In recent years, early-stage fundraising for startups has begun to collapse. According to some estimations, venture capitalists have started to invest in later-stage deals, causing seed deals to drop by nearly 50% since 2014. As a result, small companies in their Series A funding rounds are having trouble attracting investors.
Yet, even with less investment capital readily available, attracting investors is more important than ever before. With the added impacts of changing regulatory laws, gaining investment capital from venture capitalists and angel investors is a crucial and safe way to help launch innovative startups.
Small business owners are bound to make mistakes as they learn how to raise capital along the way, but they can still avoid making the mistakes that other entrepreneurs make as they attempt to draw in prospective investors:
Mistake #1: Team Cooperation and Responsibilities are Unbalanced
As you grow your business, you need to invest in your team to build cooperative and innovative working relationships. Investors want to see passionate leaders that are capable of eloquently detailing and executing large-scale plans. As a small business owner, your leadership should complement the skills and track record of your team. Investors may also ask to meet the whole team from the beginning instead of offering capital while you assemble your team. In small businesses especially, poor team relationships make seed investors apprehensive. Investors need to see that all founders are compatible and equal players. In fact, research from the Harvard Business Review shows that teams with positive work cultures are more productive. In addition, new founders may want to spend time coaching and preparing their team on how to speak knowledgeably about their roles and the company’s goals.
Mistake #2: You’re Pitching to the Wrong Investors
One major problem that small business owners regularly encounter is pitching to the wrong investors. Often, new companies pitch to venture capitalists without understanding the number of reasons why a venture capitalist would want to back them. To be desirable to VCs, a small business enterprise needs high-growth with a potential for 10x return or more within the company’s first five to seven years. VCs won’t consider investing in your company if you aren’t profitable enough. In addition, small businesses need to target and network with investors that fund small businesses within their specific industry during the Series A phase.
Mistake #3: Your Market is Too Small
Your industry’s market can indicate how much the company can expect to make in its first several years. Even for small companies, billion-dollar market opportunities can heavily appeal to institutional investors. To determine and convince investors that your market is desirable, you’ll need proof in numbers. A market-sizing analysis can offer a top-down and bottom-up profile that will help you understand the difference.
- Top-down analysis is easily calculated and many small business entrepreneurs use them frequently. They are determined by assessing the total market and then estimating your share of that market. For example, smaller businesses in mid-size regions can sell an automated tool everyone could use, but since there are only a few hundred thousand people in the local area, they could target an even smaller percentage to determine their sales. So if a business can sell 2% of a $1 billion market, they can reach $20 million in sales.
- Bottom-up analysis is a more intricate, but realistic piece of the puzzle — and that’s why investors love them! This analysis identifies where products are sold, the comparable sales of products, and the amount of current sales. The numerical results are more accurate. For instance, you can determine the number and location of shops likely to sell your product. This analysis also helps to determine the history of sales for specific products. Finding this data can be difficult, so the assumptions may be fairly optimistic and a fraction of existing premium sales. However, small business owners should also factor in sensitivities as they calculate. To get results that overperform, you can double the number or cut the number in half in case sales don’t go well. Since it’s hard to contact every shop, factor in your ability to market to each store. You may also want to consider working with a distributor as you calculate this path.
Mistake #4: Your Cap Table has Issues
Investors want founders and key employees to be responsible financial go-getters. In startup ownership structures, a capitalization, or “cap”, table, will help reflect the shared goal of generating high profits. However, many startups often make mistakes in the way they handle financial assets. As a new business, you should:
- Allow your founders to have a majority stake in the company during the seed stage
- Allow major stockholders with 20% or higher shares to become part of the business
- Be selective when giving away shares to employees. The cap table shouldn’t be so crowded that founders are giving away shares too freely
These steps can help you show investors that you’re carefully considering each financial decision when hiring, training, incentivizing, and relinquishing employees.
Mistake #5: You’re Underprepared
Like any industry, preparation is essential for you to show investors your abilities, financial mindset, and strategy. Conduct your research on investors and their goals so you can determine if your company is a good fit for their portfolio. As you get to know investors, time management will remain necessary to maintain healthy, reciprocal relationships with investors.
Although these fundamentals are commonsense, many early-stage entrepreneurs tend to forget these basics. In addition, organization is a necessity that will help you stay updated on data and emerging trends. Before you even begin fundraising, you’ll need to create a “data room” with information that investors will want to know during the due diligence process. The following data documents are essential to preserve in shareable folders so that you can answer investors’ questions immediately:
- Updated pitch deck
- Financial data — Performance history and future growth projections
- Charter documents — Incorporation certificate and bylaws
- Confidential information — Invention-assignment agreements for founders and employees
- Cap table — Standard and reserve shares or convertible notes
- Founder and key employee stock-purchase agreements
Funding can take a long time to secure. During your company’s Series A rounds, keeping track of external and internal goals and figures can help you define where you want your company to go and how you want to pitch it to investors. With the focus and drive that it takes to stay organized and relevant, your small company may just find the financial opportunities it deserves.