Topical tips Routes to raising finance Source and types of finance In simple terms, once you have exhausted friendsIntroduction and family, there are 3 sources of finance for an early stage business: • • The bank Business Angels and Venture CapitalThe question of where to find funding to start or • Government grants and incentivesgrow a creative digital or innovative technology There are essentially two types of finance: debt andbusiness is a question we frequently hear at the equity. They are very different and will havemoment, as it’s on the top of the agenda for many contrasting effects on your business as it develops and grows. Debt relates to money lent to aentrepreneurs and CEOs. business, which is then repaid with interest over an agreed period. Equity is finance invested in theWith the political focus firmly on the private sector business in return for a share in the ownership of the company. Generally speaking the cost of debt isfor generating new jobs, as well as an increasing lower than equity finance, because the risk isnumber of entrepreneurs keen to emulate the usually lower.success of companies such as TweetDeck, Last.fm Government grants and incentives representor Mind Candy, locations such as the Silicon another type of finance that many companiesRoundabout in East London have come to benefit from in their very early days, and are oftenprominence. an initial source of funding. It is this type of funding that the Government is currently keen to promote to support the growth of new enterprise.The first challenge is knowing what funding isavailable, before addressing the issue of how to go The Bankabout securing it. To make matters more difficult,sources of funding change over time, and this has Banks lend against predictable revenues and profit streams, and to demonstrate this, banks will ask forbeen particularly the case recently for Government a detailed business plan, setting out in words andbacked funding. numbers the businesses current and forecast revenues, costs, cashflows, and the detailed assumptions that have been made.In this article, we aim to clearly set out the principalsources of funding available to creative digital or Since there is often a lack of a track record, andinnovative technology businesses, explain some of because there are few assets, especially in a creative digital business against which to lendthe terminology, and provide some practical against as security, early stage businesses usuallyguidance on where to find the different types of struggle to obtain finance from the banks. For their part, the risky nature of start-ups makes it hard forfunding. banks to lend in the early stages.
Routes to raising financeHowever, a bank can help in other ways: over 5 years. Often they are entrepreneurs due diligence on the business. themselves, and bring to the party bothOverdrafts, secured and unsecured loans funding and experience. The process can easily take 3-6 months. They will be looking for high returns on theirWhilst few start-ups have any assets that A typical amount advanced is in the region investment, usually 3-5 times theirthe bank will accept as security, if a of £50,000, although may be as low as investment and an exit route in 3 to 5 years,business owner is willing to put personal £20,000 but as high as £500,000 or more. maybe to the secondary market.assets up as security, such as his or herhome, the bank may offer an effective As with an Angel, a Venture Capitalist will besized overdraft or a secured loan. looking at the strength and experience of theUnsecured loans may provide some limited The EFG Scheme facilitates management team, the market potential andfinance up to £25,000, but are expensive. lending that would not the scalability of the platform. Owning unique IP, or being first to market is also veryThe Enterprise Finance Guarantee otherwise be available. attractive. At this stage, the VC will anticipateScheme that its funding will be required to enable the Every angel is different in terms of risk, product to be tweaked, additional staff andIn the UK, it’s worth being aware that return, involvement or expertise, so it’s resource to be hired, and further marketing.banks can make use of the Enterprise about finding the right angels to work with By the end of the investment period thereGuarantee Scheme (EFG). This is a and ones that work in the Technology & should be a business which can stand on itstargeted measure intended to facilitate Media sector. Asking your industry contacts own.additional commercial lending by the banks and advisors is a starting point, attendingto viable Small & Medium sized Enterprises industry presentations, seminars and This type of funding is often called “Series A”(SMEs) unable to obtain a normal networking events will also help. funding. Further funding, known as “Seriescommercial loan due to having no or B” and often in excess of £5m, would enableinsufficient security. Since Angels are investing their own the business to scale up, and may well money, they can be more cautious, but it require a change in management as theThe EFG Scheme facilitates lending that does mean they can move quickly with a business matures, since growing a businesswould not otherwise be available providing