We have been exploring various aspects of funding your business over the past few weeks. This newsletter covers the issue of making your business attractive to investors, understanding that this funding option is but one type of the various funding options available to the entrepreneur. As discussed in the previous newsletters, of more importance is actually the timing of the funding round and then of course the critical issue of the level of control that will inevitably be relinquished in the process. Timing pertains to the saying, funding is not to build the machine, but to speed up the machine.
The obvious answer to what makes your business attractive to potential investors is naturally the potential of impressive returns on their investment, with concomitant manageable and transparent risk levels before entering into the deal. Before we delve further into what attracts investors to your business, it may be an idea to consider the various types of investor funding rounds that are pertinent to this discussion.
There are various stages to the funding rounds that will determine the type of investors to attract to the business.
Most start-ups usually embark on their entrepreneurial journey by using their own money, and then of course, friends, family and fools. This is certainly the pre-seed funding stage, where the founding team is probably still in the idea stage and needs to validate the product and make their first sale. This is also known as the “Valley of Death” as most start-ups fail during this stage, which normally lasts for about two years.
The typical next stage would be the “Angel Investor” stage where wealthy individuals invest a relatively small proportion of their funds into high-risk start-up businesses. By now, the business should be beyond the product prototype stage, has a growing customer base, and has probably employed its first employees.
Venture capitalists normally follow the angel funding round in “Series A and Series B etc. funding rounds. The business is now at the scaling stage and needs the funds to grow the business rapidly and to expand exponentially. The business is making serious revenues and has a growing team of employees, probably with heads of departments and other formal organisational structures in place. One could also include private equity funds in the various “Series” funding rounds. These are funds that are managed on behalf of large investors where the fund searches for businesses that hold the potential to be made more profitable by cutting costs and then on-selling the business once the efficiencies are in place.
Beyond the VC and private equity stages one could comfortably state that you “have arrived” as this is when the business exits either as an acquisition to a larger company or to an IPO, an Initial Public Offering to be listed on a publically traded stock exchange.
In for the Long Term
It is most important to understand that undergoing a funding round is for the long-term and getting an investor into the business has been likened to marriage. As mentioned already, you will be giving away a certain level of control in the business so you need to be absolutely sure that your timing is just right, and that you do indeed need the funding at this time. It would help a lot if the funder shared your vision for the business and there was a level of trust between the parties.
Do not be distracted by the lure of huge flows of money coming into the business, rather assume the worst case scenario and put everything on paper. Many entrepreneurs have been burnt badly during the funding process, mainly due to their lack of knowledge in this process and a certain level of naivety. Never sign anything until you understand exactly what it is you’re signing.
Remember that you can only give away shares once!
So, once you have settled all these issues, how do you make your business attractive to funders?
Put yourself in the investor’s shoes and consider that you are going to give someone some of your hard-earned cash, probably a person that you do not know very well at all. Would you calmly hand a stranger some of your cash? While most entrepreneurs are focused on their product, an ideal investment has to have, yes, a working product, a market with growth potential, and a customer base that has validated the product. Beyond these, an ideal investment has to have a great team.
The investor needs to be reassured that the team driving the bus are united and unique to execute the vision and mission of the business. It has been said that there is nothing new on earth and your idea has probably been thought about many times by other people so the team is what makes the difference between the idea at 10% and execution scoring 90% for the investor.
As mentioned previously, the investor needs the promise of a great return on his or her investment. This will be satisfied by the long term prospects of the company and the vision of the team in this regard is crucial, and it will be important to get the investor buying into the long term vision as well.
Investors tend to follow other investors. Investors also want to know if there are other investors in your company, and remember, this could include the “friends, family and fools” brigade, even if they may be minority shareholders. If you have a high profile investor already in the business, this could certainly make your company more attractive to other investors as they would assume the earlier investors would have conducted a thorough due diligence on the business.
Important to potential investors would be how the business has applied the proceeds of the previous funding round to scale and grow. This will give the investor and idea of what your team is capable of doing with their money.
While most entrepreneurs shy away from the numbers, this will be the aspect of the business that potential funders will spend the most time to study and understand these meticulously. Your company financials are the objective embodiment of all your blood, sweat and tears to get it to where it is in a position to be funded and you should also know your numbers intimately. Most start-ups will have a fairly rudimentary idea of their long term financial growth curve, the financials serve as an objective roadmap to give the investor an idea of the way forward based on the recent past.
There are generally two types of funders in the start-up space, those driven by trust, and those that make fact-based decisions. Trust-driven funders include the likes you, the founder, friends, family and fools, your first employees who often provide “sweat” labour, crowd funders, and some angel investors. Fact-driven investors will be the serious money, and include venture capitalists, banks and of course, once listed on a stock exchange the public shareholders will probably only have your annual financial report to make their decisions.
It would help to get professional guidance on issues such as financial projections to help investors understand what their potential Internal Rate of Return (IRR) they could realise by investing in your business.
The numbers are all-important so ensure you have been absolutely meticulous in preparing them with the investor’s point of view.
Potential investors will insist on a thorough competitor analysis before thinking of ploughing money into your business. Some entrepreneurs, especially in the ICT industry, hold the opinion that their idea, product or solution is so new that there are no competitors. As mentioned already, there is probably a version of the idea somewhere in the world, the major difference being the team you have assembled to take yours to market. The point is, you will have competitors, whether presently or in the near future once your product gains traction and starts getting noticed by the larger players in the market.
Your competitor analysis should, however, showcase how you set your company apart from the competitors and should outline what elements make you unique thereby providing an edge of sorts over them. This could be along the lines of distribution channels, intellectual property, partnerships, or reach. You will need to show how your business will be able to outperform your competitors in your industry.
While there are several mandatory and non-negotiable components to attract funders to your business, you and your team are a vitally important attraction of the funding pie. Be proactive and conduct your own due diligence on your company, as though you were a potential investor. Analysing the product, market, interrogating your financials, and objectively assessing your team will help you take an objective view of your business from an investors point of view.
Huizenga,N,. Investor Readiness. Slideshare. 1 June 2015. Accessed 09 May 2016 from: