Assessing potential sources of financing to support growth opportunities
Most businesses will consider fundraising at some stage during their journey. You may need to fund your overseas expansion strategy, further develop your technology and products to be the clear market leader, or boost your workforce and move into larger offices. Alternatively, maybe your business has stagnated and needs a cash injection to achieve your strategic goals.
Whatever your situation, the good news is that more fundraising opportunities exist than ever before and it is important that you are doing the right things to strongly position yourself for a fundraise should the need ever arise.
The fundraising life cycle
From an investor perspective, there are six stages of fundraising (note that the sizes and equity stakes may differ per sector and geography):
- Self-funding: the founder’s personal capital injection to form the company.
- Friends and family: money to get things moving, $50k – $200k for < 5% equity (don’t offer too much equity or burn bridges).
- Seed stage: first round of outside capital often from angels, $1m – $2m for < 20% equity (typically across two phases with increased Enterprise Values for each). Find angels with wisdom, wealth and willingness to help.
- Early stage funding: usually from venture capital firms and high net worth individuals once you have a more formal board and leadership team. A classic Series A is $3m – $5m for 20% equity.
- Growth capital (later-stage funding): typically once revenue run rates exceed $5m and you have proven scalability. Investors are typically mid-market private equity houses and trade investors. Equity stakes and cash injections vary wildly at this stage but founders and management teams will often be left with < 10% equity in a business valued > $30m.
- Mezzanine round: congratulations if you have made it to this stage and have a valuation in the $100millions or $1billions! Typically the final fundraising round prior to an exit, often from large private equity houses or trade investors.
Early stage funding versus growth capital
One of the biggest mistakes that companies often make is failing to recognize the difference between early stage funding versus growth capital. The difference is significant, with early stage funding based more upon the potential of a business plan, often referred to as “hype” given the lack of trading and financial track record; whereas growth capital involves the scrutiny of financial records and the performance against forecasts, with a lot more focus placed upon valuation multiples against key financial metrics.
Many businesses with a trading track record try to benchmark their requirements against “similar” recent fundraises which are actually early stage funding, and then struggle to understand why investors treat them so differently. Not only are the fundraises completely different, but so is the pool of potential investors.
Early stage funding options
For businesses in the early stage process, it is very difficult for investors to determine the full potential of your business or your likelihood to meet any financial forecasts. You may still be in the process of developing your products or in the early stage of trading, with minimal track records.
Your target investors may include venture capital, high net worth individuals, venture debt and crowdfunding. Given the amount of uncertainty and high levels of risk involved, your investors will be looking for significant returns on investment, often in the double-digits, and will typically invest across a range of portfolio companies with the knowledge that many of the companies will go bust. They will expect regular business updates but will typically leave you to run the business and will offer minimal strategic input.
Early stage investors tend to focus on the likelihood of achieving a successful future exit, for example: how your technology differs from competitors and how quickly you can scale your revenues. They will scrutinize revenue growth forecasts, gross margins and future costs, key metrics and milestones, the amount of funding required, details of expected future equity rounds and your future exit strategy.
There will be huge assumptions within your business plan and much of your fundraising success will depend upon the level of excitement that you can create amongst your target investors. There will be lots of emphasis on the size of the market opportunity and the ability of your management team to deliver the full business potential.
A business ready for growth capital will have fully developed products, a $5m+ trading track record and an established management team. The basics of the business model will be more proven, although there may still be a lot of hype around the fundraise for any potential new products or markets. However, investors will be able to review your historic and current track record and hence will start to form a view on whether you are likely to deliver your future financial projections in the timeframes suggested.
Target investors for growth capital typically include trade corporates and private equity houses, although grown-up companies may also be able to approach debt lenders, capital markets and family offices. Given the increased maturity of the businesses and hence reduced risk of business failure, the expected level of returns are more modest and there is a lot more scope for negotiations. They are often more strategic investors, providing vital input into the strategy and supporting the business in key areas, for example introductions to target customers or potential management team hires.
Later-stage fundraises often offer liquidity events to entrepreneurs, early stage investors and share option holders. They provide a great opportunity to motivate the management team by triggering an exit event and allow the entrepreneur to de-risk their personal financial position, whilst continuing to lead the growth of the business as a future shareholder. They also allow management teams to tidy up the share capital table of the business and provide exits to non-strategic early stage investors, allowing the business to replace them with higher-valued strategic investors going forward.
The level of scrutiny within later-stage transactions will be much higher than for early stage funding, with due diligence for private fundraises and rigorous processes for a capital markets placement. You are likely to need a range of advisors to support you during such a process including lawyers, accountants and investment bankers.
Note that the processes for later-stage fundraising are similar to those for a trade acquisition or private equity majority buyout, hence management teams sometimes choose to run both processes at the same time. Depending on the offers received, they can then decide whether to exit the business or to create a liquidity event for willing shareholders as part of a later-stage fundraise.
It is very easy to look at the recent impressive list of mega deals and think that it is easy to raise money. However, a survey of CFOs and an in-depth analysis of successful fundraises shows that, whilst the best businesses are raising records amounts, the remaining companies continue to find it very challenging.
Many investors have lost a lot of money on previous high-multiple deals and are becoming more picky about the types of investments that they enter into. Investors are also now more demanding than ever and have very high expectations of company management teams. It is vital you ensure that you have everything in place before approaching investors. Once they form an impression of your company, it can be quite hard to change their views!
Your finance leader will be heavily involved throughout a fundraising process and advisors will typically also play a key role, however the CEO should lead the investor presentations wherever possible. A CEO is best-placed to articulate the business vision and to answer any challenging questions, and must be capable of generating lots of excitement around the investment opportunity. They are responsible for leading the business and hence need to gain trust from the investor community. At the very least, ensure that they attend the pitches for your top few target investors.
Within your teaser documents and presentations, you will need to successfully illustrate the following matters:
- Define the size of your target market using reliable third party metrics.
- Analyze the level of competition within your market niche.
- Build a flexible financial model with various scenarios and validate your key assumptions against reliable market data.
- Benchmark your business plan against any existing companies who have published KPIs;
- Articulate your go-to-market strategy and customer acquisition costs.
- Profile the past experience of your management team and state why they will be successful within their current roles.
- Clearly present the purpose of the fundraise and what the funds will be used for, such as the investment in people, product, technology, growth, etc. You should build at least two scenarios into your financial model, illustrating the financial projections with and without a fundraise, to demonstrate the incremental increase and hence the potential return on investment.
- Set out the future exit strategy and how you will achieve your target valuation so that an investor can form a view on the level and likelihood of achieving their desired financial return.