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From unicycle to unicorn - your funding journey

Last updated
18th June 2021
Written by
Sam Simpson

From bright idea to fully funded

We've got a number of blogs covering various elements of your start-up journey, but we thought it would be good to write one tying them all together and include some other important elements which we think you should be considering along the way.

Some are 'nice to do', some best practice, some essential if you are looking to take on investment and some are legal obligations.

Contents:

  1. Every founder journey starts with a great idea
  2. The founding team
  3. How to split equity amongst founders?
  4. Choosing a name
  5. It's all about the branding
  6. To incorporate or not?
  7. Decide on a funding strategy
  8. Web, marketing and comms
  9. The other (really!) important stuff
  10. Obtaining SEIS or EIS advance assurance
  11. Preparing to talk to angel investors
  12. Finding angel investors
  13. Valuation
  14. Why do people raise over multiple funding rounds?
  15. The funding round itself
  16. A word about warranties and disclosure
  17. After the funding round
  18. Working with an advisor on your round
  19. A summary of the critical path

Every founder journey starts with a great idea

So you've thought of a great idea, but is it unique? There is certainly something to be said for having an idea that gives you first mover advantage in the market.

But we wouldn't be too obsessed on an idea being truly unique. Facebook is a great example - it wasn't the first in its field and it wasn't the first to be successful either.

A potentially interesting strategy is spotting a great idea from another market or geography and shifting it or realigning it to another area. For example, Starbucks started when the founder brought Italian barista-style coffee to the US in 1971. It could be said Whitbread did the same with Costa in the UK over 20 years later in 1995.

TODO - Uploaded image description

Whatever your idea, hopefully you are excited by it and it passes the Ikigai test – bringing together your professional and personal interests and passions. If not, are you sure you want to dedicate a substantial proportion of your life to this endeavour rather than another venture?

The founding team

CB Insights states that "Not the right team" as the third most likely reason for a startup to fail, so making sure your team has the necessary capabilities and is suitably aligned is absolutely key.

Some investors have a strong desire to see an investee company have more than one founder, some are more relaxed with just having a single founder. Most investors will like to understand the broader team though and would ideally like to understand the credentials of the founding team, any other identified team members and any advisors to the board too.

So why do investors prefer to see a broader founding team rather than a sole founder? Research shows: Teams with more than one founder outperformed solo founders by a whopping 163% and solo founders' seed valuations were 25% less than teams with more than one founder.

Many founders are still working full time in their 'pre-entrepreneur' job at the point they raise funding on the basis that they will quit when they close their funding round and then work full time in start-up. This is fairly common and most angel investors won't be disturbed by this at all.

Founder Collaboration Agreement

Regarding the founder alignment, we very strongly suggest that you invest an hour to negotiate and document a Founder Collaboration Agreement at this stage and we provide a useful (and free!) founder collaboration agreement template for doing just this. An hour completing this template could save you from being part of a nasty statistic - that 65% of high-potential startups fail due to co-founders falling out.

How to split equity amongst founders?

One of the key considerations when setting up a business is how the equity in the company should initially be split across the founders. Some people opt for equal allocation, some people allocate based upon expected effort or some other up-front negotiation. Some people consider an alternative, built around allocating equity based upon the amount that a person contributes to a company over time. This is only relevant for early stage businesses pre-funding round but is a really nice way of preventing a number of challenging circumstances, such as a founder disappearing and keeping equity or people contributing more or less than was originally envisaged and having the wrong level of equity in the business.

This scheme is called Slicing Pie. You can buy the handbook on Amazon and there is also a handy Excel based calculator you can download for free.

At the point that you take on your first investment you should 'crystallise' peoples contributions (and therefore equity) at that point, but whilst you are bootstrapping the Slicing Pie seems like a very elegant way of tracking contribution and ensuring that leavers are treated in a way that is fair to both the exiting founder and everyone else.

Choosing a name

A unique, catchy name that all founders agree on sounds simple, right?! In my experience, it takes much longer than expected to land on a perfect name – partly because it’s so subjective, and partly because so many great names have already been snapped up by someone else. We provide some advice on this topic.

