The Essential Guide to Earlier Stage Corporate Finance

First Edition

The Essential Guide to Earlier Stage Corporate Finance

By Malcolm Evans

This guide is an introduction to the main issues and concepts of earlier stage corporate finance. It is a baseline of essential knowledge for business builders and their advisors.

This information can save potential funding seekers (and potential funders) a great deal of frustration. The intention is to share insights which are not easily available elsewhere.

In our experience, a lot of currently available advice tends to suffer from:

A failure to appreciate that the funding environment, like most areas, is influenced by fashion and fads, as well as by rational decision making.

A lack of understanding regarding which funding options are more available than others to various projects.

A failure to insist that projects thoroughly test themselves against demanding funding criteria.

A lack of appreciation that investment capital will naturally seek to mitigate risk and maximise returns and that these objectives need to be recognised and accommodated within constructive and frank discussions.

In addition, there is currently a widespread tendency within enterprise support to create:

An artificial and unhelpful gap in the business planning process - by developing plans with little attention to capital and cashflow issues and only later seeking to graft on haphazard and emergent financial perspectives.

As with all information provided by Funding Enterprise, this guide will be subject to updates and revisions as required.

Our guides are intended to develop understanding and capability in the workings of corporate finance. They are not intended to provide information on individual funding sources: the latter information will develop incrementally on our websites and will also form part of our seminar activities.

Malcolm Evans, February 2011. www.corporatefinancenorthwest.org [email protected]

Funding Enterprise “Freeing-up Capital to Grow Great Businesses”

This guide covers:

Funding Categories: 4setting the funding context via our Funding Enterprise Framework.

Funding Drivers: 12examining the main motivations for seeking funding, which in many cases are insufficiently considered and, in others, quite surprising.

Funding Options: 15the “unwritten rules” of what may be suitable and available – not just another reprinted list of various agencies/organisations.

Funding Valuations & Ethics: 30an outline framework for assessing valuations and setting appropriate value creation goals.

So you want to start a business, or to scale something you already have going?

Contents3

1. SOCIAL AND ECONOMIC CONTEXTAs soon you start to engage actively in a funding search, you may find that you are put into

a definitional box. It is important that you understand the trends and processes that will,

to varying degrees, shape your search.

Many younger businesses these days have, or will have, some engagement with the

enterprise support sector.

This might include the various mentoring schemes, early stage grants of various types,

spin-offs from college/university studies and research, work re-entry schemes,

apprenticeships, networking groups (physical and online), funding networks, funding

events, European Regional Development Fund/university-delivered seminars, incubator

membership, or inputs through “high priority” or other localised support schemes.

You may not be connected with any such activities and you may enjoy a combination

of such an exceptional idea, talent, fast cash generation and pure luck to expand straight

through to larger and mature funding environments (or even to avoid all outside

investment).

However, lots of earlier stage organisations do have some of the above connections and,

whether they do or not, currently in-vogue business categories and development models

affect both the availability of funding and to various degrees the plans and self-projection

of individual projects and businesses.

This is particularly the case when a significant proportion of available funding, both by way

of loan and equity, is delivered through European/government-sponsored sources.

Funding Categories

This section covers two areas. Firstly, we describe the current political and economic context of enterprise funding, which in various ways will influence and affect the majority of funding quests.

Secondly, we introduce the Funding Enterprise Framework, so that individual projects and businesses can obtain a clear sense of where they sit within the matrix of funding possibilities.

4 Funding Categories

2. THE ENTERPRISE SUPPORT SECTOR NEEDS YOU TO BE BIGA fashion over the last few years has been to squeeze the majority of earlier stage

activity into the “entrepreneur” camp. This mentality might assume that a neighbourhood

nail bar both requires and is serviced by the same support network as a biotech R&D

genetics project with worldwide implications. Such an approach may also just as likely

lead to the downplaying of smaller and traditional activities, as they display limited

“entrepreneurship”, whatever of their employment and contribution possibilities.

At Funding Enterprise we make no judgements about the worthiness of any particular

business (as long as they are sustainable, decent and legal) but we are concerned about

some of the assumptions currently being made from within academia and the enterprise

support sector, which in turn filter through into government policy.

A recent development beyond the “entrepreneur” fad is the growing currency of

“high growth”. This is directly intended as a winner picking strategy.

Whilst well-intentioned in its core objective to hothouse potential excellence, it tends

to be stretched far too far by agencies and training providers seeking to maximise their

impact (and, in the case of the commercial trainers, their revenue).

Politicians, national and local, understandably latch on to entrepreneur and high growth

discourses as they deliver hope of recovery during sketchy economic times.

But all of this can generate a you-must-be-big-quick-fits-all mentality.

However, there is nothing wrong with individuals seeking to establish a self-employed living

either by themselves, or within small clusters of like-minded individuals. Indeed, these are

things to be actively encouraged, albeit with a robust sense of realism over expectations

of scalability.

Such activities might include anything from a family chip shop to a local book keeping

practice. Neighbourhood businesses like these are one of the mainstays of a prosperous

economy and vital providers of localised employment.

And the “high growth” rhetoric can easily be over-used. We have seen many instances

where advisors have encouraged the excessive upscaling of intentions and potential,

leaving the promoters of modest but sustainable enterprises both confused and exposed.

We are quite explicit that Funding Enterprise is primarily concerned with scalable

businesses which can develop some substantial value (although we also research

and campaign on issues applicable to all earlier stage business).


However, we are also very clear that we neither disregard the contribution of more

specifically lifestyle businesses, nor do we attempt to somehow “rescue” lifestyle

businesses from themselves by injecting them with high growth magic (if such a thing

is possible). Nor are we business sector snobs.

An over-emphasis on as fast growth as possible also carries risks for the projects which

genuinely possess the potential to scale to considerable size. All the talk around relentless

growth and rapid success can lead to an under-focus on business fundamentals and over

optimism in the ease and pace of development.

The chief funding implication is that cash requirements can be largely overlooked,

or hopelessly under-estimated, both in quantum (the size of an individual investment,

as opposed to valuation, which is the agreed total value of a business) and timescales.

The key lessons from this overview of the prevailing social & economic context are:

• Resist the pressures to be forced into projecting growth patterns and strategies which

may seem inappropriate to your own project.

• Be exceptionally clear-headed about realistic resource requirements and timescales

of potential growth.

• Remember that many third parties have a vested agenda in your project. This can be

anything from fee generation to political ideology: your own focus must remain the

viability of value creation within your ideas, plans and resources.

An important lesson is that there is a grave danger that the unsung heroes of economic

stability – sustainable local businesses – may be overlooked in favour of the high growth

obsession. Worse still, restricted bank funding may quietly kill off many of them.

3. BUTCHER, BAKER, WEBSITE DESIGNERAt the opposite end from the fad and fashion end of the business category spectrum,

there is traditional business sector labelling based on business activity, e.g. butcher, baker,

website designer, grocery retailer, widget manufacturer, software services, software

application developer etc.

Although accurate and usefully descriptive, this task-labelling is not by itself of huge direct

use to funding principles (for example, “grocery retailer” might range from a single corner

shop through to a major multinational superstore chain).

Whilst enterprise support activity talks up potential through the language of

entrepreneurship and high growth, traditional economic data gathering uses terminology

descriptive of business process. This can be highly informative to policy in such areas as


skills and training but it is too detached for our main purposes from the fundamentals of

value creation.

