You have a vision. A great idea. You’ve run it past friends, family and trusted colleagues. They think it’s great too. And now you want to build that idea into a successful business.
In the current climate, what are your funding options for getting that idea off the ground and into people’s hands?
Firstly, you’re going to need to understand how funding typically works.
How funding typically works
The history of investment and startups goes back hundreds of years. So although your idea may be new, the path to getting your business funded is not. You’re about to walk a well trodden path, one that has survived more than a few global catastrophes.
Has startup investment changed much since Covid?
Yes, and also no. There are established stepping stones for investment and options for each stage of a business’s growth. It’s a structure that evolved over a long time, and it’s survived recessions, depressions and wars. Sure, things have changed in the post Covid world, but this path remains valid.
Investors have to keep investing. The machine can’t suddenly stop because the consequences are too great and big chunks of entire economies depend on it.
The fact that most governments immediately ramped up their innovation investment funds as part of their Covid recovery plans shows how important and valuable entrepreneurs with good ideas are.
So opportunities do exist. If you’re an investable startup that’s active in a robust field and you present yourself well, you’re going to find funding.
Stages of investment
Generally an investor will specialise in a specific stage of growth. It’s rare, but not unknown, for a startup to skip many rounds – most of those unicorn startups (valuations of a $1bn or more) you read about have actually been on a cycle of raising money for many years. At some point those unicorns were preseed too.
So what are the stages and how do you access them?
We’re going to focus on preseed, seed and early stage funding here. The information below isn’t exhaustive – funding is a complex area – but it will serve as a good starting point. We recommend taking advice from a qualified financial adviser when you consider any investment and the liabilities and risks that come with it.
Getting from vision to full concept takes time, effort and inevitably money.
Most often that very early funding comes through founders, friends and family (FFF).
Sure you can do your own background work and set things up in your spare time, but at some point you’re going to need to buy things and pay for professional services.
Preseed funding provides the money founders need to get their idea firmed up, their startup incorporated and ready to get off the ground by accessing the first proper step in the funding journey; seed funding.
Funding that’s typically for a proof of concept or prototype of your product.
Like preseed, seed funding often comes from founders, friends and family. There are government funds, startup incubators and some angel funds that will consider preseed too.
Whoever you approach, you’re asking investors to buy into something that’s really still just an idea at this stage, so you’re looking to validate your product or service; how does it fit into the market? What’s the business model? What’s the real potential?
“At preseed you are all an investor really has that’s a tangible indication of how successful your idea could be. They’re investing in you, so it makes sense to focus as much on positioning yourself as investable as it does your idea.”
Seed investments are usually pre-revenue, but even without a real product or service you can generate revenue, prove a market fit and raise your value for subsequent rounds. What you’re doing there is managing risk for both yourself and your investors. But that’s another article.
Why you might consider funding using founder, friends and family money:
- Nothing focuses the mind quite like the fact that you’re spending your own money. And the responsibility of spending friends and family money? Even more so.
- Want to test the conviction of your co-founders? Then asking them to put some money into your collective idea will bring forward any warning signs you might have missed up until now.
- Demonstrate you have skin in the game. Nothing says “I believe in my idea” to an investor more than having your own money in it.
Incubators and Accelerator
Incubators and accelerators offer startups funding, office space and support by way of networking and partnerships. Some are government funded initiatives, often within universities. Others are privately funded as part of investment groups. Sometimes large businesses will create programmes to attract and have early access to startups in specific fields like automotive, AI or whatever is considered hot at the time.
Why would you want to consider an incubator or accelerator?
Incubators are very selective – only the most promising ideas, presented in the best way will usually make it onto their programmes. So you’ll pretty quickly get a feel for how your idea stacks up. But even if you don’t make it onto one, the process of pitching and getting feedback will help you improve your idea and how you present it. Resilience is a required trait – what have you got to lose?
