WHY IT IS NEEDED
1. Why and when to look for the investments?
There are different stages of startup lifecycle, when company grows from the idea/concept stage through the launching and up to the maturity stage. All these stages require investments of a certain scale.
Usually, the first steps of a startup are based on the financial injections made by the founders themselves. However, at some point, it may happen that the company reaches the limits and face the fact that in order to grow and/or to enter new markets, the external investments are necessary. Funding can be raised from different sources, which we will discuss later in the chapter. The decision to go and meet the investors is one of the most important steps in the life of a startup. Founders have to prepare their mindset, expectations as well as the strategy of how they will go through this process.
Some startups, especially the young ones and those working on complex projects, e.g. related to medicine or space explorations, often perceive the external (entrepreneurial) venture capital financing as the way to build own business with other people’s money. However, the reality is quite different. Every investment leads means giving away a part of the company and the dilution of the company control that you previously had. That is why you need to think carefully before taking this step. The best time to start talking with the venture capital is when you have some key metrics to show – already developed the MVP (minimum viable product), initial sales, customers, and the extra funding is necessary to speed up the things. This means you have such business model that works with the small investment made by the founders themselves.
Keep in mind that it takes time to raise the capital. Give yourself a plenty of time for this. Usually it takes 18 to 24 months to attract the investments. It does not mean you have to pause all the other processes of the startup, on the contrary – business progress in terms of sales, client base, brand building is of key importance during (and after) the fundraising process.
2. The Cons and Pros of raising the capital
The opportunity to raise external money may be tempting; however, before entering this train, founders of a startup have to understand the cons and pros of raising the capital.
Let’s start with examples of the positive factors (Pros):
- extra money will help you to speed up the journey and results of a startup;
- high available budget can be used to develop and improve the quality of your product or service and thus to increase the chances of success;
- very often investment comes with the influential people, contacts behind; you will definitely feel the positive impact of this as more doors will be open for you;
- the journey of raising the capital (especially successfully doing this) will help to build your brand and benefits of being known and recognized in the business world.
The dark side (cons) of raising the capital:
- the process will ask a lot of time and some money (everything costs);
- investors’ money comes together with the loss of full control of the startup; you will have to compromise and sometimes it means detouring from your own plans;
- you will have less of the startups’ profit as you will have to share it with the investors;
- it might be difficult to feel the constant burden owing to others;
- big money brings a danger of conflicts among the co-founders and sometimes this can lead to the termination of the relationships.
Sources of Capital
Startup businesses may face many challenges when trying to find money both to finance the basic needs of startup development and to boost the business. Banks look for businesses with guarantees and even with the very good business plan of your startup – to convince bank to provide a big loan for startup – can often be “mission impossible”. However, there are many other financing options available to the entrepreneurs. You can be creative and combine a few of sources of financing at the same time. Here are the main sources of capital to be used for startup financing:
- Bootstrapping (or self-funding) can be the best option in the initial phases of startup, when the co-founders manage to finance the business by themselves. This is very much related to entrepreueneurial mindset as the (co)founder(s) takes the risk to invest his/hers own money while understanding how the world of a startup works (e.g. the rate of success or failure). Later it can turn into advantage when talking with the investors for it serves as an excellent proof of how much you believe in your startup and how hard you are willing to work to reach the success. The bright side of bootstrapping – you can control the business and do not need to report and be accountable to any investors who most likely will want to participate and get money back (and to do it fast). The other important thing worth mentioning is that for some companies bootstrapping is a temporary phase as the company grows the financial needs grow together. Thus, at some stage, in order to boost the development of a company it is most likely you will need to look for the investor. The advice here – do not do it too fast, wait for the right moment when you really need those money, as every investment means you have to give away a part of your company. Thus think strategically and if you can grow your startup to a big company only using inner resources, you will be much more happy and will have full control of your startup.
- Bartering is when startups exchange the resources. For example, if one startup has a spare office space and the other company has a good programmer (who has some free time), companies can lend each other these resources and thus save some cash.
