Every growing business needs an influx of capital to scale up. In this session with Michael Kindrat-Pratt, Managing Director at Rev1 Ventures, will walk through everything you need to know before raising money. This webinar is for companies who are new to raising institutional funding or who want to better plan for their next raise. This session will guide you through a practical approach to creating a capital access plan and covering the fundraising process’s critical elements.
About the speaker
Mike manages our State Auto Labs Fund, a $25mm corporate venture capital fund that invests nationally in the insurtech vertical. He works closely with the State Auto Labs team on due diligence, valuation, investment terms, closing, and portfolio management. Mike has 10 years of early-stage investment experience, investing in 50 portfolio companies over that period via venture capital funds and angel funds. Mike holds a BS with concentrations in finance and accounting from Boston College’s Carroll School of Management.
Well, good morning everybody, thank you for joining us today to talk about Raising Venture Capital. As Matt mentioned, my name is Michael Kindrat-Pratt. I think this is my second time doing a presentation to Cultivate. I think the first time I was down in the Grove City location was to do a presentation on business plans, probably around a year and a half ago and I gotta say, it is a lot more fun being in person and getting to see everybody and being in the same room with everyone, but we’ll still try to make this an informative and interactive session today. And who knows, maybe we can see the light at the end of the tunnel where we could all be in person again here. Hopefully in the near future because I would really enjoy that.
So, Matt mentioned that I’m over here at Rev1 Ventures. And for those of you who don’t know Rev1, we’re a startup studio located in Columbus and we work with entrepreneurs all over Central Ohio that are trying to get their business to start up. And so we work with partners like Cultivate very frequently and we try to pair entrepreneurs with advisors up at Rev1 that can bring them through the process of getting their business up and running, connecting them with service providers here in Columbus like lawyers, accountants, and bookkeepers, and development shops. And we also, on the other side of our business, manage about a hundred million dollars in capital that we make direct investments in startups through the concept, through early stages of their business.
So that’s the side of the world that I sit on at Rev1. I have been on our investment team going on for seven years now. Specifically, my role is that I manage our State Auto Labs fund which is a fund that we manage in partnership with State Auto Insurance Companies here in town and it is an insurtech fund that invests in insurtech companies across the country. So I spend most of my days meeting with and learning about new businesses, and listening to pitches, and working companies to our diligence process, and trying to close on investments, and manage the portfolio they’re after. So I’ve been doing early stage investments for about 10 years now and prior to that, started my career in the investment banking industry in the homebuilding sector.
So thank you for having me here today, excited to speak with you. As Matt mentioned, if you have any questions, please feel free to throw them in the chat and we’ll try to address them as we work through the presentation and if we don’t get to them, we can tag on to them at the end.
So the outcome today, we’re talking about venture capital, right? And we wanna focus on two things primarily today. The first is: What are the things that you really should know about? What do you need to know? What do you need to understand? How do you prepare yourself for entering the realm of trying to raise venture capital? And then the second thing is, we wanna talk about and dress some rules of thumb before startups raising capital in the Midwest, right. The track or the road to raising capital in the Midwest is a little bit different from what it’s like when you’re out in San Francisco or Boston, and so we wanna talk about some of those things here today as well. So those are the two things we’re really gonna try to target as our discussion points here today.
FACTS ABOUT VENTURE CAPITAL
Not for Every Company
So we’re gonna start with some basic facts about venture capital. And the first one that I think is really important to mention is that venture capital is not for every company. Some of you may have heard this quote from an investor – his name’s Josh Kopelman, he’s the founder of First Round Capital – and he says, motorcycles are common, jet planes are rare. VC’s sell jet fuel – which doesn’t work on motorcycles – Bad stuff happens if VCs push jet fuel on a bike owner or if a bike owner thinks that they can fly. So it’s okay to build a business and not raise venture – I think that’s point number one.
Not Everyone Raises VC
There are so many successful businesses that generate a ton of profit and are very good businesses for their founders that never touched venture capital, and that’s okay because in reality, there’s only a very small fraction of companies (less than 1% of all businesses) that ever raised venture capital. However, if you’re a technology company and you have designs of growing very quickly and scaling very quickly and becoming a large business, many of the companies that have successfully go on that route have access to venture capital and it can be a very powerful tool in your arsenal as a founder if you are able to access venture capital and it is the right fit for your business.