Incubators should offer you more than just funding, in fact some programmes offer very little funding. They could also offer you:
- Partnership opportunities
- Office space (and a Covid safe place to work as a team)
- Preparation for graduating out of their programme (i.e. next round funding)
- Or early access to acquisition or corporate level funding
Overall, all being well, you should come out of an incubator or accelerator with a validated business model ready to hit the market and your next round of funding in place.
Incubators and accelerators are most suitable for heavily tech focused startups where the founders want to build, own and manage their own tech teams.
With those teams comes a lot of work, responsibility and sometimes risk – you’ll be giving equity to your team and, if it’s not working out, getting that back can be a challenge. The right incubator will help you with all that, so you can remain focused on bringing your vision to life.
What do incubators and accelerators take from you?
Unsurprisingly incubators and accelerators want something back for their investment in you and the programmes they run. They’ll usually take an equity stake in your business.
How much? Pre-COVID it was typically around 10%. But be prepared to face steeper demands and tougher negotiations in a post Covid world.
Handing over a share of your business happens at each round of investment, it’s called “Equity Dilution” and if you go down the funding route you’ll need to get used to it. But as you’ll see later, there’s a sting in the tail and it pays to plan ahead when giving away shares in your startup at the early stages.
Angels and Angel Networks
Angels are wealthy individuals looking to make investments using their own money. Usually they come from an entrepreneurial background themselves, having founded and exited businesses.
Angels are often looking to invest more than just their money – they can offer you connections, experience and often mentorship.
At the less personal end of the angel investment market are the angel networks. These are organisations who bring together groups of angels and match them to your investment opportunity through events – pitch competitions and networking events.
In the UK most angel investors work with the government’s EIS scheme, which makes it extremely tax efficient for them to put up to £1m into startups in each tax year.
Angel networks are businesses in their own right and they will usually take fees for membership and/or a cut of any investments they help broker. As investors are much harder to find than investment opportunities, that burden usually falls on the founders seeking investment. You’ll often be asked to pay to join a network. That’s something to bear in mind.
Early Stage Investment
Making it to early stage investment is a big milestone for a startup. Generally it means you’re revenue generating, probably through a minimal viable product or prototype. Although perhaps not profit making.
At this point investors are looking for businesses that they can help rapidly scale through making cash injections.
In the UK typical early stage raises have been between £250k and £1m. But there are no firm rules. Bigger raises happen less often and go through venture capitalists (VCs), who are the gatekeepers to one or more funds. These funds can be mind bogglingly big – the UK’s top tech VC funds each have over £1bn – still small fry compared to the top US and Asian funds.
Things get tougher here, as you would expect. There will be hurdles to jump to access VC funds and having a history of savvy decision making will help you at this stage.
For example there will be a pre-money valuation requirement. That’s a valuation of your business before any investment. That valuation is usually built around a multiple of profit and/or revenue spread over however many shares your investor is going to get. So the more of your business you have retained, and are prepared to offer, the more attractive you will be to a VC.
If you’re at preseed now, consider the above paragraph carefully because it pays to know where you might end up when you come to a seed raise. If you can demonstrate revenue, profit and low equity dilution you’ll increase your valuation.
“Making savvy equity dilution and revenue decisions at the preseed stage based on understanding how a VC raise might look later will help improve your position. Plan ahead.”
Raising money can be a complicated business but it always pays to think like an investor. Regardless of the stage or the amount of money involved, the one thing they are all trying to do is understand and manage risk.
Funding models aren’t usually simple at this stage and startups often carry investors through from previous rounds. A new investor may want to buy-out others, but will also very often welcome a round that’s a hybrid mix of angels and VCs – it shows confidence and reduces risk.
There are many other options for funding through seed and early stage.
Government backed funds
Government backed funds are especially worth exploring as governments look to stimulate and invest in their economies post Covid. These tend to be innovation and technology focused.