In summary of this discussion of business categorisation so far:

• Funding seekers and funding providers need to be able to meet within a common

language of how investment and activity can create fresh value.

• All parties need to avoid fashionable jargon which under-estimates the slog and the

cash demands of bringing to life even the most promising of business plans.

We have thus developed:

4. FUNDING ENTERPRISE FRAMEWORKIn the context of this Essential Guide to Earlier Stage Corporate Finance,

“Earlier Stage” spans:

• Fully formed and detailed plans to launch and develop a business.

• Businesses already with some activity and substance which may be coming out of

their planning phase with encouraging early results, or which might already have built

up an early trading record.

There is a clear difference between service businesses which can sometimes create

at least some activity on limited funds (and, indeed, in some cases scale through to

maturity on modest funding) and projects which demand significant investment before they

can achieve any trade.

The latter would include a sophisticated IT outsourcing operation requiring varied and

substantial specialist labour expertise and, obviously, any form of manufacturing which

requires significant plant.

Such projects as these, pre-funding, can only research, test and plan in as much detail as

possible – they cannot realistically be expected to move beyond market research without

the investment to enable commencement of any meaningful trade.

“Bootstrapping” is a term much in vogue at the moment. It refers specifically to leveraging

ongoing growth from resources as they are generated within young companies. In a slightly

more generalised sense it means making a little go a long way.

Whilst there is much to be said for establishing a business on leanness and for seeking

early breakeven and profitability, there is also a widespread under-appreciation of how


nearly all businesses require some funding, even if only for the raw essentials of travel,

sustenance and communication.

This resourcing short-sightedness is matched by an ongoing over-optimism regarding

the sheer time and effort it takes to gain marketplace traction with all but the most brilliantly

persuasive of offerings.

Much of the “mass market” earlier stage business support in the last few years has fallen

within the general mentoring and/or marketing areas. This has been driven by the huge

numbers of government advisors (a function now being moved from employed positions

to voluntary mentors), private sector providers and the universities. Higher Education

Institutions have realised that they can generate substantial supplementary funding to

support payroll and research activities by entering the business advisory market.

Whilst the topics of support in themselves are important (without passing quality

judgements on the merits of individual support providers), much business advice has

become divorced from the realities of funding and the drivers of sustainability and profit.

The fact that much business growth relies on the marriage of compelling activity with

profitable investment is the primary focus of Funding Enterprise.

Beyond our category of Earlier Stage Funding is Development & Mid-Stage Funding – and

this area will be will be the subject of a separate Funding Enterprise guide.

We have developed and use our own typology for enterprise funding, which offers a

logical framework for considering financing needs and financing opportunities.

It is something which works in a practical way, both to help keep track of funding

possibilities and also to assist funding seekers in analysing the realities and potential

of their own organisations. Whilst the Funding Enterprise Framework takes into account

all business stages, our primary focus within the Funding Enterprise organisation is on

younger and developing companies – the SME heartlands.

Here are the Funding Sectors, Funding Scales and the Funding Stages of the

Funding Enterprise Framework:


Funding Sectors:We identify five Funding Sectors (it is quite likely that a business might move and expand

across Funding Sectors during its lifetime). The definitions of all components of the

Funding Enterprise Framework are developed in such a way as to highlight commonly

occurring features of the funding process (whilst accepting that individual projects always

also contain a certain degree of uniqueness). These are the Funding Sectors:

Fixed RetailOnline RetailConsultancy Manufacture Low-ResourceManufacture High-Resource

And these can be sub-divided into Funding Scales as:

Fixed Retail ScalesA: e.g. local, general pet store

B: e.g. national chain of themed coffee

and sandwich shops

C: e.g international chain of branded

youth fashion outlets

Online Retail ScalesA: e.g. watercolour painting consumables

supplier

B: e.g. national property rental tenant

finder

C: e.g. international discount book and

music provider

Consultancy ScalesA: e.g. local book keeping service

B: e.g. national employment legislation

compliance and HR outsourcing

C: e.g. sophisticated major corporation

IT systems integrator

Manufacture Low-Resource ScalesA: e.g. wedding cakes and muffins

to local outlets

B: e.g. branded snackfoods for garage

forecourt and convenience stores

C: e.g. collectible soft toys

Manufacture High-Resource ScalesA: e.g. niche components for UK

defence industry

B: e.g. components for European

aerospace industry

C: e.g. surface coating technology for

textiles, paper and packaging

manufacturing worldwide

The three Scales (A, B & C)

can be generalised as:

A: Of localised, or highly specialised

intent, likely to sustain a smaller

operation.

B: Of larger regional or national scale,

or specialist export markets.

C: Substantial operations with the

capability of significant national

marketplace share and/or successful

export growth.


Whilst, as we have said, it is possible that a business may develop across all three stages

over time, from a funding point of view it is also quite possible that a business may have

the intent to begin at stage C. It takes talented – and, usually, sector-experienced

promoters – to deliver on such ambitious plans and they will require sophisticated

and committed funders.

Following on from the five Funding Sectors and the three Funding Scales, we identify five

Funding Stages, three of which are of primary interest to Funding Enterprise and two of

which are of secondary interest.

Five Funding Stages:PlanningProving Transitioning Sustaining Struggling

We have divided projects and businesses into these Funding Stages as they bring added

clarity to the financial and value creation dynamics directly linked to possible corporate

finance activities.

These Funding Stages run consistantly across the various Funding Sectors and Funding

Scales as follows:

Planning: detailed information is in place concerning the service/product. This includes

a competitive route to a quantified market, the experience and competencies of the key

promoters and the investment requirements, coupled with indications of potential value

generation.

Proving: business has commenced at a level beyond market research and there is harder

data available regarding marketplace receptivity and service/product delivery. The best

Proving is building up an early track record of sustained growth.

Transitioning: substantial change is being planned, which might include extra offerings,

new marketplaces, an acquisition of a complementary operation, or the exploitation of an

emergent opportunity which is a substantial change of direction. Transitioning can come

about at any stage between detailed Planning (which can throw up alternative

opportunities) and the earlier stages of Struggling (in the guise, possibly, of a radical

restructuring around a reduced and rebuilt subset of the organisation’s overall activities).

In terms of earlier stage funding, Transitioning is usually towards the later end of the reach

of this particular funding guide.

Sustaining: the business is continuing much along its historical and established lines.

Struggling: the business is under major and imminent threat through factors such as

declining sales, or declining profitability.

Again, all of the five Funding Sectors, at whichever Funding Scale, may be at any one

of the five Funding Stages.


We are primarily concerned with the Funding Stages of Planning, Proving & Transitioning.

The main corporate finance activity within recently founded and younger SMEs at these

Stages is driven by investment via equity (and through a degree of debt).

The chief corporate finance contexts of the other two Funding Stages are:• Sustaining organisations are most likely to participate in sales of themselves,

or acquisitions of others. The funding of such activity is not our first concern:

the Sustaining stage is chiefly focussed on the valuation of existing assets,

not on the creation of fresh value, which is the main focus of Funding Enterprise.

• Struggling companies are likely to be subject to emergency debt refinancing,

discounted cash calls, radical restructures, sales, or various insolvency measures,

from administration through to receivership. These are specialist and frequently

legalistic practices and not part of mainstream, growth-facing SME corporate finance.

