“I am raising money,” said the entrepreneur.
“How much are you looking to raise?” I asked.
“We are after a very large market opportunity, so I think we’ll need at least three million on this first round,” he said.
“What has the business achieved?” I asked.
“We have almost finished the first version of the product, and we are starting to talk to potential customers,” he answered.
“Sounds to me like you are getting a little ahead of yourself. I am not saying you can’t raise money from a VC. Anything is possible.
“But you will have a better chance of raising money if you know who to talk to given your progress. You’ll then make better use of your time by pitching the most qualified investors.”
All investors have investment criteria. These criteria are generally based upon the business’s stage of development.
The earlier the stage, the higher the risk and the higher the expected return.
The earlier the stage, the higher the investor’s personal involvement.
The earlier the stage, the less money required to reach the next milestone.
Here are the three stages of a business’s life cycle, the investors interested in each stage and their expected investment and return.
Entrepreneur and Angel Investment: For Business Models in Search of Sustainability
The startup’s goal is sustainability. Until the startup can generate the revenue needed to produce positive cash flow, it remains a startup. Once it achieves consistent positive cash flow, it becomes a business.
The entrepreneur, along with his friends and family, should expect to invest in the very early stages of a startup. This includes building the first version of the product and the first few customers. These customers usually pay little if anything to use the product but provide some level of credibility to the entrepreneur’s idea.
Investment: $25 to 100k
Expected Return: Zero to ridiculous
At this point in the startup’s life cycle, the angel investor will step in. This is the investor who believes the team, idea and disparate customers can be made into a sustainable company. The angel is willing to invest his credibility, money and time to work with the entrepreneur and his team to make the startup a market reality.
Angel investors should add significant value at this stage. Even though the startup has a good idea, maybe even a promising product and a good team, it is not a business. It will take a talented and committed team, including the angel investors, to apply all their experience to make it into a business.
Investment: $250k to 1,500k
Expected Return: 10x to 20x
VC Investment: For Business Models Requiring Execution for Growth
This is the sweet-spot for the venture capitalist. The business model is figured out. The business knows what they sell, who they sell to and how to sell the product. The pricing is figured out. They know how to install it and support it profitably.
At this stage, the business needs the capital and the right people to make it grow. These are the resources of the venture capitalist. They have the money and the stable of talented people to build extraordinary value quickly.
VC’s do not want to sit in board meetings whiteboarding how to create a sustainable business. They want to be on a board that is discussing execution strategies for fast growth.
Investment: $3mm to 10mm
Expected Return: 10x to 15x
Private Equity Investment: For Broken or Slow Growth Business Models
If a company doesn’t exit at the right time, they inevitably exhaust their market opportunity. This results in no to slow growth and greatly reduced value. The company is sustainable but is priced at a multiple of earnings, not a multiple of revenue.
This company is attractive to private equity investors. These investors buy the company for three to five times earnings. Their ultimate goal is to increase earnings and sell for the same or higher multiple. They achieve this goal by restructuring the company.
They first cut operating expenses and then sell off non-strategic lines of business to get some of their purchase price back. And finally, they put similar businesses together which increases sales on reduced expenses. This is their operating formula to create increased value. It isn’t pretty, but it is highly profitable.
Investment: $20mm to billions
Expected Return: 2x to 5x (Dependent on deal leverage)
Get Honest with Yourself
Raising money takes the same care as defining your go to market strategy. When going to market, you need to know who will be most interested in buying your product at your price point. When looking for investors, your product is your company’s stock.
Why is your company stock attractive right now? In other words, why would someone want to invest in your company today?
Then, determine who is your best prospect. Determine the best way to connect with them, make your pitch, and then listen to their offer.
Every investor, family, friends, angels, VCs and private equity, has investment criteria. You must meet their investment criteria if you expect to make the sale. The alternative is to pitch blindly hoping to find the needle in the haystack.