VC Firm Investments
Also, VCs don’t only just invest in software. Different venture firms all have different target markets and target sectors and industries that they invest in and so these all just comes down to doing diligence on the venture firm that you’re speaking to specifically because there are venture firms that invest in consumer packaged goods, there are venture firms that invest in media businesses, there are hardtech companies – so if you have a physical good that you’re producing, there are VCs that invest in that – agricultural technology, food and beverage, life sciences. Those are all, really, key themes in the venture industry that there are tons of venture capital groups that invest across these. So you don’t necessarily have to be a software or software business in order to access venture.
VC is a Commitment
And then the last piece just as a pry on the venture is that if you do decide to go this route, it is a commitment. It is a commitment on behalf of the venture funds that you raise from and it’s also a very important commitment from the business. Once you take institutional venture capital dollars into your business, you’re really committing your company to a certain path – and we’ll talk about what that path looks like in a little bit but – you’re fundamentally changing the trajectory of your business in a couple of different ways once you accept capital from an institutional investor. And I think, personally, I’m unbiased just ‘cause I’m in the industry, I think that in a lot of ways that change is a very positive change and can promote a lot of growth within your business. But it’s certainly something that you want to pay attention to and understand and make sure you’re ready for that commitment before you go down this road.
INSTITUTIONAL VENTURE AND INVESTMENTS
So how do you figure out if the institutional venture is the right path for you? So I wanna talk about a couple of facts of what it’s like accepting venture capital and raising VC and what kinds of companies typically fit into this pie.
5-10 Year Commitment
So the first thing, and I mentioned a little bit on the last slide, is that you’re really getting into a commitment. When you accept venture or when you raise venture, you’re really entering yourself into most likely a 5 to 10 year commitment and to be honest, it can be longer than that. Why is it a 5 to 10 year commitment? Well, this really ties back to the economics and the life of a venture fund and how they typically work. So if you look at a standard venture fund, usually it takes about a year or two for the partners to go out and raise that fund and then once they raise it, they’re locked into a specific timeframe, usually it’s a 10-year time frame, when they promise to their limited partners (the investors in the fund) that they’re gonna go out, invest all the capital, and within that 10 years, they’re gonna generate the full return for their fund. So what that usually looks like is the first 1-3 years of the fund’s life, they’re making their first time investments. Then kinda years 2 to 5, they’re making follow-on investments in the initial companies. Then years 5-10, they’re harvesting the portfolio, and they’re getting exits in the portfolio as well. So in reality, funds typically run 12-16 years before they’re able to liquidate but when VCs are looking for potential investments, they’re really thinking on this 10-year horizon of: “How can I deploy all the capital in my fund and generate exits before that 10-year period is up.” And that’s one reason why, if you do pursue venture and you’re starting to talk to VCs, an important question to ask and understand is where they are in their fund’s cycle? Because if a venture fund is in year 7 and they’re thinking about making an investment in you, that means the timeline for their expectations for you to exit is very different from a fund that is in its first or second year or making its initial investments. So just something to keep in mind.
Strive for an Exit
Venture investors are also really heavily dependent, as I noted, in investing in companies that are going to exit. So again, a venture investor typically is not going to invest in a business that’s just going to grow slowly and breakeven over 20 years. And again, there’s nothing that’s bad about a business like that, it’s just not a fit in the model, because if a business isn’t going to exit, then it does not fit the life cycle of a fund that I just went through.
Growth, Scalability, and Long-Term Capital Gain
Because of that accelerated cycle – that 10-year cycle – there is a need for accelerated growth with businesses. When you talk to venture capitalists, typically at the seed, the early stage, you are really looking to have- they want their companies to be able to double or triple their revenue and growth every single year, year over year. The thing that they’re looking for there is scale and growth, and they want you to build an infrastructure that allows you to continue to grow without needing to add costs in line with that growth. So that really goes to the point of scalability, right? This is where you’ll hear sort of services firms vs. technology firms and the scalability behind that. Investors want to invest in companies that are scalable. There is a component of this that- you know, we talked about commitment and really making sure that you’re right for the venture.
Willing to Share the Pie
When you raise venture, obviously, you are selling a portion of your company to that investor and perhaps you and a partner or you, individually, own a 100% of your business before you raised money or you own 50% alongside your partner, when you raise venture, you’re selling acuity in that business. And again, my personal opinion is that this can have really positive results and there are a lot of very positive impacts that a good venture investor can make on the company that should be helpful as an entrepreneur. They help a lot with strategy of the business, they should be a sounding board for you as you continue to grow and build the business. They can help, oftentimes, with connections, those can be connections to potential customers. In many cases, they will offer connections to future sources of capital because the investor that raised from day 1 isn’t going to be, most likely, the only investor that funds your company throughout the life of your business. So they can help with connections to other capital sources. They really help with governance and in a lot of cases, they will take a board seat on your board of directors. They can help make sure that the business has proper governance and that it’s going through its decision-making appropriately. And so, those are kind of, three things just off the top of the head are really important to a fund as they think about sharing a pie.