The Funding Enterprise Framework seeks to move away, as far as is possible, from fashion

and from embedded assumptions. We aim to concentrate on potential value creation and

funding requirements within the clearly assessable potential of an individual project, at a

particular time in its development cycle.

In this way, the project promoters are required to discount blind hope and unsubstantiated

claimsmaking, and potential funders may more quickly access the keynotes and the

realism of the proposal.

There will always be an element of disproportionate fashion: the early 90s saw a

widespread obsession with new web retailers seeking to displace long-established retail

chains; the later 90s saw huge interest in anything innovative within cellular; the start of

the Noughties saw a resurgence of interest in eaterie chains and other fixed retail

propositions; the last few years have seen a refocus on innovative models for the

distribution of mass market financial services and property services.

• The framework of Funding Sectors focuses attention on general marketplace issues

and also on specific opportunities within these markets. The starting assumption

is that there may well be major opportunities in any Funding Sector – and, equally,

all carry pitfalls for the unwary.

• The framework of Funding Scales captures the reach and realistic ambition of the

project or business, discounting blind hope and hype, yet is also capable of matching

the grounded ambitions of outstanding plans and promoters.

• The framework of Funding Stages allows a quick, indicative mapping of corporate

potential to possible corporate finance activity – and delivers a basic check that

a funding quest has a realistic relationship with the typical development cycle.

• The framework of Funding Valuation Quotient, which we detail later, indicates

the commitment and confidence represented in any funding package.

And beyond the role of these typologies, we will return the discussion again and again

to two basic and linked questions:

• Does this plan for value creation ring true and make sense?

• Are these the right people, given the right backing, to deliver on this plan?

We deal next with the motivation for seeking investment.


12

Funding Drivers

FAILURE: many very young start-up enterprises fail to generate an initial viable idea,

or as earlier stage businesses fail to sustain an initially hopeful idea. It is then that many

claim that they require money. The inherent failure spawns a series of “what if” scenarios

revolving around possibilities with funding. These exist more in blind hope than any

coherent business plan. This may sound harsh – but the reality is that advisors and funders

see more of these kind of funding seekers than any other single category of applicant.

This situation has been exacerbated by a public, private and academic enterprise support

sector whose own interests have not to date been best served by the simple honesty of

saying “No, I don’t think that will work”, or by pay-to-join funding locator services whose

modus operandi owes everything to membership fees and very little to even cursory due

diligence.

FASHION: for many business founders and business owners, seeking and securing

funding has become an expected rite of passage. The glamour and glitz of reality TV

shows based around business has made heroes of those who secure funding and

pantomime villains of those with whom they do battle. Some fashion-driven funding

seekers may fit equally within the FAILURE category. However, there are also many earlier

stage enterprises with reasonable promise which seek funding for no clarified reason other

than they feel they should. A related motivator is:

VALIDATION: for some, obtaining funding can become a psychologically important

component in the business growth mix, beyond any strongly identified necessity for

external investment at that particular time.

SET-UP: the reality, as we have already stated, is that businesses generally take more

money to establish solidly than is often acknowledged. Indeed, the enterprise support

sector is largely silent on this point, as small scale seed capital, outside of special

socio-demographic initiatives, is not generally available.

This is not an argument that the State should be in the business of wholesale enterprise

micro-capitalisation (though a strong case can be made for this, within the bounds

of European competition legislation) but it is a reality which sits in contrast to the clamour

for maximum enterprise stimulation. It is often difficult for even 100% services operations

to generate market traction from zero initial funds. It is also the period of no income

between quitting other employment and establishing replacement income that frequently

constitutes a very real and disabling invisible funding gap.

In our experience there are a number of key reasons why business founders and earlier stage owners seek funding. They are frequently not as clearly tied to an explicit and justifiable business case as one might expect:

13

At the other end of the spectrum are technically IP-rich operations for which trading is

impossible without significant resources. Today, most such operations tend to be spun-out

from, or otherwise connected to, various technology-specialist universities, or dedicated

innovation campuses, with the objective to share as much central resource as possible

in the earliest stages. Such institutions tend to feature their own IP-retaining policies and

often feature longer term relationships with specific venture capitalists. Whether these UK

models approximate in practice the hothousing capability of comparable U.S. campuses is

a matter for ongoing research and debate.

DEVELOPMENT & REFINEMENT: in a traditional manufacturing environment, this stage

is known as research and development. R&D assumes that evolving a commercially viable

product beyond the earliest set-up phase requires a series of experiments, reworks and

ongoing tests.

Advisors to the service sector have often been unrealistic in not sufficiently realising that

services also require a period in which creating, testing, establishing and scaling a strong

offering will take hard cash as well as great effort. Whilst in technology environments it goes

down as R&D – within service companies this period is often simply seen as mistakes.

This demanding phase in many companies’ evolution requires that the business be grown

alongside attempting to locate a sweet spot of profitability, robust offering, marketplace

uniqueness, and sustainability.

Provision is often made for this process within sophisticated and complex technology

projects by calculating the burn rate – the expected cash attrition along the road towards

breakeven and self-sustaining trade.

Businesses which have made no such provision, or have been over-optimistic, can be left

burned out, without the resources to prove or disprove their fundamental viability.

CASHFLOW GAP: The most pressing cashflow issues tend to affect businesses which

must pay promptly for the resources necessary to make sales to customers who pay more

slowly. An example might be an earlier stage food manufacturer which has secured

contracts with some larger supermarkets. Its own suppliers may demand strict

adherence to 30 days payment, whilst the new customers might expect several

months – and then only with all manner of unforeseen charges, rebates, discounts

and other strategies designed to reduce overall payment.

Even services companies, particularly those which have recently staffed-up to match

growing sales, may experience grave pressure between meeting their own costs and

clawing in cash due.

The traditional route of seeking bank overdraft funding (or loans) is far less available

post-Credit Crunch and, in any case, was often a far from ideal way of funding early

growth.

OPPORTUNITY EXPLOITATION: organic growth is one route to value creation and it has

the attraction of founder-maintained ownership. The UK, however, is generally (and this is

a very broad generalisation) different to the U.S., which more readily embraces the view

that enhanced, investment-fuelled growth is a preferable (and safer) route to maximum

value creation, even when factoring in the ownership dilution entailed.

Funding Drivers

14 Funding Drivers

Opportunity Exploitation via investment covers intentions such as the broad ambition

of securing first mover advantage, through to fulfilling individual contracts which are

provisionally booked subject to the necessary resources being available. It can be about

accelerating market share, or geographical expansion, or absorbing smaller and

complementary organisations. There is a very thin line in earlier stage operations between

the funding of the pursuit of genuine opportunity exploitation and the risk of masking

a forever unobtainable sustainability and profitability.

There is one universal rule which must always be respected: good money will not make a bad business good.

15

Funding Options

1. Key components of the earlier stage funding mixSWEAT EQUITY – refers to working without returns within your project. Whilst it can

be painful for the business builder, it doesn’t actually impress would-be funders as much

as you might hope. Few commercial equity funders are going to factor it in seriously,

so don’t overplay it. Sweat Equity is more a universal reality of the start-up landscape than

a particular highlight of any specific funding equation.

SAVINGS – very useful: it can often be astonishing what are the exponential success

possibilities opened up by having some real money – even quite modest amounts - at the

absolute start. Even if trade proper due to resourcing needs cannot begin before substantial

fund raising, a little cash reserve gives promoters some space to explore their options.

