We invite Investors to join us at our events to hear pitches from 4-6 start-ups seeking growth funding. You will have the opportunity to discuss the deal with fellow investors and then get to know the founders further during our networking lunch. To join us please email Suzanne Bicheno email@example.com.
Is it time to pack in the 9-5 and start being your own boss? Entrepreneurship is thriving and it’s a great time to launch a business. If you are ready to take the plunge, there are a few things you need to consider before branching out on your own. You could have a brilliant idea but if you don’t have the skills to implement it then it’s a non-starter. Equally, you could have a brilliant skillset but if the market isn’t there then you’re not going to make money from it. You need to be strategic when starting your own business. Ask yourself three questions: 1) What do customers want? 2) What do investors want? 3) What can I realistically deliver?
Spend a few months going for walks or drinks down the pub and allow your mind to wonder free exploring different markets, products and customers. For a little structure, use this checklist and save yourself time by obeying the do’s and don’ts.
- Large market and growing market:
Think about a large market which is still growing and if it is recession-proof, even better! For example, the value of the global virtual reality hardware market could be as high as $62 billion by 2025. Conversely, creating an enterprise for female snake owners aged 21-30, will not allow you to scale (excuse the pun). A small market will not attract investors or generate sustainable profits. However, do not try to be everything to everyone. A lack of focus is unattainable. It makes it difficult to market your product and your customers won’t understand the value you deliver specifically to them. So, target a large and growing market and then be specific within that market about what you offer.
- Solve a Problem – be the morphine not the aspirin:
If you have a headache you could survive without the aspirin, if your leg was cut off you might not survive without the morphine. So, try to create the equivalent of the morphine. Understand what frustrates people, what are their challenges in life or work? What do they want solved?
- USP or Disruptive Technology:
Investors love tech! Why? Because tech allows you to scale. Now not every entrepreneur needs to be in tech – what a boring world that would be! But if your goal is to become a unicorn ($1bn company) then you will need tech to scale. If you can protect your tech then even better! This means patents or airtight copyright. But patents are hard to obtain so do not let this be a deal breaker for you. Think how you can do something better, faster, cheaper or more fun!
- Profitable Market:
You could have the best idea but if customers can get it for free elsewhere or it’s not enticing enough to spend big bucks on it then you won’t make a profit. There’s a saying, “there may be a gap in the market, but is there a market in the gap?” Create a financial model to understand your costs and how much you can charge for your product or service, test the price you set (not with your mum or spouse! With real potential customers) and determine whether it can be a multi-million-pound business. Personally, I don’t believe you have to be revenue generating immediately (unlike some Investors want) sometimes revenue focus can squish growth, but equally think about how you could make money from it fast enough to please investors.
Some do’s and don’t to help guide your business idea evolution:
- Think big: Big markets, big profits, big ambition.
- Be free: Don’t limit yourself to realism – making it happen comes later and you’ll pivot 10 times before the final version anyhow!
- Problem solve: Go talk to people – friends, corporations, bartenders, retail assistants – anyone who will give you the time. What problem do they have and how could you solve it?
- Become obsessed with an idea for the sake of it. You may go through 10 ideas before you settle on the one with potential. Leave your ego at the door.
- Go any further forward with the idea until you’ve spoken to over 100 potential customers.
- Worry about sharing your idea. First, people are more obsessed with their own ideas than yours. If someone likes it they will either want to join you or buy you, they don’t want to go to the trouble of building it themselves. Second, you need to share it to get team members, customer feedback and investment. Third, and no offence intended, but your idea will not be that original. There will be a form of it somewhere. Secrecy is not the key to success.
Bear in mind, these tips are designed around budding entrepreneurs who will need to seek investment and want a multi-million-pound enterprise. Some of you will simply want to cover your bills and pay for that holiday in St Bart’s. If that’s you then you don’t need to be investor focused and you can cater to smaller markets. Think through why you’re doing this and where you want to go. If you’re doing it for flexibility, freedom and work-life balance, then a life-style business, consultancy or e-commerce can satisfy your goals. If you’re doing it because you believe you can create something better than what exists and want to take on big corporates, then you need to have an investor mindset and a customer focused strategy.
