What is a “Start-up”?
In the world of business a start-up is a company designed to grow very quickly by attracting a large market. Generally speaking a start-up is a company in its infancy, although not every newly formed company is a start-up. In fact, millions of companies are started every year in the world but only tiny fractions are deemed start-ups.
So, what is the difference between a start-up and a small business?
Start-ups are different from traditional or small businesses primarily due to the rate of their expected growth. Small businesses are driven by profitability and stable long-term value, while start-ups are focused on top-end revenue and growth potential. By design, the essential aspect of the business is rapid growth and this means that they can sell to a very large market in record time.
Additionally, start-ups are often disruptive – it is almost a prerequisite. They tend to produce or operate on products or services that do not yet exist, or are drastically changing the delivery of a particular good or service in an industry. A start-up is usually looking for those valuable ideas that most of the general public either haven’t considered or simply don’t understand.
How fast does a company have to grow to be considered a start-up?
There’s no precise answer, and interpretations tend to vary enormously. However it is possible to consider the sort of growth that successful start-ups tend to have.
Successful start-ups tend to have three phases:
- An initial period of slow (or no) growth while the start-up tries to find it’s niche;
- the start-up successfully find a way of reaching the mass market and a period of rapid growth begins; and,
- eventually the start-up becomes a large company. Growth will slow, partly due to internal limits and partly because the company is starting to bump up against the limits of the markets it serves.
Together these three phases produce an S-curve. The phase whose growth defines the start-up is the second – the ascent. Its length and slope determine how big the company will be in the long-term. The slope is the company’s growth rate. If there’s one number every founder should pay attention to, it’s the company’s growth rate. Generally if you know your business’ growth rate, you know how well (or poorly) you’re doing.
Great measures of growth rate tend to be revenue and customer base. Often these metrics will work hand-in-hand with revenue likely be a constant multiple of active users.
What is a start-up ecosystem?
A start-up ecosystem is formed of influential individuals, start-ups, and various types of larger organisations who all co-operate (either physically or virtually), interacting as a system to create and scale-up new start-ups. A start-up ecosystem can provide a great host of resources such as technical skills, networking and funding.
What are start-ups incubators and accelerators?
Incubators and accelerators are some of the most important organisations in a start-up ecosystem. In addition to helping start-ups fast track their learning process, accelerators and incubators also help start-ups steer clear of mistakes new businesses make, and help connect them to appropriate parties that can help them further.
What are the advantages of these programs?
The main advantages are: (i) shared learning and mentorship (helping avoid typical start-up pitfalls and speeding up your efforts); (ii) access to capital, either within an incubator or post an accelerator; and (iii) the PR value and exposure you get from these programs (not to be underestimated).
What are the differences between an incubator and an accelerator?
Incubators “incubate” disruptive ideas with the hope of building out a business model and company. The start-ups possess an idea to bring to the marketplace, but no business model and direction to transition from innovative idea to reality. They usually give early stage start-ups the right tools to boost their company forward such as co-working space and mentors. One of the main purposes of an incubator is to push start-ups to test their products as much as they can and develop a business model. Think of them as business school, where start-ups learn how to run a successful start-up.
Incubators operate on an open-ended timeline. They focus more on the longevity of a start-up and are less concerned with how quickly the company grows. It is not uncommon for incubators to mentor start-ups for more than a year and a half. An incubator often locates your business in one central work space with other start-ups.
Accelerators, also known as seed accelerators, are for more developed start-ups as their purpose is to “accelerate” growth of an existing company and focus on scaling a business. Accelerators operate on a set time frame, which usually lasts three to four months. During this period, start-ups build out their business with the support of mentors and capital provided by the accelerator. At the end of the program, start-ups receive the opportunity to pitch their businesses to investors.
What are the disadvantages?
Programs like these can:
- Be distracting with the many meetings and events with mentors and investors getting in the way of focusing on your own project;
- be confusing with various different opinions i.e. ‘too many chefs spoil the broth’; and,
- sometimes be less productive due to their nature of office-sharing, especially if that incubator is supporting other under-performing companies.
How are start-ups financed?
Start-ups are intended for rapid growth, and as such need financing to match those ambitions. Start-ups often seek external funding at an early stage to allow them to progress to a stage of generating their own revenue and profit.
The most common avenues of funding are:
- Business Angels
An angel investor is someone who provides their own personal funds. They will often insist on having an equity interest in your business and may also be directly involved in the business, although often not to the extent of becoming a member of the company’s board. They may also provide contacts, experience and skills.
- Venture Capitalists
Venture capital firms are professional investors whose money comes from a variety of sources – corporations and individuals, private and public pension funds, foundations, etc. Rather than individual investors, winning venture capital usually involves a whole firm – investors, board members, and people whose job is to generally help your business develop. Those who invest money in venture capital funds are called ‘limited partners’; those managing the fund and working with individual companies are called ‘general partners’ and these are the people who work with the start-up to ensure that it’s developing.