Large Market Opportunities
And then lastly, as a company, you really- if you’re pursuing venture capital, you wanna make sure that you are targeting a really large market. And the reason behind this is because a venture capital fund is looking to make substantial returns. They want to invest in a company when it is worth 5 million dollars or 10 million dollars or 20 million dollars and they want that company to grow to, potentially, have a billion-dollar outcome on their investment. You can’t grow a company to be worth a billion dollars, most of the time, if you’re targeting a market that’s only 50 million dollars large. So it’s hard to target a niche market and really be in line to raise venture capital because it’s not going to meet those objectives for the VC. And I do wanna mention that it’s okay for you to start in a small niche of a larger market – we really like that strategy, that’s called the wedge. So you know, if the first, sort of, serviceable, obtainable market you’re going after is a hundred-million-dollar market but once you, sort of, tackle that, it opens you up to a 500-million dollar market or a billion-dollar market, then that is a perfectly fine strategy, but you just wanna make sure that there is that broader market that you can eventually tackle after your first strategy plays out.
Michael: Matt, I saw a couple things in the chat, are there any questions that we need to address yet?
Matt: I think we’re good so far.
Michael: Okay, great! Thanks.
So, let’s talk a little bit about venture capital expectations. So, what are VCs looking to get out of this partnership that you are working on with them?
Seed Funds & Angels
So Seed Funds and Angels, are looking to get a 10 – 20x return on their capital – that’s cash on cash return. So, if I invest 10 dollars in your company, at the end of the day, I’m really looking to get a hundred or two hundred dollars out of that investment and I’m trying to get that in somewhere between a 7-10 year timeframe. And that really triangulates down to valuations and how your company will be valued based on these returns. If you think about exit types, a 50 million to a 100 million dollar exit could potentially be a very big win for a fund our size. So Rev1, we got about a hundred million dollars in capital under management, a 50-100 million dollar exit would be a really nice win for us. But, if you’re managing a 500 million dollar fund or a billion-dollar fund, think about what exit size a company would need to achieve in order for that to matter to get a return for that investor.
So, that’s why as you’re thinking about the funds you’d like to target for your venture raise, think about the stage that you’re at. It’s unlikely that a 500 million dollar fund or a billion-dollar fund is going to be able to write a 200 thousand dollar check into your business. And it has nothing to do with your business itself, it just has to do with the fact that in order to really make a return on those larger funds, they need to be deploying a ton of capital every time they decide to write a check. So, particularly, when you get into the early stages of investment, you’ll talk to a lot of funds that say: “Look, we need a minimum allotment of 10 million dollars or 20 million dollars to be able to put into this round for it to move the needle for our fund and our investment.
And then, investors often invest across multiple rounds of financing over time. The nice thing about getting an investor in early is you have an opportunity for them to continue to invest in the business in your later rounds. Typically, investors won’t just cut a single check and stay out, oftentimes, you’re granting them a right to continue to participate in future rounds at their existing ownership level. So the nice thing is, as you get an investor once if you’re hitting your milestones, you’re doing well, there’s a high likelihood that they will continue to invest in the company moving forward.
Exits and Exit Strategies
Exit strategies are very important. Even when we’re looking at a concept stage company – a very early stage company – we still want to know that that team has thought through what the eventual exit will be for their business and who are the potential purchasers of this company down the road. It might be 5 to 10 years away, but we need to start thinking about these things from the onset in order for the strategy to start taking shape.
Board Creation and Financial Reporting
And then the other big piece around expectations is, when it’s just you running your business or it’s you and another partner, perhaps, you don’t have a form of the board set up at your company, and governance is kind of easy and simple because it’s just you and one other person that you need to make decisions when a venture fund will come in, it is almost certain that they will require the creation of a board to whom the CEO reports. And that means changes in a way that you need to monitor and report on your business because your venture investors are going to want to know how things are going. And in some cases, they’re going to want to be involved in decision-making across some important decisions too. So, just to give you an idea of how governance works, when Rev1 invests in a company, our default at the earlier stages is to have a monthly board meeting. It’s not that you need to spend a ton of time creating a beautiful deck every single month but these board meetings should really be of value to you. It gives you access to a sounding board, you can ask for help, and it really positions your company to raise funding and to have a highly functioning board dynamic, because future investors are gonna wanna know about your board. Things that you’ll be covering at board meetings are your actual operating results vs. your budget, what is your runway – that is a really important piece – how many months of runway do you have before cash runs out, any hiring plans that you have in motion, any development plans, kind of sales pipelines, any opportunities and risks you see in the market, and really getting around this cash runway piece is, you’ll find that you’re always planning for what the next raise is, right? ‘Cause if you raise capital, you’re likely burning in your early years. When do we need to raise capital again, how much do we need to raise, and who are our targeted investors.
