Following on from a post I did last year Mike Butcher of TechCrunch Europe has made his thoughts about the realities of connecting to a famous tech blogger into a slideshow.
If you want to get your startup noticed, look at it from his perspective as a journalist and what generates page impressions!
In the 2011 Autumn Budget Statement from the Chancellor, it was stated by George Osborne that wealthy investors will have a one-off opportunity to earn tax relief of 78%, if they will support business start-ups, the hoped for growth redemption incentive for the UK economy.
To recap, I wrote about the Enterprise Investment Scheme (EIS) scheme earlier in the year. In summary:
Now there is another program called the Seed Enterprise Investment Scheme (SEIS) which goes even further from April 2012:
I am still waiting to see what the position is going to be on Inheritance tax and the minimum holding period.
Let’s run some examples here:
If you made a capital gain of £100,000 you would normally pay 28% of that in CGT. If you invested that £100,000 in an SEIS you would pay no CGT and you would get £50,000 in income tax relief. So for an investment of £100,000 you only pay £22,000!
If you make any losses, say the company you invested in goes to the dead pool, you can offset this loss against up to £50,000 of gains in future years.
It seems there may also be good news for offshore investors. At the moment if you invest in a UK company and you are a non domiciled person in the UK (i.e. you do not pay UK income tax on your worldwide earnings) then you would be exposed to 28% CGT on any profits plus you would pay 50% income tax on any money you bring into the company, the Government now plans to reduce that to 0%.
Tech entrepreneurs may only be liable to only a 10% tax rate.
More news follows….
Accelerator organizations are becoming more popular as they provide a much more hands on approach for investors and tech entrepreneurs. This is Angel Investment on steroids. Normally a selection of promising companies are chosen to take part in an intensive 12-13 week boot camp away from home that will:
At the end of the 13 weeks all the companies are put in front of a group of angel investors and VC’s and the winners will receive funding.
For entrepreneurs it is a great deal, because there is no way, from a cold start, you could get:
1. Massive publicity and recognition
2. Access to Industry Mentors (and ongoing communication)
3. Access to Institutional and High Net Worth Investors (and ongoing access)
4. For founders, it is a great platform to build on even if they do not build on their initial ideas or company
Free office space and the funding is secondary for most companies, the funding really covers your expenses for 3 months as some companies will be relocating.
Some accelerators like SeedCamp are Europe and even US wide and hold these events all across the world. They also hold shorter one-day events where investors can meet with founders.
For the VC’s and Angels who attend such gatherings and become involved with them it is an easier way to spot potential investments after much of the initial screening has been done as well having issues such product/market fit, team alignment, pitch, market size and many other issues dealt with. It also eases the Fear Of Missing Out or FOMO which has caught many VC’s out.
US accelerator programs have upped the game by offering larger financial incentives that is put on a program such as Y-Combinator, TechStars or Founders Fund. “….each new company accepted into TechStars will receive an additional $100,000 in the form of a convertible note. That will be effective for all 2012 programs, and is on top of the $6,000 per founder that TechStars provides in its 12-week boot camps in exchange for a 6 percent equity stake in each startup.”
Accelerators can be broken down into three types, they all do the same thing but have slightly different agendas:
1. Government sponsored (measured in how much employment can be created)
2. Institutional Investment, mainly from large VC firms
3. Angel Aggregation Funds from individual Angel Investors
Seedcamp is a classic example of an accelerator that is funded by VC companies some of the fund is used to pay the operational costs of the programme and some is invested into startups. The return for any accelerator is usually on the equity they take, plus likely positioning themselves so they are offered first refusal on any follow on funding. Another metric that is used to measure success is the number of companies that go on to raise further funding.
Institutional VC’s are not set up to ‘discover’ potentially exciting web startups, there is simply too much work involved and geographic dispersion for them to be effective. A relatively small percentage of their managed funds can be invested into Seedcamp for example and in return they are presented with vestable ‘cleaned’ companies during a demo day.
However, Accelerators are still a relatively unproven business model as they are so young, with most not more than 4 years old. For any investment vehicle the return on the fund is the measure of success, so time will tell. I am under the impression that any investment company or Angel can invest in an Accelerator portfolio company but whether that is post ‘demo day’ or prior I am yet to find out. YCombinator in the US is one of the longest established accelerators (more than 6 years) and has more data then here in Europe.
There are some criticisms of accelerators but I think they are vastly outweighed by the benefits and I would encourage any startup to actively get involved.
