New sources of funding bring difficult choices

The digital revolution is in full swing, spearheaded by entrepreneurs employing technology that is disrupting sectors from finance to food shopping.

Digitally focused companies such as Uber, the taxi application, and Zopa, the peer-to-peer lender, have emerged in the past decade alongside large numbers of others who are shaking up traditional industries.

A benefit that many current start-ups enjoy, compared with immediately after the financial crisis, is that it has become easier to access financing.

Louise Beaumont, of GLI Finance, a company providing funds to small businesses in the UK, says the explosion of the alternative finance industry coupled with a rejuvenation of the venture capital sector means that entrepreneurs have many more options.

“As a result,” Ms Beaumont says, “the question for many start-up founders is not, ‘Can I get funded?’, but more ‘What kind of funding is right for my business’s long term growth?’”

The ready flow of funding has enabled many technology start-ups to join the “unicorn” club — those that have achieved a valuation of $1bn.

In some cases, unicorns emerge as their investors seek to inflate the company to a size that potentially crowds out competition.

Rishi Khosla, an entrepreneur who has founded businesses including research firm Copal Amba and challenger bank OakNorth, says: “The concept of overfunding a player in a particular category is to crowd out competition and become the dominant player. Some companies raise so much, that the closest competitor does not have the same resources.”

Tim Levene, a disruptive technology investor and entrepreneur who runs Augmentum Capital, says it is rare for a fast-growing internet business to achieve unicorn status without raising meaningful capital. “To grow organically is simply not perceived as ambitious, and in a world where first-mover advantage is often critical, to stand still is to stack the odds against you,” he says.

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There is also some concern that the digital boom in part resembles aspects of the dotcom era. “It feels a bit like 2000, when clicks mattered more than revenue,” says Stephen Newton, founder of Elixirr, which focuses on fostering digital disruption.

“Profit, or a clear strategy to profit, matters more than achieving a $1bn valuation. It’s not about raising huge amounts of cash so that the founders can relax, breathe easy and slow down for a bit. A real entrepreneur doesn’t need a status symbol, they only need to find a way to build their business to the next stage of growth and then onward from there.”

But raising money for a company is also a constant balancing act between control and achieving growth.

Nick Hungerford, founder of online wealth manager Nutmeg, who has lived in Silicon Valley and has experience of pitching start-up business ideas, says: “On the one hand, control is where you don’t sell shares to outside parties. You get to own and run your business, growing slowly but surely. You dictate who you work with, how you work and when you work.

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“On the other hand is growth, where you take outside capital and aim to grow fast. It’s your responsibility, but you don’t get to make all the decisions.”

Raising outside finance may not be essential for some businesses, but it is often tough for start-ups without significant personal resources or that are not making sufficient returns in excess of costs to grow.

Crowdfunding is way of raising outside finance that has emerged in the past decade, pooling small sums from many individuals who in return, receive a stake in the start-up or rewards, such as a product sold by the company.

Mr Hungerford says crowdfunding has significant advantages. “You can create a brand as you fundraise, you’re not subject to the type of restrictions that venture capitalists add, plus your shareholders become your advocates.

“But crowdfunding as a source of business funding is tiny compared with venture capital, where billions of dollars are invested each year.”

Indeed, in spite of the hype surrounding crowdfunding, experts doubt it will replace venture capital as the main source of start-up funding.

Mr Newton of Elixirr says: “Crowdfunding has yet to mature, but it will never replace venture capital. Generating a large number of passive investors can be great for evangelising your product, but it’s no substitute for a hands-on investor who will guide you and plug you into their network.

Similarly, Mr Levene says crowdfunding will “absolutely not” replace venture capital.

To grow organically is simply not perceived as ambitious, and in a world where first-mover advantage is often critical, to stand still is to stack the odds against you

“Crowdfunding is becoming an increasingly viable option for early-stage businesses, but it is still in its infancy and riddled with challenges. Some platforms are adopting more rigorous screening processes, and I have no doubt that there will be several companies crowdfunded on the leading platforms that will fall by the wayside.”

So, while it is easier to raise funds now, those in the industry stress that entrepreneurs should not underestimate the challenges involved and the importance of selecting the right source of funding.

“In the end, every company should be grateful for cash if the terms are right,” Mr Hungerford says. “Personally, I’d love to see more British companies raising billion-dollar investment rounds. We have the ideas, talent and energy to overtake Silicon Valley in the race to be the world’s hottest technology venue.”