4 Best Practices for Raising Capital2 January, 2020
Companies often investigate and pursue funding sources during a transition of ownership, as a way to accelerate product development, to improve their sales process, and for many other reasons that may fuel corporate growth. While it’s a necessary process, finding the right source of funding is also stressful and fraught with uncertainty.
The main reason for the challenge in finding funding is the low probability of receiving it. The chances of getting venture funding are between 0.2 and 0.5%. Only one in three companies make it through to due diligence and one in ten actually receive funding.
1) UNDERSTAND YOUR STAGE IN THE INVESTMENT
It is crucial to select an investor that is best suited to your organization’s transition stage, as noted in the chart below.
|Amount||Risk||Potential Return||Investment Stage|
|Government||Small to Medium||Low to Mid||Medium to High||Any|
|Crowd Funding||Small to Medium||Mid to High||Any||Early|
|Angel Funding||Medium to Large||High||High||Early to Mid|
|Friends & Family||Small||Any||Any||Early|
If you only need a small amount of seed money, possible sources include government funding, crowdfunding or from family and friends. Government funding is often provided in the early stages, for seed or startup funding, and tends to cap at $2 million. Government funds are often given to low-risk organizations likely to have a high return on investment. For early to mid-stage funding, crowdfunding has become increasingly popular and successful, especially after a company has been unsuccessful in gaining funding from other sources.
If your company seeks mid-stage growth funding or later stage bridge funding, angel investors and venture capital are more appropriate, as these investors are more willing to take a risk if the potential return is high.
2) MATCH YOUR NEEDS WITH THE RIGHT VENTURE CAPITAL ORGANIZATION
If your organization strategically selects which venture capital (VC) organizations you send proposals to, you will have a higher likelihood of success. It is important to look for VC organizations with the skills that add value and/or fill a gap in your organization. For example, if you seek to expand into the Asian-Pacific market, you will need a venture capital firm with experience in that market.
You also want to make sure your company and the VC firm have similar investment timelines. If you have a business plan that says you will achieve the highest level of growth in ten years, you wouldn’t select an organization that wants to exit in five years.
It is advisable to reach out to potential investors in your geographic area and industry sector. Not all venture capital organizations invest in companies that market in a different country. You will also appear unprepared if you pitch a solution to a VC for an industry in which they don’t typically invest. Having a strategy for pitching the right venture capital firm will increase your odds of gaining funding.
A fundraising process can take six to twelve months. It is best to plan for more time than you may actually need and to not assume that it will go smoothly from the beginning.
Companies generally receive the highest valuation when they reach out to investors when they are growing and have funds left to execute plans for the future. If you exhaust your resources before looking for additional funding, you will have little negotiation leverage when discussing your organization’s valuation. With spare resources, it will be easier to negotiate an agreement and avoid terms that don’t meet your needs.
Investments are often linked to your ability to grow and meet a potential target. It is therefore important to correctly map your growth targets to the stages that funds will be released. If you don’t get a required investment at the right time, you may not be able to meet the growth target that is needed to release future venture capital funds. Missing growth targets can damage broader investments and affect your ability to raise additional funds in the future.
4) REDUCE THE PERCEIVED RISK
Most investors adjust future cash flows based on perceived risk. If risk is high, the amount of money you will get is much lower. Thus, you want to reduce the perceived risk to minimize the rate of your discounted cash flow.
It may be possible to reduce perceived risk by showing:
- You have a previous track record of growing companies from the ground up.
- You are in financial control and have met your cost projections.
- Other companies in your sector have made money for investors from their products and solutions.
- You have learned from the challenges/pitfalls that other organizations in your sector have had.
- You are trustworthy, perhaps because you have used your network to gain a referral or introduction to the VC you are pitching.
- You understand your industry sector, competitors and market-share capabilities.
In order to become one of the “lucky 3” that make it to the due diligence stage, make sure you have a well-developed business plan that shows your vision for the type of transformation you are pursuing. Tell a compelling story to help investors see why your organization has the potential for a high return. And don't get discouraged by one "no" – successful companies may receive dozens of rejections before finding a willing investor.