If you have started your company and are looking for growth funding, then please contact the Kent Investors Network at www.kentinvestorsnetwork.co.uk.
In order to secure investment, you will apply to many angel networks or VCs. You should try to attend networking events where investors may be present as meeting someone in person is the best way to secure investment. Once you apply to these investment groups, your proposal will be reviewed usually by a board and they will decide whether to invite you to pitch or not. Make sure you only apply to groups which you are eligible for / meet their investment criteria. A life science fund is never going to invest in retail so don’t waste your time and theirs.
How to secure a pitch
You could have the best business in the world, but if you can’t communicate this in your investment deck then you won’t get a foot in the door. An investment deck is a 10-page PowerPoint providing an overview of your business. You may be tempted to get create and do a video or something else, but ultimately, the investors need to look at the numbers and share it with the board so stick to the simple PowerPoint. Your 10-page deck must cover:
- The idea: What is your business? I’ve been on calls for 20 minutes and the founder still hasn’t explained what his business is. Keep it simple and spit it out!
- The problem you’re solving.
- The size of the prize – show them the money! Investors will only be interested in a large or fast-growing market.
- Defensibility – do you have intellectual property? Is it protected? Could someone copy you overnight, if not, why not? If so, what will make you succeed over them?
- Exit – when will you exit and to whom? What will be the investors ROI?
- Team – do you have the experience to do this?
- Financials – high-level revenues and costs to date and forecast
- What you’re asking for – how much you’re raising, at what valuation and how their money will be spent
Once you’ve been invited to pitch, prepare, prepare, prepare. I’ve seen brilliant entrepreneur bomb in the dragon’s den as they did not practice their pitch. You will be given anywhere from 5 minutes to 30 minutes to pitch so prepare versions for 5, 15 and 30 minute events. Whether your pitching to customers or to investors, some nuggets for success remain the same:
- Dance: Body Language
- Be confident. If you don’t believe in yourself, neither will they
- Smile, enjoy yourself
- Use your hands to illustrate points but don’t conduct an orchestra
- Move gently but purposely back and forth or side to side but do not pace erratically
- Stand tall
2. Sing: Voice / Tone
- Slow down! Even without hearing you, I know you’re speaking too fast. It’s better to say less and leave them wanting more than to gallop through your pitch and no one understand you
- Don’t be monotone, inject life into your voice
- Sound positive and confident, show energy and passion
- Articulate! Be clear, be heard
3. Lyrics: Words / Content
- Be clear and concise, less is more on your slides and what your say
- Don’t get lost in the weeds
- Prepare you story, know it by heart in case technology fails you and so you can deliver it at networking events
- Know who you’re pitching to and tailor it to them – analytics, visionaries etc
- Signpost your story – let them know what you’ll cover / Say what you’re going to say, say it, tell them what you just said
- Don’t be defensive to any tough questions, take them on board and thank the person for their insight
I coach people on pitching so if you would like some help for any pitching, presenting or public speaking then please do get in touch firstname.lastname@example.org.
What Investors look for during your pitch
While you’re sweating up front, this is what the investors will be looking out for:
- The team – Especially positive if they have worked together before or have built a successful business before
- IP portfolio – Especially in early stage tech firms
- Sector – Investors back what they know (so check out their portfolio).
- Traction in large, growing markets
- Financial indicators – Gross margin is a favourite
- Entry valuation – A black art…
- Exit route – Can I get out? When? How? Valuation?
- Due diligence – any skeletons?
- S/EIS (Seed Enterprise Investment Scheme) offers 50% tax relief. EIS (Enterprise Investment Scheme), you can raise up to £15m over the lifetime of your business and investors can back up to £1m each year.
Consider when you raise money. If you are desperate and tomorrow you’ll need to shut down the company, then you have very little bargaining power. Raise early. The below graph illustrates your relative bargaining power over time.
