Raising capital is one of the most monumental decisions any solution provider will make. Friends, family and angel investors are great options early on particularly during the heavy product development stage. For the purpose of this post I’ll focus on the move to sophisticated venture capital and private equity firms. Some guidance:
Have the majority of your product development risk behind you. Risk assessment drives almost every decision from the VC perspective and the more risk that is mitigated then the more likely a capital raise will succeed and at a better valuation. Most VCs would prefer to provide growth capital on the assumption that product risk is minimal.
You’d don’t always need tons of customers before raising capital, but the customers you do have must be fabulously happy and referenceable. The VCs will call those customers and look for any signs of discontent.
Do the valuation math and be realistic. Valuation is obviously a huge factor in fund raising. This is a complicated subject and can’t be given justice in this post, but one of the most important elements of valuation is revenue and the believability of revenue projections. Good VCs attempt to triangulate revenue based on three approaches: a top down marketplace-level analysis; a bottom up assessment of current and future pipeline of named prospects; and a staffing analysis of the headcount necessary to hit the numbers. If these three approaches don’t approximate the same answer then it raises red flags that can either kill a deal or reduce valuation. There are many other factors in valuation, but if you don’t get revenue right then the other factors tend to become moot.
Develop an outstanding business plan. While revenue is key there are many other factors in developing a business plan. Good VCs are effectively financial engineers and they can dissect a P&L or balance sheet in their sleep. Be prepared to support any and all assumptions built into a plan.
Align the executive team to a razor’s edge. VCs make investment decisions based on their confidence in the executive team every bit as much as the business plan. Everyone must be passionate, professional, competent and singing from the same hymnal.
Prepare for the distraction. Fund raising can be very time consuming both in the preparation and the execution. The process can easily take 6-12 months. Make sure the business doesn’t fall apart while the executive team is focused on fund raising.
Be realistic about the potential for dilution. While there are always exceptions, it is often the case that early stage investors (friends, family, and angels) came in at an unrealistically high valuation. VCs have little concern for previous investors. Harsh, but true, and they will not factor previous valuations into their deliberations (unless they themselves are a previous investor). These are difficult conversations to have with early stage investors who have been so loyal and patient, and yet these discussions must be had. You have to make the case that a smaller percentage of a much bigger pie is worth more than a larger percentage of a smaller pie. It is vital that early stage investors are both supportive and realistic about the fund raising process.
There are so many moving parts to fund raising and I can’t possible do justice in a few paragraphs, but I hope this post provides the reader with some food for thought.
By Lance Jacobs
Lance is a veteran of the retail technology space, having grown and orchestrated a liquidity event for both TCI (acquired by Retalix / NCR) and KSS (acquired by Dunnhumby). He has learned much along the way and at this stage of his career has a genuine desire to give back to the industry that has been his life’s focus. Lance roots for the entrepreneurs of early and mid-stage tech companies that drive innovation. He serves in an advisory role, providing strategic and tactical guidance across strategy development, sales & marketing, product development and management, finance, and implementations. Lance can be reached at lancecjacobs@gmail.com, or 520-906-4313