Once you've finalised the name, it is a great idea to create relevant accounts on social media to ensure people don't register them when they see your company being incorporated. Your sector, model (b2b vs b2c) and demographic will dictate which social media platforms are going to be most important. For services aimed at professionals, LinkedIn is a must. For apparel aimed at a younger audience, maybe Tik Tok or Snapchat.

It's all about the branding

So you've picked a name - designing a logo and associated branding should be straightforward? Not in our experience, it's just as challenging and time consuming.

We really like using 99designs - it's excellent value (important for any startup), straightforward, relatively swift and the results are usually very good.

Once you've selected a name and logo you may want to consider trade marking either or both. Applying for a trade mark takes time and money and some people consider it unnecessary. Trade marks only cover the classes that you apply for and you need to pay per class. There are also nuances around applying for a series of trade marks.

We have seen start-ups create an (un-trade marked) recognisable brand and then be bullied from using the trade mark by someone who filed to register it (see "first to file").

To incorporate or not?

First you need to decide whether to incorporate as a limited company or adopt another structure. We've covered that topic in depth in another blog but if you want to take on funding then you'll almost certainly incorporate as a limited company.

If you decide to incorporate then the process of actually incorporating is relatively straightforward - we cover that in this element of the blog.

A note regarding having sufficient shares in circulation

Ensure that you have enough shares in circulation so that the maths work out correctly for the particulars of your round. For example if you and your founders have a 100 shares between you and your PMV is £1m then every additional share you offer costs £10,000. What if someone wants to invest £25,000? Well that's not possible - you can only sell then 2 or 3 shares, so they can invest either £20,000 or £30,000.

Many founders have incorporated their startup with far too few shares - 1, 100, 1000 are common. You may therefore wish to consider sub-dividing shares before taking on investment - this can be done swiftly online at Companies House. Subdivision (or 'share-splits') turn each share in your company into a number of other shares, which will allow you to achieve more granular investment amounts.

Don't forget, if you subdivide your shares you also alter the nominal value by the same ratio. So if you specified a nominal value of £1.00 on incorporation and then sub-divide 1,000 shares into 100,000 then your nominal value will change to £0.01.

The exact value per share is a function of the pre-money valuation and number of shares in circulation so don't be too surprised if someone wants to invest £20,000 and, due to the maths, they actually need to invest £19,996 or whatever, in order to allocate just a whole number of shares

And what about subsidiaries?

When looking to take on investment, the motto 'KISS' (Keep it simple stupid) should certainly be applied in this respect. The vast majority of companies we see seeking investment are single company entities. This reduces complexity and is easier / cheaper to manage.

There are many reasons why people may consider a group or parent with subsidiary / subsidiaries is appropriate but the SEIS/EIS legislation applies some constraints to these structures.

The key rule to keep in mind (there are more - the devil is truly in the detail!): SEIS/EIS investment can only be made into the ultimate parent organisation. It is not possible to take SEIS/EIS qualifying investment in any subsidiary. This alone may make a group structure unattractive.

Also worth noting that the company "has not been controlled by another company since the date of your company being incorporated" - so you can't 'spin out' a subsidiary and then be eligible for SEIS or EIS.

More details can be found via HMRC.

Incorporation expenses

A note on expenses - you will no doubt incur costs before you have incorporated. Examples of these expenses could be fees for logo design, for virtual registered office services or paying an advisor such as a solicitor or accountant.

You can / should keep a note of these and keep the receipts and claim these from the company as a business expense. This is an entirely reasonable thing to do and any investor would not be surprised to see these costs.

If the company cannot afford to pay these expenses immediately - for example until you obtain external funding - then it is reasonable to add them to a director's loan account.

Building an ethical business?

Many founders wish to build a business which is socially responsible. This could mean the business fully embraces ESG (Environmental, Social and corporate Governance factors) or a subset that suits the founder / the type of business.

There are some useful resources available if you wish to explore:

  1. Tech Nation have a great resource on how to build and run a business which embraces Diversity and Inclusion.
  2. We see many business adopting (or working to obtain) B Corp status. The FounderCatalyst paperwork can be made 'B Corp compliant' - see our blog for more details.

Decide on a funding strategy

Once you've got the above covered (or at least underway!) you will want to consider your sources of funding - we've written another blog post on the types of funding available for you to consider. This includes grants, debt options including bank debt, equity options including crowdfunding, angel investors or VC.

