Essential Guide to Earlier Stage Corporate Finance

8/7/2019 Essential Guide to Earlier Stage Corporate Finance

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First Edition

The Essential Guideto Earlier Stage Corporate Finance

By Malcolm Evans


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This guide is an introduction to the main issues and conceptsof earlier stage corporate nance. It is a baseline of essentialknowledge 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 advicetends to suffer from:

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

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

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

A lack of appreciation that investment capital will naturally seek to mitigate risk and maximise returns and that theseobjectives need to be recognised and accommodated withinconstructive and frank discussions.

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

An arti cial and unhelpful gap in the business planningprocess - by developing plans with little attentionto capital and cash ow issues and only later seeking to grafton haphazard and emergent nancial 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 andcapability in the workings of corporate nance. They are notintended to provide information on individual funding sources:the latter information will develop incrementally on ourwebsites and will also form part of our seminar activities.

Malcolm Evans, February 2011.www.corporate nancenorthwest.orginfo@corporate nancenorthwest.org

Funding Enterprise Freeing-up Capital to Grow Great Businesses


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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 casesare insuf ciently considered and, in others, quite surprising.

Funding Options: 15the unwritten rules of what may be suitable and available not just anotherreprinted list of various agencies/organisations.

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

So you want to starta business, or to scalesomething you already have going?

Contents3


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1. SOCIAL AND ECONOMIC CONTEXTAs soon you start to engage actively in a funding search, you may nd that you are put intoa de nitional 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 theenterprise 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, fundingevents, European Regional Development Fund/university-delivered seminars, incubatormembership, or inputs through high priority or other localised support schemes.

You may not be connected with any such activities and you may enjoy a combinationof such an exceptional idea, talent, fast cash generation and pure luck to expand straightthrough to larger and mature funding environments (or even to avoid all outsideinvestment).

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 modelsaffect both the availability of funding and to various degrees the plans and self-projectionof individual projects and businesses.

This is particularly the case when a signi cant proportion of available funding, both by wayof 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 invarious ways will in uence and affect the majority of funding quests.

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

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2. THE ENTERPRISE SUPPORT SECTOR NEEDS YOU TO BE BIGA fashion over the last few years has been to squeeze the majority of earlier stageactivity into the entrepreneur camp. This mentality might assume that a neighbourhoodnail bar both requires and is serviced by the same support network as a biotech R&Dgenetics project with worldwide implications. Such an approach may also just as likelylead to the downplaying of smaller and traditional activities, as they display limitedentrepreneurship, whatever of their employment and contribution possibilities.

At Funding Enterprise we make no judgements about the worthiness of any particularbusiness (as long as they are sustainable, decent and legal) but we are concerned aboutsome of the assumptions currently being made from within academia and the enterprisesupport sector, which in turn lter 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 theirimpact (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- ts-all mentality.

However, there is nothing wrong with individuals seeking to establish a self-employed livingeither by themselves, or within small clusters of like-minded individuals. Indeed, these arethings 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 keepingpractice. Neighbourhood businesses like these are one of the mainstays of a prosperouseconomy and vital providers of localised employment.

And the high growth rhetoric can easily be over-used. We have seen many instanceswhere 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 researchand campaign on issues applicable to all earlier stage business).

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However, we are also very clear that we neither disregard the contribution of morespeci cally lifestyle businesses, nor do we attempt to somehow rescue lifestylebusinesses from themselves by injecting them with high growth magic (if such a thingis possible). Nor are we business sector snobs.

An over-emphasis on as fast growth as possible also carries risks for the projects whichgenuinely possess the potential to scale to considerable size. All the talk around relentlessgrowth and rapid success can lead to an under-focus on business fundamentals and overoptimism 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 whichmay seem inappropriate to your own project.

Be exceptionally clear-headed about realistic resource requirements and timescalesof potential growth.

Remember that many third parties have a vested agenda in your project. This can beanything from fee generation to political ideology: your own focus must remain theviability of value creation within your ideas, plans and resources.

An important lesson is that there is a grave danger that the unsung heroes of economicstability sustainable local businesses may be overlooked in favour of the high growthobsession. Worse still, restricted bank funding may quietly kill off many of them.

3. BUTCHER, BAKER, WEBSITE DESIGNER At 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, softwareapplication developer etc.

Although accurate and usefully descriptive, this task-labelling is not by itself of huge directuse to funding principles (for example, grocery retailer might range from a single cornershop 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 terminologydescriptive of business process. This can be highly informative to policy in such areas as



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

We have thus developed:

4. FUNDING ENTERPRISE FRAMEWORK In 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 builtup an early trading record.

There is a clear difference between service businesses which can sometimes createat least some activity on limited funds (and, indeed, in some cases scale through tomaturity on modest funding) and projects which demand signi cant investment before theycan achieve any trade.

The latter would include a sophisticated IT outsourcing operation requiring varied andsubstantial specialist labour expertise and, obviously, any form of manufacturing whichrequires signi cant plant.

Such projects as these, pre-funding, can only research, test and plan in as much detail aspossible they cannot realistically be expected to move beyond market research withoutthe investment to enable commencement of any meaningful trade.

