| Informed Funding |
Message from Chris Dines, CEO of Informed Funding
In last month’s newsletter I committed that Informed funding would continue to provide businesses with a breadth of information and direct contact they need to raise finance for their growing businesses. Testament to this commitment is that we now have more than double the amount of funder microsites than any other funding platform. Not to be complacent, we are continually reviewing and evolving our platform to ensure it provides educational, insightful and useful information that supports businesses in finding suitable funding providers. Over the next few weeks, you will see that the Informed Funding website is even easier to navigate and provides easier access to the fantastic tools to help you hone in on the most suited funders based on your needs. Watch this space!
Not only have we made further progress with Informed Funding, but we have also recently refreshed the Alternative Funding Network (AFN), a division of Informed Funding. The AFN shares market intelligence and thought leadership on the issues that matter in the SME finance space to funding providers. Not only do we have a new look with a new logo, but we have also appointed Andy Davis as the Programme Director. Andy has had a longstanding interest in the business finance market, previously as Editor of FT Weekend and more recently as a researcher, commentator and advisor on the game-changing developments unfolding in the SME funding market. In 2012 he also published the first comprehensive research on the emergence of Alternative Funding Platforms in the UK. Andy will be driving our AFN, providing great news and content every week. Below you can see for yourself the quality and insight Andy offers, with his first of many blogs, this one on SIPPs, ISAs and P2P lending. If you are a funder and would like to join the Alternative Funding Network, you can find out more here and register here.
Regards
Chris
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Established systems have a habit of managing to absorb and assimilate innovative newcomers – how else, after all, would these systems end up becoming established? This familiar process is under way now as the world of alternative finance meets the world of government-approved tax wrappers for retail investments, namely Self-Invested Personal Pensions and ISAs.
Stephen Cave of Evolution SIPP says that his company is meeting three P2P platforms a week and already has arrangements in place with nine enabling investors to lend within a SIPP wrapper, thereby gaining the benefit of tax relief on their contributions and tax-free gains within the wrapper (over and above the new £1000 a year personal savings allowance from April 2016, which was announced in the Budget). This is already proving appealing to some: Kevin Caley, co-founder of Thincats, says that there is around £7m of SIPP money active on his platform (including his personal fund) mainly thanks to Thincats’ efforts from the beginning to find SIPP providers willing to partner with the platform.
From the investor’s perspective the appeal is obvious – the tax relief nicely cushions any realistic default risk on a reasonably diversified loan portfolio, while the seal of approval from an external, Financial Conduct Authority-regulated SIPP provider gives an additional level of comfort that the platform has robust processes and that due diligence is being carried out on borrowers to reasonable standards.
However, as the panel discussion at the latest Alternative Finance Network seminar on April 15 made clear, in spite of this progress there is a long way to go before alternative investments such as these will be absorbed fully into the retail mainstream. Perhaps they never will be. That’s not to say they won’t become significant; just that change is likely to be gradual and the investors who will probably use these products may well remain a minority.
There are several reasons for thinking this:
· P2P SIPPs are still the preserve of Sophisticated Investors and High Net Worth Individuals. To open a P2P SIPP, an investor first has to be judged sufficiently experienced by the firm that provides the SIPP account, such as Evolution, rather than by the P2P platform itself. SIPP providers are regulated by the FCA and are obliged to ensure that investors are able to gain access only to asset classes that are “appropriate” for their level of financial knowledge and experience. In practice, this means that most retail investors will not be considered sufficiently expert to open a SIPP and use it to invest in P2P loans. This may change over time as the P2P industry develops a longer performance record – SIPPs themselves used to be the preserve of wealthy, sophisticated investors but are now mass-market products. However, it will probably take a while.
· More broadly, the question of “suitability” is a hot topic at the moment – the FCA is currently scrutinising wealth management firms very hard on how they make sure that the investments they advise their clients to purchase are “suitable” for them. This makes it even less likely that these firms are going to start advising wealthy clients to put money into a relatively new and little-understood asset class such as P2P lending. Since a great deal of HNWI money is under the care of these professional “wealth managers”, this is likely to limit the potential flow of “advised funds” into P2P and related SIPPS, leaving them mainly as the preserve of wealthy and experienced DIY investors.
· SIPPs that permit P2P investments allow their holders to invest across every platform that has been approved by that SIPP provider. In Evolution’s case that means an investor could place money on nine platforms (and counting) via a single SIPP account, giving plenty of opportunity for diversification across different types of P2P asset. The same probably won’t apply when P2P investing via an ISA eventually becomes possible – perhaps from April 2016. Instead, it looks as though individual platforms will themselves become ISA providers offering a new, third type of ISA devoted to P2P assets. Since investors will only be able to open one such ISA per tax year, this will restrict them to investing on just one platform via their ISA for that year, making it much harder achieve diversified exposure. Again, this looks very much like the sort of investment that will appeal to confident DIY investors but one that will involve more work and effort than most others will be happy to put in. How are they going to decide which of a number of platforms they are not already familiar with should be the recipient of their ISA money?