Web, marketing and comms

Now is a good time to consider:

  1. Your website - this will take longer to build than you think - especially putting together the content that will populate the site. Investors of any type will generally expect to see some kind of web presence when you start speaking to them about investing.
  2. How are you going to launch and handle communications in general? This really is important as it covers how the outside world will view your business – from the words you use to describe it, to your place in the market. Some of the skills you may have in your team, for example you may have some enthusiastic users of social media, others you may need to bring in when the time is right – for example digital marketing. We've got a blog for that too.

TODO - Uploaded image description

The other (really!) important stuff

There is a laundry list of other things to do, and the following is a non-exhaustive list of things to consider. We have not tried to describe the dependencies here - and the items are not necessarily in the correct order for your circumstances. There are some interesting complexities - for example, any investment money under SEIS or EIS must be paid into a company account, for example - so you need a bank account before you can take on investment.

Obtaining SEIS or EIS advance assurance

If you decide to raise funding utilising the SEIS and/or EIS schemes (and this is why you should) then you will want to apply for advance assurance. We provide all of the help that you need to undertake this step for free when you sign up to use FounderCatalyst for your funding paperwork.

It is worth reading our recent analysis which demonstrates the impact of EIS to an angel investor's average rate of return.

How quickly will HMRC respond? The response from HMRC on an advance assurance application is variable. The fastest response seen is a positive "You've got advance assurance" email in 2 days, the longest (even without queries / changes) is over 45 working days. This was during Corona so HMRC had their hands full, we imagine. In any event, you should plan on a minimum of a two week turnaround just to be safe.

Given that some angel investors won't even consider looking at investing in your business until advanced assurance is confirmed, you should apply for this sooner rather than later.

How much can I raise under EIS and SEIS?

You can raise up to £150,000 under SEIS in total, and up to £5 million each year under EIS, to a maximum of £12 million in your company's lifetime. If your business is classed as a "Knowledge Intensive Company" (KIC), then these figures change to £10m per year up to a maximum of £20m.

Should I just get advance assurance for SEIS?

Producing an advance assurance submission is time consuming. Even if you are unsure if you will ever need to undertake an EIS based funding round, it makes sense to seek advance assurance for both SEIS and EIS at the same time rather than have to do two submissions - adding EIS to an SEIS advance assurance submission is just adding one further form - 95% can be copy and pasted from the SEIS form anyway.

Similarly, if you are eligible as a KIC under the EIS scheme, it may make sense to apply for this initially rather than re-apply at a later date.

Am I a qualifying trade?

Before you start your application, it's worth checking the guidance for both SEIS and EIS to ensure that your company is eligible for the scheme(s). Most importantly make sure that your business is undertaking a qualifying trade. The vast majority of companies do qualify, but you still need to check.

Is my business 'in time'?

Strict time limits apply to companies wishing to seek investment by both SEIS and EIS. In brief, a company must receive all SEIS investment within 2 years of starting to trade. For EIS this is a more generous 7 years. There are nuances, but in general 'starting to trade' means the date of first commercial sale. There are lots of other rules to consider.

So, if your business has been running for 3 years but you really want to take advantage of SEIS, could you simply close your existing business and start a new company? Not so fast: as part of their standard due-diligence before approving advance assurance, HMRC will check Companies House and other records to apply the test: The first commercial sale is taken as the earliest made by any person who previously (at any time) carried on a trade which was subsequently carried on by the issuing company.

What documents will I need to apply?

To apply for advance assurance, you need to submit several supporting documents and forms to HMRC. These fall into four categories:

  1. Those produced by FounderCatalyst and found in your Intelligent Data Room, such as Articles of Association and Shareholders Agreement;
  2. Those created by you for your investors as part of the fund-raising round: pitch deck and 3-year financial forecast.
  3. Other company documents you need to provide; and
  4. Specific forms that HMRC require you to complete.

Preparing to talk to angel investors

To take on investment from angels, you'll need to have a pitch deck and a forecast model as a minimum. If this is an SEIS round then most investors will understand if you don't have a full business plan in place at this stage. For further rounds it will almost certainly be required.

