The main concern most entrepreneurs have is funding. Portico Ventures can support you with introductions to appropriate funding streams ranging from grant funding to venture capital (VC) investors.
Intro to financing routes
Most start-up stories begin with the entrepreneur investing their own money and time into the idea they believe in, holding impromptu pitches in front of friends and family, or working weekends to get an initial case ready. The key benefit of being recognised as a university spin-out is that your idea is usually taken more seriously at the outset and you can get input from the academic inventor early on. Beyond this, more established and larger scale funding solutions will be needed to enable you to develop a working MVP, to understand the specific needs of your target customers and adapt your product/service, to expand your customer base and grow your company.
The funding routes below cover the overwhelming majority of start-ups looking to fund their development and growth:
- Bootstrapping. This is a very early stage financing method where you use your income or savings to fund initial work on your ideas, which is why bootstrapping founders usually focus on minimising operational costs. However, it tends to be very short-lived, as personal finance can usually only cover initial work; beyond this, founders generally resort to other funding methods.
- Debt. Borrowing money entails having to repay the loan and the accumulated interest from the company’s profits within a fixed timeframe. While rates might be lower than the equity equivalent, the likelihood that your business will be in a position to have enough revenue to cover interest from the start is extremely low. At later stages in company evolution, debt might become a preferable option.
- Equity. This option exchanges shares in the company for cash. It is by far the most widely used funding route; more information on a typical angel/VC path can be found in the next section.
- Revenue. If you already have an MVP, you might be able to fund further development through your sales, without having to take on debt or give away equity. This funding method can only be relied upon once you have a stable product and established customers, with regular cash flowing into your business. While co-developing the product/service funded by a customer contract might give you access to further funding, be very careful about the customer’s expectations regarding ownership of the resulting IP, or implications of restrictions on sales to their competitors. Take legal advice is you are considering such a route.
- Grants. Especially at the beginning of your journey, grants can be very helpful, as they bear no interest or equity charges. UCLB can recommend internal UCL grants, as well as government or private grant sources, that fit with where your idea is at the moment. Do take into account the fact that, once you are incorporated, you can no longer receive grants that cover 100% of your costs (as that infringes state aid regulations), so do take this into account when deciding the appropriate time to incorporate.
- Crowdfunding. This funding route only works well with certain types of businesses (mostly creative B2Cs) and can take two forms: reward-based and equity-based. The former is designed for pre-launch product-centred companies and allows them to raise funds from future customers for final product design and manufacture by effectively “pre-selling” a hotly anticipated product at a special early bird rate. The latter is a mix between a typical equity round and the decentralised online format of a crowdfunding platform, whereby investors can decide to invest small amounts in a start-up (as low as £20) in exchange for shares. Both forms take an all-or-nothing approach, which means that, unless the funding target is reached, the business does not receive the funds.
The graph below summarises the amounts and typical stages at which various types of funding might come in as your business develops and grows.
Standard funding stages
Most of our spinouts choose to fund their development through equity, sometimes supplemented with grant funding or debt. The typical business is likely to go through some of the stages described below. However, as many seasoned entrepreneurs would warn, the timeline and magnitude of investment at each stage will differ greatly from one company to the next. Moreover, other funding routes and models could be considered in between rounds (or instead of rounds), so your own journey might end up looking completely different.
1) Seed Funding
This corresponds to a time in the spinout life where you are developing your product/service, trying to demonstrate that it can fulfil a market need, adding value for both customers and the company. The funding in this round can come from sources as varied as business angels, accelerators, early-stage venture capital etc. Seed funding rounds usually come in two flavours:
- Priced: In this case, the start-up is given a valuation and shares in the company are purchased by investors at the price determined by the valuation.
- Unpriced: Often seed rounds are unpriced, as the value of a company is hard to determine at this point. Instead, an agreement is put in place between the investor and the business to issue shares in the future in exchange for an upfront loan. This exchange could be done through:
- Convertible loan notes, issued as debt that converts into equity under conditions such as the raising of funds under a priced round. They are the preferred mechanism for Venture Capital early-stage funding. Do take into account the fact that this financial instrument involves debt, which means that the company will need to pay interest on the money received through the convertible note.
- ASAs (Advance Subscription Agreements) and SAFE notes (Simple Agreements for Future Equity) are financial instruments that also convert into equity but that are not issued as debt. They are more likely to be used early on by Angel investors. They have the advantage of bearing no interest; as they are issued on short term, they usually bear no maturity date and have fewer terms. ASAs are also EIS compatible: an HMRC scheme that incentivises private investors of qualifying start ups with significant tax breaks.
Other provisions to watch out for as part of your unpriced funding agreements are discounts and valuation caps. The former give your investor the right to convert their loans into equity at a reduced share of the the next (priced) round (standard discounts rates are around 20-25%). The latter put a ceiling on the valuation of your next (priced) round for the purpose of calculating the loan conversion price and is seen as a protection mechanism for the investor to ensure that their loan converts into a reasonable percentage of the company in case of an extremely high valuation at the qualifying (conversion) round.
2) Series A
With the funding from your seed fund, you have built your proof of concept product/service and understood how the business will operate. You have likely understood that your customers are after more than what you can currently offer and you have developed a plan for how to meet real life requirements to and be attractive to a larger number of customers. You have also understood what your optimal business model looks like and can make a clear argument about it based on your experience with the first prototype. At this point, you are likely to have limited, if any revenues and therefore will need to consider raising more funding to keep the business operational.
