Venture capital

Share Equity: Once it’s gone, it’s gone

Equity Sometimes there is little alternative but to issue shares to investors, employees and other stakeholders. If the company’s an early stage company then it has little else to ‘sweat’ to release some cash.

You might be able to benefit from the Seed Enterprise Investment Scheme (SEIS) or the Enterprise Investment Scheme (EIS) but – although technically related to your company – it is the investor that pockets the tax relief (not you). You might be able to squeeze some more cash out of the investors by virtue of the tax relief they will receive but (as the rules currently stand) you have to issue shares to them in return for their investment.

Whilst money for salaries is tight, employees may benefit from an approved share option scheme like the Enterprise Management Incentive Scheme (EMI). Although they only hold a piece of paper entitling them to the shares at some point in the future (say on an exit), you must still take into account the post dilution shareholdings once their shares are issued.

So you started with 100% of the company and very quickly you might find that your shareholding is down to not much over 50%. And then there’s that big VC round you’re contemplating in a year or so – further dilution to come…..

There is only ever 100% to divide up. For each 1% that goes it has gone (probably) for ever. Often it is a price worth paying as the old saying goes,

“its better to have 40% of a successful large pie than 100% of a failing tiddler”

But at every stage you should try to ensure that you have explored incentives that do not require you to part with your equity in your company. 

So you could look at R&D tax credits and grants. Also, further down the line the Patent Box could shave some much needed cash off your corporation tax bill.  These Government tax incentives and grants do not require you to give up any of your shares in return for the cash and so could allow you to get further down the line to achieving your milestones with no further decrease in your shareholding.

Often in practice, companies have little alternative but to push through with investment for shares in the company but its always useful to remember that there are other (non-equity) funding avenues available.

Image: Creative Commons License Richard Potts via Compfight

What is SEIS?

SEIS: Startup term I wish I understood but was afraid to ask!

Here is a brief overview of the Seed Enterprise Investment Scheme from a company founder’s perspective.

Armed with more knowledge about this fantastic UK tax incentive aimed at start ups and early stage growth companies, hopefully we can get more impetus behind this government scheme and more backing for promising new companies.

If you need any specific advice, please contact me.

Or try our SEIS DIY Kit.

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25 years v 5 projects: Same yet (monstrously) different!

Lasers

“Life is long – if you know how to use it…”

– Seneca

I am unsure if it is my background of working with venture capital backed businesses but I always find myself thinking in 3-5 year time horizons.

So when I am advising businesses on strategy or exit planning this seems a natural reference point as this is the typical timeframe VCs will tend to use in seeking a return for their investors.

But I think this 3-5 year timeframe is useful for entrepreneurs with respect to how you plan your life.

Let me share a personal example: I try to view my working life in 3-5 year periods and try to allocate a project to each. I use the term “project” broadly which could mean a business, career, job, vocation, whatever. So there is 3-5 year time period to build it (whatever “it” might be) with a view to an exit or delivery on the next phase of growth within this timeframe.

Why is this important and how does this thinking help?

Well I am fast approaching the grand old age of 40 and I have been working on my current project for just over 4 years so I am now thinking:

“I have 4-5 projects left in me – what might they be?”

Thinking I might have 20-30 years of working life ahead of me allows for lazy thinking. In contrast, thinking I might only have 4-5 projects left to immerse myself in over the remainder of my life is sobering (to say the least). 

So rather than plodding on with your business or career, ask yourself how long you’ve been working on your latest “project” and how many projects you might be lucky enough to fit into the remainder of your life?

You might just find your thinking changes and you have a little extra zip in your step – and you might just surprise yourself…

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Getting the most out of SEIS to fill the funding gap

Meet Drink Think, Start-Up Cafe, Coventry Univ...The Seed Enterprise Investment Scheme (SEIS) provides an excellent opportunity for early stage fast growth companies to access funding from founders, family, friends and business angels.

In essence it rewards investors by allowing them to reclaim income tax at a rate of 50% of their investment under the scheme (limited to £100,000 investment per tax year) plus a potential capital gains tax free disposal after three years.

But such a generous tax break comes with (many!) terms and conditions….

Common areas where there seems to be much head-scratching is around the limit for the SEIS investment into the company of £150,000 in total; the limit of £200,000 or less gross assets and the 30% connection test. Note these are just a few of the conditions!

Given the above, how can founders make the most of this SEIS tax break whilst getting the funding they need?

  1. Try to spread the £150,000 total investment between investors / founders to avoid breaching the 30% connection test e.g four individuals with 25% each can work well
  2. Remember the test for the £200,000 gross assets is applied immediately before the issue of the SEIS shares – so you could seek external (non-SEIS) investment top-up funding afterwards. Note that EIS funding is only available once 70% of the SEIS funding has been spent.
  3. Investor(s) could invest an amount as a subscription for SEIS shares up to 30% of the share capital and then loan the remainder.
  4. Investor(s) could invest further amounts in a company by subscribing for less shares but with the remainder being credited to share premium e.g. if an investor / director already holds 29% of the ordinary share capital they could invest a further sum (subject to the SEIS limits) for a further 1% of the ordinary share capital with the remainder posted to share premium.

