Facebook, Twitter, Uber, the list of tech businesses that have been hugely successful goes on and on. But how many have failed in their venture to be the next big thing?
Tech businesses need investment in terms of time developing a product, technical input, creating a legal structure for their business, possibly premises, marketing the product often on an international scale and protecting the ideas behind the business. Usually the venture is the founder’s full time job or will, at some stage, need full time commitment. This means that the business needs to pay a wage and engage employees - all of this comes at a cost.
Post recession, many banks will only lend against tangible assets. This is something that tech businesses don’t tend to have. Investment for start ups is difficult to find. Often the founder and family members will be prepared to invest but this needs to be treated, in their mind, as gift since, if the business fails, it will matter not how many shares have been issued and at what cost, the shares will all be worth nothing.
Tech businesses need to identify and protect the value in their businesses from the outset since this is their main, if not only, asset. It is no different to a property, machinery or tools of the trade but because it can’t be seen or touched, people often fail to define rights of ownership and secure the property. This means that the registration of trade marks and designs and clear, well thought out contracts with suppliers, employees and consultants to the business, setting out ownership rights in relation to all of the business’ intellectual property, is essential. Disputes over ownership can be very costly to resolve and leaving it to the law to decide ownership rights, in the absence of clear terms, is a risky strategy.
If the business needs to operate from a third party platform, then it needs to ensure that it can’t be prevented from operating in the event that it doesn’t pay the third party’s bills and needs to have a contingency plan for the possibility that the third party may cease to trade.
Thought should be given to the manner in which funds are invested into a business. Shareholders can only expect a return on their investment if the company has distributable profits. If the company fails, then any value in the business will be realised to pay creditors and the costs of the insolvency process and not towards paying back shareholders. Investment can be made by way of loans to the business but even then, the unsecured lenders will rank alongside all other creditors and any security may not realise the full amount owed.
Directors of tech companies often find themselves funding start up costs themselves, hoping to get the money back when the business takes off. If the business starts to fail, then the director may want to reclaim the cash injected, before the inevitable collapse. However, loans to the business which are repaid to the director up to 2 years before insolvency may well be clawed back by a liquidator or administrator as a “preference” – i.e. the director has been favoured over and above other creditors who must wait in line for payment.
Some tech start ups may never make enough money to cover costs. Directors (or those acting in that capacity) should be wary of incurring debts if there is no reasonable prospect of them being paid. Directors can be personally liable for wrongful trading in these circumstances. Directors should be careful not to use the company’s bank account as if it is their own, record all transactions properly in the company’s books and should not use HMRC as an extended credit facility, otherwise they may face personal claims and, potentially, disqualification from acting as a director if things go wrong.
Entrepreneurs should consider all of the options available to support their business and formulate solid prospective plans. For example, given low interest rates on savings and a tougher lending regime, crowd funding initiatives have become popular ways to raise funds and speculate on investments. It is yet to be seen who are the winners and losers in the long term and which of these initiatives can offer value for money.
There are specialist lenders in the market that will lend against intangible assets so it is worth understanding the value of patents, trademarks, copyrights and trade secrets.
Finally, it is worth investing in the basic tools needed to ensure that all those involved understand their rights, remedies and risks, whether that is through shareholder agreements, loan agreements, procurement contracts, trade mark and design registration or proper advice and assistance from professionals at the outset.