AXIAL CAPITAL

Raising capital is a sign of big step-change for any startup. And as you review term sheets and investment offers, you can expect to factor deal fees into the investment terms (and therefore your own capital model). If this isn’t something you’ve encountered as a founder, deal fees are an implicit part of the venture ecosystem and should be factored into your investor ROI forecasts – ultimately it’s real investment, impacting your real returns. When understood properly it’ll help a founder to foster more aligned investor relationships, with everyone on board for achieving real returns in the long run.

Let’s unpack what deal fees are and why they exist.

Why Do Deal Fees Exist?

Simply put, professional investors are in it for the long haul. Venture capital isn’t a quick-turn business – it takes on average 5-8 years before an investor sees a return. In that time, investment firms are sourcing & assisting startups, conducting due diligence, negotiating terms, and providing hands-on support. This requires dedicated teams and real operational costs. Deal fees help ensure investors can do their job well so you get the backing and expertise you need to grow.

A Look at Common Fee Structures

• Traditional VC Funds
  These funds charge 1.5%–2.5% annually over the first five years of the fund, tapering off later. Across a 10-year cycle, this adds up to around 15% of the total fund size. Smaller funds may also pass on some legal or diligence costs to startups, but this helps ensure the investment process is robust and well-supported.
• EIS & VCT Funds (UK)
  Thanks to generous government tax reliefs, these funds often charge startups a 1%–4% upfront fee for diligence and legal work, plus an annual 2% fee. Some GP’s will ‘gross up’ the investment to account for these costs, meaning a founder might receive the amount of capital initially requested – but with higher equity dilution accordingly.
• Venture Debt Providers
  Deal fees here include a 1%–3% arrangement fee, plus interest ranging from 6%–12%. These costs are offset by the flexible, less-dilutive capital that debt provides, helping you scale without giving up the same degree of equity as straight up investment (VD often carries warrants for limited equity in return for the risk involved in providing venture-based capital where other lenders simply won’t.
• Corporate Venture Capital (CVC)
  CVCs often absorb some of the ongoing operational costs internally, but when leading rounds they may include diligence or legal fees. These investors bring strategic value and industry insight and often a more hands-on approach to growth over the long run.
• Angel Networks
  They charge up to 10% or more of funds raised for their efforts, often with an annual monitoring fee where the network is more active in supporting a founder’s future growth. For very early-stage companies, this access to the network can be a game-changer and well worth the fees.

A Summary Thought

Deal fees are a sign of a serious investor. They reflect the time, resources, and expertise being committed to your success. As you build your company, understanding the economics behind venture investing will only make you a stronger, more confident founder. And behind the numbers is the more qualitative value of a stronger support team and a more valuable network to open doors along the way – something any future proofed business will want to demonstrate!

As a general rule our investment focus is across B2B platform & services industries, but now and then we see a business with a consumer focus in their revenue model which drives strong B2B2C channels for sustained growth – and with our first digital MedTech investment we saw just that.

Five years on from investing into RXLive and securing co-investment from the UK and North America of more than a million dollars, we’re excited to have completed the investment cycle with an agreed secondaries sale including our syndicated investors. It’s always a tough market for any growth-stage company, both in terms of capital raising and in their efforts to generate incremental revenue & margins (ideally with both being increasingly positive!), and in the case of RXLive the energy-filled founder continued to deliver on m-o-m growth throughout the investment period. A testament to his passion for the technology he created!

An exit can take a variety of forms, where you can chalk up one more successful exit (or not!). In a market that feels the blunt end of government-led reductions in the national health budget, a MedTech that is inextricably linked with that health system can only thrive within the limitations of what that health system makes possible. With the timing now right for the business to restructure as it enters the next phase of market positioning, all stakeholders have done well to complete the exit process through a secondaries transaction that will allow us to take the next cohort of our portfolio through a similar cycle of growth. And for RXLive it’s full speed ahead with the new round of investment and a new direction.

