‘Mutually favourable’ might sound like the obvious choice when negotiating terms for venture capital to fund a startup’s growing success – and it can be done!
However, it’s all too common for the negotiated terms to be unfavourable to one side or the other – even when everyone has the best of intentions.
Startup Founders Need to Ask – What’s In It For You?
Well-managed venture capital funding can take a deserving startup from early success and skyrocket it towards that coveted unicorn position – but it’s never a guarantee and success is always an uphill struggle!
Not only do startup founders need to work tirelessly to make their vision a reality, but they also need to work with their investors in order to secure the funding and support required to keep everything moving in the right direction.
Everyone who participates in the early stages of a startup wants to see it succeed – whether it’s just for the bragging rights or to protect their investment.
Sharing in a startup’s success can create an awe-inspiring payout. However, it’s never a sure thing and the statistics are truly concerning.
In fact, 90% of startups fail – but finding support and sharing the shoulders of giants in your industry can be the key to helping founders secure themselves a position in the coveted top 10%!
Friends and Family, Angels, Private Equity, and other early participants all wish to provide support that can help a startup succeed, but creating mutually favourable terms for VC funding is always a balancing act.
Founders need to consider deeply the value of support and what is a fair exchange for it – particularly when it comes to securing the right amount of startup funding.
So Why Settle On Funding?
Without a doubt, venture capital funding is often a highly-desired and inherent aspect to the overall success of a startup.
However, it is not the only choice for provide financing and there are many risks and benefits that need to be considered before any founder makes the incredibly important decision of entering into a funding agreement with anyone.
There are essentially two sides of the coin that need to be fully understood by all parties involved:
- Venture Capital Investors
- Startup Founders
Each side has competing interests as well as unified objectives – but it takes understanding and negotiation to find mutually favourable terms that support the actual success of a startup.
Venture Capital Investors are understandably reluctant to take on the risk without a clear projection on how they can protect their investment in a startup. They can only make a limited number of commitments, which means they constantly need to evaluate and choose between potential candidates that may all look very promising. Many VC investors seek out terms that are very favourable for them in order to sway their decision on where they invest their money – typically this means a sizable portion of the pie.
Startup Founders can be reluctant to hand over ownership. Every founder has poured hours of dedication, time, and their own money to give life to an idea and it can often be difficult to imagine giving up even a sliver of their work in exchange for funding. While funding is typically desired, there is a widespread belief that giving up equity is the best way to get venture capital. While it may be the most common way, too often the terms negotiated are less than favourable for the founders. This can cause hesitation in many founders who are attempting to balance the need for funding with their desire to retain equity in their startup.
The balance between startup founders who need funding (but want to retain equity!) with investors who want to provide funding (but get their share of the pie!) is negotiated and boiled down into a document that is referred to as a terms sheet.
If this is the first time you have heard of a terms sheet – here is a resource that provides a great example of a term sheet template that might be used to outline the terms by which an investor would commit funding to your startup.
We will explore the technical side of securing startup funding more below, but first a word of inspiration!
Founders: Make the Dream Count!
Below, we outline everything you need to know to secure venture capital funding on favourable terms. Your success depends on so many factors within and outside your control. Make sure that everything you’ve built with all that time, effort and money receives the best recognition possible.
Investors: Make the Startup Magic Happen!
Make sure the Startup Founders that you’re dealing with have prepared themselves (preferably, as outlined in this guide) for a better chance of success. Your success as an investor is measured by the success of the startups that receive your venture capital funding.
Experts and Supporters: Make Their Efforts More Rewarding!
Often the unsung heroes of the startup ecosystem are the professionals, subject matter experts, consultants, service providers and organizations who nurture developing Startups. Helping a startup to negotiate favourable terms and find success with venture capital depends on the valuable support you share.
Everyone: Make Your Contributions Count!
When Founders are properly prepared, with the assistance of startup supporters, to seek Venture Capital from Investors on mutually favourable terms, it can be a magical combination!
Count on it to win!
If you’d like some additional inspirational and insightful reading – be sure to check out The Innovation Superhighway by Debra M. Amidon.
Startup Funding – The Most Important Business Decision A Founder Will Ever Make (and Make Again)
If your startup does grow into the hundred-million-dollar business that you believe it to be, VC negotiations and funding agreements could become the most important business decision that you ever make.
You may have heard that bootstrapping is the way to grow your business, and while this is very smart for some companies, it is absolutely the wrong move for others.
When you are growing a business you need to recognize all of the options that you have before you make any decisions!
Do you build your startup by yourself?
Do you partner with someone?
Do you sacrifice equity for investment?
There are so many answers to questions like these, but making the right decision can take your idea from the drawing board to profound success.
Of course, making the right decision is much easier said than done.
Founders are constantly balancing the challenges of entrepreneurship and it’s not possible to be the expert on everything.
This is why it is so important to look towards mentors and supporters to help you find the right choice. They can be there to share their experience and knowledge in ways that are incredibly valuable to any young startup.