- Friends, Family and Fools (3F) are first and closest line of investors who are willing to support your startup and your dream even when having in mind the fact that less than 5 percent of the startups outlive the period of 3 years. The dark side of such financial aid is that you can come with different opinions that eventually lead to disagreements within the family and among friends (especially when the company/project fails).
- Partnerships with corporate companies can also be a good possibility for startup to raise capital. Some large corporations with strong financial record are willing to hire their spare money. Startup can be approached by such a corporation and receive an offer to make the partnership. The aim of such partnership is that both sides would benefit from this agreement. Both parties can either agree to share the revenues that will be generated from this partnership or, for example, to give a percentage of a startup in exchange for the particular services or other benefits it can get from the corporation.
- Pitch contests / hackathons is a very good place both to receive funding and to get feedback, validation of your product or service from various organizations or investors. Do some research and analyse the startup ecosystem in your region. This way you can find smaller pitch competitions (e.g. Business Hive Vilnius, 1776 Challenge Cup, Power Up etc.) which would be a great test area before applying for global Pitching events (e.g. Startup World Cup). There are plenty of pitching event which are organized every month. Spot them and try not to skip it, this way your startup will have a chance to add e.g. 2000 Eur (depends on the event) in one time and perhaps every month.
- Grants – there are various financial opportunities provided by government. Startup can participate in various entrepreneurship promotion initiatives (e.g. Kauno startuoliai) and win the money necessary for your startup. If you develop high-tech product (e.g. medical device), you can look for the national funds which promote the collaboration between business and universities. Prepare the application form together with University professor and in case of success, you will get the research labs that are full of expensive and necessary equipment while the Professor will be happy to publish a paper about the research you make together. This road can be exhausting but a good thing about it – this money does not have to be paid back and in most cases the government does not ask for interest or control of your business.
- Business Accelerators are in a way a safe zone or bootcamp for entrepreneurs and startup companies, where they can find all the support they need in the very beginning of company development in exchange for equity. It includes free (or “symbolic fee”) office space, consulting/mentorship on product/service development, marketing, networking opportunities, potential follow-up investments etc. These accelerators can be funded by government, universities or large companies and can have interest in a particular field, e.g. some of them invites healthcare, IT startups, others look for startups that focus on B2B business. Therefore, if a startup decides to apply for accelerator – this should be done with great attention when selecting the best corresponding institution.
- Business angels usually are wealthy people with spare/available money and willing to invest it into the early stage startup he/she thinks have a potential. The amount of investment might be very diverse, starting from 10 000 up to 1 million euros. In exchange, angel investor will ask for an equity share of a startup and very often, he/she will participate in life of a company when making important decisions. Usually, these are business professionals with very good technical and/or managerial knowledge, as well as valuable experience, which is beneficial for the startup development. It is important to target and carefully choose the angel investor you would like to work with. Do not do it randomly as some of them might be professional angels that make at least 5-6 deals per year (they know the needs of the startup and how the whole system works), while others – occasional angels (make only few deals per year and can be more difficult to work with).
- Crowdfunding is another non-traditional way to finance the startup. This is a practice when startup company puts the description of a project (text explanation, video) to online platform (e.g. kickstarter, indiegogo, gofundme etc.) where people from around the world can invest in the project. Usually this is early/concept stage project and startup use crowdfunding to get money for product development and first production. To put in simple words, crowdfunding platform is a place where the entrepreuneurs with concept stage products meet such people/investors who are looking for innovative products and are ready to invest a small amount of money. In exchange, they will ask to be the first consumers, i.e. to get the product as soon as it is produced. If startup manages to raise the money with crowdfunding platform, the company can get the proof of concept, great marketing tool, feedback from potential consumers.
