The number of early stage technology businesses continues to increase in Scotland with various technology incubators and universities providing more support than ever before to help entrepreneurs develop their ideas into a business. However, creating a successful technology business will require investment and this is rarely a simple process.
The level of investment required will be different for every business, but for most technology businesses the funding model will be very similar with significant investment needed early on to develop and commercialise the technology before there is something tangible to take to market. This creates an extra level of risk but the risk should be offset by the potential returns.
Any business looking for funding must consider all options including grant funding, debt funding and equity Investment. However, most early stage technology businesses will find that debt funding is a non-starter so grant funding and equity investment should be considered as the most likely sources. Grant funding will be available for certain technologies but in most cases the level of grant funding will be limited so equity investment will almost always form part of the overall funding requirement. Therefore, identifying and attracting the right equity investor to the business is critical for most technology businesses if they are to succeed.
For equity investors, technology has led the way in creating quick returns which are rarely seen with more traditional businesses and double digit returns are not uncommon. However, with this comes the risk that the technology will take longer to commercialise, require additional investment or even become obsolete. As a result, the fundraising process becomes much more challenging as investors increase their level of due diligence when faced with a potential all or nothing return.
Thankfully the prospect of backing the next technology success story is where many investors want to be, so now is a good time to be looking for investment. But with more technology businesses competing for investment, here are some key points that every business must consider and address before starting a funding process:
- Can the business show credible market support and demand for its technology which will create a commercial business if successful?
- Can the business clearly demonstrate the level of funding required and what the funds will be used for? Any credible investment opportunity should be supported by a robust set of cash flow projections and appropriate financial controls to manage cash flows post investment.
- Does the management team have the experience and expertise to deliver the plan? If gaps are identified in the management team then these can be filled by non-exec directors or strategic advisors.
- What possible exit strategies have been identified? Investors will ultimately look for a return on their investment so it is important to consider the most likely exit routes and share these with potential investors.
- Has a realistic timetable been established to complete the fundraising process? This should also include a list of key roles and responsibilities for each of the parties involved.
In practice, some of the most common issues that we have seen from businesses looking for investment and which should be avoided include:
- Starting the process too late which can result in the business running out of cash or missing a critical launch date.
- Not asking for sufficient funds at the outset leading to multiple unnecessary funding rounds.
- Entrepreneurs spending too much of their own time looking for funding rather than developing their business.
- Unrealistic business valuations which have no backup to support the value.
- Not seeking professional advice on potential tax planning or structuring opportunities which could make the investment more attractive.
Completing a successful funding process will ultimately come down to having an attractive investment opportunity which considers and addresses each of the points above before being presented to potential investors.
By Brian McMurray, Partner & Head of Equity Funding at Anderson Anderson & Brown LLP
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