I can’t tell you how many emails, WhatsApps, DMs, etc. I get asking for advice on how to raise funding. Over 90% of the requests lack a basic understanding of how to raise funding for your start-up.
Here is a simple and high-level thread on what you need to know.
Not all investors (funders) are the same. You have to understand that most individual investors that “take a punt” on businesses are very different from institutional investors that have a fund mandate.
So first understand the nature of the investor you are approaching.
The individual investors typically invest as angel investors very early in the funding lifecycle for a business.
Angel investors are very important because they typically force the entrepreneur to think about professionalizing their capital raises.
For most angel investors, a simple & clean cap table is very important.
What is important for most angels is a forecast of how investment rounds affect dilution, ownership, valuation & distribution of proceeds to the founder & investors through a detailed exit waterfall.
See, as you are reading this you should be pulling out key lingo. Understand the key phrases and terms like:
c. distribution of proceeds;
d. exit waterfall;
Note them down, and call Aunty Google. It’s hard to raise start-up funding from serious investors unless you can fluently speak the language investors. One more thing friends, everything I know I learned.
Don’t be discouraged or put-off by the language. Just take a deep breath & remember that remaining teachable is a very important part of the growth mindset.
There are several online resources that you can use to learn how to build cap tables. THIS IS CRITICAL.
You don’t have to know how to do it, but you must be able to read & understand it.
So, if you are raising you to have to consider questions like:
1. Do we have a shareholders agreement?
2. What is the value of my business based on?
3. How many shares am I willing to offer?
4. Do I have a tiered shareholding structure?
5. Can the business take-on debt?
The most contentious issue for non-listed assets has to be valuations.
Typically, the management or the founder feels that the business is worth more than the market is willing to pay.
This is the sentimental premium attached to the business.
The founder will tell you about the toil, lack of sleep, personal financial sacrifices, near-death experiences, broken relationships, and even abandoned pets to make you see the value of the business through their eyes.
But the investor is only concerned with making a justifiable investment case based on a sound investment thesis.
The valuation can not be overcooked at entry. This will make it much harder to extract the upside value in the business … unless it is TRULY exponential, and those businesses are few and very far between.
Few read the center-pieces in an article so if you are reading this you must be paying attention.
Here is a treat: https://captable.io
Follow the link to a FREE platform to help you build your own cap table.
The most commonly used for start-up valuation methods are:
1. Discounted Cash Flows ( you did those in 1st year Comp Maths remember?);
2. Net Asset Value;
3. Earnings multiplier;
4. 5x Your Raise ( I hate this one);
5. Comparison Method;
The first three are the easiest to understand. Lots of literature out there for founders to learn about how they work, how the models are built, & how they inform an investment decision.
Over the years, I have seen the “5x Your Raise” method come across my table a few times.
This model is basically the VCs looking to protect themselves by ensuring that they enjoy minority protection rights in the business.
So they take the amount that you are asking from them & assume it to be for a minimum 20% stake in the business. Voila, minimum EV.
The Comparison method is based on studying the most recent valuations of a similar start-up with similar fundamentals & a similar TAM and then mathematically extrapolating a number from that. TAM is the total addressable market.
You do it every day at your Pick n Pay.
- Pick one item.
- Make a judgment.
We have used the Comparison method too.
But there are some things you cannot input into a valuation model:
1. the quality of the management or founder team;
2. the relationships that they enjoy;
3. decent board;
4. ability to access markets;
5. probability of future cap raises;
Point: valuations are not perfect. We have found a mix of various methods to be the best way of arriving at a sound number. What’s worse is when the deal is syndicated & the different investors around the table disagree on value.
Jeez! I could write a book.
So. Its easy. Learn about the investors you are approaching. Understand & be able to justify why you need the runway. Build & defend a strong cap table.
Bonus Tip: this will get me into trouble with my peers.
GET A KICK-ASS DECK. Investors like to act like the PowerPoint presentation doesn’t matter. Almost as if the first impressions of the business don’t sway the energy they commit to the business. Believe me. It does.
So invest in a kick-ass deck and thank me later.
Now back to your regular scheduled program.