We have a blog on how to create a great pitch deck specifically.

It depends upon how sophisticated your angel investor is, but whenever I am approached to invest, I quickly work through the following preliminary questions:

  1. Can I see your pitch deck, proposed term sheet & 3 year model? You should have these to hand (you'll need the pitch deck and 3 year model as a minimum to apply for SEIS/EIS advance assurance). If not, then it is worth producing them and polishing them before reaching out to any potential investors. You can produce a term sheet for free on the FounderCatalyst platform.
  2. How much are you raising and at what valuation? How much is already committed? Ok, this is 3 questions but they are all related and hopefully very easy to answer. Lots of people dodge putting the valuation in the pitch deck which is odd as its the very next thing they'll be asked.
  3. Are you SEIS or EIS eligible? If so, do you have advance assurance in place? Many angel investors will only consider investments that are SEIS or EIS eligible and even then they will only start considering your investment in earnest once you have advance assurance confirmed.
  4. Do you have a lead investor in place? Many investors like to see a lead investor in place. The lead investor typically has a number of functions - they will lead the due diligence process (meaning that the other investors don't have to do the heavy lifting), lead the negotiation on behalf of other investors and will typically be part of the ongoing advisor team.

Thinking of setting a minimum ticket size?

Some founders prefer to set a 'Minimum investment of £20,000' or similar. The theory being that you need to talk to a lot of investors if you are trying to raise £300,000 and people are contributing just £5,000 at a time.

A strong counterargument is presented in this blog. The example is from the US but I think the same principle applies here: they secured about of their funding rounds from an investor who personally only invested $5,000 but made a number of introductions that resulted in $700k being invested.

Finding angel investors

You may have already found your investors - either family and friends or via contacts from industry. However, if you need to find your angels then FounderCatalyst has partnered with a couple of organisations whose raison d'être is to match founders to investors. We will make personal introductions to these organisations and explain the pros and cons to the options.

Broadly these options are:

  1. Angel Networks / Private Equity clubs. Most of the times (but not always) these will charge a fee for arranging your investment but can often be a 'one stop shop' where a founder can obtain a full round of funding in one place.
  2. There are matching platforms that connect founders and angel investors. Often free but require you to 'kiss more frogs' than some of the other options.
  3. The UK British Angels Association (UKBAA) offers a DealShare platform where deals are shared with hundreds of corporate / institutional members and tens of thousands of individual members, and many scour DealShare for new interesting potential investments.
  4. There are brokers that will act as a virtual member of your team to: 1) go to the market and hunt out investors who are keen to invest in businesses like yours; and 2) open their little black books to match you with some of their investor contacts. This typically attracts a % fee payable on funds that they directly find. The benefit to using a broker rather than a Private Equity Club is that a PE Club would typically negotiate a tougher set of terms on behalf of its members compared with individual investors found by a broker.

Valuation

A round's pre-money valuation (PMV) is always an interesting topic. For later stage businesses, there are rafts of market standard ways of valuing a business (multiple of EBIT, multiple of revenue, discounted cash flow, First Chicago Method, the Berkus method and many others).

None of those are really useful for first round valuations, though. Businesses at this stage may not even have an MVP in the market and almost certainly won't be scaling yet.

So, ultimately, this will come down to market demand. Angels that look at your business will most likely have their own scoring scheme (either documented or just by instinct) and will decide how much they are willing to invest in your business (if anything!) and at what valuation. This very much isn't a science - even for a data-driven investor, this will be a joint heart/head decision.

If it helps, a typical evaluation process for an angel could cover the following items:

  1. Full time management team experience of startups and running a business
  2. Full time management team experience in sector
  3. Full time management team attitude and passion to succeed
  4. The Beachhead market is validated / tested
  5. The Total Addressable Market is large, established and there is clear demand
  6. The proposition is compelling and has a clear ROI (Why? Problem? Solution)
  7. The company has proprietary technology or defendable advantage
  8. MVP maturity
  9. Company has patented technology or methods
  10. The company has paying customers already
  11. There is a recurring revenue opportunity
  12. The business model is highly scalable
  13. The potential return on investment is significant
  14. There is a clear and realistic exit strategy

One school of thought is that you should not disclose your PMV in the pitch. Instead, you find an investor willing to be 'lead investor' and negotiate the PMV with them. This then forms the PMV for the rest of the round.