Investor expectations at Series A is a 10x return on their investment, which means that you will need to demonstrate how the company can achieve that valuation over a 5-10 year time frame. This requires a clear understanding of the needs that your solution can address, of the size of that market and your route to securing a significant portion of it. This may also be the first priced round and is often stated in terms of a valuation both immediately before and after the funding round:
- Pre-money is the company valuation before the new infusion of funds.
- Post-money refers to the valuation after the round is complete. It is the sum of the pre-money valuation and the amount raised during the current round.
You will also see reference to the Share Price which is the pre-money amount divided by the number of shares authorised by the company at the time of the investment event
This valuation enables you to calculate the shares to be allocated to new investors which will be reflected in your capitalisation table. You will also use your ‘cap’ table to account for shares set aside to be allocated as options.
3) Series B
This funding round is usually targeted at funding revenue growth activities, such as increasing market reach. Usually, businesses in this stage are comfortable with their stage of product development and will now invest more heavily in sales, advertising etc. Funding at this stage comes mainly from Venture Capital funds.
4) Series C and beyond
Late investment rounds are used to secure funding for scaling activities. Most late-stage investors (late-stage VCs, hedge funds, investment banks, private equity etc) expect a doubling of their capital injections, so take that into account when planning your expansion.
What to expect from a funding round
Before considering how to move from development needs to pitching to receiving funds, you will need to clarify how much money you need to raise, how much effort that amount will be able to cover, and what timeframe you want it raised in.
While each spinout might have a different experience of a typical funding round, some of the key milestones are covered below.
1. Finding investors
When considering investors, you should view them as partners in your spinout, as after investment it is in their interest for your company to do well. Beyond the funds, they also bring extensive contact networks in industry and wider investment circles. As a budding researcher-entrepreneur, you should do a bit of research up-front on the most relevant investors in your field, understand who and what they have funded in the past, the investment values they tend to prefer and who they tend to collaborate with. Target investors that have shown an appetite in your narrow field or that are well connected in the market that you are trying to enter.
Introductions to the wider investor community can be mediated by Portico Ventures, friendly funds, academic and industrial contacts etc. Ensure you have an “elevator pitch” ready for such introductions and follow-up with a brief description of your technology and how you plant to make money from it. When planning your round, take into account the fact that this stage can take months.
Following a first exchange, investors will want to see your business plan and/or a pitch deck. The latter is a 15 slide investment presentation that covers the product and its competitive advantage, the target market, the business model, investment requirements and key team details. Following that, you may be invited to present your pitch deck to the investor. Your presentation should show your deep understanding of the market you are tackling and the challenges you may expect to come across in reaching it, including the costs of getting there; ideally, you should have key team members present to respond to questions on both the business and the technology side of your spinout. Ensure that the focus of the pitch is on the product/service and its route to market, instead of the technical innovation behind it and be reasonable but not overly ambitious with your forecast revenue growth curve.
Further information on what your pitch should include can be found on the Pitching page.
3. Initial due diligence
Following a successful pitch, investors will start a due diligence process into you and your idea. You may have to supply further information on your plans and technology, demonstrate that you have rights to the IP you are using, have follow-on meetings etc. This step can take several months, depending on your particular situation.
Note that some investors like to co-invest, as it spreads risk while allowing the business to raise more funds (and have higher chances of success). In cases where investors syndicate, one (the Lead Investor) will be chosen to handle most of the negotiations. The lead could also help you secure further investment if you do not have co-investors lined up.
4. Term sheet
Start-ups that successfully complete the previous steps will be offered a term sheet: a brief document covering their conditions for investment. You are advised to seek legal support in interpreting this document, as it is crucial in understanding the nuances of the investor’s expectations of their investment and may impact how you can run your business in the future. The key points to expect in any term sheet are:
- Valuation, the price at which your firm is valued by the investor.
- Investment sums, covering total to be invested by each party and if tranched, the terms triggering the release of the next amount. If investment is to convert at a later date, pay close attention to the timeline and conditions for conversion.
- Class of shares to be awarded to investors in exchange for their investment. Some investors may request preference shares and/or participation rights; ensure you have proper legal advice on understanding what this means for you and other shareholders.
- Information on whether the investors expect (and the number of) board seats, determining who has the majority of votes in case of a board vote.
- Investor consent rights, which typically allow investors to veto company-level decisions where this is a chance that the action may eg affect the value of their shares.
- Terms of investment, setting out expected milestones, corporate governance rules and expectations of communications with shareholders.
- Size of option pool to be created, which is typically between 10 and 20% for an early-stage company.
5. Detailed due diligence
Usually taking place after the term sheet has been agreed and signed, the detailed due diligence phase allows the investor(s) to have a clearer view of your company position, including points around IP rights, contracts, technical competence, finances and team members. Serious investors will go into significant depth and will expect quick turn-around on each question. You will only receive the agreed funding after passing this due diligence step, so preparing a due diligence pack in advance might not be a bad idea. It should contain your business plan, system architecture description, IP licences, IP strategy, board minutes, company registers, financial accounts and executed contracts (employment, supplier, customer as appropriate).
6. Documentation and completion
Once your investors are satisfied with the results of the due diligence, you will need to work with your appointed lawyer, the appointed UCLB business manager and the investors’ lawyers on developing the formal investment documentation. You are required to have legal representation of your own at this step, as you will need to ensure the offered terms are fair and reasonable for the stage of investment and have the resource to negotiate for you where relevant. UCLB lawyers are not able to represent spinout companies as this would put them in a conflict of interest situation (as they are employed to represent UCL / UCLB’s interests).