10.1 Introduction

At risk of stating the obvious, money is required in substantial quantity to fund all stages of technology and product development activities. And the rate of spend increases as the technology advances in maturity along the technology readiness level (TRL) scale, usually by several orders of magnitude. In the early stages of a project, there might be just a handful of people involved in the development work, but even this will cost tens of thousands of pounds or dollars per year, if properly and fully costed. In the later stages, the potential rate of spend could be up to a million per year, even for a very modest programme and, of course, tens or hundreds of millions a year for a large undertaking, such as a new automotive or aerospace programme.

There are multiple potential sources of funding for company growth. Each source has its own characteristics, and there is overlap in terms of what each category might cover, depending on the approach taken by individual funding organisations. Most engineering companies use a combination of those listed in Figure 10.1.

Internal sources are always the starting point, including an individual's own time and money in the case of a start‐up through to cash flow generated from sales with established companies. In the latter case, companies have to generate enough cash to at least maintain the competitiveness of their current products.

The friends and family category is self‐explanatory. It is the next port of call for new organisations at the very early stages of their development, with its obvious limitations and pitfalls, but an essential ingredient in the development of very new organisations. Other sources will not lend money unless there is some personal money at stake.

Once beyond this stage, there are several private, professional equity funding sources, ranging from angel investors and crowd‐funding through to private equity companies. Their approaches vary widely in terms of the levels of funding that they can offer and the point in the company development cycle where they are comfortable to participate. In all cases, they will scrutinise very closely the risk/reward profile and the business plans of candidate organisations.

This then leads to wider equity funding, which could come through some form of initial public offering that would bring into play a range of institutional investors. These sources of funding are mainly relevant to organisations that are quite well‐established in terms of products, markets, and sales revenue but are looking to expand.

Finally, multiple forms of grants available from regional, national, and supra‐national (EU) public programmes that specifically target technology development, this being seen as a means of encouraging economic development. Allied to these, a number of countries have national networks of engineering facilities, established by public funding, to support the practical development of new technologies.

Each of these sources is discussed in more detail in the remainder of the chapter, with emphasis on early‐stage funding, which will be of most interest to the entrepreneurial engineer.

10.2 Internal Funding

For start‐ups, internal funding often begins with the entrepreneur's own assets, including time and energy. For established companies, new technology and product development is usually funded out of operating cash flow, although additional funds may also be sought to finance development of products for new markets. Industry sectors develop their own norms, over time, in terms of how much should be spent on these activities to remain competitive. Expressed as a percentage of sales revenue, expenditure on R&D can vary from 1% to 2% in industries with a low dependence on innovation up to 10–20% in the case of pharmaceuticals or the technology (IT) sectors. Companies that are not profitable enough to fund sufficient development end up being taken over or going out of business, inability to fund enough development being one of the classic causes of long‐term business failure.

Companies will normally budget how much to spend on technology and product development, so specific programmes of work require, in effect, two rounds of internal approval:

• Agreeing overall R&D expenditure over, say, five years on multiple projects –normally a board decision on a rolling annual basis
• Agreeing the go‐ahead for individual projects as they reach approval stages –normally delegated, depending on value.

Internal approval follows similar disciplines to external fundraising, as shown in Section 10.12.

10.3 Friends and Family Funding

If an individual, or a small group, are in the very early stages of developing a technology and are not part of a larger commercial organisation then, after personal resources, friends and family are realistically the only means of raising funds. These supporters will be investing as much in the person, or people, as in the technology itself. They will probably need some persuasion before parting with their money and hence a business plan, at least in verbal outline form, will be needed as well as the ability to convey the plan in a convincing manner, and answer questions. The latter will be good practice for future funding requests to banks or other independent funders.

Money from friends or family could come in the form of gifts, loans, or an equity stake (i.e. part ownership of the developing business). Whatever form is chosen, writing down and signing an agreement is always a good idea, as is a record of how the money is to be spent.

Family funders with some business experience may also play the role of advisers. They should be aware that engineering development is expensive when it comes to hardware, testing, and intellectual property protection, unlike, say, software development, where much can be achieved with little expenditure other than time.

They are likely to show some flexibility during the ups and downs of a fledgling organisation, provided that the founders show some sacrifice as well and communicate progress proactively. Funding of this type should hopefully take an organisation, and its ideas, to a point where it has progressed sufficiently to seek independent funding.

10.4 Angel Investors

As the next step after friends and family, ‘angel investors’ are one of the most frequent sources of seed funds for early‐stage companies. Such investors are typically relatively wealthy individuals, or networks of individuals, who will provide funding from their own money for start‐up companies in exchange for equity, or convertible bonds (loans that convert into equity), in the company. For tax reasons and to ensure that the entrepreneurs retain a majority stake, angels will not take more than 30% of a business's equity.

