Early risers

18 October 2006

Raising early-stage finance is often a tortuous process - but it's getting easier. A recent g2i workshop explored some of the funding options available for start-ups

'It's a minefield,' said one entrepreneur, of the search for early-stage funding. 'I thought I'd get funding in six months,' said another, 'but it's been 18 months and I'm still no closer. Once I've got some money in, I can pay someone else to do this, but at the moment, it's taking up all my time.'

These comments, voiced at a g2i workshop on Sources of Finance last week, are typical of company founders' concerns about raising finance. It's difficult to understand the different types of grants and tax breaks available, they argue, and equally tortuous to run through the applications process.

The good news, however, is that moves are afoot to simplify things. Take the DTI's grant funding. Previously, there were up to 700 business support products available from the Department, but this has now been consolidated into just ten.

Three of the more common finance sources - the LDA Grant for R&D, the Small Firms Loan Guarantee scheme and tax credits - were discussed in detail at the workshop.

The LDA Grant for R&D

The Grant for R&D, previously known as the SMART grant, is now administered by local agencies - which in London's case means the London Development Agency. This discretionary grant is specifically designed to help the development of new technology, with a requirement that the research must lead to technically innovative and commercially viable products or processes.

Innovation is of course a difficult concept to pin down. But according to Gary Hellen, LDA R&D Grant manager, having a high level of 'technical risk' - the risk attached to the technology - is a key requirement for projects to secure funding. 'We step in where banks and other sources of finance won't go,' he adds. 'We expect you to have looked for and exhausted all other sources of finance.'

Other key criteria, according to Hellen, are the level of innovation, the Intellectual Property (IP) potential, the commercial opportunities, financial and management ability, design, and environmental and social issues. The R&D grant also requires match funding - this can come from any number of private sources, including a loan from the bank under the Small Firms Loan Guarantee scheme (see below)

If the criteria look onerous, it's worth bearing in mind that the chances of success are high. London received 200 R&D grant applications last year, of which 40% were successful. They catered to four different types of projects - micro (less than 10 staff and under ₤2m turnover), research, development and the rarely awarded exceptional development.

To maximise your chances of success, Hellen's advice is to be realistic about the innovation and risks; be clear on the IP and financial situation; and above all, know your audience. While you might play down the risk and the urgency of your financial need when you pitch VC investors, he argues that the opposite approach works better for the R&D Grant, where you should emphasise the technical risk and the reality of your funding situation.

Small Firms Loan Guarantee scheme

The SFLG scheme, whether it's used to match fund a grant or as a primary source of funding in its own right, is growing both in volume and ease of access for small and mid-sized businesses, fuelled in part by banks' greater familiarity with the programme. A joint venture between the DTI and several lenders, including Barclays, the scheme is intended for companies that don't have the traditional security needed to guarantee a loan - such as stock, property or machinery. Technology companies usually fall squarely into this bracket.

Kate Tisdale, relationship manager in Barclays' technology and telecoms team, says: 'All bank lending needs to be secured. This is a scheme for directors who don't have that security - as opposed to those who'd rather not use it. So bear in mind property, stock and shares, and life policies with a cash-in value would be expected to be used as security.'

Since its inception in 1981, the DTI has guaranteed 100,000 loans. Companies must have an annual turnover of less than £5.6m and must have been paying corporation tax for less than five years. Loan applications are assessed by the bank, which takes 25 per cent of the risk, and then the DTI. Bear in mind that companies pay a premium of 2% interest to the DTI above the bank's rate, so it's not the cheapest way to borrow.

Tisdale stresses that although firms can apply for £250,000 over a period of two to ten years, this is not free money: 'A common sticking point is that firms need to prove they can service and repay the loan. The business plan has to be watertight to get through the banks' lending approvals process.'

Tax relief

While banks and the government might seem like obvious places to turn to for finance, one less obvious source is HMRC. But R&D tax relief of 24p in the pound can be claimed on loss-making developments. 'It's an odd concept,' says Neil Pamplin, client service director for entrepreneurial and private client tax services at Grant Thornton. 'When you think of finance, you think of the bank, business angels, VCs and maybe an IPO, but you don't necessarily think of the taxman.'

Among the various qualifying criteria, applicants must emphasise innovation. 'Entrepreneurs almost always underplay what they have developed,' says Pamplin. 'If nobody else is doing it then you are being innovative. And it doesn't have to be a product - if you are creating a process nobody else can do then you are innovative. The biggest claim I have made for a client was in a large engine refurbishment plan, where they changed their process around and in the course of this became innovative.'

One final point to bear in mind when you seek multiple sources of funding is the danger of running into conflicts. If a project is being funded through one type of DTI grant, for example, it will most likely not be eligible for the R&D grant at the same time. Equally, if a project claims 'government notifiable state aid' like the R&D grant, it will probably not qualify for tax credits.

By David Longworth, Webster Buchanan Research