The process of raising capital is straightforward, but not easy. Whether you work with an investment firm or raise funds from friends and family, successfully raising capital requires a high degree of focus and a significant commitment of time from company founders and key management.
The capital process can be described in three steps:
- Develop a business plan with well-thought out assumptions about how the business will grow and develop. Include financial projections based on the amounts and uses of funds required to achieve the milestones at each stage of development.
- Identify specific sources of capital, with consideration of the company’s geography, industry sector, and stage of development. Build relationships with targeted investors that are a good fit for your business.
- Define business success for the company, including the time horizon is to achieve such success and how the rewards of that success will be realized, including identifying the potential acquirers of the business. What would the company need to look like to attract potential acquirers? Why would acquirers buy the company?
Following the best practices listed here can increase the odds of success, but there are no shortcuts or sure things.
1. Build a concise and defensible business plan and supporting financial projections that show how much capital the company needs and how that capital will be used.
The company’s business plan is the foundation of every viable capital access plan. Based on the assumptions of the plan, determine the cash required month by month, quarter by quarter to achieve meaningful commercial milestones that move the startup from concept stage, to seed stage, to cash-flow breakeven, to growth? Milestones typically relate to market validation, product development, talent acquisition, first customers, and growing evidence of product-market fit.
In every startup, effective cash planning and management are critical. What are the company’s track record and plans for bootstrapping —using personal resources and cash flow generated from revenue to fund the business instead of raising capital? What is the outlook for early customer revenue? Will early adopters help fund development or prepaying for the product? How much cumulative capital will the business need before it is cash-flow positive? What are the events that could accelerate or delay revenue?
A company’s first-round of funding probably won’t be its last. It’s not improbable that a startup will need three to four or more rounds of financing over the life of the company.
Investors craft their rationale for investing in a company around a specific investment thesis: Why will this team with this product win in this market? Help them answer this question with as much supporting details and justification as possible.
Investors focus on the quality of the jockey (the team), the horse (the product/technology), and the race (the market opportunity). While some investors emphasize team over product or vice versa, prospective investors will heavily scrutinize the overall quality of the investment opportunity in deciding which companies they will ultimately fund.
Once investors decide to engage in formal due diligence on an investment opportunity, they will analyze financial projections and look at a multitude of scenarios to further assess the quality of the investment opportunity and to develop a perspective on the targeted size of the round, ideas to manage risks, and the likelihood and magnitude of additional capital needed for the business to reach scale and cash-flow breakeven.
2. Identify the sources of capital and develop relationships with investors.
As described above, many factors contribute to an investor’s interest in and ultimately the decision to invest in a company.
It is key to identify investors that focus on the sector, stage, and geography of your business. For example, some investors will not invest in pre-revenue companies. So, if you’re pre-revenue, focus on investors that will invest in pre-revenue companies. Many angel investors look for companies that are no more than three-hours driving distance. Keep in mind that investors have a target market, too, based on company stage, size of the round, sector or industry, and company geography. Investors expect returns and control.
The following are the typical sources of capital available to startup companies by stage. Please note, that while the round sizes by stage (Concept, Seed, Early, and Growth) referenced here are considered typical, the size of rounds could be much higher at any given stage, depending on the deal. A detailed review of these sources can be found in our article, Sources of Capital for High-Growth Companies.