The hypergrowth needs of fast-growth startups have turned the old rules of venture financing on their ear. Five-year exit plans, 20 percent annual ROI, and 12-month negotiations are no longer the norm. Today’s venture capitalists have more money to invest, but they expect more in return. Raising capital is an intense process, which can be made easier by taking into consideration the ten rules outlined below.
1) Ask for the right amount of moneyBelieve it or not, you can actually lowball your company out of the running for financing. Venture capitalists know how much money it takes a typical fast-growth company to get started, and they want to be sure you have a clear idea of what will be needed. VCs also often have a minimum investment, and can’t be bothered with companies whose funding needs fall below that threshold. So how much do you ask for? That depends on the investor, your industry, and the stage of your development. To gauge ongoing trends, research recent deals through trade publications such as Red Herring and VentureWire, and through news release sections of VC Web sites.
2) Know the different development stagesPlan your fundraising strategy through several rounds by presenting a realistic timeline for subsequent financing stages. This shows the investor that you’ve carefully planned your financing needs, and have a pragmatic outlook for your business’ future. The basic VC development stages are:
Seed financing — This is the initial investment used to get a company started and registered, hone the business plan, and begin development of a sample Web site. These funds often come from the business owners themselves, or through independent investors. Typical amount: $100,000 – $500,000
First stage/startup financing — Once the business idea is fully formed, these funds are used to build a management team, get the site ready for launch, and support the first few months of commercialization. Typical amount: $3 million – $5 million.
Second stage financing — Once the site is up and running, these funds are used for advertising, marketing support, building the customer base, and ensuring there’s enough money for fast growth. Typical amount: $10+ million.
Third stage/bridge financing — This round is used to bring a company to an IPO. These funds are usually paid off with the proceeds from the offering. Typical amount: $20+ million.
3) Build your management teamTalent is the number one thing VCs look at, especially for fast-growth companies where an idea’s execution often spells the difference between success and failure. Investors want to see a management team with previous startup success and expertise in areas related to the line of business. If your team is light on relevant business experience, consider hiring consultants and other outsiders who can fill this gap. For instance, if you’re building an Internet retailing business, bring in a consultant who can give you inventory management skills. In addition, VCs want to see plans for how your management team will evolve in relation to your company’s growth. When will you need to bring in a seasoned CEO, for example. Finally, consider creating a board of advisors consisting of people who influence your industry and know how to build businesses. Investors will appreciate the insight they can bring, and their participation demonstrates an ongoing commitment to your firm by a respected entity.
4) Watch your financials… but they don’t really matterA venture capitalist is not going to invest in your business based on its numbers. The reason is that nobody can accurately predict how a new business will turn out, especially in emerging business markets where growth patterns are still undefined. That said, VCs will examine your numbers closely, and use them to gauge how seriously you’ve considered the size of your opportunity and the costs of bringing your product or service to market. Avoid making grand growth claims — while you may believe you are capable of becoming a $500 million business within 5 years, this kind of wild projection may turn off investors. Build your projections from the ground up, based on customer segment data, spending habits, and the success of other fast-growth businesses with similar models.
5) Demonstrate multiple revenue streamsBe sure your business plan shows a number of ways your company will seek revenue. Many fast-growth startups make the mistake of basing financial projections on a single revenue source, yet investors often want to see multiple revenue streams. This is because having more than one revenue source will provide a fallback position should your initial revenue stream not develop as planned, which is a distinct possibility for an unproven business model.
6) Show high-profile partnersYou can build credibility by aligning your company with well-regarded, established firms, both offline and online. Internet startup success is often based on networking — the ability of a business to leverage other people’s assets to build its own. Strategic alliances that improve your talent pool, provide channels of distribution, or increase your visibility will demonstrate that respected companies are willing to work with you, reducing the amount of due diligence a VC has to undertake.
7) Sign some customersNothing impresses funders as much as signed contracts. These demonstrate to investors that clients support your product and company. Short of current customers, establishing prospect references — ones that are willing to work with your business if certain criteria are met — work well. Have a list of these references available for potential investors to contact.
8) Snowball your funding opportunitiesThe hottest VC deals are often those that appear to be the most urgent. Few things appear more urgent to VCs than funding offers that are on their way from other investors. The momentum these opportunities present can help you sway fence-sitters and give you greater leverage to get the best deal possible. Be careful, however. This tactic is only effective if genuine term sheets are in the works, and you can be sure a VC will call around to confirm your claims.
9) Be prepared to vestSince a fast-growth startup’s management experience is crucial, VC’s want assurances that you and your team will be with the company for the long haul — or at least until they’re able to cash out. As a result, you can expect them to make vestment requests that require you and your key managers to stay with the business for a set amount of time before your shares take effect. Basically, the VC is hedging its bet. By addressing the vestment issue in your plan or presentation, you’ll demonstrate your ongoing commitment to the venture, and possibly ease concerns that may otherwise arise.
10) State the exit strategy clearlyVenture capitalists don’t make investments out of kindness. While your business plan and presentation may get them excited about investing in your project, you will need to show them how they can get out of it. VCs used to expect their exits to come four to five years down the road. For Internet ventures, they expect more rapid paybacks, often in as little as two years. Be explicit about where you expect your company to be at that time. Will it be a stand-alone firm? Will it be bought? Will you file an IPO? Be sure to provide a rationale for this vision.
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