· That brings us to the question of retail financial advisors. As Dan Kiernan, Research Director of Intelligent Partnership, explained at the AFN seminar, alternative investments such as P2P lending have gained very little traction among retail financial advisers, a crucial group that shape the decisions of millions of mass-market retail investors with relatively modest sums to invest. Without the advisors’ support, P2P will struggle to become part of the investment universe that these people occupy. Advisors are reluctant because, although they can clearly see the potential benefits of adding P2P investments to client portfolios, they are nervous about this young and relatively untried asset class and see huge potential downside for themselves if they recommend it and something goes wrong, with little upside if things go well. Some are also concerned that their professional indemnity insurance will not cover them for esoteric alternative investments such as P2P, leaving them uncomfortably exposed should problems arise.
· On a practical level, advisers are generally unfamiliar with P2P platforms and asset classes, and are receiving approaches from individual platforms rather than an industry acting in concert through its professional bodies, which Kiernan argues is what’s required. Partly as a consequence, advisors lack tools to research the market broadly and – inevitably, given how young the industry is – they do not have access to the sort of long-run performance data that they are used to having for other potential investments.
If that all sounds unduly pessimistic, it shouldn’t. There are a lot of missing pieces to the jigsaw that will limit how quickly mainstream retail investment absorbs the P2P world. Indeed, the idea that P2P loans are about to vault into the middle of mass-market retail investing, even with the arrival of ISA eligibility, was never realistic and anyway would be unmanageable for an industry still in its infancy. Highly seasonal flows of hot retail money would be a disaster for platforms that need to source a steady and sufficient flow of quality lending opportunities. Equally, P2P lending is not saving. It’s far riskier than that and is therefore unlikely to be suitable for large numbers of people who are mostly sitting in cash, even though the returns are dreadful.
But that still leaves P2P platforms with a big market to aim for. There is a lot of money under the control of DIY investors – just look at the £46.3bn of mainly equity and bond fund holdings on Hargreaves Lansdown’s Vantage platform at the end of 2014, for example. There is plenty more growth to come from engaging with the growing minority of active DIY investors before the P2P industry needs to worry about the cash ISA-owning majority.
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It is one thing wanting finance to grow or improve your business, but it takes a lot more to identify the right type of finance and the right provider. Not to mention the dilemma of choosing how much to apply for and then actually getting an acceptance offer on the best terms available to you. With Cash as our King in the world of fast-growth business, it is really important to plan ahead to ensure you are fit for the right type and level of finance at the right time. Here we attempt to guide you on some of the core practical points you need to account for.
Skin in the game:
You need to be clear about what potential investors or lenders are looking for and, from your perspective, what you are prepared to give them whether it is equity, paying an interest rate, providing security etc. Finance can facilitate many different business life cycle phases with bank loans or seed capital at the start of the cycle through to buying out other investors or potentially buying a whole company outright further down the line. It could also be a combination of debt and equity funding, first to raise money to develop a product or service and then investment to grow sales and expand into new markets. At each milestone for your business there is a number of different and alternative finance options open to you – if you haven’t previously raised business finance dozens of times, then make sure you seek the right business growth advice to guide you in the right direction.
Clear, realistic plans:
You need to be able to show a plan to investors or lenders that will give them a timeline of their investment or debt facility from the initial finance through to their exit. Whilst funders realise that this is not an exact science they are looking to see how their finance will grow the business (or for lenders, the likelihood of full repayment), what goals and milestones you will achieve and when, and crucially how, this investment or loan will end to satisfaction. Will they be bought out at the end? Will the company be working towards a public market listing? Will the loan be repaid against the terms agreed?
Breed funder confidence:
Funders want to be confident that you are going to be able to deliver on your business plan – their profit depends on it, just as your business depends on your customers to pay in order to make a profit and living. Do you have accurate and realistic financial information and projections? They want to see your past performance, up-to-date accounts and recent monthly management accounts. For future performance they are looking to see solid projected profit & loss, cash flow and balance sheets. They want to know how fast you can grow but need to be sure you can justify your forecasts. And remember: lenders and investors in particular like to ‘back’ people. They want to see your business succeed and are looking for a strong management team who can take this financial plan forward.
How much and when?:
Once you’ve got your finance plan in place you need to decide what finance you need to fund anticipated and desired growth. This can be a daunting task but you don’t have to do it alone. Services like the Advantage Strategic Performance Assessment (SPA) look at your business as it is right now and show what your next steps should be for growth including when you might want to seek finance, and where to start (or which path to follow). It takes ten minutes to do the initial test as a business or financial health check.
Where?:
It isn’t always just a question of getting ready for finance either. Finding finance can also be an issue. Where do you look to find the right kind of finance for your business? There are dozens of different business finance products, and hundreds of providers. Informed Funding is helping break down the barriers with their wide ranging resources and funder network.
For more information or advice on getting your business fit for finance, contact the ABP team on 0203 3840276, through [email protected] or via contacting us through our website .
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There is a vast array of different types of funding options for businesses. In this newsletter we provide an overview on a further three funding methods firstly, with a deeper look into Venture Capital.
What is venture capital funding?
