Financing growth & avoiding dilution

Savings, Angel Investors, Venture Capitalists, Venture Debt - what to get when (& a bit about how)

So let's start with a very busy chart and probably the only thing you need to look at if you're in a hurry. There are four main things to look at: Survival rate (bar chart), Valuations (line), Financing options (second row of boxes), Founder share (bottom row of boxes, with the percentage that keeps getting smaller).

The chart is based on our best estimate for averages for US Start-Ups. Figures in Europe are less readily available so it's hard to be as scientific, but anecdotally, we think they are about the same.

#1 - Founder share matters

Let's start with the elephant in the room that no one ever likes talking about in the world of venture capitalism: the share of the business the Founders keep hold of. As you can see from the chart, by the time a business is sold, the average Founders only own about 12% of the business.

Of course, that needs to be multiplied by the value of the business, but that's down to you - if your idea is great, and you can execute it well and sell it to customers even better, then the value will be created independent of how you finance your business. Dilution matters.

#2 - Therefore, financing matters from day 1

Most businesses are started with the Founders, their friends and their family's savings. Realistically, no-one else is going to invest in an idea. You'll need to at the very least build it before you can convince even the most daring Angel Investor to come in.

You can however be smart about making your cash go further. For starters, make sure you claim R&D Tax Credit on any R&D you do, and if you can, get a government grant. HMRC will refund you about 1/3 of your R&D spending. Government grants like Innovate UK typically refund 70-80% of your expenses on a project, though only about 1 in 12 applications succeed. R&D Tax Credits and government grants are usually mutually exclusive.

Both of those are essentially "free money" the government makes available to help early stage companies. Despite this, we see far too many Start-Ups spend too much time chasing Angels (and being diluted in the process) rather than try to get a grant or making their own money go as far as possible.

First build it with your (and the government's) money - before you chase Angels.

#3 - Sales before Angels

Once you've managed to get something built, remember Peter Thiel's gospel: "you've invented something new but you haven't invented an effective way to sell it, you have a bad business - no matter how good the product." If you can't sell it to customers, you're not going to sell it to anyone, including Angel Investors.

The point of getting Angel Investors is to accelerate your growth, not to kick-start it. You should have some sales, or a readily converted pipeline with contracts signed before you go and see Angels.

#4 - Series A - before, during & after

The answer to when to do a Series A is as late as possible. The more sales you have, and the more milestones you've hit in product development, the higher the valuation you will achieve on your Series A.

A loan may therefore be appropriate to bridge (and delay) Series A. Lenders will likely not bridge more than 10-20% of your expected Series A. Once you are pulling the trigger on your Series A, you may consider doing Venture Debt alongside - lenders will typically lend up to 25% of your Series A in Venture Debt, reducing dilution.

#5 - Growth Loans (aka MRR/Revenue Sharing)

Growth Loans are a relatively new product. The loan amount is based on your existing or contracted revenues, and the lender will be repaid monthly. The advantage is zero dilution, and repayments flex with your revenues. The disadvantage is costs with a high fixed upfront charge, relatively short durations, and inflexibility.

Wrap-up

Dilution is unavoidable but it should be done on your terms rather than on the Venture Capitalists'. Using some debt can help achieve this.