Entrepreneurs – 6 things to know about your first funding round
For many entrepreneurs completing their first round of funding is a well earned validation of the time and energy they have to put into their venture.
As investors and founders both know, however, such a round is hopefully only a preliminary step on the company’s journey. Getting the first round right can ensure a long and fruitful upward trajectory for the business, but there are some pitfalls to avoid. Here are six things entrepreneurs should bear in mind.
1. You should probably start looking for funding earlier than you think
While the adage “raise cash when you don’t you need it” has become a bit of a cliché, it does reflect the fact that it can take a while to find funders and actually get cash through the door. You do not want to be trying to raise investment when you are too close to the end of your cash runway. If it is your first time raising external investment, you could well be looking at a six month process.
2. Make sure you don’t breach financial promotion rules
One thing that often gets overlooked by entrepreneurs is that, as a general rule, it is illegal in the UK to make financial promotions to the public. There are lots of exceptions to this rule, but there are normally a few hoops you have to jump through first (hence the disclaimers you so often see on decks). Your solicitor should be able to guide you through what you need to do depending on who you are raising funding from.
3. Don’t forget SEIS / EIS
SEIS and EIS are two government investment schemes that all UK founders should be aware of. They are remarkably generous, especially SEIS (which is designed specifically for seed investment). The schemes work by giving investors tax reliefs in relation to the money they invest with you, provided various conditions are met.
Before you go out to get investment you should ensure you know whether any amounts invested would qualify for the reliefs. This is something you can ask your advisors to help with, but the gov.uk website has a useful summary: https://www.gov.uk/topic/business-tax/investment-schemes.
4. It’s not all about the money (1) – find the right investors
There is a temptation to accept the first offer that comes along – after all you don’t know if there will be a second. However at this stage in a company’s lifecycle investors are more than just providers of cash. Consider (i) what the investors provide in terms of credibility, expertise and contacts and ii) what they would be like to work with. You might consider asking to talk to the founders of other companies they have invested in to help with this.
5. It’s not all about the money (2) – don’t ignore the other bits of the term sheet
Once you have investors lined up the next step is normally the parties signing ‘heads of terms’. These set out the key commercial terms of the investment ahead of the detailed investment documents being negotiated and entered into.
Near the top of a term sheet will the economic terms (i.e. how much cash is being invested and the shares the investors will get in return). These are clearly very important, but the rest of the term sheet is not just boilerplate.
In particular, a lot of the other terms will be control provisions, e.g. whether the investor will be entitled to appoint a director to the board of the company, whether they be able to veto certain decisions, what rights will they have in future funding rounds, and whether there be vesting provisions in relation to your shares. These will make a real difference to your business and should not be ignored.
Most of the terms are not legally binding, but generally it’s pretty difficult to go back on the provisions on the heads of terms without seriously annoying your investors. It is therefore making sure (i) you ask your advisors whether what you are signing up to are market-standard for your type of deal (ii) you are happy with the level of control you are giving up.
6. Keep it simple
We realise there is some irony in lawyers telling anyone to keep things simple. However we often see start-ups make things too complicated when they raise money from non-institutional investors in particular.
For instance, there is little point creating complex shareholder agreements or share classes if you are planning to another round of funding anytime soon – most institutional investors will insist these arrangements are replaced when they come in any event.
You should also try to keep your shareholder base as small as possible. It is remarkable how much stress shareholders with very small shareholdings can cause founders. Even if they leave you to run the company in peace, the need to consult them and get them to sign transaction documents can be painful when you are raising your next round.
Every negotiation and every entrepreneur is different. There are always unexpected hurdles to securing investment and a cookie-cutter approach, although tempting, normally does not work.
Boodle Hatfield is fortunate to act for successful entrepreneurs, investors and high-net-worth individuals and families. We are well placed not only to advise on the nitty gritty of the legal terms, but guide you through the fundraise process. Please get in touch if you have any questions about securing investment.