FAMILY & FRIENDS – often referred to as a Family & Friends Round, whereby a close

grouping of people stump up what is frequently the highest risk capital of all. It can be great

if you can acquire this absolutely first stage investment. Numerous successful businesses,

particularly those which absolutely require some hard assets, owe their existence to this

kind of funding. It is also a great leveller of false hope and hyperbole. Does it really feel

right? Does it seem OK to take money off these people? Is there genuinely a fair chance

of really good returns, or are you just shooting in the dark and projecting all the

exaggerated confidence you can scape together?

Although technically most Family & Friends money goes into businesses as equity

(sometimes instead as loan) – that is, long-term money with ownership rights – we are

treating it separately to EQUITY as defined later in this typology. Family & Friends is

normally of a modest scale and of a relaxed nature, free from various restrictions and

obligations, which makes it significantly different in possibilities and character from

substantial, externally-raised equity.

GRANTS – there have been a few around in recent years. Many of my friends have availed

of Innovation Vouchers to improve their online presence. There have also been a number of

This section comprises two sections. Firstly, we review the main components in the corporate finance mix as they tend to concern earlier stage businesses.

Secondly, we revisit the Funding Enterprise Framework and offer a set of example businesses and possible funding scenarios across each of the Funding Sectors and across each of Funding Scales. In this way we wish to share numerous perspectives and insights, thus offering the promoters of individual projects new ways in which to consider their options.

16 Funding Options

apprenticeship and intern schemes running, which have created early labour possibilities.

Intelligently thought-through training support can also help plug specific labour shortages.

But grants are only some icing on the cake if you can get them, not the substance of any

funding mix. There will continue to be some grant possibilities floating around, whatever

the cutbacks, and you should keep yourself fully informed of what is available. With regards

to R&D grants, daunting complexity of access has been a key factor in recent years,

with the vast majority of UK R&D grant funding ending up with only a small number

of major and established corporations.

You should always thoroughly examine the local and otherwise incentivised opportunities,

which are prone to geographical variation and continual change. In recent times there have

variously been grants or other funding/support opportunities, including awards, returning

to work, graduate entrepreneurship, rural enterprise, women’s enterprise, BME enterprise,

and other small pots open to specific criteria.

LOANS – here’s the short story: there never was a huge amount of loan funding for earlier

stage businesses, nor was it often the most appropriate kind of funding, and there is even

less of it around at the moment. The reason for my rather sweeping statement about the

inappropriateness of loan funding is very simple – the majority of earlier stage businesses

which require funding could equally well do without incurring the repayments that loan

funding requires.

Businesses that can rapidly be so robustly cash positive as to be capable of loan

repayments, on top of the 1,001 other calls on cash, are rare indeed. Fresh enterprise

creation is very different from using loans to buy existing businesses with proven cashflow

– and even in these latter cases loans are currently proving hard to obtain.

There have recently been various plans for some of the banks to create pots of money

to sit somewhere between equity and loan in risk profile and obligations - but it is as yet

far from clear whether such concepts will materialise, or be available in sufficient amounts

to represent anything other than a drop in the ocean.

A number of bankers have explained to me, privately, that earlier stage funding via loans

was probably an area which high street banks should never have entered in a major

way in the first place; it simply wasn’t the type of business risk to which banks were

designed to expose themselves in any large measure. It was something they drifted into

over time and through competitive positioning against their peers: now none of them

wants to plunge back into this market.

If you do wish to pursue earlier stage bank funding, be aware that in the rather unlikely

event of its availability, it will almost certainly come with a level of security that will effectively

make it a personal loan against you and your assets.

17Funding Options

There are some exceptions to this: within each UK region there are various loan funds,

State distributed and EU-backed, which will consider loans, usually in the up-to-£50K

bracket, for businesses which have been refused bank funding. Two provisos are that

even these sometimes require a personal guarantee and, by and large, they would only

be open to operations which fall developmentally towards at least the mid-point of

earlier stage as defined herein.

OVERDRAFTS – overdrafts can be dangerous things for businesses, particularly so for

earlier stage enterprises (and they are exceptionally hard to obtain currently). An overdraft

is simply an expensive loan with onerous conditions. A frequent problem is that taking on

an overdraft usually brings some short-term relief, then long-term pain - sometimes

terminal. It is often extremely difficult to generate sufficient funds to pay off an overdraft

and thereafter it can act as a millstone around the neck of a small business. The same

goes for factoring and invoice discounting (the acceleration of cash out of sales before

they are settled by the customer). All of these banking products are, quite legitimately,

designed to generate banking profits. But however they are dressed-up, they cannot

conceal or mitigate against the reality that businesses are forced to use them as a poor

substitute for additional equity.

EQUITY – the lifeblood of capitalist enterprise: long-term money which sits within

a company in the hope of capital accumulation. Whereas Family & Friends investment

is essentially an act of faith in you from your close circle, private investor, business angel

and institutional equity is based on a more rigorous assessment of the enterprise’s

prospects and usually matched to more specific objectives and tighter obligations.

Equity comes mainly from these three sources: private individuals, investment funds and

flotations on stock markets. Only the first two – private individuals and investment

funds - are immediately relevant to earlier stage enterprises.

Private Investors

Private investors typically range from associates a little beyond the remit of a

Family & Friends seed round, right through to high profile specialists in a particular sector.

Private investors who tend to make a habit of earlier stage investments go by the name

of business angels, who may operate individually or in syndicates.

On occasions, business angel matches appear to be made in heaven, when expertise and

support accompanies hard cash into earlier stage companies. But business angel

matching also suffers from two systemic problems:

• There are frequently more tyre kickers and time wasters in the mix, as well as

accompanying armies of advisors and self-styled introducers, than there are

genuine potential investors.

• Conduits to improve introductions and match making come with their own issues.

Publicly held investment fairs, frequently with a horribly contrived reality-TV style

adversarial culture, run the risk of parading precious intellectual property and ideas

before all and sundry. More reputable attempts to establish contacts and courtship

between projects and potential investors, such as those established by Regional

Development Agencies, often still expect a considerable amount of potentially

sensitive information to be widely distributed all-but blindly.

18 Funding Options

Funding Enterprise is committed to improving the flow of introductions and activity

between promising earlier stage companies and value-adding investors. We will play our

part both by creating new channels for introductions and also by reviewing and

campaigning on appropriate and enabling tax regulations.

Investment funds

The first iteration of this Essential Guide is being prepared at a time of exceptional flux

within the enterprise support and investment landscape.

A general backdrop is the emergent situation with regard to the Local Enterprise

Partnerships (LEPs) and the Regional Growth Fund (and what may follow its three pay-out

rounds), which is intended to replace RDA cash distribution.

There is talk of “bundled bids” to meet the £1m minimum application threshold.

But however the new support and funding environment pans out, it is clear that areas

which enjoy unified, determined, competent and creative LEPs will be in superior positions

for any assistance going. At this stage it is very uncertain how much, if any, of the RGF will

filter through, as direct cash support (or useful indirect supports), to any region’s individual

enterprises.

LEPs will either emerge as lean and effective replacements for the RDAs, or as

emasculated talking shops. It will take at least a year or so for the picture to become clear.

