Funding the future of your startup - from bank loans to angel investment

Whether your business reaches its goals in 2 years or 10 years will probably come down to the availability of cash. At one end of the scale you can bootstrap, sweat the business for all it’s worth and insist everyone brings their own teabags to work. At some point you’ll score those big clients over your competitors and then you’ll kickstart your growth plan, right? At the other end you take on a bank loan, sizeable investment or give away more than you want to in equity. Sure, your team has cappuccinos on tap, but at what price? Of course, the ideal funding solution lies between these two.

In reality, businesses take on funding for one of three reasons:

1. To develop an idea into a product in the market.
2. To fund an expansion.
3. To provide working capital.

The two main funding solutions are via debt (for example bank loans) and taking on investment for equity in your business. But how do you choose which one is right for your business?

Firstly, make sure you’re not missing a trick by pursuing one or more of the following options:

• Grants from the likes of Innovate UK - whilst these grants promise ‘free money’ beware time-intensive applications and reporting. You may also need to ‘match fund’ – where you need to find equity investment at the same level as the grant itself.
• Family and friends - gifts or interest free loans, though mixing business and your personal life can be tricky!
• Cashflow review - could invoice factoring or invoice discounting help to address cash flow ‘pinch points’?
• Reward based crowdfunding - If your business intends on making a b2c product then this flavour of crowdfunding (for example via KickStarter.

So, let’s look in more detail at the two main funding options:

Debt solutions

These include loans from banks and other lenders and you may find that a simple overdraft facility is sufficient for your needs.

The main benefit to taking on debt is that you don’t give away equity and there is usually control and transparency about how and when it is paid back. On the other side of the coin, most bank instruments require personal guarantees from all directors – genuinely putting their homes at risk if the company defaults on the loan. In clear contrast to taking on investment, you do need to repay the loaned money! Sometimes interest is repaid through the life of the loan, sometimes it is ‘rolled up’ to the end of the term. You will pay an interest rate commensurate with the bank’s estimation of the risk of your business failing.

Equity solutions

These generally involve selling new shares in your company. You don’t need to repay the money invested, instead investors will most likely be looking to ‘make a profit’ when you sell the business.

Recent research [1] shows that one third of startups actively looking for funding didn’t achieve it. Similarly, Beauhurst [2] reports that only 25% of investments made in 2020 were first round (down from a whopping 92% in 2011).

The key questions when looking at an equity solution are:

1. What is your company’s valuation (‘Pre-Money Valuation’, or PMV) at the point of taking on funding? Setting the valuation too high and you are unlikely to attract investors. Too low, you’ll be giving away more of the company than you need to.
2. How much are you raising? Generally you’ll want to raise 15-20% of the PMV - any more and investors will be wary that you are giving away too much equity.

There are a number of options available to you when selling equity in your company in return for investment cash:

Angel Investors:

Angels consistently invest circa £2bn per year in startups [3], with each investor making an average of just over three investments a year, with most angels investing around £25k.

The Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) offer very lucrative tax breaks to investors in qualifying companies.

Generally, the terms requested by angel investors will be significantly more ‘founder friendly’ than those from Crowdfunding or Private Equity, which is a significant benefit. A drawback for taking on angel investment is the amount of time it takes to ‘kiss a lot of frogs’.

Crowdfunding:

In 2020, 382 out of circa 1,300 equity investments involved Seedrs or CrowdCube, the dominant crowdfunding players in the UK, investing over £230m [2].

Generally, the terms requested by crowdfunders will be more onerous than angel investors and there will be a fee, sometimes as much as 7%, on any money you raise by this route.

Venture Capital:

In 2020, even for a first funding round, VC invested in nearly double the number of companies than the next most active investment group, angels (see 16.2 in [2]).

A venture capital investor will generally want to lead a round, though they may also be happy to co-invest with others. They will push you hard on the terms and generally undertake more due diligence than other types of investors but they are also more likely to participate in future funding rounds.

Short term wins and long term gains

There is no ‘one size’ fits all solution. Some businesses will need short-term cash flow and a bank loan or overdraft will be a perfect fit. For longer term investment, an equity solution will be a better option.

Each type of funding has pros and cons - for many, the thought of betting the family home on a bank loan issued with a ‘personal guarantee’ will be a step too far. Similarly, the thought of having to report to investors may not be desirable.

This article was originally published in Business Leader magazine

References:

1. Merixstudio "State of early-stage startups 2021"
2. Beauhurst report “The Deal 2020”
3. UKBAA & BBB report “The UK Business Angel Market 2020”