The common route is equity share or a bank loan and whilst readily available these are not without pitfalls and obstacles.
Our knowledge working with companies, investors and financial groups have given us an insight into the options available for companies, the risk and benefits of each option and not just from a legal perspective but a practical and operational one. This unique position enables us to, without conflict, set out all the options available to our commercial clients, advise them on the selling features of each, package the legal work accordingly and then refer them to the correct financial advisor to progress along their chosen route. The most important thing is a business is armed with all the facts and options and understands what he actually needs and wants before he enters the arena to negotiate for investment.
Options available to a business ready for investment
- Take advantage of relevant tax reliefs, for example – SEIS/EIS where you do offer equity shares, but often the motive for purchasing these are tax benefits for the investor rather than active control of the company. You can set the price, dividend payment schedule, buy back timeframe and under these structures the investor receives 50-30% tax back on the sums encouraging them to invest more. It is advisable to apply to HMRC for advanced assurance to make sure your set up qualifies before you embark on the costs of setting this up. Whilst this may be an attractive option the rules are complex and it is important that you have a trusted accountant on board who is knowledgeable of the rules and updates. There are also restrictions on which companies qualify, the investor and what the money raised can be used for so you may end up disqualifying an investor if you are not careful and up to date. There are also administrative requirements required which may add to the cost of the operation.
- Bank Loan – traditional means of generating money and cash flow for a business, but with rates at an all-time low this is even more attractive than before. Here you give no equity away and the interest repayments are often less than an investor expects, but without doubt you founders will be required to give personal guarantees. Offering guarantees pierces the limited company protection you have so you must make sure you are fully aware of your liability and take advice. Often you are ‘jointly and severally liable’ meaning the bank doesn’t have to recover its money from all directors or in equal shares it can go after all or one of you for the entire debt.
- Corporate Bond – This is debt financing where you are not giving away equity, no personal guarantees are required, but you are offering up your businesses collateral as security. You can create a fixed term bond usually 3-5years where you agree a % payment each period payable to the investor. At the end of the period the capital is repaid or you can offer to convert this to shares or continue for a further period. The benefit is you set the rate and give away no control or share in your business, but you do need to have a repayment plan in place and maintain the interest payments, otherwise the collateral held in security will be sold. The costs of such a vehicle do mean this is something you would embark on where you require over 5 million investment.
- Venture Capital or Angel investments – there are many portfolios of investment groups looking to invest in companies in lieu of a healthy shareholding. The type of investor will depend on your needs as to whether you want an active leader for the company or a silent group of investors with money only. You will need to negotiate terms as these professional investors will want a good return and equity share and you need to understand fully their conditions; what you will get from them in return; and how do you get them out I it doesn’t work or you get an offer to be bought out, as you might not want them blocking this. Often these groups have a designated time period for a return of which you need to be fully aware. Often groups will charge around 7% or more for progressing the investment so you must be aware of these commission sums. We have seen groups charging an ongoing annual sum together with the company having to pay high salaries of incoming executives who are appointed by the groups. This could end up being substantial sums.
- Crowdfunding is a concept that is taking off especially in the technology world. This raises finance through a large number of people investing small amounts, usually through the internet or now developed Apps. It involves three parties, the project owner seeking finance, the platform which acts as an intermediary and the investor. The purpose of the platforms is to match investors and projects together. This means no control is given away over your company, you will have to pay a commission to the platform. One possible downside of equity crowdfunding is that you suddenly may find yourself with a number of minority shareholders all of whom are owed duties by you and your company (or a nominee company operating in a similar way). This is a relatively new concept and yet largely untested. The growth of crowdfunding has taken place in a financial upturn so it is unclear how it will fare in a financial ‘downturn’. The procedures and policies in place for ‘investors’ may not stand the test of litigation should the spotlight be turned on these platforms as it was on the banks during the credit crunch.
