From the outside, the world of investment-backed start-ups is the glamorous side of the start-up world. Headline announcements of 7-figure Seed & Series A rounds attract plenty of interest on social platforms but mask the real truth.
The truth is that this world of Venture-backed business is strange and confusing to those new to the game. For every celebrated successful raise announced, there are hundreds of failed rounds. Then there are those deals that did get through, with Founders & Investors on both sides of the table regretting the decision.
Investors have a whole unique language full of technical jargon that can even have seasoned finance professionals scratching their heads.
Then you have the seemingly mammoth task of understanding what these investors actually want and why they chose specific deals.
For a founder to come into this game inexperienced, without support and unprepared is enough to scare them off forever.
Despite all of this, I am a big fan of getting the right Investment at the right time, on the right terms can bring to a business. One of my clients just sold his firm for $30m+ within three years of starting, and this would never have been possible without the Venture Capital Investment backing he received midway through that journey.
The key to getting this right is to be fully prepared!
Securing Investment is a huge topic, far too big to cover in one newsletter, so this post should serve as an introduction to Investment and have you thinking clearly about how to prepare for this journey. I have plenty of content to share in the future, delving deeper into how to actually secure Investment.
The importance of being Investor ready
Timing
Timing is vital. The time it takes from initial outreach to closing a deal often catches the inexperienced founders out. The average time is six months +. For this reason, you must start the process way before you need the funds.
Timing this journey to ensure you do not run out of cash is the difference between life & death for start-ups. At an absolute minimum, you want to close this process with at least a cash runway (how many months until you run out of cash, based on current spending) of 3-6 months.
Competition
Investors will receive hundreds or even thousands of outreach yearly from businesses looking for Investment. You have one chance to pique their interest and stand out from the crowd.
Even after you have captured that initial interest, it’s very easy to lose it again. If you don’t have the information, documents and answers that they want to see to hand almost straight away, they will move on to the next deal.
Preparation
I recently saw someone describe Angel Investors as doing the foxtrot, slow, slow, fast. They can be slow at showing initial interest, but they want to move fast once they have.
What will you do if they say they are interested and want a link to your data room, which you don’t have? You don’t want to be caught with your pants down - it’s embarrassing and makes you look silly!
What are Investors looking for?
Every Investor will be looking for something slightly different, especially between the various investor groups (covered below), but there remain some constants:
An Investable Founder
It may be a cliche, but investors are looking for the right type of person to invest in, not just a business idea or model they like. This becomes even more important when the business is pre-revenue or early stage - it may be all they have to go on.
A Model that Works
Anyone investing needs to see a business model that works. It amazes me how often founders focus on a great product or service but forget to show how this will make money! It must deliver profitability or at least a route to it and work at scale.
Product Market Fit
Do you really understand the market? Even better, can you prove that clients want what you are selling AND are willing to pay for it at a price that makes sense?
An Investment that fits their criteria
Every Investor will have certain criteria around the investments they make. It’s your job to find this out and check you are a good fit for each other based on the following:
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Industry
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Deal Size
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Investment Stage
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Exit Plans
Route to Exit
Paper gains for investors are a pointless vanity metric. They care about getting their money back out of the deal at a high multiple of the original capital. Show how and when they will be able to exit.
Financial Readiness
There is no quicker way to blow up a potential deal than having a sloppy financial report. Get your house in order before you start this process! Make sure, at the very least, your bookkeeping is tight, and you have regular clear management accounts.
Although you will share some headline figures from your finances in your pitch, the real test comes after. For any investor that is still interested, they will ask to see your data room.
The Data Room is a secure area/folder containing the financial and legal information any investor would need to decide on the deal. Keep it simple and well-organised. You will need to include a lot more at the Due Diligence stage but to help secure the initial decision, here are some of the basics to have ready in your data room:
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Previous Accounts
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Management Accounts - P+L, Balance, Balance Sheet, KPIs
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Financial Model
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Cashflow forecasts
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Cap Table (list of shareholders and %)
Cashflow
No sensible investor is going to give you money without some trust in the fact that you will manage it well.
They will want to see a Cashflow forecast showing how this money will be spent, what the burn is (how much you will spend each month) and the runway (how many months your cash balance will last) pre & post-deal.
They will also be looking to ensure you have the right processes and skill sets to actively manage the cash carefully once the deal has closed. If you don’t have the skill set in your founding team, then using a fractional CFO like me here can help give the Investor confidence.
I once heard of a founder who ran out and purchased a brand new Ferrari the day after his investment deal closed from a VC - oh dear!
Typeosrs of Invest
To maximise your chances of success, it’s essential to understand who might be willing to invest in your business based on your stage and deal size. Each category of Investor will work differently.
Here are the five different types of investors:
Friends & Family
Asking people you already know who like you (presumably?) can be one of the easiest and quickest ways to generate Investment and get your business off the ground. This relies on you having a close group of well-off individuals, so it isn’t available to everyone. The deal size (the amount they invest) will likely be small. Make sure to treat this Investment like any other and get the legals taken care of to avoid any messy arguments further down the line. There will be very little due diligence to respond to making a deal quick and easy to agree.
Accelerators & Incubators
For the high profile incubators, competition for a place can be fierce. Being accepted into a well-known start-up accelerator or Incubator can be a great way to launch the business. You will likely benefit from support & mentorship that may otherwise be hard to come by. You could also get great media exposure, depending on the group. The downside to this type of Investment is that it can be costly regarding the equity you must give away. As much of it is in exchange for services rather than cash, you could need to raise another round with outside investors earlier than planned but with less starting capital to negotiate.
Angel Investors
Similar to accelerators, Angels will likely provide support and mentorship but with more cash on the table. They can help provide valuable connections and will often be able to introduce you to VCs when you raise your next round. These can often be Entrepreneurs who have already had a large exit from their own business. You will need an adequate response to due diligence, but as they have nobody else to report to, they can move quickly to close deals.
Venture Capital (VC)
The deal size for VC funds can be much larger than the options above. Some can provide support and mentorship, whilst some may be more hands-off. The amount of equity you will be required to offer will be substantial. These funds will have strict criteria for making investments and must undergo full due diligence. Depending on the size of the funds, decisions may need to be agreed upon by the Investment Committee, so it can be slower to close a deal. Understanding that successful VC funds make most/all of their gain from one to two deals (the Pareto Principle comes into play here, or the 80/20 rule) gives you a clear insight into what they seek. A 10x minimum gain in 3 years - they won’t be interested if you can’t show a path to this exit level.
Private Equity
Typically Private Equity firms come into play at a much later stage of the investment cycle, Series C or full buyout, but we do see some that will come in at Series A. The typical deal size must usually be a minimum of £5m. Private equity is looking to take fewer risks, so the model needs to be proven already. They are looking for a business that they can scale and then eventually exit.
The Next Steps
If you have given proper thought to the decision to raise Investment and followed this guide to start the journey, then this is an excellent point to seek help from an expert who can guide you through the next stages.
Next up, you need to work on the pitch deck, fine-tune the pitch and work out how to reach out to the right investors - something I will cover in a future post.
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.