So those are some of the expectations that you might expect when you go and raise a venture round.
COMPANY CAPITAL POOL
So, fundraising is hard, newsflash, right? It can especially be difficult in the midwest. So, this Venn diagram on the right-hand side, kind of all the fundable companies that are raising the same amount of money as you. And then on the left-hand side is sort of the venture capital appetite, right? So the biggest circle there is all the venture funds that have some kind of capital to deploy. And then the slightly smaller circle there are the venture capital funds that invest in your stage and in your sector – so we talked about, sort of, scoping the industry. And then the other sector is VCs investing in the midwest, right? Which is an even smaller pool here. And then the overlap there, where the green circle and the purple circle interact, that is sort of the pool of capital that is available to your company after you work through those different scenarios.
I think one thing that’s really important if you do choose to pursue a venture is to treat your investors like how you would treat your sales pipeline. You wanna cast a wide funnel at the top and you wanna start qualifying which investors are most likely to actually invest in my business and that can be anything from stage to industry, to geography. You wanna try and qualify that as quickly as possible so you’re not wasting your time talking to venture funds that are unlikely to invest in your company.
I wanna focus really quickly on the C of the stage piece here because that’s probably one of the top components when you’re talking to a venture firm is understanding what stage they invest in. So, institutional venture typically is going to invest across the seed stage, the early stage, and the growth. Some funds might invest across multiple of those stages, and some may decide to focus on just a single stage within that. So seed, at the seed stage, you typically kinda have limited sales, you have, maybe, a couple of pilots, and you’re raising your first institutional round of capital. At the early stage, that’s kind of your series A and B stages – that’s what most people are talking about when they’re talking about raising an institutional round, you kinda have product-market fit at this point, you’re really trying to hit the accelerator on your business – and then the growth stage, this is typically kinda series C+ (you know, series C, series D, series E…), that’s where you’ve really found product-market fit. You’re raising capital just to pour the gas on your business and really start scaling it.
And I wanna walk you through just a couple of examples of what this looks like for you as you’re trying to raise capital here.
So this is an example of a seed company, probably having somewhere between 0 and a million dollars of annual revenue, maybe a handful of customers. It’s usually you, maybe a co-founder and a couple of employees. If you’re a software company, you have an engineer on staff or maybe some kind of technical lead that is helping to build a product. Usually, at this stage, the valuations for companies are between 2 and 5 million and companies are raising somewhere between 500k to 2 million for their business. At this stage, you’re really looking at institutional seed venture capital funds like Rev1 Ventures. You can also work with Angel investors, and sometimes if you’re lucky, you can attract the attention of a strategic investor – perhaps a customer that’s in your industry wants to make an investment in the company, they can participate in rounds as well (although they typically skew later stage).
The next will be an early-stage company- Again, think of this as your series A/series B stage company. These businesses usually have a product-market fit that has pretty much been validated already. They’re generating somewhere between a million to 10 million dollars of annual revenue. They have very meaningful customer traction – so they’ve been adding their customers since the seed stage – and they have some kind of scalable sales method that they have put into place as well. At this point, you are starting to bring on a lot of employees. You probably have a product manager at this point, you’re adding your sales team, you’re adding your development team- again if you’re a software company. You’re starting to think about having a finance function within your company and all the reporting that you’re gonna need to be doing to investors in the business. Valuations at this stage- it’s very broad but it can be anywhere from 10 million dollars to 75 million dollars, and companies at this stage are usually raising somewhere between 2 million to 20 million dollars of capital to help fuel their business. At this stage, you’ve probably worked your way out of Angel investors and you’re really focused on Institutional and Strategic venture firms.
And then lastly, this is a growth stage company. These are like- think of these as series C/series D. Usually, these businesses are generating more than 10 million dollars in revenue. They have demonstrated scale, the ability to pour money onto their sales team in order to generate additional sales in the marketplace. A lot of times, looking at businesses that have over a hundred employees and your valuations are somewhere north of 75 million and the investment amounts that your raising can be anywhere from 25 million up to hundreds of millions of dollars at this stage. Again, you’ve got a lot of growth stage institutional venture capital firms that will participate in this round, but you’re seeing private equity come down to play in this phase more and more frequently, and strategic investors are very heavily allocated in the growth stage as well.
