For most companies, fundraising isn’t about $100-million rounds and “unicorns”. It’s often an anxiety-ridden, lonely, frustrating process filled with uncertainty and self doubt. Despite the stories out there, raising venture capital isn’t easy for most startups.
Entrepreneurs are always evaluating tradeoffs, such as valuation and structure (which we’ve written about before here). But there’s much more, so we’re sharing the below list of questions we often hear to help shed light on the realities of raising capital.
1. When should we raise capital; how do we time it right?
You should only raise capital when you’re “ready” to execute a process, but determining when you’re “ready” is the hard part. You’re never actually ready: There’s always another close milestone that’s going to increase your valuation, there’s never enough time to prepare. At some point you just have to push yourself out there and begin.
In the best case scenario, raise capital when these three criteria are true:
1) You have sufficient cash runway to provide you flexibility in the fundraising process so your back isn’t up against the wall (yes, that old adage ‘raise money when you don’t need it’ is true!). Runway = negotiating leverage.
2) You’ve achieved the necessary milestones to get the valuation you think you deserve.
3) You’re thoroughly prepared to deliver a knock-out pitch and efficiently respond to diligence requests.
2. What does a typical company raising a Series C look like, and what are the right milestones we need to hit in order to ensure a successful raise?
There are so many factors that go into pricing a round of private capital, that it’s almost dangerous to draw specific conclusions from other companies. There is no right answer. Every company is different. Every management team is different. And the market conditions are always changing.
Just remember that regardless of size or what a round is called (seed, series A, B, C, etc.), it’s all about the alignment of capital to milestones. Use that rule to keep yourself grounded. The more traction and the greater the growth, the better.
3. Should we ask for a specific valuation?
While it’s certainly true that some companies can name their price, the reality for most startups is about taking the best offer the market delivers. Asking for a specific valuation can sometimes be a risky negotiating strategy. If you ask for a valuation of $x and the investors pass on the opportunity because they don’t think the company is worth $x yet, going back to that same investor with a lower valuation rarely leads to a different outcome.
By the way, even if you don’t ask for a specific valuation you’re probably providing valuation signals without even realizing it. When assessing a “valuation ask” by an entrepreneur, investors also consider implicit signals like the proposed size of the raise, the price of the last round, the total amount of capital raised, and the number of rounds of capital raised.
4. How much capital should we raise?
Of course you want to be strategic about the amount of capital you raise, not least because of sensitivities about dilution. As such, you want to size the round in a way that gives you sufficient cushion to get to the next set of milestones and valuation inflexion points.
What you do not want is to end up a “tweener” caught between rounds! In investor jargon, “tweener” is a polite way of saying your valuation expectations are too high for the financial or operational traction you’ve achieved so far. To get yourself out of this position, you can (1) lower valuation expectations or (2) improve execution and grow into those valuation expectations. Neither are optimal in the middle of a fundraising process.
5. What investors should we target?
The most important thing to focus on here is finding investors that are appropriate for the stage of the company: e.g., an early-stage company should focus on early stage investors. And if the startup is still in “company building mode”, then focus on targeting investors that are company builders.
You can always move onto later-stage investors as the company matures, but it’s hard to go back to an early-stage investor after bringing in a later-stage investor.
6. What are ‘crossover’ investors?
Crossover investors typically invest in the public markets, such as mutual funds and hedge funds, but also invest in private companies.
An increasingly important group of investors, crossover investors can be very valuable partners to a startup — particularly as it approaches the IPO stage. They can help a startup start transitioning to life as a public company and make the IPO process less jarring.
7. Should we include ‘strategic’ investors in our round?
A simple way to think of strategic investors is as ‘corporations that invest in startups’ — everything from corporations with large, dedicated investing organizations (with significant amounts of capital allocated just to investing in startups) to those who have made only one investment in their history (using cash straight from their balance sheet). Strategic investors can be valuable partners.
The advantages of strategic investors include expanded distribution, implied credibility, and technology sharing. On the flip side, choosing some strategic investors over others could mean closing off potential distribution channels. Understanding how a strategic investor seeks to work with its portfolio companies is an important ‘reverse diligence’ step entrepreneurs need to take before deciding whether to work with one.
