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Why Your Start-up Should Skip The Seed Round

Don’t tell your frugal grandpa, but these days, you can’t do much with the typical $2 million seed round.

Matt Holleran

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When enterprise cloud start-ups meet with us, one of the first questions we ask is: How much capital do you need?

The companies we meet with are typically pre-product with small teams, around two to 10 people. They almost invariably say they need a $2 million seed round, for the simple reason that, today, just about all seed rounds are $2 million.

Our next question is: What can you accomplish with $2 million? If they’re honest, they’ll say, “Not enough.”

We then tell them that we agree. In our experience, $2 million is a little light. At this point, more often than not, they’ll breathe a sigh of relief and say, “Yeah, by our calculations we really need $5 million to get to the next stage.”

So, this raises the question: Why even raise a seed round?

Don’t tell your frugal grandpa, but these days, you can’t do much with $2 million – not in the enterprise cloud realm, anyway. These companies are attempting to build very important products for the enterprise. They are trying to solve weighty problems for business, and getting to their first product offering requires the help of experienced, high-quality engineers who (news flash) do not work for free. There are also early sales and marketing challenges that these start-ups need to get right.

Related: Seed Capital Funding For South African Start-Up Businesses

And yet, so many start-ups are still stuck on the $2 million seed round. That’s what the market expects, so that’s what they’re conditioned to ask for – instead of the larger amount that they really need.

We need a rethink here. In fact, there is no longer a Classic Series A market. That’s because the capital requirements for today’s enterprise cloud companies are a lot different than they were 15 years ago, when cloud companies first burst onto the enterprise computing scene.

In theory, new cloud companies need a lot less capital to get off the ground due to lower upfront startup costs, cheaper technology and a wider range of distribution options. OK, fine. But it’s still hugely important to get the right pieces in place and build a solid foundation. And no matter what anyone says, that does not come cheap.

So, how much is the right amount? For early stage cloud business application companies, we believe the real capital requirement is about $5 million. That’s how much you need to hire seasoned executives, prove out an acceptable level of customer success and really start to refine your customer-acquisition model.

But here’s the other problem: The traditional Series A firms are now so large that they need to put much more money to work – a minimum of $10 million. So, that sweet spot between $2 million and $10 million is not really being addressed in the venture world.

And it needs to be addressed. Today you have that headless syndicate of $2 million to $3 million seed rounds composed of 12 different angels and a few seed funds that have already invested in 70 other startups. This is not a great situation for startups. After all, most of these investors aren’t signing up to provide hands-on advice or help with the hiring of key employees.

Plus, $2 million is just not enough capital to build out a product and team that’s ready for prime time. For enterprise cloud startups, the seed round is simply not that effective or efficient.

So, what’s the solution? My advice is to simply skip the seed round.

That’s not to say there isn’t a place for seed funds and angels. Of course there is! In fact, as a managing partner at a Classic Series A firm, I welcome these investors, because they can play a critical role and add extremely complementary value to the Classic Series A syndicate.

At the same time, they also understand that $2 million is not sufficient for today’s cloud startups. We want leading seed firms and value-added angels to join us as co-investors so they can avoid the headless syndicate syndrome and help provide cloud startups with the capital the really need.

Related: 10 Tips for Finding Seed Funding

The reality is that today’s venture capital market is not really optimised for early stage enterprise business companies. At one end of the spectrum, seed investors are not in a position to provide the long-term capital or board-level support that startups need.

At the other end, traditional venture firms have grown in size and have raised progressively larger funds. As a result, they are looking to write bigger checks of $10 million and above. That means they require startups to have a considerable level of traction and be further along in their development before making an investment.

This is why we need a return to Classic Series A investing.

What the market really needs are venture capital firms that are truly built for early stage investing, and that are led by seasoned operating partners who themselves have been entrepreneurs, who are connected to the top players in the cloud market, and who can provide that kind of insight and advice needed to build global, category-leading companies.

More than ever, enterprise cloud companies need honest-to-goodness Series A investors that can help them accelerate growth and maximise their true potential.

This article was originally posted here on Entrepreneur.com.

As general partner of Cloud Apps Capital Partners, Matt Holleran works closely with entrepreneurs and executive teams to help them build global category leading companies. He has 12 years' experience in successful business app companies including Salesforce.com, and 12 years of VC and private equity experience.

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How to Guides

What Can A Business Loan Be Used For?

Read on below for what you can use these loans for.

Amy Galbraith

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Sometimes in the business world, you might need a financial helping hand. This is especially true if you are starting out as a business owner or building your business from where it already is. This is where business finance can be highly useful because you can use it for any number of issues that your business might be facing.