minimum of process and due diligence. is a very different skill from starting alenders with a partial Government However, still expect to have a 3 year business.guarantee for 75% of the loan value. The business plan.lender is still responsible for the decision As with Business Angels, there are lots ofas to whether or not to lend, and can ask Usually they will want to see a great VC’s around, and your advisor should be ablefor a personal guarantee for the remaining management team with a strong track to help identify those VCs that have a25%, although not as security over a home. record and specific expertise. Whilst they particular interest in investing in your sizeThere is of course a cost, with a premium do not necessarily expect to see a finished and type of business.of approximately 2% payable per annum product or game, or revenues, they willover and above what the lender charges want to see there is clear vision and Super Seed, VC Seed, Private Equitywhich is payable to Department for strategy. Their money typically will oftenBusiness, Innovation and Skills (BIS). help develop the product for market, help Other terms often heard are VC Seed and strengthen the team and help attract VC Super Seed, and these plug the gap betweenInvoice financing funding down the line. Seed and VC.Banks also use what is known as invoice London Business Angels Private Equity is for larger amounts still, andfinancing. If you can show the bank you (www.lbangels.co.uk) is one example of a is simply VC funding on a grander scale.have a regular and predictable cash flow, Business Angel syndicate, offering Blackstone and Apollo are two well knowfor example from a particular contract, they £100,000 to £1million to high growth, examples.may offer you a percentage of that cash innovative and scaleable businesses fromflow as an overdraft facility. across the UK for a 3-5 year period. They Large corporate (and some smaller have a particular focus on technology (web, corporates) mobile, software, medtech, cleantech), andBusiness Angels and Venture businesses have to be registered for EIS toCapital Another source are investment funds set up be of interest (see further details below). by large corporates – these are really a form Other networks can be found through the or seed or VC funding. For example, bothFamily and friends fill in the gap at the British Business Angel Association Google and Orange have established suchlower end of the funding equation, typically, (www.bbaa.org.uk/member-directory). operations.before business angels, VC’s or banks areinvolved. Venture Capital Google Ventures, which was founded in March 2009, is broadly interested in start-Business Angels and Seed capital Venture capital represents a step up, and is ups in industries including the consumer a subset of Private Equity. Amounts internet, software, hardware, clean-tech, bio-Business angels are private, high net-worth advanced typically range between tech, health care and others. They investindividuals who are prepared to invest their £500,000 and several million, where the amounts ranging from tens of thousand ofown funds in private companies for VC provides funding in return for equity dollars to tens of millions of dollars,convertible debt or an equity stake in a and/or loan capital. depending on the stage of the opportunitybusiness. Sometimes they will operate as and the company’s need for capital.part of a syndicate and often are members Venture capitalists are investing the moneyof a network to get access to potential of others and on behalf of the VC firm, and Similarly, Orange’s Innovacom investsdeals. Since the risk is high at this early therefore prior to any investment they will between €2 million and €10 million overstage, they may expect 10 times returns perform legal, commercial and accounting several rounds, usually starting to work with
Routes to raising financea start up during the first round of funding. Although it is winding down in its current and must hold an investment for at least 3One notable and interesting source is US form in line with the Regional Development years.mobile game developer, TinyCo, which has Agencies, from March 2012 Business Linkrecently set up a $5 million fund devoted to will be an online based advice platform, This means an immediate investment offinding, funding and marketing promising supported by a call centre. £100,000 attracts an income tax deductiongames for iOS and Android, providing up to of £30,000 for the investor. There are also$500,000 for approved projects. The Technology Strategy Board, which is reliefs for losses, capital gains andwww.tinyco.com/tinyfund. sponsored by BIS, is a further source of inheritance tax. For these reasons, it will funding. It runs various national and help a company attract investment if itBusiness Growth Fund international competitions for funding at qualifies and is registered for EIS.This is a recently launched £2.5 billion fund any point in time, such as the competitionsupported by 5 of the largest UK banks, entitled the “Internet of things” offering For Venture Capital Trusts (VCT), theand offers equity investment finance of £2- £5m of funding, and the Tech City qualification criteria is the same as for EIS.10 million