Jonathan Dane of Defiant Capital goes over some of the absolute basics that are often overlooked when entrepreneurs are on the road to seeking capital for their ventures. Below is a handy check list, but listen to Jonathan provide more detail and a bit of knowledge from the trenches. It's a great listen whether you're building you first company or your fifth!
In every business lifecycle there comes the time to consider raising external capital. Typically this occurs at an inflection point where external capital is needed to accelerate business growth or bridge the gap between inflection points. Regardless of need the decision to raise external capital should not be rushed, as it will have a long-lasting impact on the company (including the Founder giving up some control).
As investors into early-stage companies we have had the opportunity to see the spectrum of companies – those with one person teams and those with 100 person teams, those that are ready to accept hundreds of millions of dollars of capital, and those on the brink of failure. What follows are the five key takeaways from these discussions that we think every company should keep in mind when starting to raise capital.
Early-stage investing is about people
Before getting into the subject of this article, one last point. From an investor’s standpoint, early-stage investing is as much about investing in the Founder(s) as it is the company. During a capital raise Founders should be prepared to answer tough questions, have investors dissect their company (and management decisions), and question growth plans. These questions and discussions can sometimes be tense, but they are what give potential investors the comfort needed to invest.
With that said, here are the five things to know before raising external capital.
1. Have a clear vision of your company’s growth plan, including how you will ultimately exit
When meeting with potential investors it’s important that a Founder's vision and growth plans are confident, actionable, and most importantly, understood. Be ready to discuss your key product lines, addressable markets, and what you expect to drive growth (i.e. marketing, macro-tailwinds, etc.)
Potential investors are ultimately investing to earn a return and so they will want to understand the growth trajectory of the company, as well as how their investment will someday be returned (i.e. what's the exit). Whether it's interest payments, debt maturity, or an acquisition/public markets exit, a clearly articulated exit plan is important so investors have realistic expectations.
2. Know how much capital you need, why you need it, and how you plan to spend it
In our experience many start-ups and Founders tend to be too laid back in their discussion around the amount of capital raised, and their potential use of it. It's important to have a strong rationale for the size of the capital raise, as well as how you plan to use it at the company. Most investors will require a detailed understanding of how that capital is going to be utilized, and statements such as "build out the team" are vague and don't provide the insight an investor will want to hear.
During these discussions be as specific as possible when addressing questions over the use of funds. If it's to build out a team, break it down between business development, engineering, administrative staff, etc., and then also explain why the ramp-up in personnel is needed. If it's to ramp up inventory or cover increased operational expenses (e.g. new facility), talk through that in detail with investors.
3. Be able to discuss your company's financial model, including profitability metrics
Any potential investor into your company will want an accurate view of your financial position. From an investor's standpoint it's important to understand if this is a company that is on pace to exit and ramping up growth, or if this is an earlier stage company that will likely require further rounds of financing.
At a minimum this means having a dynamic Excel financial income model that shows historical financials, as well as projections. Most investors do not expect audited financial statements at this point but showing you can accurately track income/expenses internally is important. Be ready to discuss the basic attributes of your business and its profitability - what's the cost of the product, what is the cost to acquire a new business, what is the expected burn rate, etc.
4. Think through your team structure, advisory board, and personnel requirements
The best Founders are the ones who have the vision to grow their company but are also humble enough to embrace the help of advisors. Prior to seeking external capital we suggest adding strategic advisors, and even an Advisory Board to the company (significant capital investments often require Board seats, so be prepared for that discussion too).
As we noted in the introduction investing in an early-stage company is as much about the people as it is the company. Investors want to know who is running the company - who are the key decision makers and operators building the product? Who is driving the growth - is the CEO doing all the business development, or is there a strategic hire? Being able to clearly articulate the organizational structure and key personnel (internal and external) is important.
5. Review your company's legal structure
Before seeking external capital ensure your current legal structure supports it. Is your company operating as a single-member LLC? Does your company have an Operating Agreement? How many legal entities does your company have, and which one are investors investing into? While some individual investors (e.g. friends, family, high net worth individuals) may be comfortable investing in LLCs with boilerplate operating agreements, most institutional investors (and individuals writing larger checks) often require your company to operate as a Corporation and have a finely tuned Operating Agreement and legal structure.
Final advice – be prepared to work
Raising external capital is an important milestone for any company and can help catapult the growth of your business. That said, raising capital is difficult and arduous, and will require significant time and attention. Between investor meetings, document requests, and follow-up due diligence requests, time will be stretched. Throughout the process you (as the Founder) must remain engaged and committed, meeting with prospective investors while simultaneously continuing to run the day-to-day operations of the company. Before starting the process, ensure the company truly needs it, and you are committed to the process of getting it.