When you apply for any business loans you should know what you want to use the money for. For example, asset financing is used to lease, hire or purchase new equipment or vehicles for your business.

Small business loans can be used to boost your business funds or for purchasing new premises. Interested in applying for business finance? Read on below for what you can use these loans for.

You can purchase inventory

If you sell products, the chances are that your cash flow can often be dictated by having to restock your shelves. But if you have a business loan, you can purchase more inventory to replenish your stock and stay in operation throughout the year.

Purchasing new inventory during seasonal dips, such as selling out of items during the festive season, can become expensive. This is where finance can come in handy. You can have the funds deposited into your company bank account and use it solely for restocking your shelves, allowing better management of accounts during these trying times. It is not a long term solution, however, to use a loan to purchase inventory can be helpful for small businesses just starting out.

You can upgrade equipment

Having outdated equipment will put you at a significant disadvantage to your competitors. This can be remedied by taking out business asset finance in order to upgrade your current equipment. You can lease, hire or even purchase everything you need to maintain your original business plan.

For example, a transport or logistics company can use this finance to improve their fleet, to upgrade their current trucks, or to provide new technology to drivers to help them navigate the South African roads. If you are a boutique design agency, you can use your loan to purchase new computers with the latest software so that your staff is always on the cutting edge of all trends. On your loan application, be sure to list what you plan on using the money for so that you have accurate estimations of your interest rates.

Keep your office operational

Keeping your office operational means that you need to pay for day-to-day expenses. This can include anything from replacing an old coffee machine so your staff stays caffeinated to paying the utility bills so that your office does not go dark when you need electricity the most.

This could be seen as starting capital for small business owners, which you can then supplement with more income or repay once your business starts to earn more and become successful. You could create a list of all of your needs, such as paying lights and water bills or fixing kitchen equipment and look for those that you need to focus on the most. For example, your staff could bring their own lunches into the office in case you need to replace the fridge or you could strike a deal with a nearby coffee shop to save yourself from spending unnecessarily on expensive coffee equipment.

You can boost your marketing budget

Marketing is not easy to understand for everyone. While you might have a brilliant business mind, your aptitude for selling and marketing your company might not be your strong suit. This can be helped by investing a business loan into a marketing company for your strategy, which can help build awareness about your business and make it a success.

You will have improved brand visibility and can reach customers in new and exciting ways. And you will also see a significant return on investment when reports and analytics come in showing your business’s performance. Marketing is an integral part of building a flourishing business, so using your loan for this purpose would not be a waste. Be sure to speak to your lender about whether this is an acceptable use of your business finance and what the interest rates would be.

Final thoughts

A business loan can be a sound investment, especially if you consider what it can be used for. You could look into purchasing new inventory for your shelves during a busy shopping period, or upgrade your machinery for your next big project. You can use the money to keep your day-to-day expenses from becoming overwhelming or boost your marketing budget so you can reach customers and build your business.

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How to Guides

Does Your Business Really Need Funding?

Strategy, risks, and opportunities.

Carl Wazen

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cash-machine

Businesses need capital to grow, and most small enterprises rely on external funding to meet this requirement. While accessing funding can be challenging for entrepreneurs, taking on the financial commitments of a loan should never be taken lightly. Many small businesses fail because repayment conditions are so onerous they impact cash flow, and business owners end up blacklisted, which dampens their future prospects.

First, ask yourself some hard questions

Before you decide to apply for that loan, cash advance or capital injection, make sure that your business really needs funding. Critically evaluate your business. Consider that you’ll ultimately need to give something back for that funding – an equity stake, or interest payments.

Determine how much the extra funding is worth to you, and what would happen to your business if you couldn’t get it.

Define your goals

The type of funding you need (and how you validate it in the application) is dependent on your short- and long-term goals. If you’re not currently on track to achieving your business objectives, determine what stumbling blocks or pain points are holding you back. Ultimately, you should be certain that the capital will help you achieve your objectives.

Related: Government Funding And Grants For Small Businesses

Evaluate your financial pain points

Next, determine which of the identified obstacles can be overcome with extra money. While most could, a loan may not be the answer. Entrepreneurs often use financing to temporarily plug holes, instead of fixing them. Without addressing the root cause of the issue, the business will continue to struggle, while also dealing with the extra debt.

It is also important to consider the nature of your requirements, and the impact this will have on finances. For instance, using a loan to hire more staff requires upfront funds before additional revenue can be generated. The same applies to sales and marketing initiatives.

Expanding your footprint as part of a strategic plan to grow your business also requires funding, but these are usually long-term loans that take more time to pay back. A thorough evaluation is needed to determine the potential return on investment and compare it to other opportunities.

