most successful businesses use their network to persuade 2-3 key people in the industry to join their board.
This can be very helpful in terms of:
- Giving confidence to investors that someone is overseeing corporate governance and representing minority shareholders’ interests
- Assisting with fundraising through introductions
- Supporting the executive management team in acting as a sounding board
- Making introductions to key market and strategic partners
- Giving strategic guidance to manage the growth of the business through to exit
- Providing credibility to external stakeholders
Watch out for chairs or non-executive directors who, as a condition of investing require annual fees in cash.
Have you prepared balanced 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.
Have you kept the investment structure simple?
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.
Are you prepared to provide 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?
Is your fundraising spread sensible?
The “fundraising spread” is the minimum and maximum you are raising, all at the current share price (valuation). For example, you could be looking to raise a minimum of £450,000 and a maximum of £750,000.
Having a very wide fundraising spread can call into question your strategy. It can come across as’ just give me as much as you can and we’ll spend it’, which is never reassuring. In addition, the share price/valuation is likely to be different the more you raise and mature as a business.
Do you know how you will spend the investment?
Investors will want to have some idea as to how their money is to be used. This could be sales and marketing, tech development, new hires or working capital.
Importantly S/EIS funds cannot be used for certain items, for example (a) buying a freehold property, (b) acquiring shares in another business or (c) paying off existing loans.
What are the most likely 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.
These are just some of the questions you’ll need to answer before you can start raising capital. The idea of getting a cash injection to grow your business can be an exciting one. So exciting that it can be easy to underestimate the planning and hard work that goes into a successful fundraise. Make sure your plans are realistic and thought through – it’s the very least investors will be looking for.
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