Sharing the Shoulders of Giants, we can see so much farther than standing alone. Let’s work together to avoid the pitfalls that undermine so many entrepreneurial journeys and startup ventures.
What Makes A Startup Attractive To Venture Capitalist Investors
If you have decided that securing startup funding is the right choice for your company – then the first step is to understand what makes a startup appealing to venture capitalist.
Venture capitalists are always analyzing risk vs reward.
The risk of investing in any new business is high, so if your business wants to attract funding than you clearly need to propose a high-reward and low-risk business plan to anyone involved in a potential investment deal.
This is simple economics when speaking to any venture capital investor – but it doesn’t amount to everything.
Beyond a strong demonstration of tantalizing reward and reasonable risk – VC investors typically look at four strong indicators for a potential investment project:
- A Big Idea
- Huge Potential For Profit
- A Passionate Business Owner
- Realistic Predictions For Growth
Mix these aspects with strong relationships for your recipe to successful funding!
Does Your Startup Have A “Big Idea”?
Investors are typically after big ideas!
VCs want to put their money into the types of projects that could change the world. Not only does a project with an innovative idea present awesome potential for profit – it is also something that people are proud to have participated in the creation of it.
The world is changing quickly and there is a lot of room for innovation with the emergence of new technologies, philosophies, and pressing global challenges that need solutions.
Ideas that make a big impact and drive sustainable innovation will always be more appealing to those looking to invest.
Is There Potential For Profit In Your Startup?
There isn’t really much secret that all investors are looking to find a good return on their investment.
It’s the basic premise of venture capitalism and investing of all types. Investors want to put their money into a project that demonstrates good potential for profit.
Even impact investors who are concerned with driving social and environmental benefits, still want to find a financial return on every dollar that they spend.
Founders need to clearly demonstrate that their idea and business will successful turn profit if they ever want to remain appealing to VCs.
Are You A Passionate Startup Founder?
It’s not just great ideas and profits that VCs seek – it’s also great people.
VCs want to invest in a team that has the drive and determination to back up their brilliant idea. Founders need to demonstrate their passion so that their investors are just as excited about their startup as everyone else involved.
“Yes, you need to appear professional if you are going to be starting a serious business, but you need to show some passion and enthusiasm. Start-ups are hard, and they take a long time, and you will need to show that you have the inner drive to get through the highs and lows.”
Are Your Predictions For Growth Realistic?
It can be easy to get carried-away when making predictions on the future growth of a company.
It can also be easy to over-promise or make inflated claims in the hopes of attracting investment.
However, a solid business plan is always rooted in reality and professional investors are very capable of identifying accurate representations of a company’s growth. Projections of future profit that are either made up or artificially inflated in order to hook an investor’s interest is the best way to kill a deal.
If you want to be appealing to VCs – then you need to demonstrate real numbers that investors can trust. This mean clearly communicating a path to success with realistic predictions that mirror industry standards.
When Is The Right Time To Seek Venture Capital Funding?
With an understanding of what makes a startup appealing to VC investors – the next question that a founder should consider is when is the right time to seek funding for their startup?
Is it too early to prove potential success?
Is it too late to find investors still willing to get on board?
Is it the right funding choice for your startup?
The purpose of venture capital is to grow your startup faster and larger than possible by any other means. The post-money valuation of your business needs to be significantly higher than the pre-money valuation otherwise why would you accept the dilution that happens to you and your earlier investors?
Pause and take a deep breath…
Ask yourself – is your startup successful enough yet?
Many founders are too eager to fund their business growth through venture capital and willingly accept the resulting dilution.
To see if you are truly ready for VC funding – feel free to Reach Out to Paul Erb Consulting and discuss the right path for you!
My Startup Is Prepared For Funding – What’s The Next Step?
If you have developed your startup to the point of demonstrated success and you are prepared to take the next step – then it’s a great time to start seeking venture capital funding about nine months (or even more) before you might need it.
Although this timeline can vary depending on the startup and its needs – the general rule of thumb is if you are prepared for funding then you need to seek it in anticipation of actually requiring it.
If you are ready to take a leap into seeking startup investment, then broadly your next steps will be:
- Prepare Your Business Plan and Pitch Presentation
- Find Potential Investors
- Pitch Investors Effectively
- Negotiate A Deal With Interested Parties
We will walk through each of those steps below – but first let’s look at a few alternatives that you might not have considered yet!
But Wait! Venture Capital Investment Is Just One Option…
Before you go looking for those Venture Capitalists to invest in your Startup, how do you know that’s the type of investor you want and are ready for?
There are many businesses that have made it to the big-time without venture capital funding, and there’s no why reason why your business can’t be the next one.
Here is a list of alternative types of funding that any startup founder should consider before seeking VC funding:
- Personal and business loans
- Friends and family equity rounds
- Angel investors
- Startup ecosystem resources, funding and awards
- Equity for expertise
- Licensing agreements
- Initial coin offerings (ICOs)
- Creative business funding
It’s often well worthwhile to build a solid startup foundation using other funding sources before turning to those Venture Capitalists. This will help ensure that your startup has reached the level of success that is necessary to appeal to the pockets of venture capitalists. It will also help founders make sure that they have a solid understanding of what their business needs to succeed.
