Ross Stupart, of accounting group RSM, weighs up the pros and cons of possible sources of investment for innovative Scottish businesses looking to drive growth.
Accessibility of funding remains a particular challenge from many in the tech sector which can hold back the pace of growth of a promising business.
Given that in Edinburgh alone the jobs in the digital tech sector increased at more than three times the UK average from 2014 to 2017, according to Tech Nation’s 2018 report, constraining the growth of Scottish tech businesses could lead to restricting the growth of the Scottish economy as a whole.
So, how do Scottish tech businesses source the funding required to fuel growth?
There are a range of options, but the most common funding stream for start-ups is angel investment, which can deliver vital cash and expertise to fuel projects.
However, this type of funding tends to be committed in a series of smaller funding rounds rather than perhaps in larger tranches that would allow for a prolonged growth push. This can mean that management gets absorbed in regular follow-on fund raises and therefore the pace of growth may be constrained.
The major benefits however are that the commitment of funds from many angel networks can provide access to matched funding from the Scottish Investment Bank and the networks and expertise that can come with angel money.
Some angel investors will have a strong entrepreneurial track record and could be willing to bring their expertise, networks and connections to the table which may be more valuable to the investment-seeking business than their money.
The limiting factor is that accessibility to angel funding tends to be closely linked to the availability of Enterprise Investment Scheme (EIS) tax relief. Therefore, if the business does not qualify for EIS due to the nature of its business or perhaps the business has been operating for more than seven years but has not gained traction as the market was not ready for the technology during its early years, accessibility to angel funding would be limited.
From a practical perspective, crowdfunding is very similar to having angel funding and would often also be paired with EIS tax relief. Should a business raise investment via a crowdfunding platform, the entrepreneur should be aware that they may end up with a significant number of minority shareholders which would need to be managed.
Raising funding via the crowd does not come with expertise and networks like business angel funding may do. However, one of the major advantages of raising funds via a crowd is that it can be done quickly and that the business may be able to turn the investor base into brand ambassadors who are advocates for the business wherever they go.
Also common in Scotland is venture capital (VC), private equity (PE) and growth capital. All are similar, but VCs tend to invest in the equity of early stage businesses that display high growth potential, and PE houses focus on more mature businesses. By their very nature, venture capital investments are higher risk and therefore venture funds operate on the basis that some of their investments will not succeed. This means that they need some investments in their portfolio to generate super returns in order to keep investors happy.
Again, the aim of private equity and growth investors is to invest in growth potential companies and to exit with a strong return on investment. However, this type of funding comes later in the business lifecycle, often when the business or technology is proven to be sustainably revenue generating. This type of funding will also tend to come with expertise, access to networks and insight to drive the performance and strategic direction of the business.
In terms of availability and accessibility of funds for tech businesses in Scotland, we are blessed with several active angel networks with an appetite to commit funding to promising businesses with good quality management teams. Accessibility to crowdfunding is simple given that it is a platform-led mechanism for reaching a wide range of potential investors, although obtaining visibility on a platform does not necessarily mean the funds will follow.
There appears to be significant amounts of growth funding out there looking for a home within the right business and for the right management team.
While there are several early stage VCs operating in Scotland, there is not sufficient capital solely in Scotland to support the plethora of opportunities that the country is producing when it comes to early stage technology plays. Scottish tech entrepreneurs are therefore forced to look further afield for their funding.
- Ross Stupart, head of technology and media in Scotland at accounting group RSM.