The list of to-dos before funding your business is extensive.
The VCs, accelerators and serial entrepreneurs will ask you: “Do you know the problem you’re solving? Do you know your customer? Do you know your total addressable market? Do you know how you’re going to do sales and distribution or your go-to-market strategy? Do you know your pricing strategy? Do you know who your competitors are?”
And yes, all those questions are critical. My specialty is finance and accounting, and I want to help you avoid some serious mistakes I’ve seen in pitch decks. I want to focus on six items you need to nail before you start seeking capital. Everything is interconnected: the numbers, the market, the customer, etc. These mistakes often involve two parts of your pitch conflicting with each other–which doesn’t make you look good.
Today, there’s a wide spectrum of capital out there from venture equity to commercial debt and a lot of funky stuff in between. This list of six tips helps not only for the venture-backed company trying to raise VC money, it is also effective if you’re trying to raise debt from a bank, another capital source, or a hybrid. I think these strategies work across a wide array of capital sources, including elements of equity and debt, mezzanine debt with kickers, or revenue-based loans.
#1: Know Your Unit Economics
When you seek capital, show that you understand your unit economics.
When you are looking for funding, you need to show clear evidence as to why your unit economics are the way they are. Unit economics are easy to understand for a widget, but even if you offer a subscription-based service or something more abstract, you need to know: how much money do you make when you sell one product? How much does it cost to sell one product? What price do you charge, how much does it cost to acquire a customer, and how much money do you make each month or over a period of time? How long do customers typically stay?
The second part of understanding unit economics very well is understanding how it scales as you grow. Your 101st customer is likely going to be more expensive than your 1001st customer in terms of scalability and what you’re adding into. From what I’ve seen, this has to be well thought out and inclusive, very inclusive thinking in terms of your churn, your acquisition, your upgrades, your downgrades. As much as you can put in there, understand your unit economics before you go out and talk to investors.
#2: Align Your Capital Needs and Story with Your Business Story
Sync your business story and financial model before you seek financing.
It may seem obvious that your capital needs and capital story need to be aligned with your business story. But I have seen too many business pitches to investors where the pitch story says something completely different than the financial model that’s presented along with it. I’ve seen a pitch deck say the products will launch in Q2 while their financial model says Q4. Ouch.
In terms of product profitability, in terms of the go-to-market strategy, in terms of when the product is going to be launched—these things need to be aligned. Even how you’re going to acquire your customers in your story must match the spend in operating expense or marketing or sales expense in your financial model. That’s super critical.
Just this week, I looked at a financial plan that had significant growth in sales headcount in 2018, yet the associated revenue growth in 2018 and 2019 from this headcount was paltry. There appeared to be little analysis of sales productivity in the model, a clear disconnect.
#3: Align Your Capital Plan and Milestones
Take an investor mindset: choose milestones that elevate the value of your company.
An entrepreneur once told me, “I’m raising money for 18 months.” I didn’t understand what this meant so I asked. He said, “Well that’s what I heard I should do. Investors don’t want to go longer than 18 months.”
I told him, “No, that’s not the point at all. Investors are trying to gain confidence that their investment will fund the company through the next milestone. They’re trying to say, ‘I’m putting money in your company, a buck, and by the time you’re done with this round of financing, I want the company to increase in value to, let’s say, two bucks. I want you to create value and I want to be sure this money will get you someplace.’”
So many times, I see a capital raise where the use of the capital is not tied to an outcome. “I need a million dollars to make…” what? You need a milestone first: to create such-and-such efficiencies, or to buy and install capital equipment to make production more efficient. If the financial outcome of that takes more than a million dollars or you don’t achieve the milestone with the million dollars you’re asking for, then you’re only part of the way there.
My advice is to show that the capital you are raising will get you through your milestone—and not just to the milestone, but through the milestone and out the other side. Choose a milestone that increases the value of your firm. In some sense, this is the variance between equity and debt, but from an equity standpoint an investor is going to say, “I need to increase the value of my return.” A debt person is asking “How do I get my money back” in terms of risk.
Value increase incentivizes early investors. You need to climb that staircase of value and make your company more valuable. You want to raise it upfront—that’s what they call it. That’s why your capital needs have got to be tied to getting through those milestones.
Don’t stretch it out. It’s got to be a short amount of time in which this is achievable and it’s got to be meaningful. Not just, “Yeah, we’re going to get 100 customers.” That’s not a meaningful milestone. Yes, 100 customers are more valuable than 10, but what are you truly proving out with your business?
A milestone is something much bigger, like: a product release, a product feature set you’re developing towards, setting up a certain seller network, or that you’re going to get your medical device through regulatory approval with this capital. A medical device that’s approved by the FDA and approved in Europe to sell to pan-European countries is a hell of a lot more value to the investor than an unapproved idea.
I’ve got three more pointers for you Part 2.