- Risk capital or venture capital (VC) investments. If all of the above-mentioned funding options are relevant for the concept stage startups, the risk capital usually invests its money into the companies that have already shown good results, have customers, earn income and are maybe even in the profit zone. In most cases, such startups approach the VC funds when they decide to expand, enter new markets and are very clear about why they need this money and where it will be spent. It is worth mentioning that VC funds usually invest in the high-growth potential startups, focused technology innovations (e.g. biotechnology, IT). Founders of a startup have to keep in mind that risk capital investments are the most expensive ones. In most cases, the venture capitalists play a “high risk and high potential reward” game, and thus have a portfolio of the firms they invest into. If you convice VC funds to provide you with capital, they will in return ask for a percentage of the company and will participate in the life and development of a startup. Thus, be sure that you trust the investor as he/she will be spending a lot time with you while participating and weighing the decisions related to the management of the company. Besides, VC funds expect to get both the money and the profit back once the startup sells its shares to the public (IPO). Remember, the rate of successfully raising VC investment is only up to 3 percent and it takes a lots of work to get this money (read more: Jeffrey Bussgang “Mastering the VC Game: A Venture Capital Insider Reveals How to Get from Start-up to IPO on Your Terms” (Penguin Group, 2010).
IPO – is an “initial public offering”. It means the company came with the decision to open up, to go public for the first time and list its shares on the stock market, where everybody can buy a portion of a company for a certain price. This way company is able to collect funds necessary for the growth of the business.
What do the investors want and what are their expectations
After you got acquainted with the alternatives of raising the capital for the startup development let us discuss what the investors expect during the meeting.
Diligence is a key word in the business world. Investors want to hear a well-thought-out business idea with the market potential. Do your homework (complete all the tasks you have been asked to do in the previous chapters) and show to the potential investors that you’ve done in-depth analysis of the idea and the field. The idea becomes your “second skin” as you give a lot of time and energy developing and working with it. It is good to show the passion you feel for your product or service. However, the danger that lies in here is that you can start seeing it as the best one and think that everybody else, including the investors, will think the same way. However, this is far from reality and to raise the money necessary for your startup to flourish, founders have to make good homework. Show the feedback from the others that would proof the demand your innovation is going to meet. Work on a good and short business plan/feasibility study where the main information and data would be available to look over.
Be prepared to answer the obvious questions, show that your are an expert in your field. At the same time, do not be arrogant and admit your limitations, i.e. what you do not know and have, while showing how you plan to get it. Personal qualities are also very important. Integrity and good character are the values very much appreciated by the investors. Show that you are person easy to get along and work with. No less is important to show that capital they would invest in your startup will be safe and they will not waste neither their money, nor the time.
There are different venture capital funds with the specific focus. Before knocking on the door, do a good research and analyse which VC funds are interested in the field your startup is working on. Find out and get to know the people working in the VC. Get yourself into the shoes of the investors and try to understand how they do not want to feel (to lose money and look foolish), what are their “pain points”, the size of the checkboxes and, most importantly what are their goals. If you are able to show you will help them to reach their goals – they will really take this as a big advantage. Usually the goals of institutional and individual investors are measured in such numbers as ROI (return on investment), cash-flow predictions, sales.
Regardless of what you read above, as a founder you must know how difficult it is to raise the investment, especially as the investors will be worried even while listening to the fantastic idea. Your goal is to deliver the perfect pitch deck so that the investor would not let go this opportunity very easily. Make them want it! Show that the business opportunity you pitch is amazing and has potential to generate high revenues. If you create a feeling this “train is leaving” and they might loose the chance to be the first in line – your chances raising the capital will go up. Yet, everything you say have to be well thought-out.
It makes sense asking oneself why investors take risk and give their money to the young company even if they know the cruel statistics – 90 percent of all startups fail within a period of 5 years. The answer is simple – professional investors have the portfolio of startups they invest in and know that 10 percent of companies that survive may well generate revenues high enough to compensate for all their other losses.
In the following section you will find out what should be delivered in the pitch deck.
PITCH DECK STRUCTURE
At this point, when you have a clear vision of your startup and know the expectations of the potential investors it is time to start working on the Pitch Deck. What is it? Pitch deck is a brief presentation of your business/startup for the potential investors as well as customers, partners or even the co-founders. Very often, this presentation is prepared with PowerPoint, Prezi, Keynote or PDF. A good pitch deck is a “must have” for every startup. If you want to be taken seriously by the startup community, especially by the investors – your Pitch Deck must be very well thought-out and delivered.