Of immediate and direct investment relevance are the new European Regional

Development Fund (ERDF) backed venture capital (VC) and loan funds. The soon-to-be

abolished RDAs have gone down the route of appointing established commercial fund

managers to administer these schemes.

Careful research and monitoring needs to be maintained over the distribution and

management of such funds. Various strands of existing research and a body of anecdotal

evidence from within both the U.K. and other European countries has in the past

indicated that:

• The management charges on such funds can significantly exceed those which are

the norm with privately raised venture funds.

• Terms can be severe (with a higher than normal ratio of quasi-loan within purportedly

venture capital investments) and quantums rather low. This is because management

priorities move from the commercial norm of maximum returns to the need to be seen

to backing as many projects as possible (hence low sums) and the objective for

the fund to sustain (hence putting out a lot of the cash as loans).

It will be interesting to see how this situation develops. Whilst there is the additional danger

of a semi-monopoly, with companies failing to engage as well with often less high profile

VC alternatives, these new measures will certainly provide competition with business angel

funding.

19Funding Options

Funding Enterprise is committed neither to the interests of individual project promoters,

nor to those of individual funding providers. Our commitment is to improving the

relationship between investment capital and promising projects in the interests

of growth and value-creation.

2. Funding Enterprise Framework case studies

We believe it is important that business founders and owners develop a clear appreciation

of how funding is a core part of their business planning process, not some kind of

after-thought.

It never ceases to amaze us how capital is often treated within enterprise support as if it

is a variable only to be considered after everything else is settled. Investment, including

the investment of capital, is utterly central to all business planning. This is the first operating

principle of Funding Enterprise.

Whilst it is envisaged that this guide will have its primary use in assisting funding seekers,

we believe it can also drive some fresh thinking elsewhere, partly amongst funding

providers but also within policy and support circles. Some of the policy questions being

raised include:

• Is a trend towards winner-picking strategies, emphasising “high growth”, overlooking

the increasingly limited funding options for the self-styled smaller businesses, which

may in fact evidence high sustainability and a major aggregated impact on overall

employment levels?

• Are there risks that a bloated and quite ineffective State enterprise support sector

will be replaced by a leaner but still quite ineffective semi-State enterprise support

sector, still under-skilled in the central requirements of value creation? What role does

the State realistically have in enterprise support?

• Do we require a much more fundamental debate about the flows of capital into earlier

stage capitalist enterprise? Have we become overly fixated on squeezing reluctant

banks back into areas they commercially do not wish to be?

To return to the Funding Enterprise Framework which we have researched and developed,

earlier stage funding needs can usefully be considered through the following typologies,

for which we now develop precise examples. This is to build business founders’ own

knowledge and to provide them with insights and benchmarks against which to consider

their own circumstances and potential.

These miniature case studies bring to life many of the core issues of earlier stage funding:

A recap of the Funding Sectors:

Fixed RetailOnline RetailConsultancy Manufacture Low-ResourceManufacture High-Resource

A recap of the Funding Sectors, including examples of the Funding Scales:

20 Funding Options

These examples are worked up in greater detail below. These funding scenarios cannot

reflect every possible situation: they are intended to help all those connected to the funding

process to understand the kind of thought processes and possibilities which best frame

and guide enterprise funding.

Where appropriate, reference is also made to the the Funding Stages typology (Planning,

Proving, Transitioning, Sustaining & Struggling).

These mini-snapshots, many of them either anonymised real companies, or composites

of several operations, assume that funding seekers intend to create a business from the

outset at a Scale A, B, or C. This approach inevitably overlooks both organic growth and

also the unexpected changes to most businesses over time.

We present these examples in this way because this guide is about earlier stage

businesses: scenarios around emergent and longer-term growth and the business

morphing phase we call Transitioning will be much more to the fore in our Essential Guide

to Development & Mid-Stage Corporate Finance.

FIXED RETAIL A: local, general pet store

This is not a VC proposition. In fact, with the possible exception of Manufacture

High-Resource, none of the Scale A projects is a VC proposition.

The main issue here is the serious risk to a key layer of the UK economy, spanning

smaller retail and smaller but sustainable other businesses, of the drying up of

traditional bank lending.

I was recently at a consultation session convened by economic policy advisors and a

chamber of commerce. A long-term and successful chip shop owner told how he had

Fixed Retail (Sector)A: (Scale) e.g. local, general pet storeB: e.g. national chain of themed

coffee and sandwich shopsC: e.g. international chain of branded

youth fashion outlets

Online RetailA: e.g. watercolour painting

consumables supplierB: e.g. national property rental tenant

finderC: e.g. international discount book

and music provider

ConsultancyA: e.g. local book keeping serviceB: e.g. national employment legislation

compliance and HR outsourcingC: e.g. sophisticated major corporation

IT systems integrator

Manufacture Low-ResourceA: e.g. wedding cakes and muffins

to local outletsB: e.g. branded snackfoods for garage

forecourt and convenience storesC: e.g. collectible soft toys

Manufacture High-ResourceA: e.g. niche components for UK defence

industryB: e.g. components for European

aerospace industryC: e.g. surface coating technology

for textiles, paper and packaging manufacturing worldwide

21Funding Options

just been refused bank financing for the acquisition of another chip shop, also with

a sound trading record.

One can understand the clearing banks wishing to withdraw from their somewhat

strained position as providers of quasi-VC and higher risk development capital.

However, a reluctance to transact simple and transparent asset-backed business

finance is another matter altogether.

This is another example of why we may need to conduct a more root and branch

debate around the flows of capital, much more comprehensive and constructive than

the ongoing cycle of Government exhortations for the banks to lend being followed by

compliant noises......and little else.

Fixed Retail – B: national chain of themed coffee and sandwich shops

Some such chains have done very well indeed, so some basic market justification

is there. But is there room for another large scale entrant? Where is this proposition

starting from, calculated opportunity or ill-considered imitation? If the promoters are

experienced caterers and themed restaurant owners, this could well justify substantial

VC and a plan to execute the simultaneous opening of several outlets and a rapid

roll-out thereafter.

The same team may choose, alternatively, to assemble an unusually strong

Family & Friends round, possibly including a couple of additional sectoral experts.

From here they might open a small chain of outlets, with a view to accelerating

through a Proving phase and thus attracting potentially even more substantial

VC backing. Whatever, the experience and the detailed plans of such promoters

permit them to play a proactive funding game from day one.

Fixed Retail – C: international chain of branded youth fashion outlets

In terms of rising through the scales (A, B & C), many of the large retail operations of

today have long-distant foundation stories of how they scaled from an initial single outlet,

or even from a humble market stall. However, one of the features which characterises

mature retail markets is the declining opportunity to achieve success via the organic

growth of a micro-business. In the UK it is now highly unlikely that a premier league

general grocery chain is going to grow from Scale A right through to Scale C.

It is possible for there to be significant asset-juggling at the topmost Scale and for

niche, Scale B businesses to emerge: but the days of market stall to a superstore in

every town within one of two generations are gone.

Within Fixed Retail we have chosen one of the few exceptions to this rule in the shape

of the fashion industry. A Scale C youth fashion chain can be designed and launched

through major private investment and VC at an immediately significant scale. It might

be country specific at first and then take on major additional investment at its moment

of Transitioning into international markets.

22 Funding Options

It is through the disruptive dynamics of flair and innovation that fashion phenomena

can emerge and develop with great speed. It is in such emergent scenarios that bold

and committed funders can reap great rewards.

