Startup Investment

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STARTUP INVESTMENT EXPLAINED

Capital is the lifeblood of any business. You need cashflow to keep business operations going, to scale faster than competition, and to acquire and retain customers. While a great business idea can initially draw cashflow from founders, family, and friends, it does require external help at some point in time. Bootstrapping, i.e., founding and running a company using personal finances only, has limitations that can be overcome through external funds.

External funds can be arranged by taking debt or issuing equity.

  • Debt can be solicited through a formal institution like a bank and draws interest and monthly payback liability. It also requires the business to be generating revenue to assess affordability of the loan repayments.
  • Hence, startup founders increasingly prefer equity financing, where investors provide funds in exchange for a stock share of the company. Equity fundraising brings in far more cash than debt, and lesser risk, that helps fuel the startup’s growth.

Every time a startup goes to the market to raise capital through equity, it is called a funding round. Each funding round is intended to give entrepreneurs and their business enough cash to reach the next milestone. As a company advances through the funding rounds, the participants of the journey change from pre-seed investors to angel investors to venture capitalists. We look at the stages and participants below, but first let us understand the rationale behind seeking investments.

Why should you take on investment?

Timely investments in your business can help you cover your initial costs and reach the planned milestones faster. There are multiple reasons to take investment:

  • To build your products/services (R&D): If you’re planning to develop a new product or improve the existing ones and need cash for R&D, investments could be the best option. Even if your business is making losses but has the potential to earn revenue in the future, you can find willing investors to support the business in this stage of development.
  • To get connections and mentorship: Investments don’t just give you monetary advantages, but also the benefits of connecting to the startup ecosystem. Investors need your business to grow in order to have a return on their own investment. Therefore, they more than often, assist startups with mentoring and connecting to relevant contacts in their networks.
  • To scale a business: A business has to make two decisions – how big you want to be and how fast you want to reach there. Fuelling your business growth requires investments and the quantum of investment depends on these two factors. You will need investment to expand to geographies, build a team, increase output etc.
  • To sustain a business: Your business idea might be brilliant but, in most scenarios, it does take time for market and customer acceptance. In that duration, you need to spend time in product development, marketing, and advertising etc., and all this needs cash inputs.

Who is an angel investor?

Angel investors are high net-worth individuals who provide funding for startups in their early stages. Angel funding precedes venture capital and is for smaller sums of money, referred to as ‘seed funding’. Since it’s a risky investment for an angel investor, it usually doesn’t represent more than 10% of the angel investor’s portfolio.

Angel investors are informal investors and are focused on helping the startups take the first steps. Their terms are more favourable than those of other lenders as they are investing at a time when the business is really just starting up. One example of a platform that helps startups in the UK meet angel investors is https://www.angelinvestmentnetwork.co.uk/

Who is a venture capital investor?

Venture capital investors are typically well-off investors, investment banks, and other financial institutions. They invest large sums in startups, usually after the startup has gained some proof of concept. They may not look at revenue but surely consider key metrics to understand the performance and potential of the business. Sequoia Capital, Accel Partners, Bessemer Venture, Intel Capital etc are some of the largest venture capitalists in the world.

Venture Capitalists, or VCs, invest in tranches called ‘series’, accompanied by alphabets. Series A, Series B, Series C is not just a logical sequencing of funding rounds but denotes a specific stage of the startup that further approximates its funding amount:

  • At Series A, the startup has a working business model, a key team in place, and a scalable blueprint.
  • Series B denotes the business scaling up, increasing market share, and outliving its competition.
  • Series C and beyond is about expanding and increasing market share. Series C puts a company on the IPO track.

What is crowdfunding?

Crowdfunding is an alternate form of raising Series A funds for your business. In this method, you share the details of your business, its development progress, and other information with the population, or ‘crowd’ on one of the crowdsourcing platforms. Interested individuals reach out to you and fund your business. In return for this investment, business owners can offer rewards on upcoming products or services, equity, interest payment, pre-order of the upcoming product or service, or can even request for funds as donations.

