Fundamentals of Capital Raising: Attracting the Right Investors for Your Business
INSIGHT
Need capital to start a business?
It's important to know how to attract the right investors and get funded.
Today you’ll learn about the fundamentals of successful capital raising and how to find the right investors for your business.
You’ll learn:
Is this a good time to raise funds for your company?
Should you take dumb money or smart money?
How much money should be raised?
How to catch an investor's eye
Is this a good time to raise funds for your company?
The answer is “Yes” if the firm and its team are ready to earn the commitment of investors. In my experience of watching market cycles of more than 20-years, general market conditions, no matter whether good or bad, do not correlate with effective fundraising.
Regardless of the times, there always appears to be more money than good deals. As a result, good companies with good stories and good teams seem to be able to get funded. In fact, some of the most successful companies have emerged from relatively tough times.
However, the process of raising funds remains very challenging due to the large number of firms seeking investment, and many investors are expecting the global economy is facing significant cyclical pressures in the coming year. A track record is much more important than it used to be.
Also, investors are usually more interested to fund deals referred by their own network, and they favor those referral sources who have a history of bringing high-quality deals with a lot of due diligence already done.
Therefore, entrepreneurs are advised to focus more on locating and cultivating relationships with potential investors or referral sources close to their target investors instead of mass mailing pitch decks.
Should you take dumb money or smart money?
There are two main types of money out there - smart investors’ money and dumb investors’ money.
Dumb investors (e.g., friends and family) are not necessarily bad, since they have money and often with very good intentions. They tend to invest based on first impressions or their prior relationships with you, and they tend to invest quickly, often without performing any significant due diligence. These types of investors can be easier to convince and, if you have enough of them, you might be able to raise most of your initial capital requirements.
On the negative side, less sophisticated investors might make your life miserable by being intrusive with their questions and suggestions. Accepting too much small money means that you will have that many more phone calls and e-mails to answer. Also, if things go wrong, less sophisticated investors may be more ready to take drastic actions to recoup losses, and may end up losing close relationships with you.
Another problem is that potential investors in your next funding round may decide to pass on the deal if they think that you have too many unsophisticated investors on board.
Smart investors (VC, PE etc) can be individuals investing from their own funds or representing the interests of clients who have placed funds with them. They invest those funds based on a deeper analysis of risks/rewards of each opportunity.
Venture capital and private equity firms with substantial resources will conduct deep and exhaustive research on all aspects of a potential investment before committing funds. Indeed, the commitment of one of these highly regarded professional firms is the highest form of validation that an entrepreneur can receive; an investment from a top VC firm can usher in a wave of co-investors and key-staff who can provide the most likely path to future success.
Bottom Line: if you plan your capital raising strategy, the first thing should do is to match your company’s funding requirements and equity story to the right types of investors.
If your goals are modest—for example, starting a small service firm—friends and family investors may be sufficient. However, if you intend to create a highly successful corporation with a significant number of staff and eventually seek an exit through an IPO, merger, or acquisition, you must be prepared to deal with highly sophisticated investors.
How much money should be raised?
It's tempting to raise as much money as you can, but there are consequences that might cause problems later on.
First of all, the amount of money being raised is a good indicator of how much the entrepreneur thinks the company is worth. The thing I find most interesting is how the company arrived at that number. - Most important question: does the assumptions make sense?
Secondly, the question is, “How much money should be raised?” The right amount of money to bring into a company should be enough to reach sufficient milestones, i.e. if all goes well, the money invested will be used to drive all sorts of risks out, or to take the company to a cash flow positive position etc. What the investors really want to know is where you're going to spend the money. Can you do it for less? What would you do if you had more money? - I mean, for the company’s use.
Third, if you raise too much money early on, you could be selling off too much of the company for too little cash.
Fourth, you should use early-stage funding to increase the company's value so that, in the next funding round, you can raise more money with less dilution.
Bottom Line: The ideal amount of money to be raised is not always clear, instead, your answer to the question of why the company is raising this amount of money is more crucial.
How to catch an investor's eye
Having sat on both sides of the desk as an investor over the past 20 years and as a capital seeker as well, I could tell you, there is some eye catchers that are going to pop out at you and really grab your attention versus those are the deals that are going in the to-do file. Here is what investors are generally looking for:
First of all, I think patents. If you see a patent, you generally know you got something there that nobody else has. It’s worth taking a look at.
Trademarks are pretty good, too.
Additionally, we like to see capital invested personally, call it “skin in the game.” We want to see management teams that have a personal stake in the business and believe enough in it to put their own money behind it before they come and ask the capital provider to add to that.
Management? This is a huge category for us. Executive summaries reveal gems and big names and experience. Companies need pedigrees.
Milestones achieved. It’s good to look at a company and see, have they made it to their stated goals so far? That’s a good indication of how they’re going to handle the capital infusion you’re thinking about providing for the company.
The value of the idea, or the product, or the service on a monetized basis. In other words, what’s the market for that idea, product, or service look like? Is it a multi-billion-dollar market or is it just a niche? A couple million here and there is a big difference.
Growing market demand versus shrinking market demand. This one is pretty obvious. Everybody wants to get in on the ground floor.
Revenue growth year over year…we always take a look back and see what they did last year or the same quarter and look for the trend. You’ll want to see that trend line steadily up. If you see it spiking up, it’s even better.
Strategic partnerships are also very, very important. Who is this company aligned with? Who is supporting the business model and enhancing it as well?
Lastly, intellectual property which is a little esoteric, but nonetheless it can be valuable. It can be booked as an asset, and it is something to take a second look at.
Strategies to help you attract the right investors
Attracting the right investor goes beyond financial metrics. It's about finding a partner who not only provides capital but contributes strategically to the growth and success of your business. Take the time to build relationships and choose investors who genuinely understand and support your vision.
Alignment of Values and Vision:
Ensure that the investor shares the same values and vision for the company's future. Look for investors who understand and are aligned with your business goals beyond financial returns.
Industry Expertise:
Seek investors with experience or a strong understanding of your industry. Industry-savvy investors can provide valuable insights, connections, and guidance.
Network and Resources:
Assess the investor's network and resources beyond capital. Strategic investors can open doors to valuable partnerships, customers, and other opportunities.
Track Record:
Research the investor's track record with other portfolio companies. Investors with successful exits and a positive impact on their previous investments may bring added value.
Risk Appetite and Commitment:
Understand the investor's risk tolerance and patience for returns. Align with investors who share a realistic view of the business timeline and growth trajectory.
Role and Governance:
Clarify the investor's expectations regarding their role in governance. Ensure there's a shared understanding of decision-making processes and the level of involvement.
Due Diligence:
Conduct due diligence on potential investors just as they will on your company. Assess their reputation, reliability, and how well they've supported their portfolio companies.
Communication Style:
Consider the investor's communication style and preferences. Open and transparent communication is vital; choose investors who value and encourage it.
Should you hire a consultant to raise capital for you?
Despite the fact that there is plenty of money out there, investors are still risk averse and more often than not prefer to say "no". So, instead of trying to raise money on your own, should you engage a professional advisor?
You probably want to seek advice if:
Capital raising is really hard, and you'd rather to use your precious time and energy on growing your company;
You've never raised money from outside sources and are unsure of what to do;
You don’t have a network of investors and potential funders, and want to access one
How can a fundraising consultant help you?
First of all, the consultant should believe in your company’s vision, your business model, your valuation, and your growth strategy;
They should understand the capital raising process and able to give you a funding roadmap;
They can help manage the process - investor outreach, raising and follow up;
They can write presentation material and help figure out your capital raising strategy more clearly;
They know who the right investors are and they can make introductions.
If you choose to work with a consultant (and there are many good ones, as well as not-so-good ones), keep in mind that investors still want to hear from you, i.e. the CEO of the company, so, be prepared!
>> I hope you enjoy reading this blog post. If you want me to help you with your fundraising, just book a call.