Venture capital (VC) funds are run by professional fund managers who invest in young businesses (sometimes including seed-stage companies) with the aim of accelerating their growth through a combination of cash, industry expertise and contacts. Venture capital mainly consists of equity investment, meaning that the VC will buy shares in the company that it will eventually sell in order to generate a profit. VC funds usually aim to hold their shares for at least three to five years and may take part in follow-on rounds of fundraising alongside new investors if the company’s growth is such that it needs additional capital. The VC will ultimately aim to exit by selling some or all of its shares to another investment fund, to a corporate buyer who takes over the business or to the public if the business is floated on the stock exchange.
What sorts of company do VCs look for?
VC investors aim to identify companies with very high growth potential that, if successful, are therefore capable of generating very high returns on their initial investment. In practice, this often means companies in fast-growing, technology-based industries such as software, online products and services, medical and green technologies and so on. It is generally more difficult for companies in mature industries that have lower overall growth rates to attract the attention of VC investors.
How much can I raise this way?
VC investments vary significantly in size but generally the minimum is about £500,000 and the maximum can be several million pounds if the potential of the business warrants it. Because VCs are professional fund managers who invest on behalf of other organisations (including pension funds, insurance companies and branches of the government) they carry out extensive due diligence on each potential deal using professional advisers including lawyers and accountants. The cost of this professional advice tends to mean that it is not economic for a VC fund to undertake small deals, which is why early-stage funding rounds are often carried out by business angel investors who carry out more of their own due diligence and so keep their costs down.
What are the advantages of securing VC funding?
Success in securing VC investment represents an important endorsement of a business and its management team because the process will have involved extensive professional scrutiny of the business and its growth plans. VC investment is likely to bring with it access to important new contacts and sources of expertise and advice for the founders as they seek to develop the company. Having a VC fund as an investor may also make it easier for the company to secure debt finance, particularly if the debt needs to be unsecured.
What kind of due diligence is involved in a VC investment?
VC deals involve extensive professional due diligence that can last for several months. The fund will scrutinise the business plan on which the investment proposal is based as well as the backgrounds of the management team. Although a committed management team with relevant experience will be well placed to seek VC funding, founders who have already achieved success as entrepreneurs in previous businesses are at an advantage where VC investors are concerned. They will also expect to see the management team commit their own money to the company.
How long does the process take?
Having made contact with a VC firm and submitted your business plan, you should expect to receive a response within a week or two. If your proposal is rejected, try to establish why it failed as that will help with future attempts. If the VC is interested, it will suggest an initial meeting to ask further questions. If successful that will lead to discussions about the value of the business and the ultimate terms of the investment, as well as detailed due diligence on your business plan and the management team. All told, you should expect this to last several months.
Do I need professional advice?
VC agreements are complex and involve giving legally binding “warranties” that certain facts that you have disclosed are true and complete. You will therefore need your own lawyers, accountants and financial advisers to help in the negotiations. Apart from protecting your interests, this will allow you to devote as much time as you can to running your business rather than being occupied full time with the fundraising process. Many VCs will be reluctant to deal with a management team that is not receiving independent professional advice.
What will the final agreement consist of?
The exact terms of the investment will be set out in the legal documents signed at the end of the process. These will include the Shareholders Agreement, which specifies the terms of the deal; the Articles of Association, which set out the rules for the running of the company; as well as any formal disclosures of information that the company makes as part of the agreement and that it guarantees are true and complete. These so-called “warranties” are legally binding and can give grounds for legal redress in the event of disputes.
Will a VC fund expect seats on the board?
Yes, in almost all cases. A VC fund will usually take at least one board seat.
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Venture Capital: Need to Know
- Any investment by a VC fund will involve the existing shareholders undergoing a significant degree of dilution as their overall share of the equity is reduced by the new money. VCs will generally expect a large minority stake as a minimum.
- Although the management and other early investors, such as business angels, will hold ordinary shares, VCs will normally insist of having at least part of their equity investment in other classes of share that have enhanced, or preferred rights, meaning that the holders rank ahead of ordinary shareholders in certain situations and may have guaranteed preferential access to dividends or other profit shares. These “preferred” instruments will usually be convertible into ordinary shares.
- VCs may also provide part of their investment in the form of debt. As well as paying interest, this debt may have warrants attached to it that give the VC a right to buy further shares in the company in future at a pre-set price.
- The costs of both sides’ due diligence in the VC deal are usually paid by the company receiving the investment. Professional fees will be taken out of the sum ultimately invested in the business, meaning that the founders’ stake is reduced slightly further in order to cover these costs.
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Mini Bonds
A mini-bond issue enables a company to raise debt funding from a group of individual lenders, usually its customers. Bond issues below €5m do not require a full legal prospectus and any bonds issued cannot normally be traded from one investor to another. In effect, most mini-bond issues are unsecured loans that must be held for their full term or until the borrower redeems them.
Larger Business Loans
Established companies that need to finance large investments will usually use a combination of deb t funding and their own cash balances. Larger loans or bond issues will need to be secured against the assets of the business and, in some cases, against the personal assets of the directors as well. They may also carry covenants that the borrower must keep within, for example a minimum ratio of earnings to interest payments.
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