Seedrs and CrowdCube are examples of equity-based crowdfunding platforms. Zopa and FundingCircle are few of the debt-based crowdfunding platforms. JustGiving and CrowdFundr are examples of donation and reward-based crowdfunding platforms.

One of the best examples of crowdfunding comes from Oculus Virtual Reality Headset. It was launched in 2012 on a crowdsourcing platform called Kickstarter. It raised a total of $2.4 million, surpassing its goal of $250,000. In 2014, while the product was still in prototype stage, Facebook acquired it for $2 billion.

What is SEIS and EIS?

Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) are tax reliefs offered by Her Majesty’s Revenue and Customs (HMRC) to taxpayers in the UK. This is one of the initiatives by the government to promote and support entrepreneurship in the UK. If you’re looking to raise capital, you can raise it under SEIS/EIS based on the following criteria. This makes the investment lucrative to the investor considering taxation benefits.

 

 

  SEIS EIS
Focus of the scheme Seed Enterprise Investment Scheme (SEIS) is intended for very early-stage companies who need to raise capital when starting to trade. Enterprise Investment Scheme (EIS) focuses on medium size startups that need capital to grow their business.
Companies that can use the scheme
  • Established in the UK and not trading on a recognised stock exchange
  • Have gross assets less than £200,000 when shares are issued
  • Have maximum 25 employees
  • Must not be a member of a partnership
  • Permanently established in the UK and not trading or planning to trade on a recognised stock exchange
  • Have gross assets less than £15 million when shares are issued and £16 million immediately afterwards
  • Have maximum 250 employees
Limit on age of company 2 years 7 years
Maximum amount that can be raised £150,000 £5 million each year, and £12 million maximum in the company’s lifetime
Maximum investment by an individual £100,000 per tax year £1 million per tax year
Benefits to the investor
  • 50% tax break
  • No capital gains tax on profit arising from sale of shares after 3 years
  • Eventual losses can be offset against the capital gains tax
  • 30% tax break
  • No capital gains tax on profit arising from sale of shares after 3 years
  • Eventual losses can be offset against the capital gains tax

 

There are certain regulations and procedures that are common to both SEIS and EIS:

  • SEIS precedes EIS, even if both are in the same funding round.
  • Most of the trades are eligible for this funding, however there is a list of excluded trades. Any company is excluded from raising funds under these schemes if a substantial element (more than 20%) of its trade falls in the excluded category. Excluded trades are the ones dealing in commodities or land, property development, insurance, banking, money lending, accountancy or legal services, and generation and export of electricity.
  • The funds raised from these investments must only be used for a qualifying activity, intended for the growth of the business. Qualifying activities include marketing, hiring new employees, developing the product etc.
  • There is a strict criterion regarding the association of the investor to the business. Neither must the investor hold more than 30% of the shares in the company nor must they be associated in a director or employee capacity. Investors must also be UK taxpayers only.

If you’d like to offer SEIS or EIS investment opportunities to potential investors, here are the important details you must know:

  • You need to offer ‘advance assurance’ to potential investors to confirm that your business is eligible for SEIS or EIS funding. For this, you need to submit an application to HMRC with the details of at least one proposed investor and requisite documentation. Once your details are submitted, HMRC takes 2-3 weeks to approve the advance assurance.
  • After the close of the funding round, when share certificates have been issued to the investors, you would need to send SEIS1 and/or EIS1 compliance statement to HMRC. HMRC then provides the investors with a unique investment reference number. This allows you to issue SEIS3/EIS3 certificates to investors, so they can claim tax relief.

Do you need expert advice?

We can say that investment in a startup is vital for its continued sustenance, growth, and expansion. However, the path to attract this investment is not that straightforward, there are many nuances in the process. Taking the help of an established expert in the domain not only assures that you’re on the right path but makes the process seamless and effective for you.

Nuvem9 has years of rich experience in assisting businesses to get equity investments. Nuvem9 will provide you with a Startup Funding Consultant focused on understanding your startup’s requirements and charting your funding journey. Get in touch with Nuvem9 for a free consultation session and discuss your company’s specific needs. Book an appointment now!