You might especially like what’s possible with creative business funding – feel free to Reach Out to Paul Erb Consulting and discuss the right path for you!
Smart Money – An Important Benefit Of VC Funding For Startups
Although these alternatives should always be considered – it’s critical to understand that venture capital investment often comes with more than just the money. In fact, most startup investors are very business savvy and understand the challenges you face and what you’ll need most to overcome those challenges.
Access to their expertise and their network can be invaluable!
This type of investment is known as smart money. It is typically related to acquiring funding from investors who can provide guidance and insight to a business in addition to their financial investment.
Smart money may sound like a dream come true if you’re new to the business world. However, it could bring its own set of hurdles.
For starters, the need to be on the same page as far as the future direction of the company is even more essential. Your personal relationship with the investor will also need to be considered.
Is this the sort of person you want calling the shots at board meetings?
Do you want a weekly call from this person?
Do they have the experience and knowledge to successfully guide your business?
Is it worth sacrificing equity in exchange for their control?
Can you find mentorship support for your startup without investment?
These are important considerations that all founders need to balance when seeking out investment for their startup on mutually favourable terms for everyone involved.
Venture Capital Funding Is The Right Choice For My Startup – What’s The Next Step?
If you have carefully weighed all of your options, listened carefully to advisors and mentors, and have concluded that VC funding is the best choice for your startup – the next steps are to:
- Prepare Your Pitch
- Find Potential Investors
- Pitch Investors Effectively
- Negotiate A Deal With Interested Parties
How To Prepare For Investment Pitching
Before you do any pitching – you need to have a solid presentation of your business, how it works, and how it will succeed.
You will also need to have a solid understanding of exactly how much funding you need to reach the next level for your startup.
It’s perhaps even more important to know how much you’ll be looking for than how you’ll use it. Just like banks offering business loans, investors are looking for a profitable relationship and would prefer to understand the business journey you are on and your track record.
Start by showing what you’re accomplishing and how you’re putting appropriate guidance to use, it’ll help in forming a trustworthy relationship together.
In order to successfully secure startup funding – you will need to ensure that:
- You have a complete understanding of your business and industry
- You have the ability to clearly communicate the essential elements of the business
- You can demonstrate success and predict future growth
Typically, expressing this to investors is achieved through progressively more revealing material:
- Elevator Pitch
- Pitch Deck
- Business Plan
The Elevator Pitch – One Sentence That Means Everything
The Elevator Pitch is a short, concise introduction that is used to clearly and quickly convey the major pain-point and your incredible solution for it.
If you can’t express your business concept in one simple introduction – then it might suggest that you don’t fully understand the complexities of your idea.
Having your elevator pitch at-the-ready is important because you never know when you’ll meet a prospective investor or supporter for your startup. If you can’t express the essence of your business with clarity to everyone that you meet, then you might be missing out on opportunities to share your amazing idea with the right person.
The Pitch Deck – A Key Funding Communication Tool
The Pitch Deck is perhaps the most the important document of your pitching journey. It is a primary communication tool that will aid you in your appeal to potential investors.
It should be simple, yet highly effective at conveying the complexities of your business and its potential for success with direct appeal to a potential investor.
There is no “right-way” to create a pitch deck – but there are many great resources that can help point startup founders in the right direction.
Here is a useful example that might help those of you in the Toronto area.
It might be tempting to include lots of details and important information, but clarity and simplicity are always best. Draw the investors attention to what’s most important on each slide, remember that less is more and a well-chosen picture is worth 1000 words!
What To Do After You’ve Secured the Venture Capital Funding
Once you secure funding for your startup – this is by no means the end of the relationship.
It’s a relationship that could last for decades if you are successful with your business.
Don’t mess it up!
When someone invests in your business – they are also investing their trust and confidence in you as a business owner. This is the value inherent in a healthy relationship and every step forward must be taken with care and consideration for all the parties involved.
If you fail to follow through on your commitments for the funding, it is unlikely that you will secure funding with them again (nor with other VCs they know).
This is an exciting time and it can be easy to get carried away.
However, it’s critical that you don’t get too caught up in the excitement of a sudden windfall. After you have secured venture capital, do NOT spend it.
Often funding is provided in tranches that can potentially cause cash flow issues; however, even if the VC has given you a lump sum, treat it as though it were paid in tranches by placing it and manage expenses in line with the growth program targets for your startup, it’s a far less risky way to utilize your capital.
To summarize, remember that even more important than the money you just received is the relationship that you are continuing to build.
There is always the potential for future funding when you foster your relationship with your VCs, and blowing all your money is not the way to do that. VCs are there to support you in your activities to scale the business. They are equipped with resources, contacts, channels, and ideas that you want to pay close attention to and respectfully listen to.
Make sure you use this authoritative guide to startup funding as a competitive advantage so your startup will grow faster and more successfully than all your competitors – Reach Out to Paul Erb Consulting on LinkedIn and let us know about your ongoing success!