Wednesday, September 27, 2023

Is Now the Time for UK Startups to Consider “Agile Funding”?

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Shreya Christina
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Whether it’s Seed, Series A, or a little further down the alphabet, everyone loves a round of funding. For founders, each new capital injection marks a new milestone on the growth trajectory. An opportunity to very publicly bank a large amount of cash and at the same time talk to the press and analysts about the strategic plan for the next year or so. For their part, investors can also grab a moment in the sun, perhaps explain their investment strategy, or simply sing the praises of their chosen founders. And in the background, journalists are lurking, asking questions, taking notes and filing stories.

But according to Anthony Rose, the exposure given to milestone financing events can obscure the fact that companies often need financing not within six or 12 months, but within a much shorter time frame. In his view, founders should consider a more agile approach to raising capital, especially in the current climate.

Rose is – together with Laurent Laffy – co-founder of Seedlegals, a UK technology platform founded in 2016 to provide start-ups with an efficient and easy way to complete all the legal work involved in raising funds from equity investors. To date, the company has facilitated investments worth more than £1 billion and is said to have closed 1 in 6 early funding rounds in the UK.

But as Rose points out, as investment in UK startups holds up, we are experiencing uncertain times in terms of both angel investors and VCs.

In the case of angels, he says investment levels are strong right now. “If an angel, if you have the capital, love the business and think you can get an ROI, you will invest,” he says. But there is a caveat. Rising interest rates may tempt some angels to just put their money in the bank. Others, if they have mortgages or other debt, will find that they have less capital to invest.

Meanwhile, in the VC market, falling valuations are hitting founders’ ability to raise capital. “If you want to raise £1m at a £5m valuation you might need half a million in revenue. If the valuations fall you could raise at a £3m valuation so you either raise less or gives away more equity,” says Rose.

Against this backdrop, Rose says it might make sense for some startup founders to raise money “opportunistically” rather than put all their faith in the big round of funding that happens every year or eighteen months. He calls this agile funding.

Seed Fasts and Rolling Closes

But what does that mean in practice? Roos cites two examples. “Ahead of a first funding round, you can quickly raise money through a seed,” he says. “Or you could do a rolling close round.”

You could characterize a seed fast as a kind of bridging financing. One scenario would be that a company is working on a financing event while needing a smaller amount of capital in the shorter term. Under a seed fast arrangement – similar to the US SAFE concept – an investor would agree to provide the capital against an offer of shares on an agreed date. An appraisal is then not necessary.

An alternative is a rolling close. You agree on a financing round but build in the option to upgrade the amount at a later date at the same or higher valuation. You can add investors as you find them,” Rose says.

This gives startups flexibility, but can also help them raise larger amounts of cash. Rose cites the example of a company securing equity financing ahead of the first official funding round. “You need some money for a financing round. Using a seed quickly will help you raise capital and also build traction before the milestone round.

An obvious question is why investors would go down this road. Investing through a single financing round means that all parties can agree on a valuation and at the same time know how much equity changes hands at a fixed time. However, if a startup raises equity in between major funding rounds, that should definitely make managing the investment process more difficult.

Rose says there are reasons why investors choose to put their financial weight behind agile investing. “Investors have found that as the markets warm up, seed fasting is a way to get a foot in the door faster,” he says.

But he recognizes that the interests of investors must be weighed. “You have to build in checks, balances and safeguards,” he says. In practice, this can mean that investments are stimulated through discounts, a limit is placed on valuations and a limit is placed on the gap between the investment and the valuation.

Drop, drop, drop

But is there perhaps a reputation problem that needs to be addressed? In one version of an ideal world, a startup knows exactly how much money it needs, raises it, and doesn’t look back until the next round of funding in 18 months. Constant demand for cash can give the impression of a company that is not managing its finances well. Rose distinguishes between this type of drip funding and startups that use the tools at their disposal to ensure they are sufficiently well-funded to achieve their goals. Seed fasts and rolling closes can be strategic tools, he says.

In other words, Rose suggests agility could become part of the corporate finance toolkit, with startups raising small amounts as needed without compromising the ability to also secure capital through milestone rounds. It must be said, Seedlegals has some skin in play. As Rose describes it, the company has taken the process of raising capital between major rounds into production, so it’s a strategy it’s eager to promote.

Top-up rounds are not new, but they can be complicated to manage. Seedlegals claims to have made the process easier by providing a platform to manage and automate legal relationships. As such, it provides another option for founders seeking capital.

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