You need to set a ‘pre-money valuation’ before you seek equity financing. This is because the investor needs to know how much of the company he/she is going to own as a percentage of the whole company. For example, if you are raising £100,000 and your valuation is £1,000,000 then the investor will own 10% of the company. The investor will always hammer you down on valuation. If you are not yet making revenue you may struggle to be valued over £500k unless you have strong protected Intellectual Property (IP) or are in life sciences or deep tech (e.g. machine learning).
Roughly, what should I expect to give away?
Different investors value companies in different ways. Some look at the quality of the idea, assets, market size and management team. Some rely on financial projections. Some simply look for “big ideas” and determine their percentage ownership purely through negotiation.
A typical first round is:
- Founders: 20 to 30 percent
- Angel investors: 20 to 30 percent
- Option pool: 20 percent
In a later round Venture Capitalists will expect 30 to 40 percent.
A high valuation is not always better. When you get a high valuation for your seed round, for the next round you need a higher valuation. That means you need to grow a lot between the two rounds. A rule a thumb would be that within 18 months you need to show that you grew ten times. If you don’t you either raise a “down round,” if someone wants to put more cash into a slow-growing business, usually at very unfavourable terms, or you run out of cash. It comes down to two strategies:
- One is, go big or go home. Raise as much as possible at the highest valuation possible and grow as fast as possible. If it works you get a much higher valuation in the next round, so high in fact that your seed round can pay for itself. If a slower-growing start-up will experience 55% dilution, the faster growing start-up will only be diluted 30%. So, you saved yourself the 25% that you spent in the seed round. Basically, you got free money and free investor advice.
- Raise as you go. Raise only that which you absolutely need. Spend as little as possible. Aim for a steady growth rate. There is nothing wrong with steadily growing your start-up, and thus your valuation raising steadily. It might not get you in the news, but you will raise your next round.
What will help bolster my valuation?
Early-stage valuation is commonly described as “an art rather than a science,” Several factors influence valuation, including:
- Traction: Out of all things that you could possibly show an investor, traction is the number one thing that will convince them. So, how many users? 100,000 users will give you a good shot at raising £1M (that is assuming you got them within about 6-8 months). The faster you get them, the more they are worth.
- Revenues: Revenues are more important for the B-to-B start-ups than consumer start-ups. Revenues make the company easier to value.
- Distribution Channel: Even though your product might be in very early stages, you might already have a distribution channel for it. For example, if you have a Facebook page of cat photos with 12m likes, that page could become a distribution channel for your cat product.
- Hotness of industry: Investors travel in packs. If something is hot, they may pay a premium.
What are the investors thinking?
- Exit: How much can this company sell for, several years from now?
- Long-term funding needs: Next they will think how much total money it will take you to grow the company to the point of exit. In Instagram’s case they received a total of $56 Million in funding. This helps us figure out how much the investor will make in the end. $1 Billion – $56= $940 million That is how much value the company created. So, everyone involved in Instagram collectively made $940 Million on the day Facebook bought them.
- Ownership: Next, the investor will figure out what percentage of that s/he owns. If s/he funded Instagram at the seed stage, let’s say 20%. Let’s assume in the end, the angel gets diluted to 4%. 4% of $940 million is $37.6 Million. $37.6 Million is the most this investor thinks s/he can make on your start-up. If you invested $3 Million in exchange for 4% – that would give the investor a 10X returns. Only about a 3rd of top-tier VC firms make that kind of a return.
What methods are used for valuing a start-up?
- Cost-to-Duplicate: considers fair market value of physical assets and how much it would cost to build an identical company. Only accounts for current state and does not include intangible assets such as patents.
- Comparable Acquisition: indication of market valuation for a company based on recent acquisitions of similar companies. Requires comparable companies to be on the market with public information.
- Venture Capital Method: Developed by Professor Sahlman, values the company on the eventual selling price of the company and divides the investors anticipated ROI to determine the valuation today.