Some Accelerators seem to be pure vanity plays by large VC’s. Dog Patch Labs in US take no equity, give free office space and access to mentors and is backed by Polaris Venture Partners who may or may not invest in Dog Patch Labs tenants. Polaris’ main focus is on seed or early stage companies and have recently opened an office in Dublin.
If you are a graduate fresh out of university take a look at these guys who are trying to turn the heads of graduates away from the city and large corporates and into doing their own entrepreneurial venture
I would heartily recommend reading the excellent piece of research in association with NESTA
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A popular way of financing a start up in the U.S is via convertible notes and is the method of choice for most accelerator programs and angel investors.
A convertible note is popular because it is relatively quick and cheap to implement and can avoid the tricky discussion around valuing a start up, at the same time it allows you to set a higher valuation on your company in the future should the business meet its milestones.
The financing works very simply:
The lender effectively gives a loan to the company that also bears an interest rate (this should be nominal) and usually has a time limit. Remember this loan can be recalled but at the same time you can remove the lender by paying off the loan if you deem the lender to be unsuitable to be a potential equity holder in your company. As an entrepreneur you should negotiate for as long a term as possible to raise the next financing in.
If your business then goes on to raise an institutional investment, for example a Series ‘A’ round, then that loan (plus any interest that is rolled up. Interest is usually deferred due to the startup’s need for cashflow) converts into equity at a discount, usually between 15% and 30%. This is to compensate the seed investor for the increased risk at such an early stage.
For example:
Angel Investor pays £10 per share. When the Series A round happens his shares convert a 20% discount (£10 x 20%) = £8. So if the investor gives a £200,000 convertible note it would effectively give him 25,000 shares whereas the Seed A investors will receive 20,000 shares.
To protect the investor, Convertible Notes often come with a ‘Valuation Cap’. The investor usually has an idea of how much the business might be worth pre-money and what he is prepared to pay for his say 20% investment. If the company does really well and raises a high valuation on a Series A round then he will be investing at a much higher valuation than he feels comfortable with and he does not share on the significant upside.
To illustrate, if the investor had capped the valuation at £2.5m then once the discounted value goes above the cap then the cap will be applied, in this case the cap would be applied at (20% x £2.5m) + (£2.5m) = £3m.
If then the Series A round is priced at a £15m pre-money valuation then the investor will get shares at a strike price of £2.5m.
Now what would happen if the company goes bust? In most cases you would lose your investment as it is an unsecured loan and it is a startup with relatively few assets. If the company is sold before the debt converts into equity the investor could get his money back including interest but you need to be careful that does not cause a cashflow problem. Ideally these scenarios need to be planned for and built into any legal agreement.
Unfortunately, most Angel investors in the UK stipulate that any investment must be within EIS guidelines and convertible debt is not a method that is covered. I blogged previously about EIS, essentially it is a tax efficient way of making an investment with 30% income tax relief and no capital gains tax on any profit after three years.
This may change later this year as the EIS has a new scheme bolted on to it called BASIS (Business Angel Seed Investment Scheme). The consultation period for these changes ended on 28th September 2011.
As with all advice, you should seek advice from an authorised financial service provider.
In the very early days of a company often two founders or more will informally come together to build a product or service. Generally it is not often worth incorporating with all the legal fees and paperwork unless it can be demonstrated that the product has potential. However, there should be some form of legal agreement between the co-founders to save some major headaches along the way.
Any shares should also vest. In other words you do not get your shares in the company immediately but over a period of years that you show loyalty and commitment to the company.
It is also very important to assign all IP to the company.
A “Founder Collaboration Agreement” sets out the parameters for such an agreement. SeedHack has started to develop such an agreement that is often used at various Hackathon events to give some structure to what can be a haphazard way to arrive at a product but can produce some surprising results and form great contacts among developers.
Download the SeedHack document.
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One of the many challenges facing the non-tehnical manager is hiring developers. To truly understand who you are hiring you need to have been a developer yourself. An analogy would be hiring a fluent french speaker when you don’t speak French!
I am a fan of outsourcing but it is not always appropriate. If you are building a product I don’t believe you should outsource as to build value in the company you should keep as much IP in the core of the company as possible. Generally speaking I have found that in house developers and out sourced developers do not mix and there can often be clashes.
I have worked in prior positions and hired developers. But how do you know you are hiring someone who is technically competent? Often I would make developers sit tests, these tests would be built using existing in house developers to build the test, outsource resources or friends who might help out.
