1. Get interest free loans where possible
How do companies go about raising initial family/friends funding and what type of share issuance do you usually issue for these initial investors (i.e. preferred shares, common shares, etc.)?
If it's a family and friends round it's most likely to be in very early seed stage. Put together a slide-deck backed up by a few financial forecasts (take no more than a week working on this though) and offer “ordinary” shares with no voting rights. If possible try to get interest free loans – much simpler. Whatever you agree to, make sure you get any agreements in writing and be sure to warn them of all the risks involved.
2. Prove the concept before raising capital
In addition, how do you as the owner protect yourself from dilution during all financing rounds? Do you issue new shares that are non-dilutable?
As a founder, dilution will be part of the game and unless you are able to put in cash to match the investors at each round you will have less of a percentage than when you start – but hopefully a much bigger company! Just be sure you get as much “proof of concept” as possible before raising capital, otherwise you will give away too much too soon.
3. Reduce equity split in three ways
When you are an unproven start-up that needs to raise money, how will an investor value your company and which steps should a start-up take to minimise the equity stake required to secure investment?
An investor will value your company based on your future promise and commitment. If it looks as if a 20% stake (for example) will make 10x return in five years then it's a fair valuation. In general a pre-sales start-up is unlikely to be over £500k. There are three ways to reduce equity given away – firstly, by bootstrapping; secondly, by leveraging equity cash with debt; thirdly, by ratcheting down – having options to buy back shares at a nominal value when achieving pre-set milestones.
4. Value your investor wisely
When an investor brings more than money to the table, how should this experience, advice and contacts be valued?
There is no structured way to evaluate this – typically you can add 2-5% for experience and advice. The “contacts” element could be measured though and it's an option that could be realised if certain doors were made open by the shareholder i.e. an extra 5% if an introduction to a Sainsburys buyer resulted in an order for example.
5. Patents are often a bonus
Do investors look for certain technologies or patentable ideas for their investments?
Yes. If at all possible investors prefer technologies that are patented or have a commercial advantage that is difficult to duplicate. However this is often a bonus. More importantly it is about the team, the idea, the market and the scalability.
6. Keep share structure simple
How should the share structure of the company be set up to allow investment? Should there be a certain number of shares in the company?
Just keep things open and simple – where no existing shareholders hold preference shares. When setting up a company allow for a large “authorised share capital” for flexibility and issue 100 or more allotted shares between founders before more shares are issued.
7. Don’t pay yourself over £30k
As part of any proposal made, should or how should salaries be included? That is to allow founders to go into the business on a full time basis.
Salaries are a touchy point but the profit and loss, cashflow and service agreements should show intended salaries over the next year or two. Most investors frown on anything over £30k a year. They want the entrepreneur to be focused on the big pay day at the exit point – just as the investor is.