What about High Technology?

The preceding points about Scale possibilities – the connection of disruptive

innovation with marketplace desire - invite a brief consideration of High Technology

earlier stage projects. In terms of high-tech growth funding, this guide has deliberately

not made such operations its primary activity focus. The sector can easily become

an obsession to the detriment of all other value-creation possibilities.

It is indeed very much possible within high-tech for massively disruptive innovation not

just to enter and lead markets but even to make massive markets from scratch in

a remarkably quick time. This is the sector’s ultimate allure.

However, similar (if rarely quite as spectacular) phenomena can and do emerge within

many sectors and we have resisted the temptation to create a separate category

of high-tech. Despite an ongoing infatuation by many with high-tech, practical fund-

ing thought is best served by considering what any particular technology can achieve

as monetisable value-add within our typology of Funding Sectors, rather than being

swept along by claims of how intrinsically clever it may be.

Finding a valuable place in the economic world is frequently a greater challenge than

simply finding something that is technologically new.

ONLINE RETAIL A: watercolour painting consumables supplier

Again, what may be a perfectly sustainable lifestyle business is not a VC proposition.

If the operation were to seek to grow substantially against a carefully researched and

23Funding Options

tested plan to run complementary ranges in a period of ambitious Transitioning,

then it might become a prospect for some of the regionally targeted investment funds,

either of the equity variety, or the bank refusal sweep-up funds. The key point is that

the days of any excitement simply in using the Internet as a distribution medium are

long gone.

Online Retail -B: national property rental tenant finder

The UK property market is vast – and so are the numbers of earlier stage companies

which have failed to carve out a sustainable business within it. Innumerable market

entrants attempt to compete in the ostensibly lucrative areas, most notably sales

commissions, and this ongoing supply of competition constantly downgrades

real-world profit potential.

A similar observation could be applied to large parts of the financial services

distribution sector, whereby commissions can be substantial but the volume of

competition and sales costs become the limiting factors

To succeed in such mature markets as a fresh entrant will usually require a

combination of attributes. These may include a disruptive distribution channel (first

competent mover advantage in new ways of doing business in both the property and

financial services markets has certainly been effective for some), sustainable margins

(but also margins that are not so very easily achieved that it makes imitator competition

too easy), a carefully judged price carrier (e.g. the embedded commissions of price

comparison sites), a fresh marketing appeal and highly nimble management.

Executed well, such agile propositions can move through Proving rapidly into major

VC-backed expansion. However, given the precision (and luck) required to negotiate

the marketplace and competitive variables, such operations are most likely

to discount at least some of the early risk through a reasonable level of personal

and private investment before commercial providers come on board. The Intellectual

Property in such operations is more in proof of survivability, than in any one thing that

is compellingly radical.

Online Retail -C: international discount book and music provider

Yes, the very idea invites the question, “But what about A****n?”, doesn’t it?

Sometimes the leverage of first mover advantage and the pursuit of marketplace

dominance is bought with vast amounts of investment money (and that is without the

subsequent and at least as substantial challenge of developing the management skill

required to maintain leadership).

There are still major online opportunities to be realised, just as there are species in the

deepest oceans yet to be discovered and universes to be imagined beyond our own.

But the funding environment is currently much more cautious than 10-15 years ago,

when certain earlier stage projects would be backed and backed again, until there

was so much resting on success that there was a tendency to keep raising the stakes,

24 Funding Options

as the fear of failure surpassed the voice of logic saying that enough was enough.

In the current climate it would take exceptional promoters with a quite exceptional

project to leverage a Scale C online retail start-up with the fullest weight upfront

funding.

CONSULTANCY A: local book keeping service

Again, it tends to be savings, Family & Friends and a good deal of bootstrapping

which are the main options for localised ventures of this kind.

Consultancy -B: national employment legislation compliance and HR outsourcing

This is the kind of operation which highlights a core corporate finance issue within

mid-sized services operations: value that can be captured in terms of an investment

exit is not always synonymous with the cash generation of the business. Quite often

the key knowledge and drive of a business can be embodied in possibly just one

person, or perhaps two or three at most.

Such a scenario of owner-driven passion will make it quite easy for medium-scale

private investors to back such a business on the up (their value realisation needs can

be met by dividends and buy-out options). However, potential larger scale VC

involvement may struggle to establish a basis on which investors can envisage a

profitable exit within three to five years.

Careful thought (not to the exclusion of the extremely hard task of building

a substantial business in the first place) needs to be given to how potentially divergent

agenda may be accommodated. It may be worth discussing early on with possible

major backers whether the key promoters may be amenable to lock-ins and/or partial

earn-outs in order to build continuity and sustainability post-sale of the business.

Management Buy Outs (or Buy Ins) are further mechanisms which can help reconcile

the aspirations of promoters with those of institutional funders. Another might be an

aggressive expansion strategy which targets acquisition and marketplace consolida-

tion to assemble capacity and competence beyond that of the original promoters.

Service companies which have low and/or legally indefensible Intellectual Property

(which is a high proportion of such companies) need to strategise (but not fantasise)

around likely mid to longer term scenarios and try to establish hypothetical matches

with possible funding requirements. This is the particularly the case with highly

experienced promoters who might reasonably expect to deliver strongly on their plans.

Funding strategy can often be much more sophisticated than simply building up an

IP-rich company as quickly as possible and everyone walking away happily after a sale

(or a flotation) within just a few years. Perhaps there used to be slightly more truth in

such a portrayal but many simplistic corporate finance guides continue to misrepresent

the subtleties of not just creating value, but also of extracting value.

25Funding Options

Consultancy -C: sophisticated major corporation IT systems integrator

Some consultancy operations are way beyond the realistic product of organic growth

and creative partnering. Traditionally the larger professional services companies,

such as accountancy practices and solicitors, have grown over substantial periods

through many mergers, takeovers and strategic expansions. Cash needs and

balancing transactions during the absorption of other practices have been

accommodated through a combination of ownership adjustments, partner cash

calls and a degree of bank borrowings.

Such a model is inapplicable to, say, IT & Communications operations which promise

seamless international support to clients who are themselves widely internationalised.

Partnership ownership and partner equity contribution might permit a basic corporate

structure to emerge but such operations will still require some substantial pump

priming,

The experience of the promoters is always going to be the prime determinant of the

funding possibilities of Scale C consultancy/services operations.

Whilst higher IT complexity may give a consultancy a flavour of defensible IP,

it is always the quality of the commercial relationships which most strongly whets

investment appetite.

The same reality applies to, say, an ambitious new advertising agency. A group of

national senior account managers, each with 20-plus successful years’ track record,

is always going to attract more backing than a roomful of raw juniors.

When you are asking for £100K, it is - What are you going to do? When you are asking

for £10M, it is just as much what have you done.

MANUFACTURE LOW-RESOURCEA: wedding cakes and muffins to local outlets

Food production either begins with at least some scale of manufacture and internal

experience and competence in establishing distribution, or it will forever struggle

to scale. That is a harsh generalised assessment but the food industry, perhaps more

than any, is staked out by practices which make major market entry extremely

difficult for even substantial newcomers. These include the credit and scale demands

of the major multiples which dominate distribution, the ever-tighter web of regulation

which governs production and the high marketing support needed to move beyond

the smallest of marketplace niches. Most of the food industry, except to highly

experienced specialists, wears an “invest with care” warning.