As we enter the new year with a number of impressive scale-up businesses joining the portfolio, the agenda for investment & venture building at Axial Capital will be as active as ever.

Founders and CEO’s building a business are typically caught short on time for almost everything – and particularly when a capital raise gets under way, it’s one more thing that demands attention when your day simply doesn’t have enough hours. This is even more acute when you hit expansion stage, and like most things if you share the burden you can achieve more with the same number of hours – and outsourcing the capital-raise efforts is a logical part of the process. The question is who to outsource to.

By outsourcing you can get support on the activities where you have most need, and better yet you can increase access to broader networks, without sacrificing the quality of expertise – and when it comes to the fundraising process, it makes sense for this to be overseen by an investor with a keen interest in seeing your business succeed. Inherent in the process of expanding your capital base a CEO can always benefit from a broader base of financial guidance, but might struggle (or simply not find it necessary) to justify full-time CFO support in-house, and particularly on a limited budget. That’s where leveraging your investor base, with a focus on your more industry-experienced investors, can be a source of (and access to) innovative solutions and sources of capital.

Consider this: hiring a full-time CFO in the UK can cost upwards of £120,000 annually. Having an investor or board member provide you with a substantial portion of those efforts might cost just 10% of that. That’s a nice buffer for your runway.

As the business grows, financial requirements become more complex. Having someone on your cap table who can actively support those future rounds is a built-in hedge against further strain on your other priorities as CEO. An active investor’s involvement can enhance credibility with other potential investors, and can accelerate the process of securing funding through each phase of growth. Ultimately the backing of an existing investor, both for the business itself and for advocating further investment into your ambition and your growth prospects, can provide much-needed reassurance to those considering a financial commitment, and can open doors to more bright minds that will add value as the business scales.

As a not-insignificant aside, it stands (perhaps obviously) that having your investors involved in the ongoing development of your capital stack can also contribute to building a strong financial foundation. This is a foundation for long-term success, putting a set of experienced minds to work for continually reviewing whether your financial practices are optimal – both now and for achieving the type of exit you have in mind. If a CEO takes those steps early on in the approach to corporate planning, the headlights can shine all the more brightly on the road ahead..

I had coffee recently with a good friend and entrepreneur who had come out into the daylight after many (many) long months of building out his latest venture. We were sitting at the window bench of a great little west London coffee & vinyl bar that we like to meet at to talk over life and business, and he made a comment that struck a chord: “sometimes you just need to know when to draw a line. And accept that even by investing more hours, more weeks of work, it simply isn’t a good enough venture to pursue in the long run”.

He was referring to his recent venture, and he was talking to the right people to become supporters of that new venture, but the committed buy-in he wanted from those people to fully validate the business model ultimately wasn’t there. As a many-times founder he’s experienced in building businesses and is aware of how important validation and a supportive corporate structure is, early doors, if you hope to deliver and to make a viable and sustainable business from a new venture.

And now to drawing a line on DD. As a corporate-led investor we have an investment model on our Ventures side of the business, and we tend to stick to it. So it was a sage reminder of how to most effectively use (invest) time when my friend said that sometimes you just have to draw a line – particularly as we receive 40+ requests each week across our Ventures and our Corporate Finance desks.

Whilst DD is a series of financial, technical and human reviews and typically involves many hours of combined efforts to agree that taking the journey together make sense, it must start with the founders of a business having an understanding and appreciation of what it really takes to build a lasting business – and not to become one more of the 80%+ of founders that see their business fail before it ever truly succeeds. At the centre of any good investment is aligned interests and a managing team that understands the value of a strong corporate structure. And it’s that critical acid test that we apply at the early stages of DD to gauge whether a business (and its founders) can see those realities and will be truly backable, which allows us to draw a line and to walk away when a founder tells us all they want is the money so they can ‘go it alone’.  

Just as we value the collective DD process that we often undertake with our co-investors, we also put more focus on those investment opportunities where the founders put value on building their business with a robust corporate structure in mind from the earliest stage of growth. And those future leaders are to be celebrated!