CAPITAL ACCESS PLAN
So, let’s keep racking here. Once you’ve made the decision that you want to start thinking about pursuing a venture round, how do you go about that? The first thing that you really wanna sit down and do is put together a capital access plan, and I think of this as your roadmap to raising money. You want to start with where you are today and think through what is your current stage, what milestones do you want to hit over the next 12 – 18 months, and how much capital are you going to need to accomplish those milestones. And when you’re thinking about your capital, remember you’re gonna need to add to your team, you’re going to need to spend money on legal and bookkeeping, you’re gonna need to build your product. These things all cost money. You’re not gonna be profitable on day one, that’s fine, that’s the expectation- no one expects that. But you really need to have a clear picture of what you’re trying to build and, kind of, capital are you gonna need to get there.
And you also need to really identify when your company is ready to raise, and this all comes down to what type of traction you’re able to prove or what type of traction will get a venture fund willing and able to invest in your company. So, you need – at the very earliest stages – you need some kind of initial indication or proxy for traction because when you first start your business, you might not have customers, you might not have revenue, but you need something to be able to start tracking to show that the business is moving in the right direction.
Most startups have some kind of validation or traction when they raise. There are some that are able to raise on sort of the back of the napkin idea, those are very rare. I think those happen when you have the right entrepreneur with the right expertise and you’re crossed with an investor that has a thesis on a particular industry or a topic. But most startups, they need to show some kind of traction or proxy for traction before they’re able to raise. So here on the slide, some common indicators that startups use:
Common Traction Indicators
Obviously, customers’ the best. If you have a paying customer that has agreed to trade money for the services or technology that you’re providing, that is the best example of traction. But if absent, there are other ways to go about this. You can have letters of intent from customers. If you have customers that say: “Look, I really like this idea of a product. I will buy it if it’s built.” That’s one way to do it. Beta’s – you can have people testing your product out in the market. Customer surveys are a really great way to do this, and we actually- we really like this. Before you go out and spend a couple hundred thousand dollars building your product, it’ll be good to survey your market. Understand that there are customers that like and identify with the feature set and will purchase your product. That’s all really important stuff to work through. On the FDA stage, if you’re a life sciences company, the metrics are completely different, a lot of the stuff that we’re talking about today would be completely different if you’re a life sciences business but perhaps your FDA stage is the right way to note your traction and where you’re going.
Customer Acquisition Cost & Long-Term Value
A couple of other things that aren’t on this sheet that I really like are your customer acquisition cost and long-term value. So how much does it cost you to acquire a customer and then once you’ve acquired them, how much value will they bring to you long-term and how that two compare.
The last thing on metrics is, once you’ve determined what metrics are relevant to your business, you need to track them obsessively. You really want to hold yourself accountable to those metrics, you want to understand what the key metrics are that the investors focus on in your industry, come up with a plan for those metrics; map them in your fundraising timeline, and you really want to ensure that those metrics are gonna be hitting a positive inflexion point right before you go out and raise capital. And the last piece is, start communicating your traction towards your metrics with the investors that you want to raise from. I think the best entrepreneurs, they put together a list of email addresses of people that are interested in their business, and they report every month around their key metrics and how they’ve been moving towards generating those metrics over the last month. So track them, report them out are all good practices to get into.
And in some cases, your most important metric might be unique to your business, right? So we all know the company Pinterest, right? Their most important metric was the number of pins people performed everyday when they were going out raising capital. I can guarantee you before, Pinterest raised the first dime of venture capital. No venture capital had ever thought about tracking pins in the past but this was a really important metric for Pinterest because it was a better activity metric than users, and it was the one thing that they track closer than anything. It really demonstrated not just activity but engagement with the platform the way it was meant to be used. It was really showing towards high-quality engagement vs. more superficial engagement. So think about your business, maybe you’ve got a metric out there that’s different than what most people are used to.
So again, figuring out your core metrics is super important to you managing your business. It helps you build up to the milestones that you need to hit, really to secure capital to your company. We’re going to talk about what milestones might be reasonable for various stages of the company life cycle as well. So, here’s a quote from Mark Suster: “Investors invest in lines, not dots.” Mark is an investor in Upfront Ventures and what this is really saying is when an investor first sees you, they have a single reference point – they’ve got one dot on the graph – and what they really need to do is gain perspective for themselves as they make a decision on whether they wanna invest or not. So how does that, kind of, inform how you interact with investors? Well, it means you probably need to start meeting your future VC about 6-12 months before you actually intend to raise, and the reason is investors want to see progress. They’re not gonna cut a check from the first meeting, they wanna see- they wanna hear what it is that you’re trying to do and they wanna see you do that over 6 – 12 month periods. So, try to build those relationships early so they can track your growth, momentum, and traction. And also anchoring your investors on certain milestones can really help you demonstrate progress over time.