8. How many investors should we approach? Can’t I approach just a select few?
You’re always striking a balance between efficiency and optimizing for probability of success when fundraising. Especially because you just want to successfully raise capital so you can get back to growing the business.
This is why you don’t want to talk to so few investors that you end up running a fundraising process multiples times — i.e., starting from scratch each time. That kind of ‘serial processing’ is exhausting. At the same time, you don’t want to cast such a wide net that you can’t deliver the personal attention required to identify the best partner for your company.
9. Can’t I just have a conversation with the investors? Do I really need to prepare a full slide deck?
Most companies — again, not just focusing on those few big-name stars or ‘unicorns’ — get very few opportunities to make a strong impression with potential investors. So treat each interaction as your last. Make those interactions count.
Don’t leave anything to chance. Take time to prepare a full deck and practice, including creating a script and doing dry-runs.
10. How long does it take to raise a round?
Some companies can get it done in a matter of days. For others it takes many, many months. Either way, be prepared for the process to take longer than you expect. Also give yourself plenty of cushion when assessing your cash runway.
To maximize your probability of success, the most important thing you can do is spend a little extra time upfront preparing for a process; remember, you don’t want to run the process twice in a short amount of time. In fact, the strongest leading indicator of successful financing — flawlessly executing on the business — happens before you talk to investors. Companies that consistently deliver strong revenue growth and attractive profit margins rarely have problems raising capital.
11. I’m worried about sharing confidential information. How much information should we share — and when should I provide customer references?
The venture capital community is built on trust and reputation. The most important thing for VC firms is their reputations and the easiest way for them to impair those reputations is by not honoring your trust. That’s why high quality venture capital firms will respect the confidentiality of your private information.
One of the potential risks of not sharing sufficient information upfront and waiting until after signing a term sheet is that the investor may change their mind after signing. You want to derisk this scenario by leaving only confirmatory (vs. discovery) diligence to post-term sheet signing. At the same time, don’t be naive: information occasionally leaks out, even unintentionally. So trust, but use common sense.
12. What kind of financial model should I provide to investors?
Every company should be utilizing some sort of financial model or set of financial projections. Even if you’re at a super early stage, you should be managing to some sort of budget in order to understand cash burn and optimally time raising capital.
Understanding cash burn is one of the most important components of a financial model, and a robust model of cash burn includes detailed headcount-driven expenses. Understanding the unit-level drivers of revenue is also critical once a company crosses into the revenue generation stage. Just remember that precision is not necessarily an indicator of accuracy.
13. Should we raise debt instead of equity?
Debt can be a great source of capital when used appropriately. It can dramatically lower the overall cost of capital and provide a lot of financial flexibility.
But, it should be used judiciously because borrowing means you ultimately need to repay that debt … and the consequences of not repaying it are severe (i.e., bankruptcy). Remember: debt is a complement to, not a replacement for, equity.
14. Should we use an advisor to help us raise the round?
Investment banks or other types of advisors can add a lot of value when raising a round of capital, particularly at the later stages. Such advisors can help streamline the process by front-loading a lot of the diligence and preparation, allowing you to focus more closely on running the company. They can also help provide access to a broader set of investors.
That said, not every company needs an advisor, and the decision to use an advisor should be made in the context of the specific situation. For example, companies that receive multiple unsolicited term sheets at compelling valuations have the luxury of choosing their investor without the assistance of an advisor.
15. Should I sell some secondary stock?
Selling stock early in a company’s life can be interpreted by potential new investors as a negative signal from the selling shareholders: What do they know that I don’t know? Is the company already fully valued?
However, selling stock may also alleviate pressures on some employees to make their ends meet and even allow them to remain committed to the company longer. As with everything here, the answer to this question depends on a set of factors unique to every company: How much stock in absolute dollars is being sold; what percentage of total ownership is being sold; what stage is the company at; has a predictable revenue stream been established; and so on.
16. What happens if I come up empty after running a process, or if the market conditions turn against me?
Successfully raising capital is never a certainty, so always have backup plans in place.
Backup plans can include doing a bridge from insiders, tapping debt lines, and reducing cash burn. In general, having alternatives provide you leverage in the fundraising process.
Steve McDermid is the Managing Director at Emerson Collective