Only 0.05% of startups obtain venture capital funding (aka VC Funding). Finding VC investors willing to invest in your startup is a question that boggles many entrepreneurs’ minds. How do you create an appealing narrative for investors that reflects your company’s viability? And, where do you find investors at all?
There’s certainly no shortage of relevant information on the internet, but creating a self-researched strategy can be daunting.
Based on many conversations with earlier-stage companies – and knowing that getting VC funding is always top-of-mind for these ambitious startups – I modeled a new, high-level fundraising strategy (as if I was just getting started myself). No two companies are identical, of course, but these general concepts can apply in some way to founders without much fundraising experience.
When I say “plan,” I mean more than big-picture goals. Do you have a detailed financial plan? Be sure to nail down the basics, beginning with a three-year financial pro forma.
I find a dynamic, three-statement financial model to be most useful when creating a pro forma. This model calculates changes to your cash balance as you tweak your fundraising strategy and revenue projections.
Do you know the most important KPIs (Key Performance Indicators) that drive your business? These are values that measure how successfully your company is meeting its objectives, often in relation to competitors within that sector.
Trace every dollar of projected revenue backward. Find the actions or assumptions that drive them. Once you have this list, be sure to incorporate them (in their own section) into your financial model, so that they can be changed rapidly.
Examples of KPIs might include, but are definitely not limited to:
Remember: your business’ viability depends on your KPIs.
I suggest fundraising based upon anticipated milestones – those expected to trigger valuation inflection points.
Using your pro forma, map out the various points in time at which you plan to achieve a key milestone. Map it as precisely as you can (e.g., down to each quarter or even down to each month).
The milestone might be:
Next, calculate the net cash burn (i.e., the rate at which a company spends cash in a given period) required to reach your identified milestones.
Equipped with this information, create a realistic fundraising plan that enables you to operate for 12 to 18 months between fundraising rounds. Be sure to build in a buffer!
Inevitably, it takes longer to raise venture capital than you think.
Lead venture capital firms could take anywhere from six to 12 weeks to reach a term sheet. Then, potentially, you need another month to close the venture capital investment and wire funds. Include some padding, so you don’t set yourself up to be in a position of cash weakness while you raise VC funding.
As an example, say the current date is 01/01/2020, and you identified two milestone estimates:
Assume also that you calculated the estimated total cash burn to reach:
Plus, your current cash balance is largely depleted.
One possible near-term fundraising plan could be to raise $250k. This funds through Milestone 1.
Then, raise the next $750k (shortly after achieving Milestone 1) to fund the business through Milestone 2.
Understand the framework for how the market may value you at these inflection points or future “milestone” dates. Your goal is to raise the money you need at each identified milestone while minimizing your dilution exposure with respect to your stage of business.
Expect an appropriate amount of dilution at each raise – not too much, but also not too little.
For example: Let’s say that you run a B2B SaaS (software as a service) business. Your research suggests that the market typically uses revenue multiples between 4 to 10x TTM revenue to value your business (hypothetically). TTM revenue refers to revenue over the “trailing twelve months,” or TTM.
Based on your research, you should anticipate the future and think twice before aggressively negotiating for a valuation in your 2020 round. That valuation could match or exceed the valuations the market will likely bear for your business in your 2021 round.
Your theoretical range is 4 x (TTM Revenue) to 10 x (TTM Revenue).
Pushing for new valuation in a 2020 round could place unnecessary strain on your future fundraising efforts. This may position the business for a “down round,” in which shares are sold for less than in previous rounds.
Build your investor wish list. Begin with who you think might be the most valuable partners to your business at each funding stage.
Look at associations, such as the National Venture Capital Association (NVCA), or research venture capital firms with an eye on sector, geography and other relevant factors, like management strategy or typical level of VC funding.
Once you have your list, understand that venture capital investors are not all alike in:
Determine which investors to target for each of your planned fundraising rounds, and get to know them early.
One thing VC investors don’t like is the notion that someone is not forthright with them.
Be open, genuine and concise. Identify your challenges and weaknesses upfront. Share your strategy for resolving those challenges. It will build trust and help illuminate issues earlier as you seek VC funding.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Raising Capital: Negotiating with Potential Investors and Capital Raising. This is an updated version of an article originally published on May 26, 2017.]
©All Rights Reserved. March, 2020. DailyDAC™, LLC d/b/a/ Financial Poise™
Scott is a venture capital investor at Lewis & Clark Ventures, a fund manager that focuses on Series A and B stage startup innovation between the US coasts. Previously, Scott managed the operations of Capital Innovators, a startup accelerator and seed stage venture capital fund for software innovation. He earned a Bachelor's Degree in Economics…
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