You’re about to give up a substantial amount of ownership to an investor or investor group. You’re thrilled to get funding, but how do you know if you’ve selected the right investors?
While it may seem like raising capital is all about winning over investors, it’s really a two-way street. Just because someone has money they are willing to invest does not mean that person and firm can add substantial value to your business or that they are the right fit.
You are choosing investors as much as they are choosing you, and you are likely going to have to live with them for many years.
Beyond the obvious reference checking (especially with fellow entrepreneurs), here are five questions that you should and need to ask yourself and potential investors.
1. What value can the investor really add?
Let’s be honest: There are investors out there that don’t seem to have a clue. It may sound funny, but I’ve witnessed this first hand – more than once as both an entrepreneur and an investor.
Entrepreneurs need to be very thoughtful about what they want and need in an investor (other than just the money).
- Do you want someone that understands what it means and what it takes to build a valuable business from scratch?
- Do you want someone that knows the inner workings of venture fundraising over multiple rounds and can help you do it right?
- Does the person need to have strong operational experience in a particular area, such as sales, marketing or product development?
Choosing an investor is a lot like getting married. This person will be in your life and sit on your board for many years. There are a lot of great investors out there, but there are also not so great ones. You need to make sure it’s going to work for you and your company.
2. Does the investor know anything about your business?
It’s not all about the money. Consider whether it’s important for your investors to understand your business model or have experience in your particular industry. Sometimes it’s crucial, other times not so much. Take a look at the firm’s current portfolio and focus areas. What does this indicate about the investor’s broader knowledge of your business?
Let’s say you are starting a digital-marketing business. Is this the first investment of that type for the investor or the third?Without prior experience, the investor may not have the right networks in place to help you or the right context for advice and decision making. Besides looking at the VC’s portfolio, LinkedIn is a great tool to help you understand who potential investors really know.
3. How committed is the investment firm to your type of business?
Just as it may be important for the specific investor to understand your business, you need to understand how committed the firm is to your particular area or business category.
Do they have other portfolio companies in the same space? Determine if it’s a major focus area for them.
- Is your company an experiment to test out a new thesis?
- Are they planning to invest in more companies like yours or are they beginning to get jaded and back away from the category?
You want your investor and their firm to be strong advocates and committed to the category.
4. At what stage is the potential investor in his or her career?
Most venture capitalists have a 15- to 25-year career in the business. Where they are in both their VC career and overall career can have a significant impact on your success.
For a partner in the first few years of his or her VC career, the lack of experience could be a real issue (especially if they haven’t had a successful established track record in a prior career) Her networks, understanding of the venture business and experience getting a company from start-up to success is not as strong as it could be.
Also her influence in the firm is also likely less than ideal – you may not get as strong an advocate as you may need in the future.
Try to understand their motivations. When someone is feeling pressure to establish his career or “brand,” his agenda may not be perfectly aligned with yours. This can result in unpredictable behavior at inopportune moments.
For example, he may advocate a follow-on investor or board member who ‘looks good’ on his resume but may not be the best fit for your business. Or he may advocate a course of action that is currently ‘cool’ in the VC or start-up world, but isn’t a viable, sustainable direction for building value in your business.
On the flip-side, if an investor is starting to scale back, his influence in the firm will start to decline. That influence is really important because when it comes time for follow-on financing, your advocate in the firm is a big factor in whether or not the firm participates. Someone late in his career may also not put as much time and energy into helping you become successful as you might expect.
When you give up a substantial amount of ownership in a company, it’s not just for the dollars. It’s for the access, the advice and the help. Make sure you understand where the investor is in his or her career. The individual’s investment should be about your company, not the person’s needs.
5. How much capital is the firm allocating or reserving for your company?
Think ahead to the next round of capital. Find out where the firm is in the life of the current fund and how much capital they are allocating or reserving for your company.
Have they fully or tentatively earmarked dollars for follow-on investment? Some firms don’t reserve any funds, and it’s a decision made at the point in time of the next investment – depending on available funds and other investment opportunities (a.k.a a jump ball). Others have a hard reserve or soft-allocated future funds.
Want Funding? Finfindeasy.co.za Founder Says You Must Learn To Speak The Language
Darlene Menzies, founder of Finfindeasy.co.za and the successful recipient of multiple rounds of funding unpacks what she wished she knew the first time she pitched her business to investors.
I clearly remember my first large pitching opportunity over six years ago. It was an evening cocktail event organised by one of the legendary pioneers of South Africa’s venture capital (VC) community, Brett Commaille. It took place on or near the top floor of the Reserve Bank building in Cape Town. One of the reasons it’s so vividly etched in my memory is that I had to climb more than 30 flights of stairs to get to it because as a chronic claustrophobe I don’t do lifts.
