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Private Finance: Business Angels and Venture Capital

NIC Document

Summary

This guide outlines how a business angel or venture capitalist can be a source of private sector equity finance for your company and how to prepare for negotiating with them.

In brief

  1. Business angels
  2. Venture capitalists
  3. Corporate venturing
  4. The private financing process

Introduction

Raising equity finance for a new venture or business growth can be critical, but also time consuming and complex. To raise equity finance, your company needs to be structured accordingly, normally as a private limited company. You should recognise that in raising equity finance, you are reducing your ownership and control of your business by selling shares in it.

Business Angels

Often involved in early stage company growth, a business angel is an individual with a background in running a business and sufficient personal wealth to invest in a new venture. They will generally prefer to invest in an industry in which they have personal experience. You can also access angel networks, in which individuals pool their resources to make larger investments. The UK Business Angels Association (BBAA) www.bbaa.org.uk is a national group that provides information on over 20 angel networks in the UK. Before making an approach to an angel or angel network, you should prepare a business plan and a valuation of the business. If you wish to take this funding route, you should also consider structuring the company so that it is eligible for the Enterprise Investment Scheme (EIS). This scheme provides tax relief to investors and enables them to gain a higher return when that investment is realised. Most angel investors will preferentially invest in a company with EIS over one that is not eligible. You can find more information on the scheme on the HMRC website: www.hmrc.gov.uk/eis.

Venture capitalists

Venture capital is a type of equity finance providing committed share capital to help companies expand. It can be used through all stages of growth, from early days to expansion, and for management buy-ins and buy-outs. A venture capitalist generally looks to invest £2 million plus with a clear exit route, via trade sale or flotation, after three to seven years. There are some venture capitalists with smaller funds for investment in early stage companies who will invest less than £2 million in a company. You can find more details on the website of the British Private Equity & Venture Capital Association: www.bvca.co.uk and the website of the European Private Equity and Venture Capital Association: www.evca.eu.

Corporate venturing

This term is used for a range of mutually beneficial relationships between any type of company, but generally between a larger company and a small independent, unquoted company. The smaller company benefits from direct capital investment, as well as by gaining valuable skills and knowledge and access to markets and distribution networks. The larger company benefits from potentially new products or technologies, without the need to acquire a new company. The Corporate Venturing Scheme (CVS) provides tax incentives under qualified conditions: www.hmrc.gov.uk/guidance/cvs.htm.

The private financing process

Company valuation: In order to sell a share of your business, you need to know its present day and future value. You can choose from a number of approaches, but without a proven accurate formula, a business is essentially worth the price that someone will pay for it. It can also be valued on net asset value (assets less liabilities) but this does not take account of business know-how or other intangible assets. More reliable valuations can be gained from:
  • Discounted cash flow methods that look at predicted income streams
  • Comparables – examining the value of similar companies within the sector to calculate a value for the business
  • Price per earnings ratios
  • Entry cost – i.e. how much it would cost to set up the business from scratch

Presentation to potential investors: Before starting negotiations with a potential investor, you need to ask yourself some serious questions and your management team should thoroughly understand and be committed to the business. Your presentation should give an accurate and detailed report on the present and future potential of the business and take into account the information that the investor is looking for. You should offer a range of options for investment.

Initial negotiations: You should be prepared to negotiate on terms other than the valuation of the investment. If a venture capitalist (VC) asks for a board appointment, ensure it adds value. The VC may want rights above the normal voting rights of a minority shareholder on decisions such as further share issues, disposal of assets, authority to incur expenditure over certain thresholds, etc. Know your bottom line position before entering any negotiations.

Due diligence: After the initial offer has been negotiated, the investor, or possibly external consultants on their behalf, will carry out due diligence to provide a detailed assessment of the financial and technical feasibility of your business proposition. The purpose of the due diligence process is to ensure that the investor is aware of any issues which may affect the ability of the company to achieve its business plan targets. The due diligence process can sometimes be used as a resource to drive down the valuation of the company.

Final negotiations and monitoring: Once the VC has completed due diligence, they will finalise the offer terms and draw up the final documentation. Ensure that your legal advisors read all documentation and check all changes thoroughly.