Investors usually expect pitch deck of 10-15 slides, and that you will be able to deliver it in under 20 minutes. Remember, the purpose of the pitch is to stimulate and encourage the interest and not to discuss every aspect in a deep manner. The goal you want to reach – to get the second meeting. The famous Silicon Valley Venture Capitalist Guy Kawasaki says you only need to give 10 slides (max 15) and this little number will have to be very concentrated in order to give the essentials of your startup. So what is the structure of the pitch deck?
Venture capitalists, founders and authors have different opinions about what should be in the successful pitch deck (read more); however, most of them agree the following elements are necessary:
- The first two slides of your pitch deck should grab the attention of those who listen. Make it stunning! Start with the company name and the person who presents as well as the contact information. Please provide a very short (5-7 words) description of your product or service which would enable you to understand what is it all about.
- Next slide should give a brief explanation of the problem you are solving. Summarize it in 1 – 4 bullet points. Give yourself enough time to prepare the description of the problem, in other words the pain you are trying to relieve. If the investor understands it, she/he will empathize with your product/service earlier. This is exactly what you want.
- The third slide should present the solution and you have to highlight the value proposition your startup your company offers. List at least three key benefits of your product or service. It is necessary to explain why your startup is doing this innovative business right now and where you expect to be in 2-3 years. Investors, especially VC funds look for the startups that create new markets and have a chance to be the dominant share in the market. If the startup decides to enter the market where the players are already there, you have to be twice as fast as the rest of them.
- In the following, fourth slide reveal the underlying magic of your solution. Venture capitalists want to know what is the technology or other “magic” behind your product or service. It would be perfect to show the demo version of your product and if you already tested your product/service in the market – show that it has worked with the customers.
- The fifth slide of the pitch deck is the key, as it presents the business model of the company. Give a very brief explanation of how you will earn the money. For example, in the original pitch deck of AirBnB (see full Pitch Deck here ) the business model is described in a very short way when saying they will take 10 percent commission of each transaction. At the same time they give few numbers/calculation, which show the revenue in 3 years period.
- The sixth slide explains Go–to–market plan. Use wisely the homework you have done after successfully completed this topic in the previous chapter of the guidelines (nuoroda į 7 temą “Go to market”). Explain the strategy of how you are going to reach and acquire the customers, what is the size of the total market, how much you are targeting and how are you going to get millions in revenues.
- In the seventh slide, show the full view of the competitive analysis. Use the information you have gathered after you successfully finished the topic “Market research” (nuoroda į 7 temą “Market research”). It is better to give a more in-depth landscape of the competition (e.g. group your competitors based on the selected criteria, like price, distribution channels, market segments served etc., or name your top competitors and their weaknesses) rather than superficial. Show that you know what are the players in the market, but at the same time tell why you can beat the market with your solution.
- Another element must show in the following (eight) slide is management team. As you have already now and noticed, the success of the startup largely depends on the team. Investors are giving their money not only for the idea but they are investing it into the team. The more diverse professionals you managed to gather the better. However if your team is not perfect – do not worry. As Guy Kawasaki says, “if your team was perfect, you wouldn’t need to be pitching”. If you have big names mentoring you – it is also worth mentioning.
- Financial projections and key metrics is what investors are really waiting for to see. In the ninth slide of your pitch deck be sure to provide a three year forecast that would cover not only the money you earn and spend, but also the key metrics (how you measure the success of your business) e.g. the number of customers, conversion rate. Conversion rate can be calculated when using the funnel principle: number of people who are suspects, then how many of these convert into the prospective customers and finally into real sales.
- Finally, in the last, tenth slide of your pitch deck introduce and explain the milestones of your startup. Introduce the investors with the current status of your product/service, what have you done till this moment and how does the near future (what’s left to be done) of your startup looks like? Give the preliminary size of the investment you are trying to raise and explain how you are planning to use the money.
You can have a fantastic product or service as well as the most professional team, but if your pitch deck is not in a perfect shape you will have great difficulties getting the attention and most important – raising the investment. Sometimes young entrepreneurs with a very good business idea but with little or no experience, and weak business plan can raise a great amount of investment by delivering great looking pitch deck.