They are often experienced individuals who may invest in areas where they have expertise and will therefore also provide guidance and mentoring. Investment periods vary widely – some may fund for about 3 years, some may place a specific time horizon of their investment of, say, 5 years whilst others may fund for 10+ years.

The level of funding provided by angels varies widely but is typically in the low hundreds of thousands of pounds or dollars, although investments in excess of a million are known. Angel investors often pool their resources so that investments at a personal level may be in the tens of thousands. They frequently band together using ‘clubs’ attached to universities, business schools, or science parks.

An important point to note is that all early‐stage investors will require a well‐formed business plan, including a demonstration of business model, market understanding, and market risks. There will also obviously be technical risks, but these are usually more within the expertise of the start‐up staff, so judging the character and experience of these people is an important but unseen part of the investors' due diligence. Entrepreneurs may be asked to ‘pitch’ to would‐be investors, especially when they are acting in syndicate.

There are believed to be some 20 000 angel investors in the United Kingdom and a quarter of million in the United States, investing some £1.5 bn and $20 bn per year, respectively. See Refs. 1,2.

In some cases, angel investments may be sufficient for the company to become viable, or sold on, but in many others funding from venture capital sources would then be sought to support the next stage of company development.

10.5 Venture Capital Funding

Venture capital (VC) funding is one of several forms of private equity ownership, i.e. where equity ownership of a business is not publicly quoted. It is typically used to cover the period from a firm's early‐stage product and market development through to the point where that company is self‐sustaining and capable of relying on public equity and/or bank debt (see, e.g. Ref. 3).

VC funds pool money from pension funds, insurance companies, private wealth funds, and sovereign wealth funds and manage it professionally. Fund managers actively participate in company management and decision‐making, often bringing expertise in finance and marketing (but rarely in technology management). Securing VC funding requires comprehensive and credible business plans so that risks can be judged. It could be argued that VCs are more risk averse than angel investors, the latter coming in at a more formative, and hence less certain, stage of a company's development but putting in less money.

VC funding could typically be used for:

• Product development and intellectual property protection
• Marketing development and product launch
• Manufacturing start‐up
• Working capital

VC funding may come in multiple rounds, known as Series A, B, C…, provided by the same investors or adding new ones as funding levels increase. Investments may be pooled amongst several VCs to spread risk.

Investments will typically be held for four to seven years and a return secured by an initial public offering (IPO) of shares, a trade sale or a sale to another VC fund. In the United Kingdom, £5 bn–£6 bn is typically invested each year by VCs in about 800 companies. The corresponding figures for the United States are $40 bn–$80 bn and 6000–10 000 deals per year.

Different VCs have different emphasis and strategy in terms of where in a company cycle they operate and may specialise in certain sectors, such as biotechnology or software. A current trend is towards somewhat later stage interventions, leaving reduced coverage for companies with technologies in the TRL 4–8 range.

10.6 Private Equity Funding

‘Private equity’ is a term that can be used generally to describe a situation where equity ownership of a business is not publicly quoted. It is also used more specifically to describe funds that acquire ownership or part‐ownership of mature companies that are not fulfilling their potential. These might, for example, be divisions of large organisations, which no longer fit the corporation's strategy. The acquired organisation usually goes through a period of major shake‐up and is then sold on, either publicly or privately, after a four‐ to seven‐year period. This form of financing has little relevance to the main thrust of this book but is included for completeness.

10.7 Equity Crowd‐Funding

A new but growing form of equity funding (and debt funding, sometimes known as mini‐bonds or P2P lending) is through crowd‐sourcing. The first examples of this form of fund‐raising can be traced back to about 2010. Arguably, the concept is similar to the way charities operate – small contributions from a large number of private individuals. Unlike charities, the contributors each acquire a small equity stake in the company making the offer. When the figures are examined closely, though, it is obvious that a typical crowd‐funding investment is more than just loose change.

The approach has been made possible by low‐cost IT platforms, supported by social media, which are used to pitch the proposed investment. It is also the subject of financial regulation as the transactions qualify as the selling of securities as normally understood. So, for example, the Financial Conduct Authority in the United Kingdom and the Securities and Exchange Commission in the United States now accredit the operation of specific crowd‐funding platforms.

The sums raised per offer vary widely, sometimes from hundreds of thousands of pounds (or dollars) up to more than $11 m for the largest example at the time of writing. Individual investments are in the low thousands, although professional investors may also take part and subscribe a lot more, sometimes taking the lead. The firms using crowd‐funding come from every sector of business. For example, the author has had interaction with a mechanical engineering/renewable energy company that raised in excess of £2 m through this route.

