You have busted your hump to get your product concept fleshed out and gained customer feedback about the importance of your solution. Maybe you even have a prototype and have been engaging with customers in trials. It could even be that you have started to generate initial revenue.
Under any circumstance, you have made the decision that you are ready to seek outside capital for you startup and move beyond the “bootstrapping” and friends and family stage of financing. Should you seek investment from a bank/lender, an angel investor or a venture capital firm? What specific angels or VCs should you approach?
There are eight primary things you need to consider before seeking outside funding for your startup, and that will help you make these decisions. Looking at these eight factors will help you determine the how, what, when, where and why of your financing round.
1. Ultimate goal and milestones
The first thing you need to have is a vision. Where do you ultimately want to take your business? To get investors excited and willing to invest, it is essential to clearly articulate your vision, exhibit passion and create excitement about your business. Once you have this big picture story, you need to have your vision grounded in an actionable plan.
What are your financial and non-financial goals for your business over the next 12 to 18 months? How much capital do you need to raise to achieve those goals? What will you do with the money? What key milestones can investors expect you to achieve over the next two to three years, and are there some big milestones that you’ll achieve in the next 12 to 18 months that will result in a step function increase in your valuation?
2. Target market size, growth and market share
Most outside investors have a particular investment thesis that they like to pursue. They invest in particular technology areas or certain vertical markets. Being able to clearly articulate your market size, market growth and your forecasted market share is essential to having credibility in your financial model. However, it is also critical to understanding which investors are the best targets to finance your company. Depending upon the stage of your company, your company might be suitable for angel investors or VCs.
3. Unique value proposition
You need to have a unique value proposition, sometimes called a unique selling proposition, for your product or service. I like to use the word value since it implies that you are looking at things from the customer’s perspective.
How much value does your solution have? It is based 100 percent on the problem you are solving for your customer. The only way to determine this is to intimately understand the customer. It is essential to have customer interaction and feedback before seeking outside financing for your startup. Therefore, it is also implied in a unique value proposition that your target customers have validated this value.
You must have testimonials and case studies that demonstrate this value. At the right stage in the process, some investors may even want to do reference calls with your key customers about this, especially in the B2B world.
4. Product-market focus
Part of your strategy needs to show that you have a specific product market focus, and this will be your beachhead for establishing your business. You can then have a roadmap to attack adjacent markets with your solution. Or you can develop adjacent products that leverage your current product to service a bigger portion of the overall business with your customer.
If you come across as wanting to do everything for everybody out if the gate, then you will raise significant concern with investors. I call this the “boiling the ocean” strategy. It is really hard to do. However, if you just focus on a single product-market segment, unless it is massive, investors will consider your idea as “too niche.”
In many cases, even if you can show that your business idea can be profitable, if the market is not large enough, investors will relegate your idea to a “lifestyle business.” This is a business where you can make a fine living for yourself and have a comfortable lifestyle, but investors can’t make much money.
You resolve the conflict of these two issues by having an initial target that is very interesting, and a roadmap that addresses a spectacular opportunity.
5. Investing your personal resources
Prospective investors will want to know that you are busting your hump in building your business and that you are willing to make massive sacrifices to make your business successful. They will also be even more impressed if you have made significant progress on the business by using your own money. Investors like to see that you have “skin in the game” or “sweat equity” both in terms of your time, and in terms of your money. This is even more significant if you have had a big exit in a former startup.
6. Desire for control
When you make a decision to raise outside capital for your company, you are making a decision to relinquish sole control of your business. This is true even if you maintain a majority interest in the company. You may also be faced, at some point, with whether to bring an outside CEO into the company.
I like what a corporate attorney friend of mine who focuses on startups and VCs says about this: “Do you want to have a CEO title or do you want to be rich and have a successful company?”
It is not always true that you need an outside CEO, but there are many more circumstances like this. See Steve Jobs, Bill Gates, Jeff Bezos, Henry Ford, Mark Zuckerberg and Michael Dell. Two notable examples of amazing companies that hired outside CEOs while they were still startups are Google and eBay.
7. Ability to service debt
If your business generates a lot of cash and you can service debt, then a small-business loan may be a better alternative than raising outside equity capital. In that case, you will be able to maintain control. It is something that some companies should consider.
8. Leverage in negotiations
The final point is knowing what leverage you have in negotiating a deal and the importance of negotiating a “fair” valuation vs. a “optimum” valuation. Each financing round in a private company is an intermediate step to an ultimate exit for your company, whether you ultimately sell your company or take it public. It is way more important to get the right investors into your deal at a fair valuation vs. the wrong investors that add no value at an optimum valuation. It is also important that you consider corporate governance and deal terms as key factors in negotiating a financing for your company. In some cases, this is even more important than valuation.
A good mentor or coach can help you if you’re looking for further advice on which funding options are right for you and your company.