Starting up, scaling up and the investment and exit process from high growth businesses in the UK – in practice

Our inaugural OC Ventures Live event brought together investors, start-ups and others working in the venture space to share first-hand, practical experiences on topics such as the current venture market, starting up, scaling and the investment process into and exit from high growth businesses, from both a company and investor's perspective.

Joining the panel were Andrew Symes, CEO of OXCCU, a cleantech university spin out, founded in 2021; Ed Klinger, CEO of Flock, a connected insurance company for commercial motor fleets; Daina Spedding, investor in growth stage businesses at BGF; and John Pearson, investment director at Parkwalk Advisers which backs high potential, but early stage hard science technology companies.

The current venture market

This year has been a more challenging venture capital investment environment than recent times. Deal volumes are down year on year.

There is a flight to quality – funds have available capital but are being more discerning about what they invest in. High quality companies are still seeing competition from investors wanting to invest.

With increased inflation and, consequently, the Bank of England raising interest rates, the cost of capital has risen. This has made investors wary of a lower return if a business does not grow as quickly as hoped.

Some funds are holding back capital as insurance for any needs of their existing portfolio companies in these financially difficult conditions, rather than using it to make investments in further companies.

Investors have seen businesses struggle and this shapes their tolerance to risk. It is also harder for VCs to raise funds while interest rates remain high, and there is caution that the UK may suffer a recession next year, contributing to investors' risk aversion.

US investors remain keen to invest in UK businesses benefiting from a favourable US dollar to British pounds sterling exchange rate, and willing to lead larger funding rounds. Investee companies may face harder deal terms to attract US investment, however. 

How are current market conditions impacting access to funding and funding terms?

The route to getting to term sheet stage in a fundraising has become harder, and terms being offered less company-friendly. This reflects the nervousness of investors.

Companies are speaking to a large number of potential investors before agreeing terms with one or a small number.

After initial contact, there is a time-consuming process with several meetings set up with interested investors to get the know the business, and the team. to ensure there is alignment of culture, intentions and expectations for the business, and a fit with personalities.

Investors will also review the data room materials. This takes a huge amount of management time and patience and financial diligence can be challenging when the economy is volatile.

With investors withdrawing along the way, despite initially appearing keen, start ups need to be resilient to rejection.

There has been greater scrutiny of metrics, and team members, so  processes are taking longer to reach term sheet execution and completion.

Negotiations have become trickier around the removal of downside protections such as anti-dilution provisions as investors seek to ensure they are protected in light of the prevailing economic headwinds.

More valuation gaps are arising, where founders are seeking a higher price than investors are willing to pay, and this is leading to more creative terms or investment structures. 

What are investors looking for?

Having a resilient and high calibre management team who can face the medium term's huge economic and business challenges with the skills to commercialise and who have good chemistry with the investment team is fundamental.

Investors also want to see defensible IP, a solid business model and plan, the potential for growth and readily accessible markets, realistic forecasts, cash headroom, and, for later stage businesses, a demonstrable track record.

A central question an investment committee will be contemplating is whether they are likely to make sufficient return on their investment to make the transaction viable. 

The round price is a matter of negotiation. Investors will be mindful of the exit multiple they want the company to achieve, while founders may resist material dilution. However, investors may walk away if founders set expectations too high as they will see a lack of alignment on the company's likely trajectory.  

What can start up or growth companies do to ensure a smooth investment process?

Ranking table

Assess each investor against several factors such as usual size of investment, sectors they invest in, where they are based, and what they say they will bring to the table – and rank them.

This will suggest where best to focus efforts. Investors will be also assessing companies against similar criteria, so it will be no coincidence that a deal is likely to be made with an investor ranking highly on the company's list.

Project management

Appoint a project manager to help run the process to take the administrative burden away from key management team members such as the CEO or FD who will need to set aside time to attend the various meetings with potential investors.

The project manager can be someone internal or external, such as a corporate finance adviser.

Prepare responses

Pre-empt questions that investors will ask about the company and prepare a document containing responses to share with all the investors.

