For startups, being strategic about when to raise capital is important, since fundraising takes a huge amount of time and effort. Courting investors essentially becomes a full time job, and can easily become a distraction for founders who need to stay focused on growing their businesses. In some cases, the fundraising becomes so consuming that founders miss important business milestones, which then disrupts the fundraising—a dangerous spiral.
To help startups determine the optimal time to hit the capital raise trail, I have outlined three key factors that help determine a “venture-worthy” company in the current market. These are:
1. The “Big Idea.” A good first filter is to honestly and objectively assess whether your startup is doing something truly unique.Novelty and originality are surprisingly rare traits; many startups are highly derivative-- a slightly bettermousetrap or an incremental improvement over what’s being done today. While a better mousetrap can be the basis for a profitable niche business, it is not usually VC fundable (or at least, noteasilyfundable—it becomes more so, with #3 below).
By contrast, pitching something truly novel, big, and audaciouscreates an entirely different response from investors. I’ve worked with startups doing something interesting but notgame-changing, and I’ve worked with startups with ideas that seemed crazy—but if they worked, they’d be huge.
The latter situation is much preferred, and makes the tiring work of raising capital exponentially easier. A really cool product with the “wow” factor or a big, audacious, disruptive concept is almost magicalin the way it can cut through the noise and generate buzz amongst jaded investors. At a minimum, VCs will take a meeting to hear what the hell you’re talking about.
2. A Well Told Story. While the Big Idea is the cornerstone of the foundation, your pitch is what gets people to stop and take a closer look. Investors are approached by literally thousands of good companies each year; an outstanding pitch will breakthrough the noise and set your company apart from the unwashed masses.
A solid pitch neatly packages the company, vision, anddealin a compelling manner (typically via your slide deck, exec sum, and model), with a narrative crafted to appeal to the nuances of what investors are looking for. It involves telling aclearand exceedinglysimplestory, so the message is frictionless and can be circulated among the partners at the VC firm and among other VCs in a syndicate. In other words, the pitch is portable (and often somewhat “viral”).
A solid pitch also includes polished and practiced Q&A, and an overall story that strikes both rational (how do I make a return on my investment?) and emotional (why do I want to be part of this vision?) chords. Bringing all these elementstogether is surprisingly difficult, but when done well it is a beautiful thing.
3. Supporting Evidence. This is the clincher, and the one most startups miss. VCs fund businesses, not concepts. A concept alone is not fundable--startups must get the fire lit; venture money fuels an already-burning fire. Or, to put it inother terms, VCs typically want to see most of the technology risk and at leastsomedegree of the business risk removed before doing a deal.
In the absence of some special factor (for example, a founder with multiple successful exits under the belt), startups need to generate some evidence of "market validation"—e.g. initial traction, early customer adoption, or a monetizable proof of concept--beforeapproaching investors. In short, startups needdatashowing the beginnings of a growth curve.
Fortunately, it only takes a few data points to show a pattern. I’ve seen startups with just a few months of live customer data get a lot of investorinterest. Investors recognize that the delta between a startup with "deal in hand" and one that "willhave a deal,ifwe raise funding" is very large, and they use this gap as a filtering mechanism.
This is why designing and presenting startup metrics plays such an important role. In a perfect world, you can show—even with just an initial, limited data set—that your average revenue per customer is greater than your cost to acquire said customer. In such conditions, an investment is a no-brainer; this is what closes venture rounds.
While I’m a huge proponent of “pitching the numbers,” qualitative evidence can be useful as well, such as blogger support, press and journalist attention, rabid Facebook fans, evangelistic Twitterfollowers, etc. Regardless of the form, it’s a powerful combination when you can start your pitch with a right-brain lead-in (i.e., an emotive, visionary angle) and finish with a left-brain close (rational, unambiguous data).
Keep in mind that raising external funding is significantly “harder than it looks”—estimates from the SBA and Angelsoft show thatonly around 2% to 5% of startups seeking angel or VC dollars actually get funded. The bottom line is that being strategic about the process— getting your act together, building a strong team, and timing your investor outreach for when momentum is picking up within your startup—will greatly improve your odds of success.