In terms of where crowd‐funding sits in the funding cycle, it seems to overlap with the later stages of angel investing and the earlier stages of venture capital funding. The further development of crowd‐funding will be very dependent on how successful exits are from the first years of its operation, something that is largely unknown at the time of writing.

10.8 Bank Lending

Banks provide large quantities of business funding in a wide range of forms, typically as loans or overdraft facilities. Banks take a low‐risk approach to lending, increasingly so since the 2008 crash. They will look particularly at the cash‐generating capability of a business and hence its ability to support the payment of interest and repayment of the capital. They will also require some form of collateral, which could take the form of machinery, land, or buildings, all assets that can be sold in the case of business failure. Asset leasing and hire purchase are variations on the same theme.

Bank lending is therefore primarily of relevance to established businesses looking to finance ongoing operations or growth. Earlier‐stage financing, if available, might have to be backed by personal assets, such as the family home.

There are also government‐backed banks, such as the British Business Bank in the United Kingdom – see Ref. 4 – which operate as banks but back companies at an earlier stage of their development. Their loans are typically quite small, c. £25 k to $35 k, so they may have limited relevance as a primary source of funding for engineering development.

10.9 Peer‐to‐Peer (P2P) Lending

P2P lending follows similar principles to equity crowd‐funding, using an IT platform to connect large numbers of small‐scale lenders to borrowers, who might be private individuals or companies. The first examples emerged around 2005, and had mixed success with early problems of significant default rates by borrowers. The process is now more stable and robust. It is regulated by, for example, the Financial Conduct Authority in the United Kingdom and the Securities and Exchange Commission in the United States. The attraction of P2P is that it can potentially offer lower borrowing rates and higher savings rates than traditional banks. There has also been some government encouragement given the reluctance of traditional banks to lend to small companies.

In order to provide adequate confidence to lenders, the managers of P2P platforms have put in place criteria to assess companies before offering loans. These are the familiar criteria such as financial track record, accounting history and general creditworthiness. Hence, P2P lending is only likely to be feasible for established companies looking to grow and not feasible for early‐stage companies.

10.10 Public Funding of Early‐Stage Work

Public funding is widely available to support many forms of early‐stage technology work, within the constraints of state aid legislation. In relation to the latter, the European Union, for example, defines (Ref. 5) three forms of R&D, which may be funded, at different ‘intervention rates’ (the percentage of a project's cost which a funding agency may contribute):

1. Fundamental research. Experimental or theoretical work undertaken primarily to acquire new knowledge of the underlying foundations of phenomena and observable facts, without any direct commercial application or use in view. Funding up to 100% of costs is allowed, but this category of work would precede the type of concept development work outlined above and is normally the province of universities.
2. Industrial research. Planned research or critical investigation aimed at the acquisition of new knowledge and skills for developing new products, processes or services or for bringing about a significant improvement in existing products, processes or services. This type of work might form part of early‐stage concept work and is typically funded at a 50% intervention rate, usually requiring collaboration between two or more partners. Small and medium‐sized enterprises (SMEs) are allowed higher levels than 50%, up to 75% in some cases. Work in this area is frequently described as ‘collaborative R&D’.
3. Experimental development. Acquiring, combining, shaping, and using existing scientific, technological, business, and other relevant knowledge and skills with the aim of developing new or improved products, processes, or services. This may also include, for example, activities aiming at the conceptual definition, planning, and documentation of new products, processes, or services. A typical intervention rate is 25% and this is very much the territory of concept development.

There is a bewildering array of public schemes, operating within the framework above, which encourage and finance R&D work. They vary widely from country to country. Some are delivered by national bodies, such as Innovate UK in the United Kingdom. There are transnational programmes such as Horizon 2020 and its successor Framework Programme 9 (FP 9) in Europe. Then there are multiple regional and local schemes. All are based on the same premise: encouraging R&D leads to new technologies and hence products and services, which, in turn, leads ultimately to high‐value jobs and economic growth.

Often, these bodies run periodic ‘calls’ where they request R&D proposals relating to a defined topic of interest with deadlines for submitting the proposal, which are then subject to independent review. Such calls are often oversubscribed, so there is competition for this funding.

Proposals are typically expected to cover:

• Why the proposed research topic has merit and (useful) novelty
• How it might be brought to market as a new product or service
• Who will participate in the programme and how it will be managed
• Why public funding should be used to support the work

Whether public funding is of interest to an organisation would depend on its preferences and circumstances. It may provide a welcome injection of funds for a tightly funded organisation. For others, the involvement of third parties, or some inflexibility to change direction quickly, may be unwelcome.

Public funding of early‐stage developments will not cover all the costs of a new development, if only because intervention rates are less than 100%. However, public schemes are in active use by the smallest of SMEs through to major players such as Airbus, Ford Motor Company, and Shell.