Many government backed funds are focused on specific fields and often have to include academic partners. You might find a requirement to provide match funding, which you may be able to do through applying your time and resources or by accessing another government backed fund.
Grants, although usually quite small, offer a brilliant opportunity to those who qualify for them. They can be the easiest to apply for, won’t ask for equity and will put relatively little demand on you.
Look out also for convertible loans – these are government backed funds that will lend money at favourable rates and, if criteria are met, convert that loan into equity at a later stage. Loans can be large and they give you that unusual and possibly useful option.
Not to be confused with founders, friends and family (FFF). This is not your average family.
Family funds are an alternative to trust funds that very wealthy families use in order to preserve and grow the family fortune. They will typically be investing in specific fields, for example the Dyson family invest in manufacturing and technology and the Green family in retail. Those are the high profile ones, but you’ll find many smaller family funds active and easy to reach through websites and events, all interested in making private equity investments.
Crowdfunding has made a huge impact on startups, particularly those in the physical product space where people are effectively preordering and supporting ideas and people they want to see succeed.
There are now also crowd equity platforms that are focused just as much on service businesses. Seedrs, for example, is about to top £1bn invested since 2011.
There are clear advantages to crowdfunding. You’re often not going to be giving any equity up and you can potentially be free from the financial risk of failure. You’ll also be able to gauge the public’s reaction to your idea before you make it, and get feedback from them along the way.
However, running a successful crowdfunding campaign is very different from seeking any other type of investment. Those who succeed have mastered PR, built communities and followers, and put a huge amount of time and effort into raising what can often be a relatively small amount of funding.
Crowdfunding might work for your startup and there are a considerable number of successful case studies to draw inspiration from. For Oculus VR it worked out pretty well. They went on to sell to Facebook for $2 billion. That earned founder Palmer Luckey a cool $500 million.
Often overlooked, banks have been in the business of supporting and funding small businesses in the UK for over two hundred years. They might help you through overdraft, debt financing or straightforward loans. Although they will ask for personal guarantees they rarely have an interest in equity.
There is constant debate around how sensible it is for founders to go down a bank loan route when the risks are so high and there are other options that don’t require personal guarantees. Banks are all about risk management, so for a startup to find it easy to actually get a bank loan seems relatively rare.
In the face of Covid, the UK government, along with many other governments, are offering guarantees on small business loans which not only derisks the loan for both the bank and the business, but in theory should make the application process easier. Pre-revenue and unprofitable businesses are unlikely to qualify, so this is perhaps still not suitable for preseed or seed stage start ups.
Are you SEIS and EIS Ready?
When you’re looking for seed funding people will ask you if you’re SEIS or EIS ready. What does that mean?
The Seed Enterprise Investment Scheme (SEIS) was introduced by the government in 2011 and is designed to allow investors to recoup a significant amount of their investment through their own personal tax relief. It effectively reduces the risk they take by investing in you and so encourages wealthy individuals to become angel investors.
The Enterprise Investment Scheme (EIS), as you may expect from the name, is similar to SEIS but for larger sums of money going into medium sized organisations.
If your startup qualifies, which it very likely will, then being registered to take SEIS or EIS investment is simple. It does come with some extra responsibilities and your best source of information on SEIS and EIS (including the latest tax relief rates etc) is the government’s website https://www.gov.uk/guidance/venture-capital-schemes-apply-to-use-the-seed-enterprise-investment-scheme.
“There are some official looking websites offering paid for advice and services around SEIS registration and set up. Accountants will offer to help you through the process too, for a fee. The scheme was deliberately designed to be easy to understand, easy to set up and cost effective to administer. Good advice is often worth paying for, but think about that before you part with your money.”
You can get a regular summary of the UK’s government backed and private investment opportunities through our Investment Opportunities Newsletter.
If you’re embarking on a new venture, or about to close your next raise, and want to know how we can rabidly reduce risk and add value to your digital product or service then get in touch.