Funding Options for Early-stage SMEs

By Jon Steinberg, Co-Founder of Mountside Ventures

Starting a business is not for the faint-hearted. As an entrepreneur, you will need plenty of determination, resilience and confidence to build a successful business. One of the most important areas to consider is whether you’d like to create a bootstrapped company; there are many successful examples.  Or whether you will need an injection of external capital to grow your product or service. If you are considering the latter, then keep reading.

We have highlighted below three options you should investigate if you are considering external finance.

Equity funding

We would like to briefly touch upon three primary sources: angels/ HNWs, angel networks, and venture capital.

Angels / HNWs

Virginstartup.org states that angels (syndicated or sole) contribute £850m per annum to UK startups, forming the primary funding source for pre-product and pre-revenue startups. Cheque sizes range from £50-£250k. The capital will be deployed at a quicker rate than institutional funds, given the low diligence hurdles.

Founders tip: to find Angels, you should first look for similar companies to yours that had an exit event and see who their early backers were. Position yourself as their next opportunity!

Angel networks

Angel networks (otherwise known as syndicates) are a group of early-stage investors, structured with a lead who conducts due diligence, heads term negotiations and sits on the board post-investment. The largest syndicates have a typical cheque size of anywhere between £250k-£2m. Industry reports detail that 80% of angels have worked in or founded a business before playing the role of investor, bringing both strategic and financial gain.

Seed VCs

The latest report from Dealroom and London & Partners shows that £7.6B of Venture Capital was raised by London businesses in 2020. After all, despite the uncertainty caused by the global pandemic, 2020 has been an excellent year for the capital’s startups and scaleups.

The main difference between VCs and angels is that VCs invest other people’s money, and angels invest their own. VCs usually require more time, more meetings and have multiple partners are involved in the final decision.

To put it into perspective, around 1500+ decks reach a VCs inbox. Only around 10 to 15 investments will be made that year, so the competition is fierce. Understanding how investors take decisions will greatly benefit you. To attract their money, you have to stand out from the crowd. The only way for investors to de-risk the proposition at the seed stage is to have underwritten conviction in the founding team and confidence in the market potential. Think 10-20x return on their investment, so this needs to fit your ambitions. But first of all, in order to grab an investors attention, you will need to build a flawless pitch-deck.

Debt funding

The majority of pre-seed/seed entrepreneurs will dismiss debt as a viable financing option at an early stage. One thing to remember, though debt, unlike equity, is a non-dilutive type of financing. It can come in many forms:

Regional development

These players bridge the funding gap for local SMEs and are typically backed by government entities like the EIB or British Business Bank.  Micro or debt finance are provided anywhere between £50k and £1m over a 2-5 year period.

Working capital

Working capital is a loan to finance everyday operations (i.e. payroll or rent). This is not to be used to buy long term assets.

Invoice factoring

Invoice factoring companies allow you to release cash from your unpaid invoices quicker rather than waiting between 30 to 90 days for customers to pay you, facilitated by selling an invoice to a third party.

Benefits:

• Extend runway.
• Minimal equity dilution.
• The facility acts as a bridge until the next round of financing (often at a higher valuation).
• Due diligence is short, with providers typically not having a board seat.
• The interest you pay on the loan can be deductible from your tax bill.

Disadvantages:

• Debt must be repaid and with interest.
• A default can lead to drastic lender recourse; where non-conventional assets such as MRR, tax credits, grants, patents or other IP and future equity rounds can be used as collateral.

Founders tip: when a default occurs, let the lender know quickly. This builds trust, providing the lender with more time to propose a solution.

Providers will look for a sticky model (B2B distribution method is often preferred). Similarly, proven founders with substantial ownership positions will be scrutinised.

Revenue-based financing (RBF)

RBF is where capital is provided in exchange for an agreement to pay a fixed percentage of future revenues to the lender until the invested amount, plus a fee, have been repaid. Companies can borrow between £10k and £1m, depending on their last month’s revenue, and may qualify if they:

• Generate digital revenue exceeding £10k per month.
• Show sufficient revenue data (>9 months).
• Show positive unit economics.
• Have a spending plan.

Benefits

• You apply in minutes and receive the funding in days.
• If your revenue slows down, so do your repayments.
• You don’t give any equity or control to external investors, nor are there any personal guarantees.
• There are no hidden payments.

Challenges

• It can be more costly than traditional loans, especially using the “multiple” system (bank debt can be very difficult for startups to obtain, however).
• It adapts better to earlier stages of startups; the total funding available typically doesn’t exceed £1m.

If you would like to learn more about these external sources of finance, then join our Investment Readiness Programme either on 7 September or 20 October. We will be joined by Mountside Ventures, who will cover in-depth the early-stage equity and debt investment process, nuances of investors, pitch decks, financial models, valuation, term sheets and much more.