Manufacture Low-Resource -B: branded snackfoods for garage forecourt and convenience stores

Here is an example of a possible exception to the rule above, or at least a project

which might attract sector-knowledgeable investment backing. Like the following

Scale C example, this investment proposal stands or falls on sectoral understanding

and marketing savvy.

26 Funding Options

Over the years I have seen so many Manufacture Low-Resource proposals which

underestimate marketing realities in a similar way, that I have come up with a specific

name for them. I call such hopelessly unrealistic projects Plates to India Plans.

They go something like this - “There are over a billion people in India. They eat off

plates. We will make plates and sell them in India – if we only capture 10% of the

market, then we will be very successful, and if we go on to only capture 20% of the

market, we will be incredibly successful!”

The start point of spotting Manufacture Low-Resource possibilities (and avoiding

getting sucked into myriad variations of marginally survivable metal bashing and

injection moulding) is to consider the manufacturing itself only as a necessary

overhead. Positioning, brand, volume and margin are everything.

With this particular example of snackfoods, it again comes down to marketplace

experience. Successful and popular brands rapidly get bought-up by the big players

if that makes more sense than a competitive, spoiler launch of their own.

Strong promoters with compelling plans can attract substantial funding within

Manufacture Low-Resource.

But it is always a question of why hasn’t someone else – someone with substantial

resources already in this marketplace – done this before? And Plates to India Plans are

always going to go nowhere.

Manufacture Low-Resource -C: collectible soft toys

Until relatively recent times there were still marketplace entrants seeking to

aggregate and leverage existing heritage assets: coal, steel, pottery, engineering etc.

Such conglomerate plays are now very rare and seem like a somewhat quaint part of

our industrial heritage (Corporate activity of this kind continues in such areas as the

conglomeration of traditional insurance funds). This kind of asset-shuffling activity,

which involves high-level share swaps, shell companies, de-listings and re-listings and

sometimes substantial private equity, is beyond the core remit of this guide: the only

earlier stage element is the new corporate shape and vehicle, whereas Funding

Enterprise is more concerned with the creation of new value through investment,

rather than with the leverage of marginal extra value via financial engineering.

A compelling focus under Scale C Manufacture Low-Resource is thus on

phenomena creation.

How is it that many stuffed toys clutter the shelves of pound shops, whilst certain

ranges have legions of committed followers, eager to pay top dollar for new releases

and forever scouting the net for collectibles?

How is that some Japanese-themed t-shirts look cheap and gaudy hung up on

market stalls but some brightly coloured Japanese-themed t-shirts can create

a massive international brand success?

27Funding Options

Behind any success emanating from basic technology (and the example here is in any

event based on sub-contracted manufacture) and what it can make lies a much more

sophisticated psychology of what sells. Any sense of build it and they will come is not

part of a smarter marketing formula. Success is not about switching on machines in

blind hope, it is driven by turning on consumers with brilliant strategy born of sound

experience and research.

Manufacture Low-Resource, particularly in relation to Earlier Stage Funding, is less

and less these days about mechanical widgetary and much more about marketplace

wizardry.

MANUFACTURE HIGH-RESOURCEA: niche components for UK defence industry

With the possibilities of tremendous financial return from Manufacture High-Resource

come particular threats. Each of these examples – A, B & C - identifies, respectively,

one of these core dangers: narrow customer reliance; limited competitive scale;

concept to commercialisation.

There are certain complex and expensive things that need to be built but which might

not necessarily make a compelling case from risk capital’s point of view.

Single customers, extremely long order placement cycles and unpredictable order

continuity do not make for the most immediately compelling investment case.

The potential downside, as in this Scale A example, of having highly specialist and

potentially high margin activities, is an extreme specialism of customer.

Two high-level strategic imperatives which derive from such issues are:

• There is still a general lack of applied focus within UK Higher Education Institutions’

technology research. Whatever the rhetoric of commercial connectivity and such

initiatives as knowledge transfer, those of us who actually consult regularly with earlier

stage academic spin-outs understand the gulf that still frequently exists between

research and an effective commercial relationship.

• There is much talk currently of creating new specialist technology centres and

support. However, whilst technology itself will continue to emerge largely in-line with

such research as is funded, commercial opportunities will continue to go begging

unless the quality of specialist marketing support is radically improved.

Manufacture High-Resource -B: components for European aerospace industry

This example is a step-change from the preceding Scale A example. The potential

barrier to securing funding (and to business success) now moves from the narrowness

of the market to the ability, or otherwise, to compete with much bigger players in a

broader but still highly specialist marketplace.

In such instances, strategic alliances can effectively be made part of the funding mix.

Just as important as capital itself can be resource synergies, additional marketplace

28 Funding Options

presence and extra intelligence regarding emergent and future opportunities.

In seeking to be big quickly, it can be useful to see on which existing tall shoulders

one can hitch a ride without losing one’s own unique personality and character.

Such relationships can also form a naturally evolving exit.

Once again, the point has to be emphasised that technical cleverness by itself is worth

very little.

The business funding process is primarily located within the art of innovative value

creation, not per se within the science of innovation.

Manufacture High-Resource -C: surface coating technology for textiles, paper and packaging manufacturing

worldwide:

The history of technology and of commercial success is littered with tales of how

great new solutions have depressingly often failed to translate through into

marketplace success.

Moving from blue sky thinking to commercial traction is about much more than simply

applying large sums of investment.

Where a lot of commercialisation funding plans fail to stack-up is they lack a sense of

incremental achievement. I have encountered many instances where companies which

are seeking to move through R&D into marketplace connection have raised an arbitrary

sum of early stage money and next seek a larger but still arbitrary sum of money.

This kind of looseness is more typical of business angel and private investor funding

than it is of VC. It does no-one any favours.

I call this Point to Nowhere Funding, which lacks any logical link between expenditure

and achievement stages within a developmental plan. This is in contrast to Point to

Point Funding, where the project promoters attempt to be able to show emergent

progress against an overall plan. Even if a first round is not going to stretch all the way

through to commercial trading, pegging funding to progress in this way gives comfort

to funders by way of deliverables and greatly increases the chance of establishing a

sequential plan for ongoing funding against measurable achievements.

The greatest achievements in the life of any earlier stage business are making its first

commercial sale and its second commercial sale (in case the first was a fluke).

The majority of start-up businesses fail before they reach this point. This sobering

reality is as true for IP-rich Manufacture High-Resource concepts as it is for any

business idea.

It is imperative that the commercial dreams – small and big - are broken down into

measurable moments of costed, cumulative and assessable activity.

29Funding Options

What about Software?

As with high-tech, we have chosen not to make a separate category of Software.

At the general integration and maintenance level, the bodyshopping sector, software

can sit within Consultancy.

At a more sophisiticated design and integration level, such as legacy rework and

e-commerce enablement, plus the development of general applications, software

moves into Manufacture Low-Resource.

As we move further again up the resource chain, into areas which involve, say,

architecture and distribution paradigms, such as pushing the boundaries of Service

Oriented Architecture and Cloud Computing, software enters the territory of

Manufacture High-Resource. This is particularly the case where there are strong calls

on highly specialist labour, coupled with extensive and uncertain R&D cycles.

