Protecting your interests when taking venture capital
The stories of companies which received investment after an appearance on Dragons’ Den are legendary, but every so often one turns down the opportunity to work with a famous investor. Such was the case with The Great British Porridge Company, whose founders decided to turn down investment from Tej Lalvani. The two directors appeared on the show in 2018 and initially accepted an offer of £60,000 in return for 22 per cent of their business, but later changed their minds, describing the investment agreement as ‘very restrictive’.
You might have a brilliant idea for a business and need money in order to get started, or you may need a significant injection of capital in order to grow a business which is already trading. While investment from a venture capitalist may seem like a tempting option, it is important to consider two significant issues;
- Are there other options available which may be a better fit for your business; and
- If you are determined to pursue venture capital, make sure you are fully aware of the consequences in the medium to long term.
‘Taking venture capital is like pawning your jewellery; it’s fast cash, but it’s also going to cost you a lot,’ says Dermot Callinan, corporate and commercial solicitor with Myers & Co Solicitors in Burslem, Stoke-on-Trent.
‘When a venture capital company takes a minority stake in a business, they have their eyes on their exit from the start. Typically, they look to keep their investments for between five and ten years at which point will want to realise the value of their interest.’
Different stages of venture capital investment
The suitability of venture capital will depend on where your company is in the business life cycle:
- seed financing allows for a business to be developed, and may be used for research and development or to produce a prototype;
- startup financing could be used for development of a product and its initial marketing;
- other early-stage financing could help with manufacturing and sales for a company which is growing but not profitable;
- late stage venture capital may be provided to companies which have stable growth, but are not yet growing as fast as predicted; and
- other venture capital, may be needed to expand an already profitable company.
A key advantage of venture capital is that it is money in exchange for equity rather than a loan, so there is no need to worry about the cost of borrowing money or meeting repayments.
Good venture capitalists play an active role in your business, bringing valuable skills and experience. They are often experts in analysing opportunities and will help you maximise the outcome for your business’s future. The right person may also have a useful network which they can tap into on your behalf.
You need to be cautious about any external investment. When someone is willing to lend money to you, it is flattering that they appear to share your vision and are willing to take a bet on your efforts, but this does not mean that your business always needs to take it, or that they are right in their assessment.
In return for the investment, you will need to sign a legal agreement which gives away a part of your business and imposes other restrictions. Before talking to a venture capitalist, talk to your solicitor about the type of security that will be required. There will be a requirement for guarantees and indemnities, particularly if your startup does not have any assets or trading history.
You will give away part of your profit (if you are making one) and the venture capitalist will get a say in the key decisions you make on behalf of the company. With your autonomy gone, you have to consult with the investors and get their consent before making any big changes, and you may lose your ability to shape your business in the future. Because of the need to consult more people, decisions almost inevitably take longer.
You may not necessarily obtain the expertise you wished for. Some venture capitalists like to take a back seat, while you might find others are too interfering. Their expectations may be too high which leaves everyone disappointed with the arrangement.
You are always accountable to your investor, which means that you may start to tailor your business to their wants rather than what you think the business needs. You will also have to spend time creating regular progress reports, as you will be required to prove your worth continuously.
Longer term considerations
One of the considerations further down the line is that people in charge of a company can change. As a small company grows into a medium sized one, you may decide that you want to remove one of the directors who signed a guarantee. What happens if you wish to move on? Are you able to see a way out?
If your business does exceptionally well, you may wish to pay the money back. This is usually possible, but it can cost a significant amount.
The importance of seeking legal advice
While it may be more painful in the short term to obtain capital via normal routes, it may well end up saving your business in the long term.
Venture capital is ordinarily pursued once normal funding routes have been refused; although working with experienced and successful investors means that you should be able to tap into their industry knowledge and experience, that isn’t always the case. You will be required to provide guarantees, and the cost of redemption may be significant.
It is vital that if you are considering venture capital for your business, you seek specialist legal advice on the terms on which you are borrowing the money and how much support you can expect to receive from the venture capitalists alongside the investment.
For advice on any of the above, please contact Dermot Callinan on 01782 525010 or email firstname.lastname@example.org
This article is for general information purposes only and does not constitute legal or professional advice. Please note that the law may have changed since the date this article was published.