Now you can evaluate developer skills online http://www.interviewstreet.com/recruit/
Developers were not always hired on getting the best results. Like all interviews it is a combination of factual and emotional outcomes. If you can, ask another developer to help in the technical evaluation. Like all professionals a second opinion always helps.
Asking for portfolio work is always good but the ideal way is to employ a developer and see how they work out but these days many developers are in short supply especially for those who have skills which are current and in demand.
It is important not to be ‘hoodwinked’ by developers once they are employed. Remember if you are not a hands on developer you have no clue if you are being told for example, realistic timelines for the development of a project or whether a particular technology is the right choice because a developer will always choose what they know, kind of if you go to the dentist and he says you need a filling another dentist may say you do not. Maybe the first dentist is having a bad month (I’m sure as a child I had healthy teeth drilled!)
A culture of second opinion can help out again here, once developers know this they will often give the right information, first time around. Developers can be quite protective and often there is a lot of professional competition between even colleagues.
To put this into context, a lot of the information above often does not apply when you are starting up a company and working with a technical co-founder.
Whether you spend hundreds or millions of dollars on marketing your web site, and drawing people to your web page you need to effectively convert that visitor to a member of your site.
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One of the most important factors for search engine optimisation is making sure your hosting server is located in your country target market.
With the advent of cloud computing this can be a disadvantage because of the location of the physical data centre .
There are a few things you need to know:
It is always very flattering to be approached by a VC for potential investment in your company but you should not be deferential to them. They will ask you a lot of questions and probe your business before any investment. At the same time you should also ask a lot of reciprocal questions, preferably before any due diligence process starts. Be patient when waiting for a response but try to set a timeframe and confirm that in your meetings.
Asking questions should be looked upon favourably by any VC company, it shows that you have done your research and you look professional, so don’t be afraid to ask away.
VC’s are companies that also have a business to run with returns needing to be made to their Limited Partners. Knowing the hierarchy of a VC firm and the roles within can you help you to make sure you are talking to the right people and that they have funds available to invest at the right point in time. Here is an example VC company structure:
Limited Partners
General Partners
Principals
EIR’s
Associates
The General Partners must raise a fund. They do this by approaching organisations that manage large sums of money on behalf of others such as Pension Funds, Endowments, Sovereign Wealth, Insurance Companies and High Net Worth Individuals. These Limited Partners will invest in a wide portfolio of asset classes such as property, stocks, bonds etc with a small proportion being allocated to Venture Capital. The VC firm must demonstrate to the LP the performance of their portfolio and strategy.
General Partners
In the VC firm the top dogs are the General Partners. These gents (or few and far between ladies) decide on a consensus basis which startups to invest in and then one GP will sit on the board of that portfolio company. Sometimes you may see the term ‘Managing General Partner’ which usually means this guy owns the actual firm and can overide all other GP’s. In other situations all GP’s are created equal and make their decision collaboratively.
Principals
These are often the GP’s understudies and perform a lot of the legwork in due diligence and in finding opportunities so they should be treated with as much respect as a GP
Entrepreneurs in Residence (EIR)
On occasion a VC firm may recruit an EIR, this is normally an entrepreneur or executive who has a successful track record and has insight into the portfolio remit of the VC and can also help out on the operational side of investments such as due diligence. Occasionally the EIR may work for a portfolio company and may hold a senior position.
Associates
These are the up and coming staff or apprentices who will progress to Principal. They are on the lowest rung of the company but they can be a gateway to a meeting with a Principal or GP.
As an example, some good questions to ask might be:
1. What is your position in the organisation?
2. How long has your fund been running for and when does it expire?
3. Can you describe the structure of the organisation and how are investment decision are arrived at? (Is it a consensus or does one person take the decision)
4. Apart from money, what can you bring to the table? (Introductions, advice, mentoring, recruitment assistance, sales opportunities etc) and can you provide examples of this?
5. Is it OK to speak to other companies you have invested in? Can I talk to people you have had to shut down and to people you have had great success with? (Essential to talk to CEO’s who have already received investment. Also cold call other portfolio companies and not just the ones you are supplied with)
6. How many boards are you currently sitting on? (If it is high, will they have time to spend with you?)
7. What are your expectations in multiples on a return on your investment?
And when all is said and done you have to feel comfortable about inviting this person into your company, sitting on your board and bringing more than money to your company. Here is a cautionary tale. and a realistic one. One more tip, always be honest with a VC and put any problems up front because they will only come out in due diligence and that is a bad way to start a working partnership.
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