If you’re an entrepreneur considering raising capital from investors to fund your business, there are a few things you should know before you get started. We created a list of tips that business owners need to know before going out there with a product, a pitch deck, and expectations of knocking out an entire raise after a few meetings with deep-pocketed investors. By following these six tips for working with investors, you can make sure that you and your business are prepared for your raise and can quickly and effectively get the money you need to grow your business.
Six tips for working with investors:
1. Know your business
Not every business model is right for VC/angel funding. If you’re trying to open a local coffee shop, you probably need a small business loan, not venture capital. Investors look for a few criteria when considering businesses. Your business should meet each of these qualifications:
- Rapid growth: Your business will double or triple in size every year.
- An experienced team: Your team includes people familiar with the industry. Preferably also at least one individual who has experience working for venture-backed companies.
- Venture companies need to be highly scalable and have the ability to be acquired.
- Disruptive: Your business should have a unique technology, product, or service that is addressing a critical need of your consumer.
- Patent protected (if necessary): Patents aren’t necessary for all technology companies—but are highly relevant for some industries such as medtech. If you think you need patents, make sure you have them in hand before you try to raise capital.
- High exit potential: Have a plan surrounding your exit. Don’t follow the misnomer that it is taboo to talk about your exit strategy. Investors want to know when you plan to be able to pay them back and expectations surrounding the projected return.
A few exceptions: There are businesses who don’t perfectly fit the criteria outlined above. A manufacturing company—for example—may not be poised for a 30 million dollar exit in five years. However, good angels and venture capitalists know which variants to look for based on the industry. Manufacturing companies will have smaller valuations, exists between 10-20 million, and slower growth. However, the risk is less for investors which makes them an attractive option for those who want to diversify their portfolio.
2. Understand your place in the financing life cycle
You’ve got an idea, a logo, and a killer pitch deck—great! But that doesn’t mean your company is ready for angel or VC funding. Know and understand where you are in the financing life cycle and raise the appropriate capital based on your place within it.
As a general rule, angels should be helping you raise your first 250,000 – $2 million. They will often syndicate or bring groups together to help you with raises that are closer to that 2 million dollar mark. If you’re still in the early proof of concept stage, you may not be ready to take on angel funding and should spend your time really perfecting your product.
By the time you head into your Series A, investors are looking for a company that has been—more or less—de-risked. At this stage, you should have more than proof of concept. Your business should know and understand your customer acquisition costs (CAC) and your lifetime customer value (LTV). You should also have about a 1 million dollar run rate and have approximately $80,000 a month in revenue. Investment capital at this stage is meant to help your business scale at an exponential rate, not build a prototype.
3. Pitch early and pitch often
While your business will need to meet certain criteria before it is attractive to investors, that doesn’t mean you should wait until prime time to get out there and pitch. Entrepreneurs should pitch early and often. If you know you’re not ready to take on funding—that’s okay. Present your product anyway— just do it with a little humility. Let your audience know that while you’re not taking on funding at the moment, you would love their input and suggestions. Challenge the assumptions you’ve made about your target customer, your product, and your business. Market feedback will help you build an intimate knowledge of your business so that when you are ready for funding, you’ll have perfected your talking points and be ready to respond to questions. Don’t practice until you get it right. Practice until you can’t get it wrong
4. Understand the cost
Angel and VC capital is expensive. Entrepreneurs who are raising for the first time often endure a bit of sticker-shock and can feel like investors are taking advantage. As a general rule, investors are looking for between a 5x and 10x return on their investment over about five years. While that sounds like a lot, keep in mind that venture capital is the highest risk class in which an investor can participate. Investors in this asset class have to make up the difference between the winners and losers in their portfolio.
Too often, entrepreneurs will go through the process of pitching their company and after attracting a few investors, gawk at the cost of capital. Understand that—yes—these funds come at a price. Venture capital is the most expensive financing an entrepreneur can take and if the price is too high, there are other options. If you choose to raise funds from investors, you should know exactly what you need the money for and how you plan to use it to help grow your business. Go in with your eyes wide open for the sake of both your business and your investors. If you’re standing in front of an investor asking for money, they’re assuming that you’ve done your homework and you actually want it.
5. Be prepared
It takes more than a great idea and a pitch deck to get funding. There are a few key things that you should prepare before you ask investors for their hard-earned cash. Here are the items you should put together:
- Team: Build a great team—preferably one that includes people with sector expertise and a few who have experience working with venture-backed companies.
- Business plan: Know who your target customer is, how are you going to attract them, what your proforma looks like, and your exit strategy.
- Proforma: Create an accurate sales forecast. It should include projections based on your channel mix and show where your company will start to scale. Your proforma is a living document that you can continue to iterate on as your company grows. It will help you understand what spend is driving customer acquisition and help you determine where you need invest funds to spur growth.
- Prototype: Have something investors can see; a working beta, a sample of your product, etc
- Product: Know how you are going to package, market, and sell your goods/services.
- Promotional Strategy: Know your customer, their pains, and what messaging will resonate with them. Don’t just assume that people will buy your product because you built it and you think it’s great.
- Partnerships: Build your strategic partnerships with people who will help you create and sell your product. Whether it’s companies who will be manufacturing your goods, building your tech, promoting your product through sales channels, or distributing your product, have some of those relationships established before you start fundraising. It will show investors that you have leverage in your market and also act as a validator.
- Paying customers: The ability to produce and sell a product at a projected price is a huge green light for investors. If you have a few paying customer on board, that is yet another validator you can bring to the table.
- Proof: Be scientific about how you build your business—especially in the early stages. Validate your assumptions and hypotheses with proof. Show investors how you have been able to gain traction with funding you’ve acquired thus far, and it will go a long way in convincing future investors that you can deliver on your growth strategy.
- Pitch deck: Have a killer pitch deck that you’ve absolutely mastered. Here are some tips to help you build it.
- Term sheet: Create a four to six page document with the terms of a deal. It probably won’t be the final version but will serve as a jumping off point to start negotiation. Angel groups will likely already have a standard term sheet on hand, but individual angels interested in investing $25,000 in your business probably don’t know how to create a term sheet and don’t want to spend $10,000 in legal fees in order to develop one.
- Due diligence: Your diligence room includes all the important documents like your articles of incorporation, financials, contracts and more. It serves as further proof to your prospective investors that you know what you’re doing and respect their time enough to come prepared.
6. Network, network, network
In addition to helping you master your pitch, getting in front of investors early on will help you start building a network. Startup financing is a relationship business. Angels and VCs are more apt to give their money to an entrepreneur they know and trust—one who has proven that they can stick it out and use feedback to iterate and improve upon their business plan and product. Remember that investors often pool their money as part of groups and thus an individual investor can be a huge advocate for your brand.
By following these six tips for raising capital, you will be more prepared as you enter your raise and ideally close your round quickly without spending too much time at coffee shops with every investor in town. If you want to know more, check out this webinar we produced with Peter Adams, Managing Director of Rockies Venture Club and writer of Venture Capital for Dummies.