These are just a handful of examples based on recent experience of advising fast growth companies and investors – as always there are many ways to skin a cat but it is important to review all options to make the most of the UK SEIS and EIS tax reliefs.

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EIS & EMI – Happy marriage or grounds for divorce?

Incentivising key employees by giving them an equity interest in the company not only makes sense from a motivational and employee retention perspective but it also makes good financial sense when cash is tight and tax can bite nastily on cash bonuses.

Many UK growing companies will qualify for the Enterprise Management Incentive Scheme (commonly referred to as EMI) which is a tax favoured share option scheme which allows qualifying companies to allow selected employees to share in the success of the company, perhaps on an exit.

Growing companies that qualify for EMI may also qualify for EIS (a similarly confusing tax acronym which stands for Enterprise Investment Scheme!). EIS is a tax break available to business angel investors in the sorts of growth companies typically favoured by EMI share option schemes.

There is normally no problem in a company acquring funding under EIS whilst incentivising key management or employees using EMI, however, one crucial point to watch is that EIS is only available in respect of new ordinary shares which do not carry preferential rights.  Care must therefore be taken to ensure that shares issued under an EMI scheme do not contain restrictions that might, by default, make the EIS shares preferential within the three year EIS qualifying period. If the the ordinary shares issued to the EIS business angel investors “become” preferred to the shares over which the EMI options are granted within the 3 year period then EIS status could be lost along with the tax breaks that go with it.

Ouch.

Although both EIS and EMI can form a happy marriage for most fast growing entreprenerial companies, they both contain strict conditions that must be adhered to if you are to avoid a potentially unsavoury divorce from your investors.

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5 tips for securing funding – Bill Morrow: Angels Den

Bill Morrow, founder of the Angel Network, outlines 5 top tips for entrepreneurs seeking funding from VCs:

  1. Make sure you can explain your business quickly and succinctly. If it takes you more than 5 minutes, then you’ve yet to get it nailed. Back to the drawing-board for you!
  2. Outline the pain that your product or service will solve.
  3. Explain how your business will solve this pain.
  4. Enthuse investors with the opportunity for growth and how you will achieve this – how will your business scale to achieve the 5x + return on investment for your investors?
  5. Set out clearly how you will spend the money that you are requesting.

Morrow also explains how it helps for entrepreneurs to “humanise” interactions with potential investors, where possible. If you can build rapport by indulging in a bit of chit-chat about the cricket or football etc then this helps build relationships beyond business.  After all, you may have to work with each other over a number of years, so its important that you can get on outside of business-talk.

Good advice. Listen to this podcast in full over at Smallbiz pod.

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IPOs for technology companies – Key learning points

Yet another insightful Techcelerate event this evening in Manchester chewed over whether ‘initial public offerings’ (IPOs) or ‘stock market listings’ are the right capital raising vehicle for growing technology businesses and the process required should they choose to go down this route.

Marcus Stuttard (AIM CEO) delivered a concise analysis of the advantages of listing on the markets including scenarios where this might not be so appropriate and then Anish Kapoor (Telecity LSE listing) and Simon Elms (Warthog AIM listing) delivered warts and all accounts of the IPO process as entrepreneurs who had been through it and managed to live to tell the tale.

Here are my notes:

  1. Choose the right broker or nominated advisor (NOMAD). They hold the key to your long term success in the market.
  2. Your management team will also be key to the success or otherwise of the IPO and beyond. Start making connections with potential non-exec directors etc who can help (sooner rather than later) with strategy and helping build your team in areas like finance and perhaps getting the wheels in motion to appoint a highly regarded chairman.
  3. Have your business model nailed down before you start the IPO process. Markets don’t like unexpected strategic changes.
  4. Be prepared for a long and arduous due diligence process in the run up to listing as lawyers and accountants crawl over your results and forecasts. Your business will be in better shape afterwards!
  5. Costs of listing are significant – both in professional fees and management time. You then have the ongoing regulatory and reporting requirements to comply with. Think through why you are seeking a listing as there could be better alternatives if you are seeking a one-off injection of cash.
  6. The flip-side of point 5 is that once you have been admitted to the markets, raising future cash is easier than seeking private / VC funding.
  7. Institutional investors like to see a track record of management having successful executed IPOs and exits. They are prepared to invest in the management team – even for pre-revenue businesses.
  8. Listings in the US are even trickier than the UK – tighter regulations etc. Proceed with caution.
  9. VCs are increasingly looking to AIM markets to invest capital. Espec VCTs. Another advantage for listing.
  10. Think about the impact on your staff and how the fluctuation of the share price might unnecessarily unsettle them. On the flip side, think of the opportunities to incentivise them with a ready market for the shares.
  11. An IPO can be great for your PR in your sector – speaking of which, consider getting a decent PR agent as part of the IPO process.
  12. For AIM you’re probably looking at a minimum capital investment of £2m+ with the majority currently in the £30m-ish bracket.
  13. As a founder, think about when you can get your cash out post IPO – you will probably find you are severely restricted in cashing out shares due to potential negative sentiment and insider info plus lock-ins. Work this out upfront.
  14. Don’t try to time the markets. You need to take the best deal you can get when presented if you are to continue to build your business and stay one step ahead of the competition.