After reaching the right floor and catching my breath I stepped into a room full of 30 or so high net worth individuals — my introduction into the new world of Angel and Venture Capital investors.
Looking back, I wasn’t as nervous as you might expect, partially, I thought, because I had prepared well and I whole-heartedly believed in the product I was pitching. But in hindsight, I realise it was mostly because I was wonderfully naïve. There are some benefits to being a greenhorn.
The pitch itself went well, I had been briefed to keep it simple and short. I described the solution we had developed, the problem it was addressing and what the size of the potential market was. I spoke briefly about the competitors and what our differentiators were, what the business model was and shared our go-to-market plan.
I covered the size and pedigree of our team, as well as my skills and experience as the founder (aka the jockey) and ended with details on how much money we were looking for and what we would use it for. I was relieved when it was over and felt confident about my delivery.
A bunch of hands shot up, which was positive. I felt encouraged; the hard part was behind me. Or so I thought. My nightmare began when I took the first question. “Great pitch, I love what you guys are doing. Please can you tell me a bit more about the traction you are getting, what your current burn rate is and how much runway you have.” My heart sank and I felt my cheeks start getting hot.
I didn’t have the foggiest idea what he was talking about. I could tell he wasn’t intentionally trying to embarrass me, but nonetheless his VC jargon made his questions sound like enquiries about cars and airplanes or something mechanical rather than anything I was working on. I put on a brave face and asked him if he would mind explaining to me what it was he wanted to know so that I could try and answer him. That was the start of a steep learning curve as I began to navigate the world of early stage capital raising.
Six years on, the South African start-up and venture capital community has matured and grown dramatically and there are many more entrepreneur events, training opportunities, start-up competitions and pitching coaching sessions, which has resulted in some of the lingo becoming more commonplace — even so, raising venture capital still largely remains a very foreign and intimidating world for novice entrants. Back then I wished I’d had access to a practical VC-made-easy glossary and step-by-step manual as a beginner’s guide. I’ve been threatening to write one ever since.
Terms you should know when looking for funding
After surviving my harrowing Q&A baptism of fire, I starting working my way through the world of term sheets and deal negotiating and came across many more acronyms and VC-specific terminology that I had to learn to interpret and understand. Below are just a few of the terms I would love to have known about and understood before my climb up those Reserve Bank building steps. There are many others.
Deck (or pitch deck) refers to the short presentation you will give to the investors. Guy Kawasaki, a well-known American investor, recommends his 10/20/30 rule as an easy guide for your deck. He says make sure your presentation consists of ten slides, take no more than twenty minutes to get through them and use a font that is no smaller than 30 points per slide.
See guykawasaki.com/the_102030_rule/ MVP (minimal viable product). This is a product developed with the minimum features to ensure it is sufficient to satisfy early adopters. The final, complete set of features is only designed and developed after considering feedback from these initial users.
Traction refers to the number of people who have already started using your product or service and provides a means of proof to the investor that people want/need what you are selling. Traction is best measured by the number of paying customers acquired over a defined period.
If you are running a business that sells products/services via subscription, then potential investors will want to know your churn rate. This refers to the number of customers who bought your product and never continued using it i.e. those you lost after acquiring them. This figure impacts your growth forecasts.
Tip: Make sure that you have built the churn rate into your forecasts so that your numbers are solid.
Burn rate refers to the amount of money the business requires monthly to cover operating expenses. You can definitely expect to be asked what your current and anticipated burn rate looks like should you receive growth funding.
Runway refers to the number of months that the business has sufficient cash to continue to operate before it runs out i.e. if you have R200 000 in the bank and your burn rate is R95 000 and you are not expecting any immediate income from sales then you have two months runway.
What investors want to know is how long the business can keep going until it has to close. Once again expect to be asked your current runway and your future runway in terms of the amount of money it will take to achieve the desired numbers.
This is a common term used to describe the kind of growth curve in a start-up that an investor is keen to see. It refers to the exponential growth of things like users or page views, but mostly to revenue, which is projected to occur once a particular inflection point is reached. Early stage investors like to invest before this point is reached and then to sell their shares once the hockey stick growth is achieved.
Related: How To Raise Working Capital Finance
Venture capitalists only plan to invest in your business for a limited time period, usually between five and seven years, before expecting to receive their returns. An exit strategy is a planned approach to them leaving in a way that will maximise their benefit and minimise damage. A typical exit strategy is a plan to sell the company once it has achieved its anticipated growth targets. In this case they may want to know who you foresee would be prepared to buy your company.
The term sheet is the document presented to the start-up by the venture capital investor once they have decided they would like to invest. It outlines the terms by which they are prepared to make the financial investment in your company. You are entitled to negotiate the terms with the investor before reaching agreement. The signed term sheet is not legally binding, unless stated, but rather it contains the final terms of the investment that will be used to draw up the legal documents for the deal. Always seek legal advice before signing a term sheet.
