In today’s business world, many early startups use their own savings and borrowing capacity to bootstrap to potentially marketable businesses. Having tapped out their own funds and those of their family and friends, these companies are faced with asking for funding from angel investors. Since there are varied information available in the internet and coupled with very entertaining angel investing tv shows, some new entrepreneurs may easily be dazzled and resort to immediate pitching of their company for external investment. Although, there are many benefits the angel investors and venture capitalists can bring to your company, it is best to know when the opportune time is to secure external funding. Below are some things to consider before a startup approaches a venture capitalist that are surely to be asked of them.
A strong established team is one of the key determinants for the investors. It is best to form a team composed of founder and co-founder, the workforce and set of advisors that are highly competent in their area of interest. When the company is relatively young, it is a great advantage that either the founder or co-founder is leading the company full time. This full-time commitment conveys a strong message that they take their business seriously and not half-hearted with a fallback position if the business fails. Together with the founders, the company must have an in-place reliable and supportive team that can deliver a quality product or service in a timely manner.
A robust differentiated product that solves a defined problem is also needed. There are many products in the market that are invented or innovated but sadly do not serve a real purpose. It maybe trendy to have these products but they do not solve a real problem to add value to customers. Investors want to become part of a revolutionary product, a game changer that brings a new way of doing things. For example, Uber Technologies has changed the decades old way of personal transportation by eliminating the need to hail a cab by the street. Its unique value proposition and convenience by using an app on your mobile phones adds value to the customers. By the Uber business, you no longer need to own a car and pay for maintenance and insurance, no more effort to drive and even hassles in finding a parking space. Uber business model solves your personal transportation needs conveniently.
Intellectual Property Protection is another key point to consider before asking for external investment. By securing a patent or trademark for your product you are protecting your innovation from other market competitors. Investors highly value it as a plus factor. Sometimes investors will wait until after you obtain this protection prior to investing. However, some investors may be willing to fund a business even without an intellectual property protection for their differentiated product.
Proven sales growth is a major factor to investors. A startup company who has been in the business for at least three years with continuing sales growth is showing a good sales record. It would be appealing to show the investors that the product has a promising demand in the current market space, or it has a potential to scale to other niche markets. When the product has shown a robust need to customers it is easier to sell in the market. Ring for example, was a new generation doorbell that has proliferated the market for its convenience of use. It answers problems in home safety. Powered by Wi-Fi and unique features, customers can easily monitor who comes in and out of their homes 24/7 with real time notification sent to their mobile. It simply altered the way doorbells and security systems had been functioning for a long time. This viable product simply put the startup in the successful position it is today by gaining remarkable sales growth.
A comprehensive business model supports investor’s confidence. A bank will not lend money without a business plan. Venture capitalists likewise would require a comprehensive business model to show how the business operates, who are the customers, how they deal with them and how do they deliver the value product, their revenue streams as well as their expenses. Your comprehensive business model must be able to show how the business will get to profitability. After presenting all this information, it is important to note how and where their investment will be allocated. Innovating your product or a single process in your operation using an external funding could pivot to another revenue sources. This is another factor that attracts investors by foreseeing the scalability of the business.
Ready to scale is ready to fund. Citing a quote from an article “raise funding when your company can no longer grow on its own”[1]. Once your company has reached its success in a certain category using its own funding, it may reach the point that it needs to scale up to either explore the blue ocean – new markets or ready to serve the red ocean – deep dive and flood the market with the product. That is the best time to ask for venture capitalist to infuse funding into your business. When product market fit is achieved there is a huge assumption that the sales growth will be very promising, and it only needs additional funding to bring it to the next level. Venture capitalists have expertise in marketing and management and may bring wide clout and resources to surely help the company get to the forefront.
Willingness to give up equity and control is a founder’s dilemma. In order to make a startup business thrive, the founders must put every effort into the business. Founders are used to controlling and deciding matters by themselves. To make their company bigger and make it a leader in the competition space it is necessary to get funding, which means giving up equity and some control and decision making. Investors have the right to protect their investment interest by participating in the operations and decision making. In order to have a smooth business relationship, it is best that the founders respect the investors’ need for some control and input to decision making to protect their investments. The trade off is how much control for how much funding. Before seeking funding from venture capitalist, entrepreneurs must decide not only how much control they are willing to offer but more importantly how much is the maximum control are they willing to give up for that investment.
An Exit Strategy is a must for venture capitalists. It may seem odd for a start up to think of an exit strategy when they are still young and in the seeding process. However, venture capitalists are interested in knowing how they will get their money out – almost always earlier than ten years. Exit strategy are usually by going initial public offering or merging and acquisition. It is important to show when is your business going to be profitable and which entities would be interested in acquiring your company. This maybe the companies you are trying to disrupt in the market. To quote an article written in Inc. Newsletter regarding a famous investor “Ron Conway has said that if he cannot think of five potential buyers within the first minute of talking to a company, he is not interested”.[2] Venture capitalist are more likely to put funding in the business if they know when and how they expect their invested funds to come out.
Be ready for due diligence before funding. Due diligence is the investor’s fact checking process. According to Mr. Chris Mirabile, Chair of the Angel Capital Association: “The reason investors do it is to convert unknowns into calculated risks; the diligence process is about understanding what you are getting yourself into, particularly in relation to the requested valuation”.[3] Investing reaps substantial benefits when the product is doing well in the market, however it also exposed to plenty of risks; market risk, financial risk, technology risk among others. To reduce the amount of risks investors would like to see transparencies about the founders’ background, experiences and skills, their connections and references in the industry. Another area is the company’s financial report, profit and loss statement, cash flows and particularly debts. The company must disclose its true financial position. Secondly, investors are looking closely to the company valuation. It is important to identify the company’s go-to-market strategy for their product. The focus is not on the whole total industry market, but the focus is the immediate total addressable market, that is what your product is targeted to and hopefully will achieve. A startup company which has been granted seed funding or convertible notes previously has potential leverage to obtain investments because it has already built some trust and credibility. Due diligence though it may seem dreadful for entrepreneurs is helpful for both parties to foster good business relationship.
So, when is the best time to seek venture funding? – when you are ready to scale. If you pitch too early venture capitalists might turn you down, give you advice and recommend you to comeback. To be successful, better prepare the above preparations discussed.
[1] https://fi.co/insight/forget-about-fundraising-bootstrap-your-startup-instead
[2] https://www.inc.com/christopher-mirabile/rites-of-passage-what-investors-mean-by-due-diligence.html
[3] https://www.inc.com/christopher-mirabile/rites-of-passage-what-investors-mean-by-due-diligence.html