The other route that governments use to encourage innovation is in the form of tax credits for R&D work. Different countries have different systems, but typically companies spending money to develop new products, processes, or services; or enhance existing ones, are eligible for a cash payment and a corporation tax reduction. In the United Kingdom, for example, up to 33% of eligible expenditure can be recovered in this way. The definition of R&D is quite broad:

R&D for tax purposes takes place when a project seeks to achieve an advance in science or technology. The activities which directly contribute to achieving this advance in science or technology through the resolution of scientific or technological uncertainty are R&D.

Most importantly, the work does not have to be successful to qualify!

10.11 Public Development Facilities

Most major industrialised countries also have groups, or networks, of engineering development facilities, supported to a greater or lesser extent by public funding, and which can be used by engineering companies to undertake development work.

They concentrate on applied research, which can be taken up quickly by industry and therefore they are a step beyond university‐style research, although there is overlap. The term ‘research & technology organisation’ (RTO) is used to describe them, and their European association, EARTO, estimates that their 350 members turn over some 23 billion euros p.a. in Europe. Their topics of interest are quite wide; not just engineering but biotechnology, digital technologies, semiconductors, energy, future cities, and healthcare are covered.

The largest network is within Germany where the Fraunhofer Gesellschaft has, at the time of writing, 69 institutes employing 24 000 people. Other facilities in Europe include the Catapult network within the United Kingdom, RISE in Sweden, VTT in Finland, and FEDIT in Spain. They are generally constituted as nonprofit organisations and are required to allow access to all comers on a nonpreferential basis. Their income derives from a mixture of public and private funding and they are active participants in European collaborative R&D programmes. Many have access to national funds set up to encourage technology development within small companies. For larger companies, the attraction is access to major facilities, such as wind tunnels, which single companies might struggle to afford.

In addition to large‐scale engineering facilities, there are countless local schemes where business is encouraged through incubators and innovation hubs where office and workshop space is provided on competitive and flexible terms to early‐stage companies.

10.12 Business Plans

External fundraising at whatever stage and in whatever form needs credible business plans. Without going into too much detail, these should be built around six points:

1. Strategy. Overall company aims, vision, and purpose
2. Market. Basis of competition, marketing plan, demand for the products or services, current and future client base, pricing, commercial model, volumes, territories, and competitors
3. Product or service. Details of current and future offerings, status of their development, development plans and timescales, risk analysis
4. Management capability. Details of key individuals, their capacity, responsibilities, skills, and track record of company leadership
5. Financial plans. Cash and financial projections as a function of time, financial track record, sensitivities, creditworthiness, accounts payable, and receivables history
6. Exit route. How equity investors will be able to exit (profitably) within a defined timescale

Internal business plans will follow a similar pattern with one or two omissions. See Chapter 5, Section 5.14, ‘Approval and Formal Monitoring of Large Projects’.

10.13 Concluding Points

Technology and product development work has to be funded to make progress. Engineering R&D can be quite expensive with the need for computing facilities, test samples, and test facilities, as well as people's time. Money spent on work of this type is a form of investment, spent now with the hope of later benefits. These returns, unfortunately, are rather uncertain and could vary on any given project from zero to astronomical – hence, portfolios of investments are better from the point of view of spreading risk. All requests for funding need to be accompanied by a strong case, not just the idea but its business prospects.

Funding is available in multiple forms from the developer's own money through to private and public sources, all requiring the developer to have some of his own ‘skin in the game’. William Shakespeare had his own views about financing:

Neither a borrower nor a lender be,

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry

His words are wise counsel when it comes to domestic finances, but business would quickly grind to a halt without borrowing and lending, especially in the field of technology and product development.

References

Four references from trade associations and a government‐backed bank provide useful guidance, plus some facts and figures about various forms of funding provision:

1. 1 Wright, M., Hart, M., and Fu, K. (2015). A Nation of Angels – Assessing the Impact of Angel Investing across the UK. UK Business Angels Association.
2. 2 Pitch Book ‐ (US) National Venture Capital Association – www.nvca.org
3. 3 The Innovation Nation – UK Private Equity & Venture Capital Association, 2015, www.bvca.co.uk
4. 4 (2015). The Business Finance Guide ‐ a Journey from Start‐up to Growth. British Business Bank, ©Institute of Chartered Accountants in England and Wales (ICAEW).

For those more deeply involved in European projects, or projects funded by European governments, this 38‐page legal document is a comprehensive guide, albeit somewhat difficult to read:

1. 5 Framework for state aid for research and development and innovation – European Commission, Brussels 21.05.2014 { SWD(2014) 163}, {SWD(2014) 164}