- Immigration investment – the current position is that where a foreign national wants to relocate to the UK he can play an active role in developing a UK business for a visa. He must invest £200-250K into a UK company in return for a shareholding and nomination as a director. The company can use the monies for its expansion or product development the conditions, to be met here, include : employment of 2-3 employees over a 3-5 year period ; maintaining payroll records and keeping the investor on as a director for his minimum term for visa requirements. For those wanting permanent leave in the UK quicker they can invest £2-5 Million into a qualifying investment which a corporate bond for a non-property related business can qualify.
What should you be asking yourself before seeking investment?
Firstly, you and your founders must decide on whether you are prepared to give away equity in your company for investment and if so how much control are you willing to transfer. What level of control do you need to retain to be able to operate your business on a day-to-day basis? Loss of control in your business is one of the biggest disadvantages involved in selling equity stakes. There are situations where the founders of a business who invested years of their life into the company, are voted out of the company by investors or driven out due to change. Be careful to consider how involved you wish to remain and if it is of concern look at non-equity investment options.
You must value your business now and what you predict it to be worth before making any decisions on the level of equity/price you are willing to accept. To do this properly can be an expensive and time-consuming exercise. There are a multitude of ways to value a business. An investor is always going to go with the one which sets the figures at the lowest possible amount.
The decision on the type of investment vehicle you choose will be assisted if you agree now, with your co-founders, on whether the objective is to grow and manage the business or package this for a imminent sale because a longer-term aim is a completely different process to a short-term build and sell objective. Ultimately investors want to know how they will get a return on their investment, make it clear within your business plan what your exit strategy is
You must understand the investors or agent’s terms and objectives as often we have found agreements containing clauses that permits them to remove founders, block sales, prevent daily decisions of a certain nature without their involvement, install expensive executives with a salary determined by them, insist on changing trusted advisors, periods of exclusivity (minimising your ability to negotiate), trade arrangements or offering discounted services to them.
How do you secure this investment?
You need to have your house in order.
- Accounts: a. An investor will want to see clear and maintained accounts, that the shareholdings are correctly registered at company’s house and you are up to date with filings, tax returns and all financial mechanisms;
- Legal documents & registrations: need to be in place and more importantly up to date and relevant. A Co-founders agreement must be in place for the protection of the business. It must adequately and concisely address all relevant issues so that an investor trusts the business is secure. All the business IP must be protected adequately and assigned fully to the business as this will be an asset the investor will want to benefit from. There must be adequate contracts in place with suppliers, customers and employees so the investor knows you are a serious business and that it’s less likely any unexpected disputes can arise or that they cannot be resolved. Any commercial property must be correctly documented. Any regulatory requirements or registrations must be in place.
- Insurance – the investor will want to make sure all cover is adequate and in place be it employee liability, professional indemnity or building contents insurance.
- Polices – depending on your business certain legalities are necessary such as Data Protection policies, Cyber Protection if in the advanced technology sector, employment/contractors policies specific to IP assignment.
You need a credible business plan
Investors are put off by long technical documents; they want to know what your product/service is , how its performing and how it is to be marketed; Investors want to know see that they will generate a return & that you have a risk management strategy. You will need to prove your business is compliant with all legal and accounting requirements so ensure financial controls are in place.
You need to be prepared
Be confident in your proposal , understand your business so you can address all the questions adequately, be clear on what it is you want and your objectives, as it’s as important the investor aligns with this as much as you fulfil his objectives. Anticipate what they are likely to ask and think about certain scenarios. Make sure their potential questions will not expose flaws in your business strategy.
You need to understand your market
Make sure you can demonstrate a knowledge of the market that your product/service is in and concisely communicate this to your investors. Investors will be holding confidence in you that you know your competitors and will want to know how you will respond to competition to put your business ahead.
You need to be informed
Understand all the options available to you so you are not forced down a route you didn’t mean to go, take time out for adequate advice and do not be afraid to ask questions, take calculated risks, but negotiate for your needs.
The Lupton Fawcett LLP Corporate Team have a wealth of experience acting for borrowers, lenders and investors across the full spectrum of finance transactions. Please contact Neil Large (Corporate Partner) or a member of the Corporate Team for further information relating to the points raised in this article.