This will avoid duplicate requests, ensure all investors get equally well thought-out responses, and will look professional. Investors use these kinds of memo to help write their own investor committee papers, meaning the investment committee is told  the company's story in its own words.

Lead investor

Choose an investor that can lead. Once a lead investor is on board, this will make putting together a wider syndicate or a later investment round much easier. 

Competitive tension

Create competitive tension and buzz to assist the process.

How can a venture-backed company ensure a successful route to exit?

Investors bring considerable knowledge and will assist management in setting realistic expectations as regards the exit valuation for the company and the timing for a proposed exit, and, alongside the company's lawyers, assisting in negotiating decent deal terms.

Engaging a competent and experienced accounting team will enable the company to defend forecasts, budgets, cashflows and other financial information that will be pored over in diligence.

Having good advisers is imperative. While there are pros  and cons of engaging corporate finance advisers on investment rounds, there is a clearer benefit on an exit to maximise value and manage the time-consuming process.

Using lawyers who have travelled with a company and management team on its journey from its early start-up stages can be extremely beneficial when responding to legal diligence requests and negotiating the sale documentation. In any case, ensuring the lawyers are familiar with quick growth companies and are expert in M&A is very valuable. If selling cross border, using a firm with an established overseas network will ensure a company receives seamless, full service advice, and will facilitate a smooth exit process.      

Considerations with overseas investors

There are an increasing number of Chinese investors showing an interest in UK start ups and high growth companies. It is likely that companies in sensitive sectors within the scope of the UK National Security and Investment Act 2021 (see our Insight) will be careful about considering Chinese or other potentially higher risk investment, as the transaction could be scrutinised and ultimately blocked.

Companies may be nervous about sharing IP with, or receiving funds from, investors from higher risk jurisdictions, and particularly a US investor may have concerns about co-investing with investors from those jurisdictions.

Aside from geopolitical tensions and risk, with overseas investors there could be language barriers, culture misalignment, geographic logistical challenges and social blocks, where building a successful business relies on relationship building, and these need to be considered, alongside the views of any existing investors, when choosing which investors to approach.

Will a new government change the UK investment landscape next year?

There is potential for a flurry of dealmaking in the run up to the general election next year, if there is a concern that a new government would change tax laws (particularly relating to capital taxes) in a way that was detrimental to investors or founders.

The other element that could affect the investment landscape will be what happens to interest rates and how long they remain at an elevated level. If we begin to see rates reducing, investment caution may ease.  A change of government may influence monetary policy; and, though currently believed to be unlikely, a hung parliament may cause economic uncertainty.

Top tips for companies fundraising 

Due diligence on potential investors

Companies should do due diligence on potential investors to ensure a good fit.

Be on the front foot

Fundraising is a two-way street – interrogate investors about their offer and level of interest to weed out those not genuinely interested in, or of interest to, the company, and there is scope to negotiate terms.

Seek and digest feedback

Management teams should listen to feedback from investors; there may be useful information in that feedback that will help attract the right investor and also position and grow the business effectively.

Have resilience and patience

A management team needs resilience and, above all, patience. The route to onboarding a VC investor can be arduous, but if the company takes the process thoughtfully and uses a well-organised approach, this will enable the company to secure the best investment available.

Use your network as a sounding board

Rely on trusted contacts in the investment or business world who can act as a sounding board on decisions such as a shortlist of investors to approach.

Choose advisers wisely

Appoint committed advisers, who will take the burden of the transaction workload from management to free them up for conversations with potential investors, guide the company through the transaction and negotiate deal terms realistically while defending the company's and management's positions.

Follow up and keep moving forwards

After a fundraise, a business should already be thinking about the next investment round. Make a note of lessons learned and contacts made. Keep contacts made through the recent process warm by setting out milestones to be achieved before the next fundraising cycle and use these as an opportunity to touch base with the contact. An investor may turn down an early stage investment on the basis it is too small, but may be interested to invest at a later stage once the business has grown further.  

Our inaugural OC Ventures Live event was hosted by Justin Starling, Rob Hayes and James Taylor, partners at Osborne Clarke spearheading the OC Ventures project.