Young companies need to think like investors before trying to raise capital
By Gary Miller – Managing Director, Consulting Division, SDR Ventures
I am concerned. No, I am worried — about how unprepared entrepreneurs of startups and early-stage companies are when attempting to raise capital, particularly over the next 12 to 18 months.
It’s no secret the capital markets (debt and equity) are rapidly withdrawing from funding high-risk investments. For example, there were no IPOs in January. Zero. According to Dow Jones VentureSource, 58 percent of IPOs completed last year traded below their issue price for all of 2015.
Why? Investors doubt the future performance of the U.S. and global economies. Adding to these doubts is political uncertainty, tensions between businesses and government and anxious investors. This is evidenced by even the largest investment banks struggling to raise both equity and debt.
Recently, the Wall Street Journal reported that mutual funds are cutting their allocations to startup investments at an accelerated pace and are making fewer new investments. This has shocked many venture capital firms and startup executives.
The receding tide of capital is forcing startup companies, of all kinds, to focus on the bottom line rather than growth at any cost.
There is a lesson here. Lower deal volume and lower valuations are ominous signs for any young company, and spell trouble for entrepreneurs seeking capital. So what can you do to increase your chances of a successful capital raise? Avoid these four major mistakes:
1) Not thinking like investors. Understanding investors’ sentiments, fears and concerns regarding investment risks is critical to raise funds successfully. Entrepreneurs often are far too enamored with their concepts and believe that the market is waiting for their “better mousetraps.” While passion is important, it must be tempered with realities of the marketplace.
2) Not having well thought-out business plans. Serious investors expect to see a detailed business plan including the following: realistic pro formas; financial models; detailed uses of funds; addressable target markets and segments; competitive threats; potential disruptive technologies; market research; first mover advantage; buyer resistance/acceptance; and exit strategies. Without addressing these issues clearly and head-on, investors can become confused, lose confidence in the company’s management team and come away without compelling reasons to invest.
3) Not raising enough capital during each round. Most entrepreneurs have not developed a capital formation strategy. Therefore, they do not know how much capital they really need or whether to borrow or sell equity.
Since many entrepreneurs have never raised capital, they tend to ask for too little from each investor in every financing round, often fearing that they won’t get any capital at all. Also, often they seek investors who may have only $15,000 to $50,000 to invest and who don’t have more to invest in subsequent rounds. The result is entrepreneurs frequently raise capital from hand to mouth, meeting “burn rate” (the monthly rate a company spends money) just to stay alive.
I call this the capital-raise treadmill. This treadmill can be perpetual and push entrepreneurs to take any amount of money from anyone who will invest and on almost any terms no matter how onerous to the entrepreneur. Eventually, they run out of investors, and their companies die on the vine.
4) Not generating revenue streams and profits quickly enough. Today, investors want substantial revenue building early in the growth stage of commercialization and profits soon after. In today’s financial environment, investors examine how fast revenues are being generated, how steep the revenue growth curve is and how soon profits can be generated.
Unless entrepreneurs can prove up their revenue models and scalability early in their growth stage (i.e., realistic plans to generate what all investors want — revenues and profits), they will fail to secure the capital they need.
Gary Miller is managing director of SDR Ventures Inc.’s consulting division, where he helps middle-market business owners prepare to raise capital, sell their businesses or buy companies, and develop strategic business plans. He can be reached at 720-221-9220 firstname.lastname@example.org.
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