By Gary Miller – Managing Director, Consulting Division, SDR Ventures
I am concerned. No, I am worried. 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. After meeting with many entrepreneurs, I find that most make four major mistakes in their attempts to raise funds.
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, 2016 – zero. According to Dow Jones VentureSource, 58% 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. Last month, Goldman Sachs tried to sell $2 billion in corporate bonds. A few days into the sale, they had only sold half of the bonds that were paying an 11% coupon — up from the expected 10% coupon. That bond sale comes at a time when U.S. junk-bonds issuances have dropped more than 70% from a year ago.
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.
This mutual-fund pullback threatens to deepen a wider downturn that has led to many startup companies’ falling valuations, shrinking ambitions and layoffs. 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 the four major mistakes discussed below.
Mistake # 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/products/services and believe that the market is waiting for their “better mousetraps”. Therefore, they believe that all they need is money to overcome any market obstacles. While passion is important, it must be tempered with realities of the market place.
Mistake # 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 for the investors. 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.
Mistake # 3. Not raising enough capital during each round of capital formation. Most entrepreneurs have not developed a “capital formation strategy”. Therefore, they do not know how much capital they really need, and they do not know whether to raise debt and/or equity during the capital formation process.
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 only have $15 to $50 thousand to invest and who don’t have the financial depth to invest more in subsequent capital formation rounds. The result, entrepreneurs frequently raise capital from “hand to mouth”, feeding the “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.
Mistake # 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 thereafter. 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 or email@example.com.
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