So what is a milestone? Here we’ve got an example of what milestones a company might be working through on this slide, but I think about milestones as achieving something that meaningfully de-risks your company in the eyes of an investor. So good milestones could be adding a first customer, hitting a hundred thousand dollars in revenue, hiring a product manager, getting a patent approved, developing a pipeline that is worth five million dollars. Those are all really important milestones that will indicate to your investors and potential investors that you’ve de-risked your company a little bit. They are really meaningful and they could cause an investor to agree that a company is making progress and that’s really important. We tend- as we’re thinking about milestones, we tend to think of milestones in 12 to 24 month time periods because if you’re successful in raising capital, the money you raised, it’s probably only going to last you for that long. So what does that mean? It’s important that you have an overarching goal of growing your business, you know, to 50 million dollars in revenue and selling it to the largest company in your reverticle, but you need to break that goal down into smaller milestones so that you can prove that you are making progress in the entrymen and de-risking the opportunity as you go. And of course, you’re gonna need resources to accomplish those milestones which we’ll get to in a second.
But again, this is just an example of how a company might think about their milestones over a three-year period. At the beginning, you’re conducting customer testing, you’re doing your surveys, and that’s kinda how you’re proving traction. And then as you move through this timeline, you know, you’re completing R&D on a prototype and you’re matching that along with your million and a half dollar seed raise. As you move into the second year, you’ve got 10+ paid pilots and you’re already working towards your seed and series A financing. And then in your three, you’ve got a hundred paying customers and you’re thinking about raising your series A round, you’re talking to VCs, and you’ve probably developed your product and have a couple different revenue streams alongside it. And then after your series A, you’re starting to target your series B. You got three hundred paying customers, a great milestone, and your additional product verticals are now coming into fruition. You’ve got product managers and a development team that’s working on and off that and you’re really setting your eyes towards how you get from 300 to a thousand recurring customers. So this is again, all examples of good milestones that might relate to your ability to raise additional capital down the line.
So as we think about, kind of, next steps and where you can continue to go as you think about raising venture and how do you prepare for this.
Associate Milestones with Capital Needs
The first thing is to associate milestones with capital needs. So we saw on the last slide that these are all milestones that are being completed and at the bottom, you have what the capital needs are here. When you have the milestones that you’re hitting, there’s also these specific times where the company is raising capital. Capital is almost always tied to the achievement of those milestones- and again, you might need to raise 10, 20, 30, 50 million dollars before an eventual exit but it’s not going to all be there on day 1. Think about your business in 12 – 24 month periods, that’s typically how the funding cycle works. What can you reasonably achieve, and when you think about what you need to achieve, what resources do you need to be able to achieve that? That’s the really important part of this because then that informs how much capital do you need to raise and what your capital plan is.
Understand your Capital Requirements
So again, you wanna sit down, you wanna think about what your value creation milestones are for the next 24 months. Some examples of this, Launch a commercial product and achieve 2 million dollars in annual recurring revenue. Perhaps you have a milestone of, you want to sign a joint development agreement with a corporate partner, that’s a good milestone. If you were again a life sciences company, maybe your initial milestones are indications of safety and efficacy in an animal model. The range can be very, very broad and is totally dependent on your business, but once you know what milestones you are targeting, sit down and prepare monthly projections for your business. We’re talking about sales, we’re talking about revenue, what are your expenditures, do you have grant income, what capital expenditures do you need to make. Once you have all of those pieces down, identify the resources that are going to be required to achieve those milestones. Who do you need to hire, how many people do you need to have on staff, who can you contract with vs. who needs to be a full-time employee. You can get to what all of those things will cost to understand how much money you need to raise. And then, typically, you wanna have some padding on that. So let’s say, you decide that for the next 24 months, you need to raise a million and a half dollars. Well, when you go to the market, you should probably raise 1.75 or 2 million dollars so you have some padding on top of your budget in case things go wrong ‘cause we know that things will always go wrong so it’s always good to have some protection there.