Bootstrapping is a term much in vogue at the moment. It refers speci cally to leveragingongoing 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 seekingearly breakeven and pro tability, there is also a widespread under-appreciation of how

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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 regardingthe 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 fallenwithin the general mentoring and/or marketing areas. This has been driven by the hugenumbers of government advisors (a function now being moved from employed positionsto voluntary mentors), private sector providers and the universities. Higher EducationInstitutions have realised that they can generate substantial supplementary funding tosupport payroll and research activities by entering the business advisory market.

Whilst the topics of support in themselves are important (without passing qualityjudgements on the merits of individual support providers), much business advice has

become divorced from the realities of funding and the drivers of sustainability and pro t.

The fact that much business growth relies on the marriage of compelling activity withpro table investment is the primary focus of Funding Enterprise.

Beyond our category of Earlier Stage Funding is Development & Mid-Stage Funding andthis 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 alogical framework for considering nancing needs and nancing 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 potentialof their own organisations. Whilst the Funding Enterprise Framework takes into accountall business stages, our primary focus within the Funding Enterprise organisation is onyounger and developing companies the SME heartlands.

Here are the Funding Sectors, Funding Scales and the Funding Stages of theFunding Enterprise Framework:



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Funding Sectors:We identify ve Funding Sectors (it is quite likely that a business might move and expandacross Funding Sectors during its lifetime). The de nitions of all components of theFunding Enterprise Framework are developed in such a way as to highlight commonlyoccurring 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 storeB: e.g. national chain of themed coffee

and sandwich shopsC: e.g international chain of branded

youth fashion outlets

Online Retail ScalesA: e.g. watercolour painting consumables

supplierB: e.g. national property rental tenant

nderC: e.g. international discount book and

music provider

Consultancy ScalesA: e.g. local book keeping serviceB: e.g. national employment legislation

compliance and HR outsourcing

C: e.g. sophisticated major corporationIT systems integrator

ManufactureLow-Resource ScalesA: e.g. wedding cakes and muf ns

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

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

ManufactureHigh-Resource ScalesA: 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

The three Scales (A, B & C)can be generalised as:

A: Of localised, or highly specialisedintent, likely to sustain a smalleroperation.

B: Of larger regional or national scale,or specialist export markets.

C: Substantial operations with thecapability of signi cant nationalmarketplace share and/or successfulexport growth.

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Whilst, as we have said, it is possible that a business may develop across all three stagesover time, from a funding point of view it is also quite possible that a business may havethe intent to begin at stage C . It takes talented and, usually, sector-experiencedpromoters to deliver on such ambitious plans and they will require sophisticatedand committed funders.

Following on from the ve Funding Sectors and the three Funding Scales, we identify veFunding Stages, three of which are of primary interest to Funding Enterprise and two of which are of secondary interest.

Five Funding Stages:

PlanningProvingTransitioningSustainingStruggling

We have divided projects and businesses into these Funding Stages as they bring addedclarity to the nancial and value creation dynamics directly linked to possible corporate

nance activities.

These Funding Stages run consistantly across the various Funding Sectors and FundingScales as follows:

Planning: detailed information is in place concerning the service/product. This includesa competitive route to a quanti ed market, the experience and competencies of the keypromoters and the investment requirements, coupled with indications of potential valuegeneration.

Proving: business has commenced at a level beyond market research and there is harderdata available regarding marketplace receptivity and service/product delivery. The bestProving 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 comeabout at any stage between detailed Planning (which can throw up alternativeopportunities) and the earlier stages of Struggling (in the guise, possibly, of a radicalrestructuring around a reduced and rebuilt subset of the organisations overall activities).In terms of earlier stage funding, Transitioning is usually towards the later end of the reachof 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 asdeclining sales, or declining pro tability.

Again, all of the ve Funding Sectors, at whichever Funding Scale, may be at any oneof the ve Funding Stages.



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We are primarily concerned with the Funding Stages of Planning, Proving & Transitioning.The main corporate nance activity within recently founded and younger SMEs at theseStages is driven by investment via equity (and through a degree of debt).

The chief corporate nance 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 rst concern:the Sustaining stage is chie y 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 re nancing,discounted cash calls, radical restructures, sales, or various insolvency measures,from administration through to receivership. These are specialist and frequentlylegalistic practices and not part of mainstream, growth-facing SME corporate nance.

The Funding Enterprise Framework seeks to move away, as far as is possible, from fashionand from embedded assumptions. We aim to concentrate on potential value creation and

funding requirements within the clearly assessable potential of an individual project, at aparticular time in its development cycle.

In this way, the project promoters are required to discount blind hope and unsubstantiatedclaimsmaking, and potential funders may more quickly access the keynotes and therealism of the proposal.

There will always be an element of disproportionate fashion: the early 90s saw awidespread obsession with new web retailers seeking to displace long-established retailchains; 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 xed retailpropositions; the last few years have seen a refocus on innovative models for thedistribution of mass market nancial services and property services.

