Previously we blogged about Top 10 tips for entrepreneurs when pitching to investors. This week we are looking at things to consider before making an investment into an Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) qualifying company. By way of background, Enterprise Investment Partners is a boutique corporate finance house specialising in tax efficient investments. We see hundreds of opportunities and wanted to share some of the key things we look out for.
The first thing that we tend to look for in an investment is a unique product, service or idea. Does the product or service solve a major problem, or have a significant advantage over other existing methods? There needs to be a clearly defined differentiator ensuring the opportunity is distinct when compared to anything else in the marketplace.
Often, as I’m sure we have all seen on Dragon’s Den and other TV shows, entrepreneurs come up with ideas for solving problems that don’t really exist as can be seen in the video below! A valuable unique selling point (USP) is therefore key to securing a business based investment.
How is the business going to generate revenue? Many tech companies such as Facebook and Twitter seek to grow their user base and then drop in advertising revenue streams at a later date. This means that it can be many years until the company begins to generate revenue.
However, more traditional businesses such as bars and restaurants will typically be generating revenues much more quickly due to the nature of their trade. It’s extremely important to recognise the potentially varied revenue streams and the timeline to revenue generation.
Throughout this process we will typically be looking at the individual/team’s capability and relevant industry experience. What we really want to know is whether or not an individual/team is actually capable of delivering the proposed product or service. Using information such as a track record and CV can help identify their relevant skills, experience and capability. Given the importance of the quality of a management team to the success of a company, reviewing credentials is time well spent.
Valuations in early stage businesses are extremely difficult and have to be managed delicately. The entrepreneur will need to get what they believe is a fair amount of equity in return for their time and energy contributed, as well as having come up with the idea/concept in the first place. The entrepreneur and investors will also need to consider the dilution of their ownership if it is proposed that there will be subsequent rounds of fundraising.
It’s important for the entrepreneur to maintain sufficient equity in the business to ensure that they remain motivated to contribute so much of their time and energy. The investor needs to obtain enough of a percentage so that they feel like they are maintaining value for their investment. Benchmarking can also prove challenging as valuations between types of business can vary significantly.
Typically tech companies will command much higher valuations than more traditional businesses based upon their future potential. Unfortunately there isn’t a standard approach for valuation, each investor needs to make sure that they are comfortable with their decisions based on current and future valuations.
If there are any potential tax reliefs such as EIS or SEIS, investors need to ensure that the company will qualify. The way this process works is companies approach HMRC for what’s called “Advance Assurance” by completing an application form. HMRC then respond to advise, based on the information provided, whether or not the company should, if it carries out the trade as described, receive EIS/SEIS relief.
If an investor has a stake in a company which no longer carries out a qualifying trade, there is then a risk that they will not receive their tax relief. Accordingly investors should seek a copy of the Advance Assurance, or at least confirmation that the company does indeed qualify for tax relief.
The content of this post is up to date and relevant as at 26/03/2015.
Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.
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