Create your Business Model
Next, you wanna create your business model. This is probably the most time-consuming part. This is where you need to think through all of the assumptions of your business. Who buys your product? How much do they buy it for? Who uses it? How much does it cost to build? How much does it cost me to sell it? Do I have to ship it? Do you have to install it? Do I have to maintain or upgrade it over periods of time? How often do I have to do that? Just think through every single assumption that you might have for your product and list that down, and at the end of the day, you need to come to a conclusion of whether you can make money off of that business model. You wanna test each of those assumptions that you made for relevance to your business at your current stage of development. Think through things like how much do you know about your customer, without knowing your customer, you can’t complete your business model. This is why, again, we work very heavily on surveying your business- your customers before you have ever even built a product. Your business model assumptions are really necessary to fuel your financial model and projection so start there before you sit down and excel, and start building an income statement, balance sheet, cash flow’, you really need to think about your assumptions first.
Create your Financial Projections
For a lot of us, this is probably something that we could use some help with. So, try to work with advisors, try to work with people who have built models before. There is some nuance to this. Anybody can build one but it can get complicated, so it’s always best to work with somebody who’s been down this road before. The financial projections are gonna be a key component in your investor presentations. Investors want to know that you’re going to be a good steward of the capital that they’re about to invest in you and that you’re going to use it appropriately and in order to provide confidence in that, you need a good plan. This wraps together all the things we talked about today. You need to align the funds that you’re wanting to raise with your targeted milestones and show how you’re accomplishing those milestones over time. And you also need to show where the company will be when you run out of money. Will you have done enough with the capital that you’re raising today to hit the milestone that you need to be able to raise another round at some point in the future. Mention that you definitely have some kind of margin of error built-in here, the ability to have some padding if things don’t go exactly according to plan, that’s very standard. And at the end of the day, you’re gonna come out with a very detailed 6, 12, 18-month budget and you’re gonna have an income statement that shows all the revenue you intend to generate, all the expenses you intend to have, and really what’s important is keeping your eye on that cash situation and making sure that the business doesn’t run out of capital and that’ll be a slide in your presentation deck and you’ll have your financial projections put together.
QUESTIONS & ANSWER
Michael: And so that is the last slide that I had prepared for you today. So I’ll be happy to entertain any questions that have come up either in the chat or happy to answer any questions around this idea of raising venture capital and whether it’s right for you and what the process kind of looks like.
Are there any kinds of exits besides selling the business?
Matt: Michael, we do have one question in the chat about what you mean by exit. Like, are there any kinds of exits besides selling the business?
Michael: Yeah, good question. So, usually, 95% of the time, when a venture firm is talking about an exit, they’re talking about the business getting sold or going through some type of acquisition. That usually means you, selling your business to a larger company in this space, or some kind of strategic investor, or potentially selling your business to a private equity fund – that can be a reasonable exit as well. That being said, there are other different ways to achieve an exit that is not as common. One of those is obviously going through an initial public offering where your shares are listed on a public exchange and investors can sell their shares on that exchange, that’s one way to go through an exit. In some cases, businesses end up cash flowing and are able to generate cash returns to their venture investors. I’ll say, that’s very rare and doesn’t always work because of the timing of the fund. Sometimes, you will have agreements that tie a payback to revenue, those are called revenue capital agreements. It’s a form of venture investing where an investor doesn’t actually take ownership in your company, they just have ownership to a certain percentage of future revenues that pays back their investment over a period of time and that generates their return. Again, those are pretty rare but it is another way to do it.
To answer your question directly, when you hear a VC talking about exit, they’re almost certainly talking about you growing the business and selling it to another larger business either in your category or your industry or through a strategic acquisition.
What sort of person can help with the nuances of the financial projections?
Matt: We have a couple of other questions in the chat, the next one was, what sort of person can help with the nuances of the financial projections? There’s a concern that they’ll miss some major components to that.
Michael: Yes so, you know, one is if your company’s a fit for working with Rev1. We are able to help with financial projections. I think other startups, like, working with other entrepreneurs that have been down this path that is able to lend a hand in terms of putting together projections, that’s another really important resource to use. And you may be able to work with some business development centres around this piece, so they might be able to put you in the right direction. There are certainly a lot of folks that are accountants that have businesses that they consult with companies, you know, that may be a slightly expensive option, but they can help with those. But, any accountants or any financial professionals that work in this are all potential resources for that so there’s a couple different options to get help. Also, there’s like, if you go online, you can find some really good templates on how to put together financial projections. It might take some learning and some muddling around to understand how they work but there’s some good basics out there that you can find online. And last piece to mention, there’s actually been a couple startups recently that – I can’t remember the names exactly, but I’ve seen them raise capital – these startups are geared specifically towards helping startups start their financial projections. Again, I don’t remember the names of it but I’ve seen two or three startups recently that have raised fairly significant rounds. Their whole thing is like: “Hum, get an account with us and we’ll help you build your financial projections.” Now, I’m sure they’ll be happy to charge you up to a 20 dollars monthly subscription fee for the convenience of using their services. I don’t know what the pricing model is, but that could be another really interesting option to look into if you’re looking for help on this.