- Discounted Cash Flow (DCF): forecast how much cash flow the company will produce in the future, and, using an expected rate of return, calculate how much that cash flow is worth.
- Valuation by Stage: designates a value to different stages of the company. An idea may be worth $250k-$500k. A strong team might push the valuation to $1m, a prototype to $2m, a customer base to $5m etc.
- Scorecard Method: Payne’s (2001) method uses comparable valuations and then compares the company using certain factors which are weighted.
- Risk Factor Summation Method: This method is similar to the scorecard method but it compares 12 characteristics rather than seven.
Ultimately your valuation will be set through negotiation with investors. You do not need to pay an adviser to set your valuation, I can tell you now, an early stage start-up without revenues will be valued between £500k-£2m. Only companies with rich IP will secure the higher end of this. If your company is valued less than £500k, it’s probably too early for you to raise money. Go back and talk to your customers and distributors, try to gain traction. If you have revenue, you could be valued at 5x your revenue, but it may not be this high if your company is not defensible (i.e. competitors could copy it overnight). Equally, it could be a lot higher if you are highly defensible and a genuine original business solving a real problem. Crowdfunding platforms will give you a higher valuation than Angel investors but then you risk having a down round when you go to raise again. You will also have hundreds of small investors who all need updating with your progress and all have rights to ask questions.
My advice, is don’t get hung up on valuation. If you find the right Angel Investors, then that could be the difference between your company being mediocre or a raging success. You may lose 5-10% more than you wanted to but if your company becomes worth £200m instead of £20m then you’re coming out on top!
Arguably the biggest challenge in leaving your secure well-paid job behind and starting out on your own is funding. You have rent to pay, food to eat and a business to launch! Unfortunately, unless you’re already well off, you will need to go through a difficult phase of not earning and needing to spend money on material, coders, marketing and more. This first phase is the ‘bootstrapping’ phase. You cannot raise money on an idea or a business plan. You need a lot more.
Before you quit your day job, develop your business plan, analyse the market, the competition and your future customers. Get out on the street and talk to customers. You can set up a website (for free) and simply state your value proposition and ask page visitors, if they’re interested in what you’re offering, then they should enter their email address and you’ll let them know when you’re live. You can also use this landing page to ask further questions to better understand your customers e.g. what price would you pay? How would you like to receive the product or service? etc.
Once you’re confident your business has a chance of success, and you’ve understood from your customers what they want, you’re ready for your ‘Friends and Family’ funding round. This is when you ask your network for ‘pre-seed’ money. This might be around £50k and it allows you to build a prototype and launch a minimal viable product. This allows you to start testing something ‘real’ with a customer. You can secure pre-orders off a prototype.
After you’ve secured your initial customers, you’re ready for your ‘Seed’ round of funding. This will usually be around £150k but can be as high as £2m. This funding helps you gain traction with your customers and start building revenues.
The next funding round is called ‘Growth’ funding or otherwise known as “Early Stage” or Series A. This financial round enables you to scale. At this stage, you should expect to have a much more formal board and team. You will be raising between £500k-£5m. The range is so large because it depends on the industry. If you are in Lifesciences or Deep Tech, chances are you’ll need a lot more funding than a retail product or service business.
Following Series A, there’s a Series B and C. At Series B, you can build groovy headquarters, make competitors give up and you are growing >£3M. By now you may own <10%. However, you more than likely will have a valuation north of £20M.
Series C is usually the final raise before going public. Your company is valued >£100m. Your company has >100 employees and is operating in more than one country. Angel investors and founders may wish to sell before this stage unless you will be a unicorn.
Finally, Initial Public Offering or IPO. The IPO’s opening stock price is typically set with the help of investment bankers.
At Seed Round you’ll seek funding from ‘Angel Investors’. At Series A and beyond you’ll seek funding from Venture Capitalists. Below explains who they are and the pros and cons of working with them.