The framework of Funding Sectors focuses attention on general marketplace issuesand also on speci c opportunities within these markets. The starting assumptionis 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 theproject or business, discounting blind hope and hype, yet is also capable of matchingthe grounded ambitions of outstanding plans and promoters.

The framework of Funding Stages allows a quick, indicative mapping of corporatepotential to possible corporate nance activity and delivers a basic check thata funding quest has a realistic relationship with the typical development cycle.

The framework of Funding Valuation Quotient, which we detail later, indicatesthe commitment and con dence represented in any funding package.

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

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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 manyclaim that they require money. The inherent failure spawns a series of what if scenariosrevolving around possibilities with funding. These exist more in blind hope than anycoherent business plan. This may sound harsh but the reality is that advisors and funderssee 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 supportsector whose own interests have not to date been best served by the simple honesty of saying No, I dont think that will work, or by pay-to-join funding locator services whosemodus operandi owes everything to membership fees and very little to even cursory duediligence.

FASHION: for many business founders and business owners, seeking and securingfunding 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 andpantomime villains of those with whom they do battle. Some fashion-driven fundingseekers may t equally within the FAILURE category. However, there are also many earlierstage enterprises with reasonable promise which seek funding for no clari ed reason otherthan 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 identi ed necessity forexternal investment at that particular time.

SET-UP: the reality, as we have already stated, is that businesses generally take moremoney to establish solidly than is often acknowledged. Indeed, the enterprise supportsector is largely silent on this point, as small scale seed capital, outside of specialsocio-demographic initiatives, is not generally available.

This is not an argument that the State should be in the business of wholesale enterprisemicro-capitalisation (though a strong case can be made for this, within the boundsof European competition legislation) but it is a reality which sits in contrast to the clamour

for maximum enterprise stimulation. It is often dif cult for even 100% services operationsto generate market traction from zero initial funds. It is also the period of no incomebetween quitting other employment and establishing replacement income that frequentlyconstitutes a very real and disabling invisible funding gap.

In our experience there are a number of key reasons why businessfounders and earlier stage owners seek funding. They are frequently not as clearly tied to an explicit and justi able business case as onemight expect:


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At the other end of the spectrum are technically IP-rich operations for which trading isimpossible without signi cant resources. Today, most such operations tend to be spun-outfrom, or otherwise connected to, various technology-specialist universities, or dedicatedinnovation campuses, with the objective to share as much central resource as possiblein the earliest stages. Such institutions tend to feature their own IP-retaining policies and

often feature longer term relationships with speci c venture capitalists. Whether these UK models approximate in practice the hothousing capability of comparable U.S. campuses isa matter for ongoing research and debate.

DEVELOPMENT & REFINEMENT: in a traditional manufacturing environment, this stageis known as research and development. R&D assumes that evolving a commercially viableproduct beyond the earliest set-up phase requires a series of experiments, reworks andongoing tests.

Advisors to the service sector have often been unrealistic in not suf ciently realising thatservices also require a period in which creating, testing, establishing and scaling a strongoffering will take hard cash as well as great effort. Whilst in technology environments it goesdown 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 grownalongside attempting to locate a sweet spot of pro tability, robust offering, marketplaceuniqueness, and sustainability.

Provision is often made for this process within sophisticated and complex technologyprojects by calculating the burn rate the expected cash attrition along the road towardsbreakeven and self-sustaining trade.

Businesses which have made no such provision, or have been over-optimistic, can be leftburned out, without the resources to prove or disprove their fundamental viability.

CASHFLOW GAP: The most pressing cash ow issues tend to affect businesses whichmust pay promptly for the resources necessary to make sales to customers who pay moreslowly. An example might be an earlier stage food manufacturer which has securedcontracts with some larger supermarkets. Its own suppliers may demand strictadherence to 30 days payment, whilst the new customers might expect severalmonths and then only with all manner of unforeseen charges, rebates, discountsand other strategies designed to reduce overall payment.

Even services companies, particularly those which have recently staffed-up to matchgrowing sales, may experience grave pressure between meeting their own costs andclawing in cash due.

The traditional route of seeking bank overdraft funding (or loans) is far less availablepost-Credit Crunch and, in any case, was often a far from ideal way of funding earlygrowth.

OPPORTUNITY EXPLOITATION: organic growth is one route to value creation and it hasthe 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 viewthat enhanced, investment-fuelled growth is a preferable (and safer) route to maximumvalue creation, even when factoring in the ownership dilution entailed.

Funding Drivers


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14 Funding Drivers

Opportunity Exploitation via investment covers intentions such as the broad ambitionof securing rst mover advantage, through to ful lling individual contracts which areprovisionally booked subject to the necessary resources being available. It can be aboutaccelerating market share, or geographical expansion, or absorbing smaller andcomplementary 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 maskinga forever unobtainable sustainability and pro tability.

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


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Funding Options

1. Key components of the earlier stage funding mixSWEAT EQUITY refers to working without returns within your project. Whilst it canbe painful for the business builder, it doesnt actually impress would-be funders as muchas you might hope. Few commercial equity funders are going to factor it in seriously,so dont overplay it. Sweat Equity is more a universal reality of the start-up landscape thana particular highlight of any speci c funding equation.

