Raising outside capital can be exciting for an entrepreneur who is ready to accelerate their business to the next stage. Much like exit planning, raising capital is a process best started early to give you time to get to know your potential investors and vice versa. In this post, we talk through how to identify your ideal investors, followed by some practical steps to winning them over as partners and how to make the most of the fundraising experience.
Finding your ideal investor
Entrepreneurs that raise money through equity implicitly take on long-term partners in that process. You will need to agree with potential investors on a valuation, but establishing how this new partnership will work is equally important. Research suggests that 70% of partnerships fail, often due to distrust and deteriorating relationships. The type, style, and experience of a potential investor can be just as important as the money they offer.
Investor Categories
In order from smallest to largest, the common categories of investors are: friends and family, angel, venture capital (VC), private equity (PE), and strategic partners. These types of investors typically relate to funding rounds as demonstrated in the following graphic:
Source: Difference Between
Investors aren’t homogenous within categories, but there are some hallmarks of each type:
Friends and family investors, which provide the majority of early startup funding, often trust the business owner and are more likely to take a silent vs. participatory role in the business.
Angel investors are often experienced entrepreneurs that, in addition to capital, can provide advice and knowledge that an early stage startup needs to survive.
VCs make multiple $1+ million investments each year, expecting some to fail, but they often demand to see rapid sales growth, which may or may not be conducive to your business goals.
PE firms tend to take large stakes, often demanding high growth with little tolerance for failure as they prepare their investments for a strategic buyer or IPO.
Strategic buyers are most likely to purchase an entire company, looking to capitalize on synergies by bringing a new business in-house to add to their existing brand portfolio.
Let Your Business Model Dictate Your Ideal Investor
Companies that generate cash early may not need to raise outside capital, at least at the start, if they can generate enough cash to scale their growth through its first phase internally. On the other hand, a disruptive new product or service with a large total addressable market (TAM) might benefit from VC funding. VCs will encourage entrepreneurs to “swing for the fences,” and while that increases the odds of striking out, the payout can be worth the risk.
Business models and goals change over time, as do investor expectations. Series A investors generally expect you to have a valid business model with some sales or customers on deck, and a compelling narrative to explain how investment would allow the company to scale revenue faster. Expectations shift in Series B towards revenue and customer growth, while Series C, D, etc. investment might be used to get the company ready for acquisition or IPO.
Modifications to the business model and goals can be difficult after taking investment. For example, Series A investors often have an implied expectation for later stage investment, but the pursuit of constant sales growth might not be right for every business. The pressure to acquire funding for your business creates a temptation to accept the first offer you receive, but aligning expectations and goals is equally important in the long run.
Estimating Funding Requirements
The first step in determining how much to raise is to establish clear business goals, whether those are product development plans, revenue objectives, profitability metrics, or whatever unique goal you are striving for. Once the goals are established, your CFO can begin to match those goals to associated costs. For example, the cost of X engineers for Y months at Z salary to develop a prototype, or a budget of marketing dollars needed to reach a target audience. An experienced hand will help avoid common mistakes like underestimating the cost to build appropriate inventory or handle customer service requests. Once you have reliable valuation estimates and funding requirements, it becomes clear how much equity the existing shareholders will need to sell to reach the next stage.
Practical Steps For Finding Investors
There are specific steps for finding investors that depend on the type of investment, but a few fundamental rules apply across the board:
Consider getting connected to future investors now, to establish credibility today for investment later
Join a networking group applicable to your business stage whether you’re pre-revenue or are going strong in year 10
Don’t limit talks to potential investors about raising capital, focus on building rapport and expanding your network
Don’t be intimidated when approaching investors. It’s their job to find investment candidates, so the odds are in your favor that they will want to learn about you and your business just as much as you want to talk to them. Even if they pass you along to someone they think could be a better fit, it helps them build rapport in an industry built on relationships.
In a later post, we will share some ideas about building the “perfect pitch deck”.
Iteration, Improvement, and Perseverance
It’s incredibly rare for a pitch to result in an immediate yes to everything you’re asking for. They say “It takes 7 no’s (or more) before you get to a yes,” and while rejection never feels good, odds are high that you dodged a bullet on some of those “no’s.” As discussed earlier, seeking investment is also about bringing on new business partners that are aligned with your business goals. The more investors you meet, the higher your odds of finding that long-term alignment. The process can easily take months of perseverance, but the longer processes can be more rewarding and long-lasting.
The Stress of Fundraising
Fundraising is obviously stressful if you need a cash infusion to keep your business going, but it also takes a mental toll even when cash is being sought to fund growth. When raising capital, a “no” means you have to keep looking, while a “yes” means you now have investors expecting you to deliver on your vision. Both are difficult roads. Fortunately, the entrepreneurial community has been developing resources to help founders and their teams cope with their stressful environments. When deciding how much capital to raise or establishing business goals, it’s important to be realistic about personal limits and manage your own expectations. It also helps to have the support of an experienced CFO who has been down the road of fundraising before and can help you navigate the ups and downs.
Incorporating Rejection and Rejecting Feedback
No one does anything perfectly the first time, whether that’s starting a business or preparing a pitch deck. As you make pitches to investors, the experience may force you to rethink some of your plans and assumptions. You should be proud of the first pitch you make, but you should also expect rejection that will lead to improvements going forward. Investors are generally happy to provide feedback when asked, and while you should listen to all, trust in your own knowledge of the market and your company. Occasionally feedback is given in bad faith, but more frequently investors simply miss extraordinary business opportunities because they don’t fully understand them. Don’t assume the feedback you get is wrong as arrogance can be dangerous, but ultimately, the pitch should reflect you and your company, which will sometimes mean rejecting investor feedback.
Goals Beyond Investment
Statistically, most pitches are not going to result in an investment, so it’s important to have goals beyond a cash raise. Possibilities include:
Building rapport that can lead to additional connections or future investment
Looking for strategic partners in marketing, supply chain, customer service, etc
Building experience and iterating on your pitch design
Interviewing investors to determine who you want to work with
Investing is about managing risk and reward, and until you establish trust with investors, the risk is difficult for them to define. In an older, but still relevant post, Mark Suster writes that “The first time I meet you, you are a single data point. A dot. I have no reference point from which to judge.” This is especially true for startups that don’t have historical data to present, but it’s valid for all businesses. Investors are making an investment in you and your team as much as they are in a product or idea. It takes time to establish credibility and pitching to prospective investors is a great way to start building that relationship.
Concluding Thoughts on Raising Capital
Finding your ideal investor is about much more than agreeing on a valuation. Gaining business partners is part of raising external capital, which means it’s important for your goals and values to align as well. If you take the time to build trust and credibility, a good business partner can provide experience, support, and connections that may be even more valuable than the funding you raise for the company.
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About the Authors:
Dan DeGolier is the founder of Ascent CFO Solutions and a Fractional CFO with nearly 30 years of experience. He is passionate about working alongside leaders of companies to help them “upward” to their highest potential. Andrew Dudar is a registered investment advisor representative whose background and career in engineering allows him to conduct financial analysis by breaking down complicated subjects and making them easier to understand.