for small and medium sized Launchpad, offering £1m to creative and However there are a number of criteria thatbusinesses with revenues of between £10 digital businesses in East London. differ, such as there being a maximummillion and £100 million investment of £200,000 per annum, and awww.businessgrowthfund.co.uk. Trade bodies can also help provide 5 year holding period. direction. At Kingston Smith we areGovernment grants and tax members of numerous trade bodies, Notably since the March 2011 Budget theincentives including Intellect, the Internet Advertising rate of income tax relief for both EIS and Bureau and the Design Business VCT is now the same (previously it had beenThe Government has a wide array of Association. Membership is often available 20% for EIS), meaning one of the principaldifferent grants and incentives available. at a very reasonable price for a start up or advantages of VCT has disappeared.Whilst it is keen to promote these to show small business.its support for new starts ups and young Research & Development (R&D) Taxentrepreneurial businesses, half the battleis knowing what the options are and where Tax incentives Credits are a further source of tax benefit.to find them. This is made all the more There are various forms of tax relief in the R&D is a key driver for productivity growth,difficult because this is in a state of flux as UK available to an investor and investee. and for this reason the Government is keenthe Government reorganises its The most common reliefs are those to encourage greater investment indepartments itself and closes various available to investors in companies innovation. Whilst the greatest value of taxquangos as part of its austerity measures. registered under the Enterprise Investment credits benefit the pharmaceutical industry Scheme (EIS) and Venture Capital Trusts in the UK, many technology companies also (VCT). For the investee companies, benefit.The primary reason for Government grants Research and Development (R&D) taxand incentives are job creation and tax credits are available if they incur qualifying R&D is defined to take place where there isrevenue generation. Secondary reasons R&D spend. a project with activities that directlyare to foster innovation and build the UK as contribute to achieving an advance ina global centre for creative enterprise, and science or technology though the resolutionensure growth is evenly spread across the of scientific or technological uncertainty.country through development zones. Some To qualify for investmentmay well argue how effective this is rightnow, however that is another discussion. under EIS, a company must In order to qualify, until 31 March 2012, the expenditure must be on qualifying have fewer than 50 projects and be of a revenue nature, withGovernment help can be broadly brokendown into grants and incentives, and tax employees and its gross spend of at least £10,000 in an accounting assets (before investment) period. This can include qualifyingreliefs, and these are discussed below. It employee costs, consumables and utilities.can also provide other advice, support and must not exceed £7million.training, and of course is keen to ensure The scheme allows for qualifying R&D costsinformation is available on line. The Enterprise Investment Scheme (EIS) is to be enhanced for corporation tax a series of reliefs designed to encourage purposes. So for an SME (broadly aHowever, it is important to understand that investments in small unlisted companies. company or group with less than 500 staff,because a business has been given By registering, which is relatively straight and either revenues of less than €100Government funding, it does not mean it forward, a company is increasing the million or balance sheet gross assets ofhas a better chance of subsequently finding likelihood of securing an investment, since less than €86m), this means for everySeed or VC funding. It might also not be a an investor will benefit from the tax reliefs £100 spent on qualifying R&D costs, 200%surprise to hear that government incentives available. For many investors, they often is allowable as a deduction for corporationtend to take longer to materialise, so an require a business to be registered before tax purposes, i.e. a deduction of £200. Thisentrepreneur should be prepared for a wait. they will make an investment. increases to 225% or £225 from 1 AprilGrants and government incentives 2012. Alternatively, a company may To qualify for investment under EIS, a choose to claim a payable R&D tax creditGrants are aimed at stimulating regional company must have fewer than 50 through its corporation tax return for aninvestment, to encourage early-stage employees and its gross assets (before immediate cashing inflow.research and development or to achieve investment) must not exceed £7million.specific policy objectives. These limits increase to 250 employees Other proposals for enhancing the relief Investors can benefit from a 30% income effective from 1 April 2012 are currentlyTo identify sources of funding, a good place tax relief for investments up to £500,000 the subject of a consultation.to start is the Business Support Finder per annum (post 6 April 2012, £1million),service at Business Link.