How start-ups can navigate the new venture capital funding landscape
After closing a $40m Series C round earlier this year, Hired CEO Mehul Patel has five pointers for start-up entrepreneurs looking for VC funding
As the temperatures of the world’s economic climate change, so do the rules of start-up funding, and the UK is among the countries affected.
According to a recent KPMG report, venture capital (VC) funding for UK-based start-ups was down for the first half of 2016. There are concerns that this trend may continue in the face of rising interest rates, China’s economic slowdown, and the EU referendum on the prospect of a Brexit.
With this tightening of available venture capital, the landscape of start-up funding and the process for those seeking investment has changed significantly.
Over the last few years, businesses have been getting funded at a furious pace, often times at unwarranted valuations and without much due-diligence on the part of VCs. Today, valuations are coming back to earth and start-ups are being put under the microscope before investors commit to a round.
The rules have changed quickly, and history has shown us that only the best companies survive when capital becomes scarce.
From my experience, here are five ways start-ups looking for VC funding can set themselves up for success:
1. Give yourself plenty of runway
Most entrepreneurs know that it’s a bad idea to wait to start the fundraising process until you’re actually in need of funds, but this holds true even more so in today’s economy.
Not only should you begin conversations with investors long before cash flow runs low, but fundraising needs to be considered an integral part of any CEO’s role.
While the next funding round might not be on the agenda for the foreseeable future, ongoing discussions with investors will strengthen relationships, and even uncover potential red flags within the business. If your business doesn’t have recurring revenue or is spending cash faster than it is earning, it’s always best to find out and fix it before it’s too late.
An effective timescale is to begin actively planning the next round’s planning process four to six months in advance.
2. Make profitability a priority
One of the most striking features of the recent change in the funding environment is the shift from a borderline obsession with growth to a growing focus on profitability. VCs today are less likely to be wowed by your growth trajectory if it’s not clear when your company will be in the black, so anyone looking for funding should be prepared to address this issue in detail.
The best way to approach such a discussion is to get out in front of it before the question can be asked. Have the information front and centre in your presentation and address potential objections proactively.
Explain exactly how much cash it will take to get there, walk through the unit economics, and explain how your business will overcome risks and potential setbacks.
3. Start broad with your potential investor pool
The days of meeting with four VC firms and then closing a deal are long gone.
You need to start broad, create a long investor list and host many meetings to find the right partner. That being said, it’s important not to sacrifice what you’re looking for just because times are tough.
VC partnerships last on average seven to 10 years, so having confidence in your choice of investor is paramount. Too many start-ups jump at the possibility of a big-name firm on their board, ultimately sacrificing clean terms or the ability to work with a partner who really understands their business.
4. Create a narrative with your investor deck
Already this year, the UK has seen the launch of more than 200,000 start-ups. This increase in start-ups, combined with a tighter funding climate, means that you need to have a well thought-out story to tell about your business and its future.
Central to this is understanding what it’s like to sit on the other side of the table, anticipating potential concerns from investors, and proactively addressing them accordingly. Half the battle is identifying potential red flags and explaining how your organisation will overcome it before a VC has to ask.
If your start-up is new to fundraising then you should find mentors or advisors who have raised investment before and can coach you through the process – helping to tell your story in a way that will resonate with investors.
Even better, if your business already has investors from previous rounds, they should be used as a dress rehearsal, gaining as much candid feedback as possible in preparation.
5. Be flexible on valuation
Today, more often than not, entrepreneurs go into the fundraising process gunning for a specific – and often overly ambitious – valuation regardless of whether or not the business actually warrants it.
What many business owners don’t realise is that a high valuation can come with a high cost in the form of difficult board dynamics, capital strategy and team morale. When a valuation is put ahead of everything else, start-ups are likely to sacrifice clean terms and expose themselves to the possibility of a down-round if the company can’t meet high expectations.
In today’s fundraising climate, valuations are falling and you need to be realistic about your start-up’s worth. A good rule of thumb is to take a look at public market comparables to determine an appropriate valuation for your business.
Fundraising is a stressful process at the best of times. In the current environment, it’s particularly challenging.
However, it also represents an opportunity for great companies to stand out from the crowd as the bar for VC funding continuously moves higher. I’m excited to see what kind of winners emerge this time around…