Alternatively, 'guestimate' where your PMV should be - by testing your pitch and PMV with a couple of angels, by looking at similar companies and finding out their PMV etc - and then go to market and see if the valuation resonates.

Why do people raise over multiple funding rounds?

There is a great tool which allows you calculate your timescale to break even and how much you will need to raise in total based upon your revenue, your revenue % growth and your costs.

After all, if you know you need to raise £900k in the next two years, why not just raise it all up front?

In very early rounds, your company will have a relatively low valuation. Many businesses go for their first raise with just a bright idea and a shiny pitch deck. At this point, your business will have a low valuation - almost certainly less than £2m. As an example, if you raise £900k of funding at a £1.5m valuation then you end up diluting yourself to 62.5% ownership of the company, so you should try to avoid that.

Instead, if you structure the funding rounds as follows:

Then the founder retains 72.96%. Proof points really matter when you stagger your fund raising tranches.

Proof points. Eh?

A proof point is an event between a funding round that validates your business in some way. Examples could be:

  1. Filing for a patent. Even better, patent being awarded
  2. Releasing an MVP
  3. First pilot customer
  4. First paying customer
  5. First month of profitability
  6. Launching a new product line
  7. Being stocked in a new high shipping / high profile outlet

A proof point will generally significantly shift your PMV in the right direction, for obvious reasons.

How much equity should I try to retain?

Ideally, you and your founders should try to retain 75% or more of the voting shares. If that is not possible, and in businesses requiring multiple funding rounds it most likely won't be, then aim for 50% of more.

Don't forget about an employee share option plan

Creating a share option plan is a great way of incentivising your employees in a tax efficient manner. Even if you don't have employees to incentivise in this way quite yet, don't be surprised if an investor insists that you create an option pool before they invest - they will realise that you'll want to create one at some point and, for an investor, it's in their interest to create one before they invest rather than after as any employee share option plan will dilute their shareholding.

It is worth pointing out that employee option pools and the individual option allocations don't carry voting rights, so for the purpose of the previous section the allocation of share options doesn’t reduce % voting rights held by the founder(s).

The impact of multiple rounds

See this amazing visualisation demonstrating a typical funding journey, covering the allocation of founder shares, an option pool, a seed round, multiple further rounds and an eventual exit.

The funding round itself

The FounderCatalyst platform produces the formal legal paperwork that you need to adopt on a funding round and helps you manage your investor engagement through the whole funding journey to the final signature.

The process to complete a funding round can be undertaken in 30 minutes (the latency caused by founders, investors and shareholders will usually mean that the process really takes a week or two) and consists of the following:

  1. A founder creates their free account and enters a few personal details.
  2. The founder adds the start-up company to the platform by entering its registered number. We then download relevant details from Companies House to save you typing that detail in yourself.
  3. You confirm the details of your co-founders, if any, and invite them to the platform.
  4. You add details of your current capitalisation table.
  5. You are now ready to start a funding round.

TODO - Uploaded image description

The funding round itself has a number of steps:

A word about warranties and disclosure

If you've never been involved with a fund raise then one of the more confusing parts of the process is warranties and disclosure, so we've got specific guidance on this step.

Working with an advisor on your round

We think we've made a complex process as simple as possible, but some people may still want the comfort of an advisor to provide formal advice at key points - such as the warranty and disclosure process, maybe.

If this feels like something you'd like to do then here's a little more on this feature.

After the funding round

Once you have received the investment money, there are some formalities that need to be undertaken. This includes filings with Companies House and managing the SEIS/EIS process.

A summary of the critical path

On the basis that you wish to get to the point of 'fully funded' in optimal time, the critical path is very likely to be:

TODO - Uploaded image description

The other items (insurances, logos etc) are all really important, however you will no doubt be able to fit those around the above activities - they are unlikely to cause a 'day for day slip' if you don't undertake them immediately.

NOTE The uncertain, long lead time item in this chart is receiving SEIS/EIS advance assurance. Again, we urge founders to submit applications as soon as you have the pre-requisites in place.

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