Evaluate if the strategic benefits will outweigh the mid-term cash flow risks.

Consider your options

Before making any financial commitment, first look for ways to optimise your operation to realise cost efficiencies within the business that can free up working capital to fund the fix.

If you determine that funding will address your pain points, by boosting inventory ahead of a seasonal spike, for example, consider vendor financing or supplier credit options before securing financing from a bank.

If you need to expand the business, look for ways to lower the associated costs. For example, franchising a new location to a competent partner can relieve you of some of the financial burden. A product-based business could perhaps generate extra income by selling via online channels, or through distributors or other retailers instead of a new store.

Related: The DTI Funding Guide You’ve Been Looking For: The What And How

Scenario planning

However, should you choose to proceed, before you sign any loan or credit agreement, make sure you consider all possible scenarios:

  • How long will it take before your investment starts covering the costs of your loan?
  • How will you manage repayments if your forecasted growth doesn’t materialise?
  • How can you pivot to reallocate resources if your plan is not working out as initially intended?

The bottom line

Before you start looking for funding for your business, critically evaluate if your business really needs it. If you decide capital is necessary to reach your goals, and you’re willing to take on the responsibility, carefully consider the type of funding that is best for your particular type of business and your specific needs.

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How to Guides

How Investors Choose Who To Invest In

Why entrepreneurs tend to focus on the wrong things when pitching to investors, and what investors are really evaluating instead.

Allon Raiz

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The hypothesis of my book Lose the Business Plan was that great businesses are not determined by Excel spreadsheets and the all too predictable J-curve, but rather by the entrepreneur or entrepreneurial team and their ability to see opportunity, navigate obstacles and make things happen.

The truth is that entrepreneurs focus on the wrong side of the coin when meeting with an investor. They focus on the deep detail of the business plan and concentrate on justifying assumptions, predicting and overcoming objections, and emphasising market potential. Yet it’s my experience that the real decision on whether or not to invest in a company is more heavily weighted towards the entrepreneur or team rather than the business plan itself.

Once the ‘numbers’ stack (in other words, the business model makes sense) and the risks have been considered and appropriately mitigated, then the real decision-making can begin. The final decision comes down to four important characteristics of the entrepreneur himself or herself.

1. Is she honest?

You may have the best business plan in the world and you may have mitigated every possible risk but, if you are not someone the investor can trust, no deal will be made. I find that entrepreneurs often underestimate the importance of their reputations and, in today’s connected world, it’s so quick and easy to reference someone’s character.

Related: A Comprehensive List Of Angel Investors That Fund South African Start-Ups

Entrepreneurs who think about the short game and make morally questionable decisions for the prospect of quick profits generally find themselves in an ever-diminishing circle of people who will do deals with them. Your reputation is everything and you should guard it at all costs.

2. Does she work hard?

I am still not resolved around the cliché that you should work smart and not hard. (Perhaps I missed the memo or was asleep during the lecture that demonstrated how this is possible.)

In a world that is changing at an astonishing rate, in an economy that is becoming more and more competitive and in a business environment that is becoming ever more complex, it’s hard work to remain relevant and ahead of the curve for any extended period of time. Every quarter sees a new trajectory that needs to be investigated and navigated. In my opinion, this requires not just smart work but hard work, too.

It’s certainly true that investors like to invest in entrepreneurs who will take their investment seriously, who take their businesses seriously, and who are on top of their games.

3. Is she smart?

Smart does not always mean book smart but it definitely means street smart. It means having the ability to read a room, to see an opportunity, to learn new skills quickly and also being able to apply new learning’s to the business.

Investors look for investees who show agility when adapting to feedback from the market, from their competitors, from their staff and more.

4. Is she ambitious?

Investors do not like investing in ‘mom and pop’ operations. They seek the highest return on investment and that comes from businesses that can scale profitably. Scale is always relative to the investor’s perspective and not your own.

An investor with a couple of hundred thousand rand to invest will have very different expectations of the size of business he or she would like to invest in compared to another investor who has tens of millions of dollars. It’s important for the entrepreneur to authentically resonate with the level of ambition of their prospective investor, and be able to express that ambition through a coherent and cogent vision, as well as a plan to achieve that vision.

Remember, no one starts out as the ideal investee. It’s something that is built up over time and requires constant maintenance and curatorship. It’s essential to continually work on your reputation, to ensure that you are up to date with your industry, and to reassess your level of competence in your market. This is the only way to make sure you become and remain an ideal investee to a potential investor.

Read next: The Investor Sourcing Guide

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