SAVINGS very useful: it can often be astonishing what are the exponential successpossibilities opened up by having some real money even quite modest amounts - at theabsolute start. Even if trade proper due to resourcing needs cannot begin before substantialfund 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 closegrouping of people stump up what is frequently the highest risk capital of all. It can be greatif you can acquire this absolutely rst stage investment. Numerous successful businesses,

particularly those which absolutely require some hard assets, owe their existence to thiskind of funding. It is also a great leveller of false hope and hyperbole. Does it really feelright? Does it seem OK to take money off these people? Is there genuinely a fair chanceof really good returns, or are you just shooting in the dark and projecting all theexaggerated con dence 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 aretreating it separately to EQUITY as de ned later in this typology. Family & Friends isnormally of a modest scale and of a relaxed nature, free from various restrictions andobligations, which makes it signi cantly different in possibilities and character fromsubstantial, externally-raised equity.

GRANTS there have been a few around in recent years. Many of my friends have availedof Innovation Vouchers to improve their online presence. There have also been a number of

This section comprises two sections. Firstly, we review the maincomponents in the corporate nance mix as they tend to concernearlier stage businesses.

Secondly, we revisit the Funding Enterprise Framework and offera 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 whichto consider their options.


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16 Funding Options

apprenticeship and intern schemes running, which have created early labour possibilities.Intelligently thought-through training support can also help plug speci c labour shortages.But grants are only some icing on the cake if you can get them, not the substance of anyfunding mix. There will continue to be some grant possibilities oating around, whateverthe 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 numberof 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 havevariously been grants or other funding/support opportunities, including awards, returningto work, graduate entrepreneurship, rural enterprise, womens enterprise, BME enterprise,and other small pots open to speci c criteria.

LOANS heres the short story: there never was a huge amount of loan funding for earlierstage businesses, nor was it often the most appropriate kind of funding, and there is evenless of it around at the moment. The reason for my rather sweeping statement about theinappropriateness of loan funding is very simple the majority of earlier stage businesseswhich require funding could equally well do without incurring the repayments that loanfunding requires.

Businesses that can rapidly be so robustly cash positive as to be capable of loanrepayments, on top of the 1,001 other calls on cash, are rare indeed. Fresh enterprisecreation is very different from using loans to buy existing businesses with proven cash ow 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 moneyto sit somewhere between equity and loan in risk pro le and obligations - but it is as yetfar from clear whether such concepts will materialise, or be available in suf cient amountsto represent anything other than a drop in the ocean.

A number of bankers have explained to me, privately, that earlier stage funding via loanswas probably an area which high street banks should never have entered in a majorway in the rst place; it simply wasnt the type of business risk to which banks weredesigned to expose themselves in any large measure. It was something they drifted intoover time and through competitive positioning against their peers: now none of themwants to plunge back into this market.

If you do wish to pursue earlier stage bank funding, be aware that in the rather unlikelyevent of its availability, it will almost certainly come with a level of security that will effectivelymake it a personal loan against you and your assets.


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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 thateven these sometimes require a personal guarantee and, by and large, they would onlybe open to operations which fall developmentally towards at least the mid-point of earlier stage as de ned herein.

OVERDRAFTS overdrafts can be dangerous things for businesses, particularly so forearlier stage enterprises (and they are exceptionally hard to obtain currently). An overdraftis simply an expensive loan with onerous conditions. A frequent problem is that taking onan overdraft usually brings some short-term relief, then long-term pain - sometimesterminal. It is often extremely dif cult to generate suf cient funds to pay off an overdraftand thereafter it can act as a millstone around the neck of a small business. The samegoes 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 pro ts. But however they are dressed-up, they cannotconceal or mitigate against the reality that businesses are forced to use them as a poorsubstitute for additional equity.

EQUITY the lifeblood of capitalist enterprise: long-term money which sits withina company in the hope of capital accumulation. Whereas Family & Friends investmentis essentially an act of faith in you from your close circle, private investor, business angeland institutional equity is based on a more rigorous assessment of the enterprisesprospects and usually matched to more speci c objectives and tighter obligations.

Equity comes mainly from these three sources: private individuals, investment funds andotations on stock markets. Only the rst 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 aFamily & Friends seed round, right through to high pro le specialists in a particular sector.Private investors who tend to make a habit of earlier stage investments go by the nameof business angels, who may operate individually or in syndicates.

On occasions, business angel matches appear to be made in heaven, when expertise andsupport accompanies hard cash into earlier stage companies. But business angelmatching also suffers from two systemic problems:

There are frequently more tyre kickers and time wasters in the mix, as well asaccompanying armies of advisors and self-styled introducers, than there aregenuine 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 styleadversarial culture, run the risk of parading precious intellectual property and ideasbefore all and sundry. More reputable attempts to establish contacts and courtshipbetween projects and potential investors, such as those established by RegionalDevelopment Agencies, often still expect a considerable amount of potentiallysensitive information to be widely distributed all-but blindly.


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18 Funding Options

Funding Enterprise is committed to improving the ow 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 rst iteration of this Essential Guide is being prepared at a time of exceptional uxwithin the enterprise support and investment landscape.