Again, as with all technologies, the key questions revolve not so much around the

technological cleverness (which must exist as a baseline qualification in the funding

equation) but rather with the methodology and likelihood of profitable adoption.

Software, at all levels, but particularly within the most lucrative parts of business

markets, is dominated by a number of key incumbents. They seek to fill every available

space with interlinked software offerings, coupled with major support operations.

Who is going to buy us, instead of our marketplace entry being blocked or strangled?

This is the question which needs to be asked at the very earliest stages of the funding

mission.

30

Valuations can easily become the most contested area of potential investments into earlier stage businesses. TV entertainment shows about business funding, now widely copied on a localised basis, have created an unhelpful picture of the optimum dynamics of successful investment.

A fully honest, open and constructive relationship between potential investee and

investor can radically enhance the chances of business success and value creation.

It will entail a comprehensive assessment of risks and potential and allow an emergent

sense of fair value to develop through mutual agreement. Any deal that closes in haste

and resentment, or even anger, carries massive risks of project failure.

Any deal where one party feels that it has achieved excessive advantage over the other

also carries very poor prospects of long-term success.

There is no single formula for establishing valuations at which funding deals are struck,

nor do we wish to try and establish one.

There is an art to getting funding right, born of long experience. A deal which is fair to both

parties and gives maximum headroom for value to grow tends to feel right, rather than be

provable in all dimensions via numerical logic.

In our experience, however, valuations can usefully be envisaged at a high level through our

five part Funding Valuation Quotient, which is the final part of the overall Funding Enterprise

Framework.

FUNDING VALUATION QUOTIENTThis typology captures the expectation and commitment level at which funds are placed

into a project or business. It is a confidence indicator – partly the confidence of the

promoters but mainly the confidence of the funders in the competence and capability

of the promoters to execute on their plans. It comprises:

Present

Present +

Present ++

Future Now

Hothouse

The details of the individual Quotient levels are:

Funding Valuation & Ethics

31Funding Valuation & Ethics

Present is the least relevant to earlier stage funding. It is a funding valuation based

mainly on historical performance and asset values. It is more about longer-established

businesses in a Sustaining mode than an aspirational figure related to future value

creation. Hence we move on to:

Present + (pronounced Present Plus) is the first step on the Quotient ladder to reflect

a relationship between current funding commitment and future potential value

accumulation. It is a rather unsatisfactory funding situation – but one which occurs

all too often. It envisages a modest quantum, coupled to a low valuation based on

moderate expectations of mid-term value creation. Thus the promoters have ceded

considerable ownership for a funding package which neither envisages, nor which

could stimulate, breakthrough growth.

Whilst this might alternatively be an expression of investor greed rather than a lack

of deep confidence, neither of these motivations are ones on which deals should be

made. Firstly, if the deal is a poor one in relation to genuine prospects, then it should

not have been done: underfunding and promoter resentment are major obstacles to

performance.

And, secondly, if there were serious doubts about core viability, then it should have

been a case of back-to-the-drawing-board all round. Either a firmer plan emerges,

or a decision must be taken (by both parties) that this project, at this time, is not a

credible funding candidate. A Present + funding proposal may well be characterised

by a Point to Nowhere Funding mentality.

Far, far too many times have I heard promoters claim that “Failure is not an option!”

Believe me, it is – and it comes calling with no respect for hype and blind faith.

Present ++ (pronounced Present Double Plus) is a more balanced situation which

reflects substantial but probably not majority investor ownership in exchange for

a substantial tranche of investment, set against valuations and goals on which both

parties are clear and confident. They know where they want to try to go next together

in terms of significant value creation.

Future Now is a more clear cut and determined play where there is a sense of a more

deeply discounted risk element. The intention is to act decisively and bring to life future

potential quickly through sizeable investment.

This confidence might come from the directly relevant previous experience of the

promoters, which they have brought to bear on a strongly evidenced Planning phase.

It might be reinforced by promising signs of growth as the business continues through

decisive Proving into encouraging trading.

Future Now strongly anticipates significant future success and reflects this

by backing the business with a high quantum to seek to accelerate growth.

It leaves a post-funding stake for the promoters of still significant ownership

(though not necessarily majority) – certainly enough to incentivise them greatly and

to allow enough headroom also for further funding rounds. There is a strong command

of Point to Point Funding – and the incremental steps mapped-out track over a lot

of territory with adequate funding cover.

Funding Valuation & Ethics

32 Funding Valuation & Ethics

Hothouse is a funding intent to hit a C Scale business at full tilt. The promoters

will readily accept quite heavy dilution in exchange for acquiring a financial partner

willing to fund totally committed execution. These are rare scenarios and will involve

a combination of gold standard propositions, high marketplace desire and/or marquee

promoters.

The Funding Valuation Quotient is our final typology, designed with the other typologies

to bring together more closely the interests of earlier stage businesses and their funders.

Founders and owners need to ask themselves where they sit in relation to this assessment

tool. Do they genuinely deserve to be assessed at least at the level of Present ++?

If not, they might well be deluding themselves just as much as the funders they are seeking

to persuade, rather than enjoin.

And for funders, if they are genuinely convinced of potential viability, are they sure that

they are giving the project the fullest chance to thrive through motivated promoters and

sufficient funding?

Because this is what Funding Enterprise is all about – bringing it from a smoke and mirrors struggle to an honest appraisal of capability and possibility. When both parties feel that there is great potential and that they have given up enough but no more, when they have agreed what they are going to seek to achieve together, then that’s what we can call enterprise funding.

SHARING, COPYRIGHT & PROPER ADVICE

We actively encourage the use of our framework and terminology. Our intention is to

stimulate more productive relationships between funding providers and funding seekers,

increasing value-added and stimulating wealth creation, with all the associated benefits

of employment and prosperity.

Whilst we assert our copyright over our work, our terminologies and typologies,

we are making them available under:

Please use our work, terminologies and typologies as you will but please don’t do so

without acknowledging where they came from, please don’t try to make money from them

and please don’t change or dilute them in case they end up meaning something which we

didn’t intend.

The key elements to which we draw specific attention are:

THE FUNDING ENTERPRISE TYPOLOGY:

The Essential Guide to Earlier Stage Corporate Finance and its associated work by Funding Enterprise and the associated work presented on www.corporatefinancenorthwest.org is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 UK: England & Wales Licence.

Funding SectorsFixed Retail

Online Retail

Consultancy

Manufacture Low-Resource

Manufacture High-Resource

Funding ScalesA: Of localised, or highly specialised

intent, likely to sustain a smaller

operation.

B: Of larger regional or national scale,

or specialist export markets.

C: Substantial operations with the

capability of significant national

marketplace share and/or successful

export growth.

Funding StagesPlanning

Proving

Transitioning

Sustaining

Struggling

Funding Valuation QuotientPresent

Present +

Present ++

Future Now

Hothouse

Other Key Terms:Point to Nowhere Funding

Point to Point Funding

Funding Enterprise (as a national

organisation)

corporatefinancenorthwest

(the web and public face of Funding

Enterprise in the NW)

None of the activities of Funding Enterprise, including this guide, can in any way be construable as constituting investment advice as regulated by law. Anyone engaging in the trading of regulated investments must at all times be so regulated and any companies engaging in fund raising should seek appropriate legal and specialist advice.

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The Essential Guide to Earlier Stage Corporate Finance

Documents

The Essential Guide to Earlier Stage Corporate Finance