So, your company is up and running, what one thing will it need to survive? Money.
The ultimate aim is to use profits from the on-going business to fund growth, investment into research and development, and/or to ensure the company is an equal amongst its competitors. However, in the early years a company will often need to raise external funding, or capital, to accelerate its journey.
Common sources of funding available to a company are:
Each source of funding has its own story, so we have set out a brief overview below for funding source options:
Assistance from a public body
To ask for funding you need to understand what is available to you. Central or local government, and other organisations controlled by a public body may be able to offer forms of assistance to your company such as grants, loans and guarantees.
Your company can use the grant to move the business forward, without having to worry about how you’ll repay the money in the future. Grants are an ideal form of funding because they do not need to be repaid. In addition, grantors do not require you to give up any ownership of your company (this means they are non-dilutive). Grantors normally require a degree of audit and reporting to ensure the monies are being used for the purpose the grant has been made.
There are several different types of grants for small businesses and start-ups. All of these grants require a lengthy application process and are usually meant to support a specific project or business milestone. Some may require you to secure matched funding from another source.
Loans and convertible loan notes
Another way to raise money for the company is through a loan. The loan instrument will set out how long the company can borrow the loan for, how much interest will accrue on the debt, whether the loan is to be secured against the company’s property and under which circumstances it is repayable. Some investors will advance monies via an instrument called a convertible loan note. A loan note is a type of loan that provides when certain triggers have been met, the entity or person who has lent the money to the company can have the money converted into shares in the company (often for a discount to the price paid per share by future investors).
Triggers will often include future financing at a given valuation (a ‘qualifying’ financing) or an exit event. In the event that the triggers aren’t met, the noteholder will have an option to convert to equity otherwise the loan will be repayable (sometimes with a redemption penalty). Convertible loan notes are typically used as alternatives to equity fundraising by growth companies as a bridge to get them to their next equity round or valuation inflexion point.
Advanced subscription agreements
An investor can agree to make an advance payment of subscription monies for shares in a company. These shares will be issued at some point in the future, on a “qualifying financing”, sale or liquidation as with convertible notes, or on a long-stop date. An advanced subscription agreement is not a debt; it does not generate interest, and it can never become repayable in cash. In order to qualify for the Seed Enterprise Investment Scheme or the Enterprise Investment Scheme (SEIS), shares need to be issued under the agreement within 6 months.
EIS/SEIS considerations
The choice between a convertible loan note or an advanced subscription agreement is often dictated by tax considerations such as the Seed Enterprise Investment Scheme (SEIS) or the Enterprise Investment Scheme (EIS). Put (extremely) briefly, these are government schemes that provide a range of tax reliefs (like income and capital gains tax) for investors who subscribe for qualifying shares in qualifying companies. Loan notes do not qualify for this relief whereas advanced subscription agreements do in certain circumstances.
SAFEs
Simple Agreements for Future Equity (SAFEs) are a relatively recent addition to the seed financing toolkit. SAFEs have the same conversion features, but lack the debt hallmarks of convertible notes (there is no maturity date and no interest). They are more akin to an advanced subscription agreement. The holders of SAFEs are able to convert their SAFEs into equity at a lower price than the investors in the subsequent financing round (based either on the discount or valuation cap in their SAFEs, or both).
Equity
The most popular option for raising capital is through investment for equity. An investor will give money to a company in exchange for new shares. By accepting the investment amount, the shareholders of the company have their ownership percentages diluted. The principal terms of an investment will be captured in a term sheet. Depending on the size of the investment, an investor may be afforded certain rights including information rights, representation on the board and participation (or indeed veto) on certain decisions or actions proposed by the company.
The future of fundraising
With the advancement of blockchain technology and tokenisation, there is a possibility that the tokenisation of securities such as shares may be used in the future for fundraisings. The company would issue security tokens containing certain rights such as the rights that are afforded to a shareholder when they hold a share in your company. Depending on the nature of the security token being issued, it may or may not fall within the current framework for being regulated or un-regulated.
At their core, tokens are digital securities on a blockchain infrastructure, however, at this current point in time it is yet to be seen if the uptake on this form of fundraising in the UK is going to be taken up on a mass scale.
For more information about funding sources or for legal support with funding rounds, contact Mishcon de Reya's Emerging Companies and Venture Capital team.