The area of government grants is complex and confusing, given the number of different schemes, the complicated nature of the majority of them, and the fact that what is available and on what basis changes constantly.
In simple terms, grants are normally associated with areas that are deemed to need assistance, whether that is due to geographic location, industry sector or some other criteria. The country is divided into areas, with the majority not eligible for regional grants. The more deprived areas are split into tiers, with the biggest and most wide-ranging grants available in the most disadvantaged areas. These grants can include investment and employment incen- tives as well as support in areas such as staff training.
Similarly, most sectors of the economy do not qualify, but certain economic activities such as the recycling of waste do. The grants available are often similar but assessed on different criteria. Details of these grants are available through the government directly or through the regional Business Link offices (for contact details see Appendix 2).
However, by far the most important government scheme to indi- viduals considering setting up their own business is the Small Firms Loan Guarantee Scheme. This scheme guarantees loans made to small firms by commercial banks and certain other financial institutions where the firm lacks available security and/or a track record. In applying for a guarantee, the lender must satisfy itself that the commercial viability of the company is such that the lender would have made the loan but for the lack of security. If a Small Firm Loan Guarantee is made available, the bank is not allowed to take personal assets or guarantees as addi- tional security, but may require a charge over whatever assets or security the company has available.
For a start-up business the guarantee covers 70 per cent on loans between £50,000 and £100,000, but this can rise to 85 per cent on loans of up to £250,000 for companies that have been established for more than two years. Not only does this scheme unlock bank
lending that would otherwise not be available to young companies, it also reduces the cost of such borrowing. Information on the Small Firms Loan Guarantee Scheme is available through either Business Links or commercial banks that operate the scheme.
Small unsecured loans up to £5,000 are available to young entre- preneurs to start up a business under the Prince’s Youth Trust. The applicant must be under 30 years of age and is usually required to show that funding has been refused by commercial lenders.
FORMAL AND INFORMAL VENTURE CAPITAL
Before we look at different sources of equity, it is important to underline the fact that there are also many different types of equity, because many people establishing a business will often be reluctant to part with equity. As well as ‘normal’ equity there can be different classes of shares with different voting rights; for example, pref- erence shares which rank ahead of ‘normal’ equity in the payment of dividends, and many other variations on this theme.
It is also worth remembering that ownership of shares in a company and control of the company can easily be separated by using a shareholders’ agreement, so that ownership of the majority of shares does not necessarily translate into control. This structure is often used when equity is injected by a venture capital firm that only seeks to own a minority stake, but needs to be able to exercise control in order to limit the risks on its investment.
External equity or venture capital can come from a range of different sources, some more formal than others. Many small firms are set up using equity provided by the founders and their friends, relatives and associates. These sources are often easier to access in many ways than more formal providers, but generally provide only relatively small amounts of money.
Raising small (ie less than £1 million) amounts of equity is often more difficult than raising larger amounts. Many of the equity funds and providers of venture capital take the view that the level of work involved is similar irrespective of the amount actually invested, and that it is not economic for them to invest less than £1 million.
The most common source of funding for start-ups and lower levels of funding is ‘business angels’. These are typically wealthy
individuals who have run businesses of their own and are looking to invest their own money. As well as their financial investment they often bring relevant experience. Business angels invest from as little as £20,000 but more commonly £100,000 plus. A number of networks exist, and through these, individual investors can club together to form a syndicate to invest larger amounts. Given the personal involvement, the investment decision is often taken partly with the heart as well as the mind, and investors normally stick to industry sectors in which they have experience. In practice, this makes the search for the right investor more difficult, but with the benefit that the investor once found can often display more flexi- bility and vision than a more professional investor. One caveat in dealing with business angels may be that they are more likely to change their minds after verbal commitment. (As an example, read the cautionary case study in Chapter 18.)
Individual investors can obtain considerable tax relief on invest- ments made of up to £150,000 if the investment qualifies under the Enterprise Investment Scheme. As well as tax relief on the initial investment, no capital gains tax is payable if the investment is held for at least five years.
Perhaps the best-known source of equity is the investment funds and venture capital funds run by City institutions. Investors in these funds are banks, insurance companies, pension funds and the like, and the funds invest in a portfolio of companies. Each fund will normally have a focus on certain sectors and on certain stages of a company’s development, as well as other criteria such as minimum and maximum levels of investment. It is worth pointing out that very few venture capital funds are really interested in investing in start-up businesses, irrespective of what their marketing material might claim. Probably the most common level of investment is between £1 million and £5 million. Most funds look for an annual return on their investment in the region of 25 per cent to 30 per cent (this level of return includes both projected dividend income and forecast capital appreciation). The majority of investment funds are members of the British Venture Capital Association.