Properly balancing the equity capital in a startup or high growth venture can be complex…
Raising Capital: 7 Key Questions You Need to Ask
Raising capital is not an easy task and is often very time-consuming, but the need to raise more funds is often vital and even inevitable for a young startup company.
If your startup is profitable already, there isn’t an urgent need to raise more money. However, if your long-term goal is to complete an acquisition or a merger, raising capital from firms and investors can help position your start-up or enterprise for success.
To make it easier for you, we’ve listed some important questions you should ask yourself before raising capital.
1. Do You Need to Raise More Capital?
Are there alternatives in place to fund your business, either from your founders, customers, suppliers, or startup grants? Does your team need more capital in general?
There are 2 types of enterprises; a startup with a moderate growth that can fund itself over the short-medium term (i.e. many startups support themselves with additional consulting work.)
If your cash burn rate isn’t high, there might not be a need for external investment.
2. Is Your Startup VC Backable?
Another thing you need to ask is whether your business is venture-backable. This is because investing in a startup company is risky (9 out of 10 startups fail).
Venture Capital firms (VCs) are often looking for investing in high growth tech companies that can yield them higher returns.
To provide those returns, your startup must often have a scalable model. That is, whilst revenues increase, expenses don’t increase at the same rate.
If you are raising capital, you should first prove traction in your business model by creating an initial product first and also show customer demand for the product.
3. How Much Capital Should You Raise?
Some claim that when raising capital you should go for as much as you can, while others might argue that you need to raise as little as you can to avoid dilution. The right way would be to raise enough to get things rolling.
As stated earlier, fundraising is time-consuming. Therefore, if you raise less now with intentions to raise more in 6 months, it is a clear indication that you aren’t aware of the rules.
So raise an amount that’ll cover you for the next 18 months or a year, and have financial forecasts that show growth, office space, increased headcounts, and server costs.
Based on the local market, a minimum seed round is around $1 million – $2.5 million, a mid-sized round is approximately $1 million while a large initial round is between $3-$5 million.
Your round size is also based on the valuations you’ve been offered.
In each round, typical dilution is around 10 to 25%, but you need to consider how to keep enough to stay put in the long run.
4. Are You Okay With the Risks VCs Poses To Your Business?
When you take on VC, you’re expected to make exponential growth. You lose the luxury to decide whether you’re making enough money for yourself and choose to exit.
If you fail to get your investors their expected returns (10x), you risk the chance of getting replaced.
Now when it comes to exits, you’ll have limited opportunities that can yield significant returns for your shareholders, who’ll often have shareholder blocking rights on a sale.
Therefore, most of the exit opportunities which could have been completely acceptable being the founder might get rejected.
This means that you’ll have to hold out for exit opportunities that are much larger and difficult to obtain.
Furthermore, your VC shareholders will require you exit within 5 to ten years.
This necessity to make an exit may lead you to opt for a half-baked exit and force an acquisition even before you’re ready – one you’d have avoided either financially or structurally.
5. What Are The Type Of Investors You Should Choose?
There are numerous financial instruments to go for, the main ones being debt and equity.
Some entrepreneurs prefer to set an explicit valuation of their business and sell an equity stake to their shareholders.
Some choose to raise the debt, which, in the following round, is converted into equity, with a market cap and a discount.
The market cap refers to the highest valuation of the company when converting. It can often estimate the maximum valuation of your company during the initial investment. It is better to discuss this matter with potential shareholders about their preferences.
All forms of fundraising have repercussions and will impact your company’s future and your personal finances – including how much equity or control you’ll retain, the type of capital you will raise in the long run, and eventually, the benefit you’ll gain from it.
6. Are You Willing To Give Up Control to Other People?
Most entrepreneurs start their startups because they prefer freedom. They don’t want someone to give directions and instead chart their own way.
But, the moment you are raising capital and you take on external funds, that changes. You’ll have investors to report to and a board of directors.
CEOs running venture-backable enterprises must be capable of managing multiple interests of shareholders. Unlike banks, equity shareholders offer more than just funds.
They provide connections and guidance and are often interested in your operations. Investors prefer working with people who don’t mind taking outside input as well.
7. How Much Of Your Time Are You Willing To Put in?
Last but not least, you should note that raising capital takes a lot of time. Most rounds take more than a month to close.
So before you plan on raising capital, consider if you’re actually willing to sacrifice months to raising funds.
Will you be able to spend that much time seeking investors? Can your startup survive when you shift your focus from it?
Note that if you give up before you reach the finish line, you’ll not only waste your time but also will not have enough time to seek other alternatives.
Finally, the most important thing you must remember about raising capital is that even though it may be an arduous process at times, it isn’t an end in itself. In fact, it’s just the beginning.
Remember that fundraising is a process with rules in play and a like-minded community built around it.
If you seek help, you’ll find founders who have gone through the process and are happy to lend you a helping hand and guide you through the process.
So don’t shy away from reaching out to other founders in the startup community or of course an accounting firm very familiar with the nuances of capital raising.
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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech companies, agencies and entrepreneurs.