How to decide what type of investment is right for your tech startup
Salvatore Minetti, CEO and founder, Prospex.ai on how to decide what type of funding is best for your tech business.
The UK has established itself as one of the best countries in the world to start and grow a business. In fact, between 2012 and 2017 approximately 3.5 million new companies were founded across Britain.
There are several reasons for this boom in entrepreneurialism, but financial support has proven demonstrably important. Specifically, a combination of private sector investment coupled with public sector initiatives have helped nurture an environment where early stage businesses can secure vital capital to enable them to grow.
Entrepreneurs in the UK are fortunate to have a plethora of places to turn when looking to secure finance for their fledgling company. Yet despite all these options – or perhaps because of the vast number of choices now available – the task of raising investment can be daunting for a startup.
So how does a management team decide which type of investment is right for their business? And how do they calculate the amount of money they need?
Deciding on the right type of investment
Fundamental to the question of what type of investment is right for a particular company is the choice between equity and debt investment.
Debt investment comes in the form of loans, which are repaid with interest over time. Such finance is typically suited to more mature businesses with a healthy turnover that enables them to repay the upfront investment made by the individual, group or company with a relatively low risk.
Meanwhile, equity investment involves selling a stake in the startup to investors – and these investors come in many shapes and sizes, from high-net-worths (HNWs) and investors on crowdfunding platforms through to the seasoned angels and VCs investors, not to mention family offices and private equity firms.
The appeal of debt investment is that it enables an entrepreneur to raise finance without watering down the proportion of the business they own. However, as stated above, it is usually not possible for early stage companies lacking in stable, sizeable revenues.
Furthermore, it is important that tech startup founders do not overlook the additional benefits that come with equity investment. Firstly, individuals or groups who buy a stake in your business will also be far more forthcoming – whether through a formal or informal arrangement – with mentorship and advice.
Another major benefit is that it enables the entrepreneur to build a loyal base of followers. For example, for companies that secure investment through equity crowdfunding campaigns, the investors that back the funding round – and ideally their wider networks of contacts – will become loyal supporters of your brand and, where applicable, users of your product. Such backing can prove vital in the early stages of growing a business.
Ultimately, entrepreneurs should always assess what they need beyond the investment itself to assess the right type of finance for them. This will also help steer them towards the appropriate sources to approach.
Take advantage of government-backed schemes
At the start of the article I briefly mentioned the importance of public sector initiatives in aiding investment into UK startups. Specifically, this was in reference to the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS).
Introduced in 1993, the EIS initiatives channelled £1.8bn worth of investment into 3,470 UK SMEs in 2016-17, with investors receiving tax breaks in return for backing scaling companies. And while the schemes are under regular review from Westminster, their role in encouraging private investment into early stage businesses cannot be underestimated.
Entrepreneurs must ensure they are fully educated as to the benefits of SEIS and EIS, as well as the regulations governing investments through these schemes.
Only raising the right amount
One final important question is still to be addressed: how does a business decide exactly how much it should be looking to raise?
It has become an increasingly pertinent point over recent years; amidst a seemingly never-ending stream of news stories about multi-million pound funding rounds for UK startups, it can be easy for entrepreneurs to assume they must secure massive investments for their business to be taken seriously. But such an approach can often be foolhardy.
Simply put, a startup should only ever look to raise as much as it needs; entrepreneurs must have a clear roadmap of what the business is looking to achieve by particular time periods and then, as best they can, establish how much external investment is required to enable the startup to reach its targets.
Importantly, founders will naturally want to keep hold as large a stake in their company as possible. Looking to secure too much too soon – when the business’ valuation will invariably be at its lowest – is an easy way for an entrepreneur to give away a significant slice of what they have worked so hard to create.
Ultimately, while the UK’s early-stage tech businesses are fortunate to have such a varied number of options available to them when it comes to raising money, the need for careful due diligence is in no way diminished.
CEOs and founders must be precise in understanding where the business is going and what level of support – financial or otherwise – they need to get there; this will go a long way to ensuring they choose the right amount to raise and the right method of raising it.
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