A general backdrop is the emergent situation with regard to the Local EnterprisePartnerships (LEPs) and the Regional Growth Fund (and what may follow its three pay-outrounds), 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 uni ed, determined, competent and creative LEPs will be in superior positionsfor any assistance going. At this stage it is very uncertain how much, if any, of the RGF will

lter through, as direct cash support (or useful indirect supports), to any regions individualenterprises.

LEPs will either emerge as lean and effective replacements for the RDAs, or asemasculated 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 RegionalDevelopment Fund (ERDF) backed venture capital (VC) and loan funds. The soon-to-beabolished 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 andmanagement of such funds. Various strands of existing research and a body of anecdotalevidence from within both the U.K. and other European countries has in the pastindicated that:

The management charges on such funds can signi cantly exceed those which arethe 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 managementpriorities move from the commercial norm of maximum returns to the need to be seento backing as many projects as possible (hence low sums) and the objective forthe 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 dangerof a semi-monopoly, with companies failing to engage as well with often less high pro leVC alternatives, these new measures will certainly provide competition with business angelfunding.


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Funding Enterprise is committed neither to the interests of individual project promoters,nor to those of individual funding providers. Our commitment is to improving therelationship between investment capital and promising projects in the interestsof growth and value-creation.

2. Funding Enterprise Framework case studies

We believe it is important that business founders and owners develop a clear appreciationof 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, includingthe investment of capital, is utterly central to all business planning. This is the rst operatingprinciple 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 fundingproviders but also within policy and support circles. Some of the policy questions beingraised include:

Is a trend towards winner-picking strategies, emphasising high growth, overlookingthe increasingly limited funding options for the self-styled smaller businesses, whichmay in fact evidence high sustainability and a major aggregated impact on overallemployment levels?

Are there risks that a bloated and quite ineffective State enterprise support sectorwill be replaced by a leaner but still quite ineffective semi-State enterprise supportsector, still under-skilled in the central requirements of value creation? What role doesthe State realistically have in enterprise support?

Do we require a much more fundamental debate about the ows of capital into earlierstage capitalist enterprise? Have we become overly xated on squeezing reluctantbanks 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 ownknowledge and to provide them with insights and benchmarks against which to considertheir 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 :


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20 Funding Options

These examples are worked up in greater detail below. These funding scenarios cannotre ect every possible situation: they are intended to help all those connected to the fundingprocess to understand the kind of thought processes and possibilities which best frameand 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 compositesof several operations, assume that funding seekers intend to create a business from theoutset at a Scale A, B, or C. This approach inevitably overlooks both organic growth andalso the unexpected changes to most businesses over time.

We present these examples in this way because this guide is about earlier stagebusinesses: 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 Guideto Development & Mid-Stage Corporate Finance.

FIXED RETAILA: local, general pet store

This is not a VC proposition. In fact, with the possible exception of ManufactureHigh-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, spanningsmaller 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 achamber 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

nderC: e.g. international discount book

and music provider

Consultancy A: 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 muf ns

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

forecourt and convenience stores

C: 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 packagingmanufacturing worldwide


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21Funding Options

just been refused bank nancing for the acquisition of another chip shop, also witha sound trading record.

One can understand the clearing banks wishing to withdraw from their somewhatstrained position as providers of quasi-VC and higher risk development capital.

However, a reluctance to transact simple and transparent asset-backed businessnance is another matter altogether.

This is another example of why we may need to conduct a more root and branchdebate around the ows of capital, much more comprehensive and constructive thanthe ongoing cycle of Government exhortations for the banks to lend being followed bycompliant 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 justi cationis there. But is there room for another large scale entrant? Where is this propositionstarting from, calculated opportunity or ill-considered imitation? If the promoters areexperienced caterers and themed restaurant owners, this could well justify substantialVC and a plan to execute the simultaneous opening of several outlets and a rapidroll-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 acceleratingthrough a Proving phase and thus attracting potentially even more substantialVC backing. Whatever, the experience and the detailed plans of such promoterspermit 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 characterisesmature retail markets is the declining opportunity to achieve success via the organicgrowth of a micro-business. In the UK it is now highly unlikely that a premier leaguegeneral grocery chain is going to grow from Scale A right through to Scale C.

It is possible for there to be signi cant asset-juggling at the topmost Scale and forniche, Scale B businesses to emerge: but the days of market stall to a superstore inevery 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 launchedthrough major private investment and VC at an immediately signi cant scale. It mightbe country speci c at rst and then take on major additional investment at its momentof Transitioning into international markets.


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22 Funding Options

It is through the disruptive dynamics of air and innovation that fashion phenomenacan emerge and develop with great speed. It is in such emergent scenarios that boldand committed funders can reap great rewards.

What about High Technology?

The preceding points about Scale possibilities the connection of disruptiveinnovation with marketplace desire - invite a brief consideration of High Technologyearlier stage projects. In terms of high-tech growth funding, this guide has deliberatelynot made such operations its primary activity focus. The sector can easily becomean obsession to the detriment of all other value-creation possibilities.

