Tech specific venture capitalists (VCs) are go-to sources for many founders seeking funds, but are they the best source for your plans? What alternatives exist? And what will each expect from your business, its milestones and its people?
“Founders need to consider different sources of finance as they scale their businesses”
The world of funding has recently modernised and diversified, partly as a reaction to the financial crisis and new sources of funding are available such as instant loans, peer-to-peer lending and equity crowdfunding. So it’s important to keep an open mind.
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Here are some tips from founders of South West tech scale-up businesses, taken from the 2017 series of Threads meetups, helping you to identify and align with your new provider of capital:
Experience of the Threads group suggests banks are still cautious on lending, some declining relatively modest loans with long-standing customers with good credit scores. Alternative methods are increasingly commonplace and the decision-making process for approval from debt providers can be more streamlined.
Founders need to consider different sources of finance as they scale their businesses. At a very early stage, grant money may help develop some intellectual property (IP). Make the most of the tax-advantaged Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) reliefs on ‘friends and family’ rounds that allow the company to start building technology and an early product.
Seed or Angel money lets you grow that initial product, hire staff, and potentially win customers. VC money helps you scale out the offering, with institutional VC’s getting involved as early as Seed rounds (smaller VC funds) right through to more mature stages where business could be valued in 100s of millions (larger VC funds).
Equity crowdfunding is worth considering to finance the business. It is increasingly common for angel or VC investments to be made alongside crowdfunding campaigns as a way of boosting round size and VC/angel money can help validate business and valuation, and generate momentum for any crowd raise.
“Do attend pitching events and workshops, as these are great practice where you can also learn from others”
Those seeking crowdfunding need an investment proposition that has a populist or consumer appeal in order to attract attention of non-professional investors. That said, crowdfunding attracts people with an interest in a domain beyond it being a hobby. Like any other investor, the main reason people invest on these platforms is to make money.
As a comparatively new industry, there hasn’t been many exits yet, so these people hold shares in businesses which are illiquid until the company floats or there is a trade sale. So unless the company is having a new share round or is being sold, it is hard to get your investment back. From an entrepreneur’s perspective it is appealing as there are fewer demands associated with raising crowd money vs institutional investment.
VCs make high-risk investments into early-stage companies identifying those highly scalable ideas which have the potential to become the ‘unicorn’ businesses that give the desired 10x or 20x return. They typically have 5-10 year life cycles. Anyone preparing a pitch to VC’s needs to understand that model.
Comparatively speaking, the resource of many UK VC’s is limited compared to US VC’s. Companies often take on investment from US VC’s as they look for growth capital and bigger cheques are needed.
Currently, VC’s are most active within the technology sector – notably software – plus life sciences and green technology. Private Equity (PE) funds take a broader view and regularly invest outside of the technology domains.
Many VC’s are inundated with requests, with a huge pipeline of prospects. Whilst they will be reviewing these and watching the market, a warm introduction will help you get in front of them. Leveraging your network, including professional advisors, for those introductions can help.
VC’s usually have deep domain understanding from operating within specific markets. It pays to become active within these industry networks, to raise your profile and make contacts.
VC’s will take a view on the profile of your leadership team; they are investing in its capability to execute, as much as they are your IP, product and business. A strong team with half decent concept may get funded over a lesser team with a better idea.
As founders, you and your leadership team will likely have to present to sources of funding; bear this in mind when hiring or preparing your leadership team. Do attend pitching events and workshops, as these are great practice where can also learn from others.
Networking is important, and best done focused on your industry domain. Identify who’s investing and try to move in their circles; ask event organisers, look at prior attendance lists, etc.
In the South West region you can consider events such as those from SETSquared, TechSPARK, UWE’s Future Space innovation hub, South West Founders, Oracle’s Startup Cloud Accelerator amongst others – not forgetting those in Gloucestershire, Cardiff et al. Events are often attended by angel investors, so pitching or technology-showcase events can help build your profile and contact base.
The terms on which VC’s invest have become more regularised over the last decade or so. Whilst founders are usually expected to give warranties about the business, typically they are capped at a multiple of their salary (1x) and VC’s won’t expect founders to put forward personal assets as guarantees.
Regionally, access to venture capital locally is still limited, so founders should grow networks in London, and also within their industry domain more generally – building expertise, credibility and contacts.
Many VC’s have previously been founders themselves and so are in tune with industry and the pressures of growing a business.
Since the recession, where many VC’s got burnt, they want to get involved earlier at the seed-round stage to start to direct the path of the company early on and before the cost-base of the business has significantly increased.
Private equity (PE) funds usually seek established businesses and typically take a controlling interest or more. The risk profile is different from VC, as PE’s tend to concentrate resource on fewer portfolio companies but will expect a return from a larger proportion of them.
PE funds typically target businesses with a sound business model, established revenues and a good team already in place, although some may take on distressed companies with prospects of turning them around by employing their own management techniques.
“The vast majority of exits for technology business are trade sales”
PE funds often take a tougher stance legally than VC. They will usually establish a new company on top of the original, using the projected revenue streams of the business to service the new additional debt, while some investment/debt may be used to fund growth.
PE is commonly used in a management buy-out context. PE funds will establish a new shared ownership between the managers and the new PE fund. A combination of the PE fund’s investment and debt finance will be used to acquire the company from the sellers, which may include exiting members of the management team and incumbent investors
The vast majority of exits for technology business are trade sales (as opposed to an initial public offering (IPO)) and to foreign, predominantly US, buyers.
Generally speaking IPOs – when you list the business on the stock market – happen much higher up the value chain for technology companies, given the regulatory burden of being listed. It can still be the preferred exit route for those companies that have no natural trade buyer and offer liquidity to shareholders. Whilst there are still some good transactions, AIM still isn’t yet seeing the transactions at the level prior to the 2008 recession.
Threads meetups are a way for founders and department heads of technology companies to share learning, experiences and conundrums. These roundtable discussions unpack topics around leadership, business and operations. Most people find at least one improvement to take away and implement.
Threads is held at 6.30 – 8.30pm on the first Wednesday of each month. Its next meetup, on Wednesday 7 February, focuses in on finding your businesses barriers to growth and how to address them. To RSVP, head to the Threads South West meetup page.
Keep an eye out for more Threads guest blogs coming to TechSPARK soon.