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Sources of start-up funding

Last updated
12th November 2020
Written by
Justyn Waterworth

OK, so you have decided that now is the right time to raise some money. You have a good idea; and you need investment to help you grow. Some companies do manage to fund themselves, (bootstrap) but these are few and far between. Depending on your chosen funding route, you may have to pitch to potential investors - this is an art in itself. Just because you have a great idea does not mean they give you their hard-earned money. Even if you do persuade investors to part with their cash, how much of your company are you willing to give away? They will probably want to invest under the EIS/ SEIS scheme? Have you submitted the necessary paperwork and has advanced assurance been granted by HMRC? You need to have done your homework and be ready to go into battle for that all-important funding. Importantly, you too need to look investable; it is not only about the company, they are just as much investing in you.

So, the good news is that there are lots sources of funding out there for start-ups. The bad news is it’s a complex process and a highly competitive market. There are literally thousands of start-ups out there trying to raise funds. You will be competing against all the others, so you need to choose the right funding vehicle for you. To help you on your journey, below we discuss the major funding options that are out there for early stage businesses:

Government subsidies and grants.

There are lots of options here, including the simplest such as a government-backed loan of up to £25,000. Have a look here where there are over 150 organisations offering access to grants and funding. Also, don’t forget R&D tax credits, which allow you to claim back for certain research and development costs each year, including in relation to employee and contractor costs. Government funds are a prevalent type of equity investor which is often overlooked!

Accelerators

Business accelerators run support programs, typically accompanied by investment, with the primary aim of growing early-stage businesses quickly. The programs usually last 3 months and can extend beyond this. Accelerators can offer everything you need to scale your start-up, and may also introduce you to networks of angel investors and experienced mentors. They often take up to 10% equity in exchange for initial seed funding averaging between £10,000 to £30,000.

According to a report published by the Department for Business, Energy & Industrial Strategy in October 2019,64% of startups consider the contribution of the accelerator they attended was significant or even vital to their success. However, this comes with a catch - accelerators are very selective, only taking on the best start-ups which apply. It is estimated that there are well over 163 accelerator programmes in the UK, so there is a big choice out there.

Business Angels

These are generally high net worth individuals who are investing their own money. They tend to be seasoned investors. Typically, they will invest between £5,000 and £50,000 and will operate as standalone individuals or join together to form syndicates.

We often hear from founders how much time and effort they spent looking for an angel investor and how much time they waste. It is not an easy process, and it can be a challenging experience lining up your angels to invest. Key here is to get a lead angel investor onboard first, who will help to attract and marshal the others. One of the most successful ways to approach an angel investor is through a warm introduction – through a friend, contact, fellow founder or company.

The UK Business Angel Association (UKBAA), which covers 18,000 investors investing through 60 groups, is a good starting point to identify potential suitors. UKBAA have also implemented regional hubs to make them more accessible.

There are also angel syndicate websites, such as AngelList and SyndicateRoom, that you can approach.

‘People buy from people’ and this phrase certainly holds true at this critical stage of funding, so ideally you need to have your pitch ready and get in front of the angels.

As mentioned in the introduction to this post, these investors will expect to invest via the very lucrative SEIS or (slightly less so!) EIS schemes. We have another blog on these schemes specifically (here) but, needless to say, your investors will be very keen to use these schemes, if at all possible.

Venture Capital

There is a vibrant venture capital (VC) ecosystem the UK. UK VC investment surged in 2019, hitting more than £9 billion, according to research by KPMG. VCs tend to focus on investing in the riskier innovative startups offering high growth potential. Investment criteria differ for each fund, but generally VCs make investments in early and mid-stage companies with the aim of profitably exiting their investment within 3-5 years. Investment levels tend to be higher than angel investors, typically starting off at £200,000 plus.

VC is seen as a high-risk asset class, as a high percentage of VC investments fail. This rate of failure is built into their investment models. What this means for you is they will want a big piece of your company equity in exchange for their investment.

There are a significant number of venture capital firms in the UK. According to Beauhurst, there were 327 active VC funds in the UK in 2019 and it’s no surprise that London dominates this scene.

The British Private Equity & Venture Capital Association (BVCA) is the industry body.

Equity Crowdfunding

Crowdfunding has been a disruptor to the traditional way of searching for that illusive investment in your company. The advantage of crowdfunding is it enables hundreds of individuals to invest in a single start-up from as little as £10. Crowdfunding also has an added benefit of generating early stage publicity and getting your name/brand out there in the marketplace.

Seedrs, Crowdcube and Syndicate Room are the main FCA-regulated platforms open to you, but there are others out there. A key fact you should note is the 30% rule. Research shows that a funding campaign that fails to get over 30% of its funding target early on finds it very hard to close. Most platforms will now insist that you have between 20% and 30% pre-loaded before they will launch your campaign to their wider audience.

At any one time, there may be up to 30 pitches on the platform, so you really need to stand out from the crowd. That said, there has been a huge increase in the amount of money invested through crowdfunding pages in the past 5 years. The 2019 leading crowdfunding platform, Seedrs, facilitated 215 investments alone. So, equity crowdfunding is an option well worth considering.

Bank Loan

The last option, which may be your first thought but probably does not end up being top of your list, is a loan from your local high street bank. These guys will not take any risk, but the upside is they will not take any equity. The process can be frustrating and take weeks (if not months) and they will look at your credit score, which must be strong. They will usually ask for a personal guarantee from you, so you need to have collateral to offer.

Since the financial crash of 2008, a new breed of challenger banks have entered the market and operate in this sector. These include Handelsbanken, Metrobank, Paragon and Aldermore. They offer business loans that can be more competitive than those of the traditional banks and are generally more flexible and keener to compete for your business.

In recent years, here has been an upsurge in online ‘banks’ offering loans. Some of them will offer unsecured loans and can be an option if you need to get your hands on the money quickly. But lending rates are likely to be higher than traditional high street banks, reflecting your risk profile. There are many providers out there some offering comparison/broker services, such as Funding Options, and some alternative approaches such as Funding Circle, although you may need two years of company accounts.

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