It is indeed very much possible within high-tech for massively disruptive innovation notjust to enter and lead markets but even to make massive markets from scratch ina remarkably quick time. This is the sectors ultimate allure.

However, similar (if rarely quite as spectacular) phenomena can and do emerge withinmany sectors and we have resisted the temptation to create a separate categoryof 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 achieveas monetisable value-add within our typology of Funding Sectors, rather than beingswept along by claims of how intrinsically clever it may be.

Finding a valuable place in the economic world is frequently a greater challenge thansimply nding something that is technologically new.

ONLINE RETAIL

A: watercolour painting consumables supplierAgain, 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


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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 thatthe days of any excitement simply in using the Internet as a distribution medium arelong gone.

Online Retail -B: national property rental tenant nder

The UK property market is vast and so are the numbers of earlier stage companieswhich have failed to carve out a sustainable business within it. Innumerable marketentrants attempt to compete in the ostensibly lucrative areas, most notably salescommissions, and this ongoing supply of competition constantly downgradesreal-world pro t potential.

A similar observation could be applied to large parts of the nancial servicesdistribution 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 acombination of attributes. These may include a disruptive distribution channel ( rstcompetent mover advantage in new ways of doing business in both the property and

nancial services markets has certainly been effective for some), sustainable margins(but also margins that are not so very easily achieved that it makes imitator competitiontoo easy), a carefully judged price carrier (e.g. the embedded commissions of pricecomparison sites), a fresh marketing appeal and highly nimble management.

Executed well, such agile propositions can move through Proving rapidly into majorVC-backed expansion. However, given the precision (and luck) required to negotiatethe marketplace and competitive variables, such operations are most likelyto discount at least some of the early risk through a reasonable level of personaland private investment before commercial providers come on board. The IntellectualProperty in such operations is more in proof of survivability, than in any one thing thatis compellingly radical.

Online Retail -C: international discount book and music provider

Yes, the very idea invites the question, But what about A****n?, doesnt it?

Sometimes the leverage of rst mover advantage and the pursuit of marketplacedominance is bought with vast amounts of investment money (and that is without thesubsequent and at least as substantial challenge of developing the management skillrequired to maintain leadership).

There are still major online opportunities to be realised, just as there are species in thedeepest 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 therewas so much resting on success that there was a tendency to keep raising the stakes,


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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 exceptionalproject to leverage a Scale C online retail start-up with the fullest weight upfrontfunding.

CONSULTANCY A: local book keeping service

Again, it tends to be savings, Family & Friends and a good deal of bootstrappingwhich 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 nance issue withinmid-sized services operations: value that can be captured in terms of an investmentexit is not always synonymous with the cash generation of the business. Quite oftenthe key knowledge and drive of a business can be embodied in possibly just oneperson, or perhaps two or three at most.

Such a scenario of owner-driven passion will make it quite easy for medium-scaleprivate investors to back such a business on the up (their value realisation needs canbe met by dividends and buy-out options). However, potential larger scale VCinvolvement may struggle to establish a basis on which investors can envisage apro table exit within three to ve years.

Careful thought (not to the exclusion of the extremely hard task of buildinga substantial business in the rst place) needs to be given to how potentially divergentagenda may be accommodated. It may be worth discussing early on with possiblemajor backers whether the key promoters may be amenable to lock-ins and/or partialearn-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 reconcilethe aspirations of promoters with those of institutional funders. Another might be anaggressive 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 matcheswith possible funding requirements. This is the particularly the case with highlyexperienced promoters who might reasonably expect to deliver strongly on their plans.

Funding strategy can often be much more sophisticated than simply building up anIP-rich company as quickly as possible and everyone walking away happily after a sale(or a otation) within just a few years. Perhaps there used to be slightly more truth insuch a portrayal but many simplistic corporate nance guides continue to misrepresentthe subtleties of not just creating value, but also of extracting value.


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25Funding Options

Consultancy -C: sophisticated major corporation IT systems integrator

Some consultancy operations are way beyond the realistic product of organic growthand creative partnering. Traditionally the larger professional services companies,

such as accountancy practices and solicitors, have grown over substantial periodsthrough many mergers, takeovers and strategic expansions. Cash needs andbalancing transactions during the absorption of other practices have beenaccommodated through a combination of ownership adjustments, partner cashcalls and a degree of bank borrowings.

Such a model is inapplicable to, say, IT & Communications operations which promiseseamless international support to clients who are themselves widely internationalised.

Partnership ownership and partner equity contribution might permit a basic corporatestructure 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 thefunding possibilities of Scale C consultancy/services operations.

Whilst higher IT complexity may give a consultancy a avour of defensible IP,it is always the quality of the commercial relationships which most strongly whetsinvestment 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 askingfor 10M, it is just as much what have you done.

MANUFACTURE LOW-RESOURCEA: wedding cakes and muf ns to local outlets

Food production either begins with at least some scale of manufacture and internalexperience and competence in establishing distribution, or it will forever struggleto 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 extremelydif cult for even substantial newcomers. These include the credit and scale demandsof the major multiples which dominate distribution, the ever-tighter web of regulationwhich governs production and the high marketing support needed to move beyondthe smallest of marketplace niches. Most of the food industry, except to highlyexperienced 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 projectwhich might attract sector-knowledgeable investment backing. Like the followingScale C example, this investment proposal stands or falls on sectoral understandingand marketing savvy.


