Seed Investment / Series A Investment
Do you have a clever piece of technology or novel idea and wish to expand your business? Do you know what are the sources of funding to expand this business? What are the key rights that an investor is expecting if they invest in your company? Read on and find out more.
In summary, this section discusses the following topics:
- what type of funding can a company raise?
- what types of companies attract venture capital funding?
- what are the typical sources of funding for an early stage technology company?
- what does seed investment and Series A investment mean?
- what are the key issues and terms of seed investment and series A investment?
See setting up company for details of incorporating a new company.
What type of funding can a company raise?
A company may wish to raise funds in order to for example, develop its technology, launch a new product or expand its business.
A company raises funds either by issuing shares or by borrowing money from individuals, venture capital bodies or lending institutions. The ability and appropriateness of either type of funding will depend on issues such as:
- the personal financial position of the initial shareholders;
- the ability to raise funds amongst their friends and families;
- the type of business;
- the stage of development of technology;
- the financial position of the business; and
- the asset position of the business.
Equity is a term which covers all types of shareholding investments in a company. Equity has the following characteristics.
- It gives the equity holder ownership of a stake in the business.
- It is unprotected so on a liquidation or winding-up the shareholders will not recover their funds until all creditors and other costs of winding up the company have been paid in full.
- When a company is limited by shares the liability of those shareholders can never be more than the amount which they invested.
- A shareholder has rights in the company; these are set out under statute and common law and can be varied by agreement between shareholders through the articles of association and/or a shareholders' agreement.
Debt is a term which covers all types of borrowings by companies and has the following characteristics:
- Debt ranks ahead of equity on an insolvency of a company. Secured debt ranks ahead of unsecured debt.
- If it is secured this means that the company has charged or pledged certain of its assets to the lender in order to obtain funds.
- From the company's point of view a secured loan will restrict its ability to deal with the assets which have been charged.
- Many lenders will not risk funds in companies with little trading history and/or tangible assets without taking some form of personal security from the shareholders or directors.
- The advantage to the shareholders and the company of borrowing money is that it allows shareholders to retain their shareholdings without dilution.
Loan notes can be a halfway house between equity and debt and be a flexible alternative.
A third party will lend money to a company and the loan will be convertible into shares at a future date or on certain events happening. There would usually be interest payable on the capital amount of the loan notes. That capital sum may be secured against assets of the company. Loan notes may be convertible into shares at prescribed prices in certain circumstances or, instead, will be repayable within a certain period or on certain events happening.
Statutory restrictions to raising funds
Companies seeking finance from investors are, in effect, promoting investments and must therefore ensure that in doing so, they comply with the relevant legal and regulatory requirements which have been put in place to protect the investor.
Section 21 of the Financial Services and Markets Act 2000 (`FSMA 2000') prohibits financial promotion communications in the UK unless they are made or approved by an 'authorised person' (that is, a person authorised under FSMA 2000 to engage in regulated activity) or unless there is an available exemption. There are exemptions available where the target audience is restricted to institutional investors such as venture capital funds, existing shareholders or creditors and certain high net worth and sophisticated individuals such as business angels (or groups of them).
Company law prohibits private companies from offering shares or other types of securities to the public (including any section of the public). However, private limited companies can offer their shares by private placement in certain circumstances.
In additional, companies must ensure compliance with or be exempt from Section 85 of FSMA 2000, under which it is provided that where securities are offered to the public (or a section of the public) in the UK for the first time, the offeror must publish a prospectus unless the issuer falls with one of a long list of exemptions from this requirement.
Seed and venture capital funding is a type of equity investment usually targeting early stage technology companies. Such early stage companies typically have little trading history and their key assets are not tangible assets, which make it difficult to attract traditionally debt funding from financial institutions.
Funds typically invest when the valuation of the company is low allowing for a rapid growth and high return if successful, but can be high risk if such growth does not happen.
The most prevalent sectors for this type of investment are technology (such as software, mobile communication and IT), cleantech (such as smart grid and fuel cells) and life sciences (such as drug discovery and medical devices).
The common expectation is that a fund will be able to realize its investment (typically by a sale or a listing) in 3 to 5 years and will want business plans modelled on this basis.
"Companies seeking finance from investors are, in effect, promoting investments and must therefore ensure that in doing so, they comply with the relevant legal and regulatory requirements which have been put in place to protect the investor."