Any further comments to add?

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A key reason why many start-up businesses fail

Here my short (impromptu) video on why I believe many business start-ups fail.

The old adage that “cash is king” remains as true as ever today, however, there is something else that I am increasingly seeing that can put the future survival of new businesses in jeopardy.

This issue is that: many startups fail to define upfront the market need or problem that their product or service will solve.

Seems obvious right?

You would think so but with so many new businesses looking to innovate into new areas and with technology providing an increasingly affordable platform on which to build new businesses, this consideration sometimes seems to get sidelined – typically until businesses seek funding and / or its too late.

So focus now on that particular market failure or wider need that your future business will plug in the world? What need are we anxiously waiting for you solve by creating your business? What frustrates you (and many others?) that your business will crack?

Be clear on the problem and your business solution and you will be one step ahead in defining future revenues and a potentially profitable business.

7 tips for start-ups seeking VC funding

I’ve been reflecting on the key business learning points emerging from the BVCA’s excellent recent event Financing & funding the digital age held in Manchester on 16 September 2010.

It was a full day of fast moving panel discussions and keynote speeches that kept coming at a relentless pace until almost 6pm – plenty to chew over hence the delay in penning this summary.

There were so many ideas and tips to unpack that I’ve decided to run a series of posts covering different topics. First up is the comments made on VC funding.

BVCA Digital Age 1: 7 tips for start-ups seeking VC funding

  1. Start building relationships with VCs who specialise and invest in your chosen sector NOW – don’t leave it until you need a cash investment.
  2. Better communication is needed between both the VC and entrepreneurial community. There was much talk from tech entrepreneurs of the incredibly frustrating “long….slow…..No” from VCs (which was tacitly admitted by the VC panelists), however, there was sound advice in ensuring that you invest some time upfront to pick the right VC – this means studying each VC’s objectives for investment (does this fit with your business?), timeline for investment or where they are in the fund cycle (have they made any investments yet, and if so, any in businesses like yours?). This should save much time and frustration on both sides.
  3. Business plans are largely a work of fiction (as things rarely pan out the way you planned them) so don’t go crazy building huge singing-all-dancing plans, however, you still need one to set out the investable opportunity for VCs to get an initial idea. The point was made (and reinforced by an excellent post and VC panellist Nic Brisbourne) that the act of sitting down and preparing a business plan helps entrepreneurs hunker down and concentrate on the business model – how is this great idea actually going to make me and my investors money? Sometimes reality strikes home when it comes to calculating the sales v costs etc. See points 6 & 7.
  4. Concentrate on clearly defining the market need that your product or service will solve rather than how sexy your technology is.
  5. Dawning of microfunding? Lower costs of entry for building new tech businesses brings into question how much cash investment entrepreneurs might need and when? Put another way, entrepreneurs might now be able to reach a much more advanced milestone in proving the business concept using just “family, friends and fools’ money” than would have been possible a few years ago – the point of inflexion has shifted along the timescale – so does this represent the dawning of microfunding and a move away from traditional VC seed funding and the timing of subsequent rounds of investment?
  6. Merits of writing a business plan for startups seeking funding is best summed up by the comment: “Execution focuses the mind”.
  7. Best of all, when you do approach VCs, present your business as “strategic opportunity” rather than a request for cash.
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Blogging as a relationship builder for entrepreneurs

I’ve long been a fan of Fred Wilson’s blog (‘A VC’) – if you’re a start-up entrepreneur or business owner you really should subscribe too.

The above video is a great snap-shot of the benefits of blogging in business. The gist of Fred’s words:

“blogging allows for the opportunity for VCs to enter into a dialogue with entrepreneurs over a period of time…to get to know one another…well before an investment decision needs to be made”

It is only fairly recently that such tools have become widely available and this has sooo much potential for every business owner and adviser.

We all now have the opportunity to demonstrate our approach to business thinking and to get to know one other (virtually) over a period of time before potentially entering into a (real-world) business relationship or project in the future.

Its all a bit like online (business) dating – but perhaps far more likely to find the right match over the longer term than traditional – yet speculative – business networking and marketing!

What are your thoughts on business blogging?

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