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26 Funding Options

Over the years I have seen so many Manufacture Low-Resource proposals whichunderestimate marketing realities in a similar way, that I have come up with a speci cname 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 themarket, then we will be very successful, and if we go on to only capture 20% of themarket, we will be incredibly successful!

The start point of spotting Manufacture Low-Resource possibilities (and avoidinggetting sucked into myriad variations of marginally survivable metal bashing andinjection moulding) is to consider the manufacturing itself only as a necessaryoverhead. 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 playersif that makes more sense than a competitive, spoiler launch of their own.

Strong promoters with compelling plans can attract substantial funding withinManufacture Low-Resource.

But it is always a question of why hasnt someone else someone with substantialresources already in this marketplace done this before? And Plates to India Plans arealways going to go nowhere.

Manufacture Low-Resource -C: collectible soft toys

Until relatively recent times there were still marketplace entrants seeking toaggregate 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 theconglomeration of traditional insurance funds). This kind of asset-shuf ing activity,which involves high-level share swaps, shell companies, de-listings and re-listings andsometimes substantial private equity, is beyond the core remit of this guide: the onlyearlier stage element is the new corporate shape and vehicle, whereas FundingEnterprise is more concerned with the creation of new value through investment,rather than with the leverage of marginal extra value via nancial engineering.

A compelling focus under Scale C Manufacture Low-Resource is thus onphenomena creation.

How is it that many stuffed toys clutter the shelves of pound shops, whilst certainranges have legions of committed followers, eager to pay top dollar for new releasesand 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 createa massive international brand success?


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Behind any success emanating from basic technology (and the example here is in anyevent based on sub-contracted manufacture) and what it can make lies a much moresophisticated psychology of what sells. Any sense of build it and they will come is notpart of a smarter marketing formula. Success is not about switching on machines inblind hope, it is driven by turning on consumers with brilliant strategy born of soundexperience and research.

Manufacture Low-Resource, particularly in relation to Earlier Stage Funding, is lessand less these days about mechanical widgetary and much more about marketplacewizardry.

MANUFACTURE HIGH-RESOURCEA: niche components for UK defence industry

With the possibilities of tremendous nancial return from Manufacture High-Resourcecome particular threats. Each of these examples A, B & C - identi es, 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 mightnot necessarily make a compelling case from risk capitals point of view.Single customers, extremely long order placement cycles and unpredictable ordercontinuity do not make for the most immediately compelling investment case.The potential downside, as in this Scale A example, of having highly specialist andpotentially 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 Institutionstechnology research. Whatever the rhetoric of commercial connectivity and suchinitiatives as knowledge transfer, those of us who actually consult regularly with earlierstage academic spin-outs understand the gulf that still frequently exists betweenresearch 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 withsuch research as is funded, commercial opportunities will continue to go beggingunless 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 potentialbarrier to securing funding (and to business success) now moves from the narrownessof the market to the ability, or otherwise, to compete with much bigger players in abroader 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


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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 shouldersone can hitch a ride without losing ones 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 worthvery little.

The business funding process is primarily located within the art of innovative valuecreation, 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 howgreat new solutions have depressingly often failed to translate through intomarketplace success.

Moving from blue sky thinking to commercial traction is about much more than simplyapplying 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 whichare seeking to move through R&D into marketplace connection have raised an arbitrarysum 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 fundingthan it is of VC. It does no-one any favours.

I call this Point to Nowhere Funding, which lacks any logical link between expenditureand achievement stages within a developmental plan. This is in contrast to Point toPoint Funding, where the project promoters attempt to be able to show emergentprogress against an overall plan. Even if a rst round is not going to stretch all the waythrough to commercial trading, pegging funding to progress in this way gives comfortto funders by way of deliverables and greatly increases the chance of establishing asequential plan for ongoing funding against measurable achievements.

The greatest achievements in the life of any earlier stage business are making its rstcommercial sale and its second commercial sale (in case the rst was a uke).The majority of start-up businesses fail before they reach this point. This soberingreality is as true for IP-rich Manufacture High-Resource concepts as it is for anybusiness idea.

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

measurable moments of costed, cumulative and assessable activity.


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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, softwarecan sit within Consultancy.

At a more sophisiticated design and integration level, such as legacy rework ande-commerce enablement, plus the development of general applications, softwaremoves 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 ServiceOriented Architecture and Cloud Computing, software enters the territory of Manufacture High-Resource. This is particularly the case where there are strong callson highly specialist labour, coupled with extensive and uncertain R&D cycles.

Again, as with all technologies, the key questions revolve not so much around thetechnological cleverness (which must exist as a baseline quali cation in the fundingequation) but rather with the methodology and likelihood of pro table adoption.

Software, at all levels, but particularly within the most lucrative parts of businessmarkets, is dominated by a number of key incumbents. They seek to ll every availablespace 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 fundingmission.


