Investing in a Seed Enterprise Investment Scheme (SEIS) start-up company should not be a shot in the dark but a careful analysis of the risks involved in becoming part of a new business.
For entrepreneurs, dressing their pitch to attract funding is crucial, but investors need to look behind the glossy cover and dig deeper into the financials.
One entrepreneur, Ben Pugh of online shop FarmDrop has revealed that one of the main concerns of a start-up is not running out of money before the business gets on its feet.
FarmDrop helps fresh food suppliers find customers and in a recent interview, he explained how he attracted SEIS funding.
His checklist is useful for SEIS investors – and here are some of his key points:
- Look at the business in detail to figure out the best type of start-up funding
Some businesses drop naturally into the SEIS model. Taking an equity stake helps with cash flow because instead of money going out of the bank to repay costly borrowing from a bank, shareholders are rewarded by dividends based on performance and benefit from growth in the value of their stake at the end of the three year program.
The nature of SEIS funding is businesses without any assets can raise funds through the scheme.
- Keep cash intact with firm financial management
Putting cash into a business is fine, but controls are needed to make sure the money is spent effectively and that the spending is focussed on developing the business.
This means the business needs management controls aimed at keeping costs down. If the business does not have sound financial management, that pile of SEIS investment cash can soon be whittled away
Pugh explains he sometimes barters goods and services to eke out the cash raised from equity investors.
- Make sure the entrepreneur takes on a share of the risk
If the team involved in the start-up have nothing to lose, the chances are they can be less motivated to make the business a success. If the entrepreneurs have no cash at risk, then question whether a SEIS investment is going to see the expected returns.
- Look for stock option rewards instead of big salaries
Stock options are a reward for hard work and incentivise the SEIS company team to work hard. Once the company is up and going, stock options can be reduced in favour of decent pay packets – which are a sign of the business performing well, says Pugh.
SEIS offers investors decent tax breaks for investing in start-ups, but investors should never forget that taking an equity stake in a new business comes with a mountain of measured risks.