The firm takes an equity stake and have a say in the future of the company and its running. In exchange for their involvement, venture capitalists often expect a high return on investment. After a period of time, often years, the venture capitalists sell shares in the company back to the owners or through an initial public offering, with the intention of making a healthy profit on their initial investment.
- Accelerators
Start-up accelerators support early-stage, growth-driven companies through education, mentorship, and financing. Start-ups enter accelerators for a fixed-period of time. The accelerator experience is a process of intense, rapid, and immersive education aimed at accelerating the life cycle of young innovative companies, compressing years’ worth of learning-by-doing into just a few months.
- Crowdfunding
Is the process of raising much capital by small amounts of money from a large number of people, typically via the online-based solutions.
What are the risks for start-up investments?
- Failure rates
Is there any type of business out there that is totally devoid of risk? Probably not, but between a start-up versus small business, there are some clear differences in the amount of risk an owner or founder takes on. Building any type of product or service from the ground up takes time, considerable investment, and a lot of focus and concentration. Sometimes, even after all that input, things don’t pan out. That’s why start-ups are far riskier than small businesses in the long run. While small businesses do take on a considerable amount of risk just by being in business, they have one difference that makes their operation less risky than start-ups: The owners usually have proven business models to look at and imitate. Start-ups don’t have that same privilege. And because small businesses are not hyper-focused on growth, there’s less risk of over-inflating too soon and losing it all due to too-fast growth.
- Competition
The start-up space is extremely crowded, and there are thousands of businesses trying to be “the next big thing.” The chances are slim that an investor identifies the ones that are going to be big, or even moderate, successes. It’s almost impossible to know whether a business is going to be the next Facebook.
- Hard to value
It’s difficult to work out the potential future value of a business. Because of this, it’s almost impossible to know what a return on investment is going to be, and how long it will take to realise any gains. This makes it very difficult to align this type of investing with life goals.
- Prediction
Venture capitalists and angel investors have experience, expertise and insight. They spend a great deal of time, resources and energy understanding the marketplace, technology trends and other information. Despite this, they cannot predict and value the real amount of risks, including illiquidity, lack of dividends, loss of investment and dilution.
Tax incentives for start-ups in the UK?
To stimulate and support entrepreneurship, HMRC offer a number of schemes, the key ones being the Seed Enterprise Investment Scheme (SEIS), Enterprise Investment Scheme (EIS), Entrepreneur Relief (ER), and R&D Tax Credits (R&D). These are all designed to help smaller, higher-risk companies raise finance by offering attractive tax reliefs to individual investors.
SEIS
SEIS encourage initial seed investment in small and early stage companies by reducing the risk to those investing in these types of companies. Investors, including directors, can receive initial tax relief of 50% of their income tax on investments up to £100,000. Plus, investors can benefit from 50% capital gains tax relief on gains which are reinvested in SEIS eligible shares (this was 100% for the first year SEIS was introduced, in the 2012/2013 tax year). Any gain arising on the disposal of the shares may also be exempt from capital gains tax, and loss relief is available if the disposal results in a loss.
The maximum amount that can be raised for each company is £150,000 pursuant to the SEIS reliefs, following which further investors will still qualify for the available EIS relief.
EIS
EIS is designed to encourage investment in qualifying later-stage companies by providing investors who buy new shares in their companies with up to 30% of their investment back via income tax relief. Plus investors can defer any capital gains tax on gains which are reinvested in EIS eligible shares, gains arising on the disposal of the shares may be exempt from capital gains tax, and loss relief is available if the disposal results in a loss.
EIS tax relief has many similarities with SEIS however the relief on income tax is 30% not 50%. Relief can be claimed up to a maximum investment of £1,000,000 and a maximum of £5 million can be raised under this scheme.
ER
ER is available to reduce the effective rate of Capital Gains tax to 10% on a limited number of disposals. Individuals must hold at least 5% of the ordinary share capital and voting rights of the company, be an employee of the company and have owned the shares for at least 1 year. This relief has a lifetime limit of £10M.
R&D
R&D relief aims to reduce the corporation tax bill of businesses that progress a particular field of expertise. If qualifying, tax relief on R&D expenditure can reach up to 225%. Businesses should not consider this relief to be exclusive to any particular field, although there are some limitations i.e. on social sciences or purely theoretical fields. If the company is making a loss then the tax relief can be exchanged for tax credit.
If you would like to discuss the development of your start-up or have questions on the above then please do not hesitate to get in touch (pa@newlawslegal.co.uk) and we will be happy to help.
Start-up bible 