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Valuations can easily become the most contested area of potentialinvestments into earlier stage businesses. TV entertainment showsabout 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 andinvestor can radically enhance the chances of business success and value creation.It will entail a comprehensive assessment of risks and potential and allow an emergentsense of fair value to develop through mutual agreement. Any deal that closes in hasteand resentment, or even anger, carries massive risks of project failure.

Any deal where one party feels that it has achieved excessive advantage over the otheralso 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 bothparties and gives maximum headroom for value to grow tends to feel right , rather than beprovable in all dimensions via numerical logic.

In our experience, however, valuations can usefully be envisaged at a high level through ourve part Funding Valuation Quotient, which is the nal part of the overall Funding Enterprise

Framework.

FUNDING VALUATION QUOTIENTThis typology captures the expectation and commitment level at which funds are placedinto a project or business. It is a con dence indicator partly the con dence of thepromoters but mainly the con dence of the funders in the competence and capabilityof 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


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31Funding Valuation & Ethics

Present is the least relevant to earlier stage funding. It is a funding valuation basedmainly on historical performance and asset values. It is more about longer-establishedbusinesses in a Sustaining mode than an aspirational gure related to future valuecreation. Hence we move on to:

Present + (pronounced Present Plus) is the rst step on the Quotient ladder to re ecta relationship between current funding commitment and future potential valueaccumulation. It is a rather unsatisfactory funding situation but one which occursall too often. It envisages a modest quantum, coupled to a low valuation based onmoderate expectations of mid-term value creation. Thus the promoters have cededconsiderable ownership for a funding package which neither envisages, nor whichcould stimulate, breakthrough growth.

Whilst this might alternatively be an expression of investor greed rather than a lack of deep con dence, neither of these motivations are ones on which deals should bemade. 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 toperformance.

And, secondly, if there were serious doubts about core viability, then it should havebeen a case of back-to-the-drawing-board all round. Either a rmer plan emerges,or a decision must be taken (by both parties) that this project, at this time, is not acredible funding candidate. A Present + funding proposal may well be characterisedby 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 whichre ects substantial but probably not majority investor ownership in exchange fora substantial tranche of investment, set against valuations and goals on which bothparties are clear and con dent. They know where they want to try to go next togetherin terms of signi cant value creation.

Future Now is a more clear cut and determined play where there is a sense of a moredeeply discounted risk element. The intention is to act decisively and bring to life futurepotential quickly through sizeable investment.

This con dence might come from the directly relevant previous experience of thepromoters, 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 throughdecisive Proving into encouraging trading.

Future Now strongly anticipates signi cant future success and re ects thisby backing the business with a high quantum to seek to accelerate growth.It leaves a post-funding stake for the promoters of still signi cant ownership

(though not necessarily majority) certainly enough to incentivise them greatly andto allow enough headroom also for further funding rounds. There is a strong commandof Point to Point Funding and the incremental steps mapped-out track over a lotof territory with adequate funding cover.


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Hothouse is a funding intent to hit a C Scale business at full tilt. The promoterswill readily accept quite heavy dilution in exchange for acquiring a nancial partnerwilling to fund totally committed execution. These are rare scenarios and will involvea combination of gold standard propositions, high marketplace desire and/or marqueepromoters.

The Funding Valuation Quotient is our nal typology, designed with the other typologiesto 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 assessmenttool. 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 seekingto persuade, rather than enjoin.

And for funders, if they are genuinely convinced of potential viability, are they sure thatthey are giving the project the fullest chance to thrive through motivated promoters andsuf cient funding?

Because this is what Funding Enterprise is all about bringingit from a smoke and mirrors struggle to an honest appraisalof capability and possibility. When both parties feel that thereis great potential and that they have given up enough but no more,when they have agreed what they are going to seek to achievetogether, then thats what we can call enterprise funding.


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SHARING, COPYRIGHT & PROPER ADVICE

We actively encourage the use of our framework and terminology. Our intention is tostimulate more productive relationships between funding providers and funding seekers,increasing value-added and stimulating wealth creation, with all the associated bene tsof 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 dont do sowithout acknowledging where they came from, please dont try to make money from themand please dont change or dilute them in case they end up meaning something which wedidnt intend.

The key elements to which we draw speci c attention are:

THE FUNDING ENTERPRISE TYPOLOGY:

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

Funding SectorsFixed Retail

Online RetailConsultancyManufacture Low-ResourceManufacture High-Resource

Funding ScalesA: Of localised, or highly specialised

intent, likely to sustain a smalleroperation.

B: Of larger regional or national scale,

or specialist export markets.C: Substantial operations with the

capability of signi cant nationalmarketplace share and/or successfulexport growth.

Funding StagesPlanning

ProvingTransitioningSustainingStruggling

Funding Valuation QuotientPresentPresent +Present ++Future Now

Hothouse

Other Key Terms:Point to Nowhere FundingPoint to Point FundingFunding Enterprise (as a nationalorganisation)corporate nancenorthwest(the web and public face of FundingEnterprise in the NW)

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

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Essential Guide to Earlier Stage Corporate Finance