The trends can be noticed not only in business ideas but in the pitch style as well. It means the visualisation of your pitch deck has to look professional and match the trending pitching styles. Go to the pitch events, look for those pitch decks that managed to raise millions. For example, take a look at these 35 Best Pitches of 2017 that investors are still talking about:
What makes investors cautious?
The journey of raising the capital takes time and you can expect to spend up to 1,5 to 2 years on this task. However, if you want to make it quick and effective, some key moments are worth taking into consideration.
- Investors care a lot about the startup team and its size. When establishing startup company founders share the equity between themselves. Later, when new, key members join the team the company can give a part of equity as an incentive to work hard and put all the efforts to make this startup a successful company. However, the investors find it complicated when there are too many people owning the company. Yet you should remember that if the startup develops a product based on technical innovation it usually has some engineers and/or technicians as the founding members. In most cases, such startup is capable of developing the technical part of a product and there won’t be necessary to pay big money for the R&D;
- Every business is a project of high risk; however, some entrepreneurs can be excessively optimistic concerning the present and future of the company. For example if you say your product has no competitors in the market – either you have not done an in-depth market research or you are simply too optimistic. Investors are smart and experienced business people who are able to identify unrealistic optimism. The advice here – weighted optimism is perceived more positive than unrealistic one.
- Numbers grabs the attention of investors and no matter if startup is very young, the progress of the company metrics (it can be initial ones) is something you must think about with care. If investors misses this traction (e.g. growth of customers, growth of the revenues and sales etc.) on your itch deck – the chances of raising the capital successfully goes dramatically down.
- Sometimes entrepreneurs create a very nice product, but when it comes to the question – how are you going to earn the money out of it, a very common answer is – paid advertisement. It takes a lot of time and money to be able to generate the revenues from the advertisement and you will be tight with money almost all the time. Thus, think of alternative sales channels you could use to generate the revenues;
- Another moment that can send a red flag to the investors is not well-thought-out size of investment necessary to speed up the startup. If you have ambitious goals and ask for inadequately small amount of money (or vice versa) you will be perceived as contradicting yourself, and it may be a sign to the investor that you do mot know what are you doing.
Practical information: funding in Lithuania and Poland
In the table below, you can find the sources of capitals your can apply to raise the capital for your startup development. Click on the links and get to know the funds you could apply.
|Nextury Ventures (https://nextury.com/)||….|
|Practica Capital (http://practica.vc/)||….|
|Open Circle Capital||….|
|Smart Energy Fund||….|
|Verslo angelų fondas I||…|
Homework: drafting the Pitch DEck
|Problem||Describe in 4 bullet points the problem your startup is solving|
|Solution||List 3 key benefits of your product|
Write the value proposition of your product/service
|Prototype||Provide the visualization of your solution|
|Business Model||Explain your business model – how are you going to earn the money|
|Go-to-market plan||What is the size of the total market?|
What is the size of your target market?
How are you going to reach and acquire the customers?
|Competitive analysis||What are the main competitors in the market? Why / how are you better?|
|Management team||Who are the key people working on the startup? Show their expertise that would prove the startup is able to reach its goals|
|Financial Projections & Key Metrics (traction)||Provide the 3 year forecast of: revenues, costs, number of customers, sales and other key metrics|
|Give the preliminary size of investment you are trying to raise; explain the current status and how you are planning to use the investment in a given timeframe|
Upon completion of this chapter you have learned that every investment leads to the dilution of the company. That is why the co-founders of your startup have to think very carefully and answer key questions before starting the fundraising journey: why and for what do you need these investments. You also got familiar with:
- the available sources of financial capital that can be used in different stages of startup development;
- the expectations of the investors as well as the red flags the investors rise when listening to your pitch deck.
- the pitch deck and how to deliver it in the way to successfully raise the capital.
If you have thoughtfully planned your startup development milesnoes, aligned them with your fundraising efforts and drafted the pitch deck that will be used when talking with the potential investors, you are on the right track to build a successful startup.