Business Angels are high net worth individuals who invest their own money into early stage new ventures. Often experienced entrepreneurs. Often provide advice and make introductions to suppliers, distributors and customers. £20-£250k is usual investment but some ‘super angels’ and angel syndicates may invest far larger amounts (£1m +). There are c.8,000 active angels in the UK.
Venture capitalists are investors who are willing to put forward a large sum of money in exchange for equity in the company, but who only get their money out once the business either is acquired by another company or goes public. VCs are professional investors that are all about the money. They normally look for investments that can provide a 6X return on their investment, so you better be prepared to go big!
EIS and SEIS relief are being considered by a large number of companies at the moment as a way of raising funds but at the same time enabling investors to obtain attractive income tax and capital gains tax reliefs.
A number of cases have been heard before the First tier and Upper Tribunals that demonstrate how easy it is to fall foul of the complex provisions granting these reliefs. Moreover, there have been a number of changes to the legislation in recent years, and more changes have been announced that will have a significant impact on the operation of the relief.
Risk to capital condition
In particular, the Finance Act 2018, which is likely to receive Royal Assent at the end of March contains provisions that are intended to ensure that there is a real risk to capital for investors in EIS and SEIS shares. The purpose of these provisions is to prevent investment in companies whose activities are geared towards the preservation of capital rather than long term growth.
A new s 157A will be inserted into ITA 2007 which sets out the “risk-to-capital condition”, which is met if, having regard to all the circumstances existing at the time of the issue of the shares, it would be reasonable to conclude that (a) the issuing company has objectives to grow and develop its trade in the long-term, and (b) there is a significant risk that there will be a loss of capital of an amount greater than the net investment return. Similar provisions will be introduced for SEIS companies.
The real aim of these new provisions is to prevent EIS or SEIS companies from raising EIS funds where there is a pre-agreed supply and a pre-agreed sale for the goods produced by the company, so that the profit can be measured with reasonable certainty in advance and the risk to capital is remote.
However, in considering the risk to capital condition, it seems clear that once the provisions come into force (a date has to be set by the Treasury after Royal Assent), any company seeking to raise EIS or SEIS funds will need to ensure they have a clear intention to grow the business. This could prejudice a range of companies that could offer EIS/SEIS shares to their investors under current provisions.
For example, an EIS company could be formed to operate a single pub under current provisions. However, once the risk to capital condition comes into force, it would be difficult to demonstrate that the company’s objective is to grow the business. Instead, the company would have to be formed with the aim of developing a chain of pubs. Companies with a single ring-fenced objective may no longer be able to raise EIS/SEIS funds.
Changes to advance assurance
It is possible to seek advance assurance from HMRC that a company is a qualifying company for the purposes of EIS/SEIS purposes. HMRC issued a consultation document in 2016 looking at the future of the advance assurance facility in view of two main concerns. The first of these was a resourcing issue, but the second was a concern that only a minority of applications actually led to shares being issued and that the service was being used speculatively to test how far particular aspects of the EIS/SEIS provisions can be pushed.
As a result, with effect from 2 January 2018 HMRC will not provide an advance assurance on speculative applications. They will provide an opinion only where the application names the persons who are expected to make their investment. This could cause some problems in promoting EIS investment as it is common for an information memorandum (IM) to include confirmation that advance assurance has been obtained, as the IM is used as a tool for identifying potential investors.
However, even where an IM is not required, a company may not be able to make an application for advance assurance until a later stage in the process than they would have done previously. Moreover, although it has always been a requirement that a business plan or similar document is provided to HMRC as part of the advance assurance application, it is likely that more detailed information will be required in order to satisfy HMRC that the application is not speculative.
In order to be able to raise funds under EIS/SEIS companies will need to focus on the content of their business plan to ensure that there is a clear objective in growing the business. This is likely to require projections for increases in turnover, staff numbers, customers, for example. Companies with a static workforce, turnover, customer base, are likely to struggle to satisfy the risk-to-capital provisions.
Where advance assurance is required, investors will need to be lined up in advance of making the application, so that HMRC are satisfied that the application is not speculative.