Do your research
My encouragement to entrepreneurs who are looking to raise venture capital is to have a coffee or two with a few seasoned founders who have already done deals in order to get firsthand insights about what to expect when you engage with VCs — from the time you land the pitching opportunity to when you sign a deal and get the money and everything in between.
The Investor Sourcing Guide
How to attract and obtain investors to your established, high-growth business.
As an established, high-growth company, you may find that you need to source capital, identify a mentor, or work closely with other affiliates to prosper. In this case, partnering with an investment holding company can be a valuable growth tool.
So, what should you do if you want to be acquired by a holding company?
1. Research everything
If you’re considering a long-term investment partnership, make sure you conduct substantial prior research. There may be many potential investment partners out there, but each has specific venture and industry directives. Get to grips with these.
Related: Is Venture Capital Right For You?
2. Be candid with yourself
The amount of capital that you need will affect which holding company you choose. In particular, you’ll need to understand what your risk profile looks like relative to the returns you expect to provide. This will also help you to source, entice, and keep the attention of the most appropriate partner.
3. Identify your must-haves
Any investment partner you choose is likely to be able to provide you with funding, a broader network, and economies of scale. Beyond these, however, you’ll need to decide on your most important benefits (must-haves), so you can target the companies that can offer you the best fit.
4. Spell out your funding plan
You’ll need to be very clear on how you plan to spend the funding you get from your investor. This plan should stipulate, in particular, how you plan to grow.
5. Scrutinise each investor
Make sure to analyse your potential investors’ investment history, so you can get a clear idea of where your interests are aligned. Look specifically at things like:
- Where investors’ get their funding
- What their investment track record looks like
- What their investment directives are
- Their appetite for risk
- The returns they usually aim for
The crux of the matter
Research is essential, no matter which holding company you hope to be acquired by. This will help you to find, attract and retain an investor who gives you the funding you need, and lends you the support to be innovative, productive, and profitable.
6 Great Tips For A Successful Shark Tank Pitch
Whilst most of us are unlikely to appear on television shows such as Dragons Den or Shark Tank there is a lot we can take out from watching these programmes.
Whilst most of us are unlikely to appear on television shows such as Dragons Den or Shark Tank there is a lot we can take out from watching these programmes. Entrepreneurs will often need to promote their businesses to prospective customers, lenders, investors, employees and even suppliers.
All stakeholders would like to know with what and whom they are dealing. They will need to assess risk and will try and evaluate the business against others who are competing for those same funds.
1Know Your Product
You should be able to describe your business within 60 seconds, in a confident and positive manner. Let the stakeholder know what particular problem your business solves which makes it viable and attractive.
Your brand and how you intend to develop it is important in determining whether they will invest or lend you money. Share critical information with them such as large customers, patents and trademarks and details of forward orders.
If you are looking for funding or investment, make sure you have the relevant paperwork to back up what you are saying.
You must have your numbers at your fingertips. A true and successful entrepreneur will know his numbers instinctively and be able to recollect and present them convincingly. Stakeholders want to know your turnover (sales) over the last couple of years, your gross profit and net profit.
Investors want to know what they are investing in and whether there is strong potential for their money to grow. Lenders will want to assess their risk — how are you going to repay the money? Moreover, you as the business owner, need to be sure that you will be able to make the required repayments.
You must know what your margin is, as this will largely determine your viability as a business. Margin or gross profit is the difference between the selling price of the goods and their cost and is usually expressed as a percentage.
3Know What You’re Asking For
Be clear as to the size of the investment you want to give away and how that determines the ‘valuation’ of the business. Therefore, if you wish to raise R200 000 for 10% of the business, that means you value the business at R2m — be sure you can back that up or you will get taken apart.
4Have a Business Plan
The best way to fully understand your business is by way of having a detailed business plan, which has been prepared whilst working through every facet of your business, from the original idea to the finished product.
As the business owner, you need to live this business plan and be able to use it as your daily guide to success. Develop it, change it where circumstances require it, but most importantly know it and understand it.
In this way, you will be able to deal with most of their questions, be they about marketing, research, international expansion etc. It is also a good idea to know your competition and what they are up to.
In most interactions, you the entrepreneur, are selling yourself. Whether it is an investor, lender, customer or prospective employee, it is their impression of you and your capabilities which ultimately determine whether they want to work with you.
Be confident, defend your position where required, as you will need to parry some blows but do not behave arrogantly.
6Learn From Your Mistakes
Many entrepreneurs who have presented to the Shark’s Den and not been able to garner investment have turned their business into great successes. You need to be able to learn from the experience, and if rejected, bounce back even stronger.
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