Now that we understand the various investment rounds that you will encounter throughout the development of your startup, it's important to have a strategy for how to identify and engage with prospects, as well as a realistic concept of how much to ask from investors.
Before we identify prospective investors, you should implicitly understand the differences between needed, realistic, and ideal investments. You should develop a separate costing outline for each, allowing you to understand what your company needs to launch, survive, grow, and return a profit for you and your investors. It will also provide you with a clearer way to identify needed, realistic, and ideal investors during the negotiation process, leading to a strong valuation of your startup.
Knowing the difference between realistic, needed, and ideal investment levels for your business will help you chart a course through each investment round, informing your negotiation decisions in terms of how much capital you need to develop your startup to different levels within best- to worst-case scenario time frames.
From my experience in raising capital, it is important to understand how much it will take to oversubscribe the round quickly, and whether you have the people whom you can tap for capital. Once you have a clear understanding of who will invest (for certain), then determine a round amount. Normally, when you are oversubscribed, the story becomes more attractive and your round is much easier to sell.
Now that you know what you need, you should focus on the valuation of your startup. This simply refers to how much equity you should give investors in return for their capital.
In essence there are two types of valuation that you will encounter:
Both types of valuation will usually contradict each other. This difference in agreement is where negotiation of terms takes place. In the end, the agreed-upon valuation of your business will depend on the following nine factors:
In essence, your job as a startup founder is to persuade investors that your business is worth a certain amount. The valuation of your startup is a fluid, subjective figure; for that reason, it is best to have a minimum and maximum range in mind rather than a single number. This will give you more room to negotiate.
The best way to show investors that your startup is worth your valuation is to have a well-structured business plan and have as much market research in place as possible, as well as a financial forecast (which I will cover shortly).
You definitely do not want to price your company too high or you will scare people off. You will need to research the market and ask around about valuations that some of your direct or indirect competitors had when they were raising money at your same stage. This type of data will be very useful, and information that you can also leverage during the negotiation process with investors.
If you want to attract investment, then you have to show why your startup is an opportunity that they wouldn't want to miss. To do this you will be required to present some kind of forecast to potential investors.
When it comes to startups it is very difficult to know where you will be in five years. Who would have thought in 2004 that Facebook would be valued at $100 billion in 2012? The forecast is your most effective persuasive tool, but it is also one of the most difficult to compile. Financial forecasts predict where a business will be per quarter, per trading year. (As I've already discussed, your timeline to reach the breakeven point should be concrete when it's included.)
Your forecast should outline the following for investors:
A financial forecast should not be confused with a business plan. It is a carefully constructed projection of company development over a given time period, taking into consideration projected sales data, as well as market and economic indicators.
Normally you would want to include at least three years so that the investor can see the key drivers of your business over the course of time. Some investors may want up to five years, but in my opinion, that's too much.
You will need someone who is very good with numbers to nail the forecast. In my case, I had our CFO very close to me when developing our forecast. Barry Shereck has taken four companies public as a CFO, so I knew I had guidance from the best, and you should take the time to make sure you have the best possible help, too, if forecasting is not your strength.
For potential investors, a strong financial forecast will help with the following five factors:
Your financial forecast is not only a critical tool to attract investment, but it will help you to show more clearly why you value your startup at a specific figure. If you can show reliably that the business should generate healthy revenue, then investors will be more likely to accept less equity in return for the same level of capital investment.
Ultimately your forecast will help the investor see how the money that is being raised will be put to use and the impact it will have on the long-term plans of the company. As I mentioned previously, it is all about speeding up the machine, and the forecast should show how the new money will accelerate things down the line.
In the sales world, we talk about “prospects.” A prospect is an individual or organization that can be considered a prospective buyer; in other words, anyone a business should contact to sell a product to because they are more likely to make a specific purchasing decision than others. Seeking investment is a similar process. Your potential investors should still be considered as prospects.
Not everyone is a potential investor, and it's important that you don't waste your time and resources chasing every single lead. Only a few will be genuine prospects, and it's up to you to decide who is and who isn't. A good potential investor should have the following qualities:
As a founder, you need to use these qualities as a benchmark, and a profile, which will allow you to more readily identify the right investors.
There are great tools available to search for potential prospects, such as Crunchbase, where you search for competitors' profiles and discover who invested in them. And with tools like LinkedIn you can find out who you have in common with specific investors, and connect to make an introduction.
Create an Excel sheet that lets you keep track of every conversation you are in with investors at all points in the process. This way you know when to follow up and how.
Identifying the type of individual who will be a potential investor is only half the battle. It is up to you as a startup entrepreneur to be proactive and search for potential investors who fit your investor profile.
Here are six effective ways to source and contact your prospective investors:
For investors, time is their best friend, and it lets them understand your execution and level of performance. It also reduces, to a certain degree, the risk of their investment if all the boxes are checked.
Unfortunately, for entrepreneurs, time is often their worst enemy. Entrepreneurs need to move very quickly when raising money, because prospects can disappear.
You can keep your business fresh in prospects' minds when time is tight by writing a blog post or sending a newsletter to your community with updates on your fundraising progress.
Now that we've discussed the process of deciding on investment amounts and identifying prospects, we can move on to creating momentum for your startup, and promoting your business as a golden opportunity for investors.