Is there any magic to determining pre-money valuation?
Matt: We have one other question on the Q and A tool. Just ask any magic to determine pre-money valuation.
Michael: Ah yes, so much magic goes into it. It’s a good question because it is a mix of art and science. At the earliest of stages, I will say that it is really cap table math. There’s a lot of cap table math that goes into it, right? Because your investors are going to be investing a certain amount of capital. The one thing that is very common is it’s not gonna be the last money that your business takes on. If you’re gonna grow the company and get very large, it’s likely that you’re gonna have to raise multiple rounds of financing. What that means is that the investor is going to be diluted over time, right? So more money comes in, their original stakes are gonna get diluted, hopefully, they put more money in but, when you think about where an investor needs to be at the stage of investment, most companies are at the seed stage, they’re needing to raise a million dollars to two million dollars in capital. If your investor wants to own 15 – 20% of the company with that investment, so that overtime as they get diluted, that will still be a meaningful outcome at the time of investment. It just sort of triangulates back to a five million valuation on the company. And so, these metrics are all out there. If you look at pitchbook reports, they talk about what the average size of a round is and what the median pre-money valuations are for companies. I will just say that over years of doing this, at the earliest stages of the concept and seed stage, it’s pretty formulaic. There’s not a ton of movement around the valuation of the company, it kinda has to fit a certain mold. Once you are an established business and you’re going out and raising an A round or B round and you’ve got a meaningful traction that you’re able to show, that’s where you start getting some differences in the pre-money valuation, but at the earlier stages, it is quite honestly my recommendation to entrepreneurs if you could find out what sort of metrics look like in your geography, what is sort of average or median, and try to look for a deal that is somewhere in that range that is going to work for you in the venture fund.
What do investors prefer? A good idea or a good team?
Matt: Michael, that’s the last question that we have in the chat, I just have one question myself. When it comes to- on one hand, you have someone with a spectacular idea and it has a great business model and they can show these wonderful projections. On the other hand, I’m sure the investors are really looking at the team, and maybe their track record or experience or if they’ve ever launched a company before or grown a company before. What would you kind of say the balance that they look for between- how do they lay that out between the idea and the business plan vs. the team that is gonna execute it.
Michael: Yeah, I think if you look at how venture funds think about this, you’ll find completely different ideas around the spectrum of you know, are you betting on the team or are you betting on the idea. You’ll find some people that say: “Oh you know, I’ll take a great idea over a great team any day.” and then you’ll find some people that say: “I’ll take a great team over a great idea any day.” and then you’ll find everyone in between. My take on this and how I look at companies is it’s all important, like everything is important. It needs to be a great idea and it needs to be a good team. That doesn’t necessarily mean that you as the CEO or the founder of the company need to have built and sold an exit at a company in the past. Certainly knowledge and experience in your company’s targeted industry is going to be important. So, if you have been working in the banking industry for your entire career and you’re starting a company and it’s a new brand of potato chips and it could be the best potato chip ever, your investor probably gonna want to see that you are bringing someone along that has some pretty good experiencing consumer packaged goods and can add to your experience in finance from your banking role. Experience doesn’t necessarily come from the founder of the business or the CEO, you can build around that but it is very important, right? You wanna see some expertise in the industry, some knowledge in the industry, that is all really important but it’s gotta be a good idea too. So Matt, I’m sorry. There’s no magic bullet on that. It’s all important and really, like, atleast at Rev1, we try to take a very holistic view of a company looking at both the product and team, the market, the financing pathway, all those things have a lot of importance to our ability and willingness to invest. So a balanced approach, I guess, is what I’m advocating for.
How often do you see a CEO in the early stage who’s not the inventor there?
Matt: Great, and then we have another question that popped up. How often do you see a CEO in the early stage who’s not the inventor there? Like an external business person.
Michael: I think very frequently. I wanna make sure I’m addressing the question. So, early stage typically means like A, B rounds. That is very frequent that you would see a CEO- if there’s intellectual property associated with the company, you’ll very frequently see like a business lead that comes in. You’ll also see the inventor sometimes, they’re taking the CEO role and they bring it to the A, B round too. I think at the earliest stages and sort of the concept and seed stage, usually it’s the inventor that is bringing the company forward and they need to kind of run it but then at a certain point, the inventor may decide that they’re not the right person to run the business so they want to hand it off to somebody else, and that’s very frequent and common as well.