START-UP ON ITS WAY TO A BIG MONEY INVESTOR
Financial support at the research stage is indispensable for the founders of new companies, and certainly without it, some endeavors could not take off in the first place. Looking at some projects, however, it is impossible not to get the impression that in our young economy, both groups (that is the founders taking their first steps in new ventures and the investors) are only in the early stages of gaining experience, making mistakes and thus still learning.
Errors in the early rounds of raising capital
One of the most common mistakes is raising funds in a hurry with the wrong valuation. This is often done without the long-term plans of the company in mind, without accounting for exit strategy planning and disregarding long-term shareholder structures.
Why is shareholder structuring important? When dividing stakes over several, and sometimes even dozens of shareholders, it becomes difficult to negotiate with a strategic investor later down the line. The greater the number of shareholders the longer the time line of negotiations, creating much more potential for problems and misunderstanding because more people need to agree or choose to move in a certain direction. When preparing for a second or third round of financing, the company in question usually approaches a professional venture capital team specializing in managing new ventures. However, because of the number of available projects on the marketplace, these skilled teams will likely choose projects that are better prepared for their involvement; not companies with a multitude of investors that often cannot agree.
Unfortunately, a shareholder who has invested even a small amount of capital can cause a significant slowing of the negotiation process with a large strategic investor without whom the company’s development would be difficult or even impossible.
Selection of shareholders is also imperative in planning for the ultimate exit strategy. Having 10 minority shareholders most often indicates frantic actions on the part of inexperienced founders. This panicked seeking of funding, in turn, increases the likelihood of taking other reckless actions, such as improperly securing the founders’ rights (i.e. too many privileges are granted to minority shareholders who can de facto block further strategic development when changes in the shareholding structure are required).
The right shareholder structure
It is important that entry of a strategic investors takes place at a stage when the company’s founders are still holding a majority stake. This guarantees the investor that the founders on whom the technology or intellectual property of the firm is based, shall remain involved in the joint venture. It also allows for more flexibility in further rounds of financing that may become necessary when scaling operations.
It is also good when all founders have equal interest in the company. The company significantly loses the chances of attracting a new investor when one of the founders owns 90% and the other 10%. With such capital distribution, the question immediately arises whether such a team has a real chance of survival. Let’s remember that experienced investors focus on teams as a whole, not solely on the individual players. A team is essentially as significant of a variable to account for when approaching a new venture as the product or service itself; if not even more important in certain contexts. With dynamic market changes, the product can be substitutable while changing the entire team is a much more arduous tasks; sometimes even impossible.
When the time for a mature investor approaches
There comes a moment when a young company needs to prepare for the stage of its’ development where the expectations of professional investors must be met. Smart money is what makes a company gain momentum, allowing for a potential exit strategy to take shape.
It is also the moment when the founders realize that the investor does not only expect a perfect product, service or technological competitive advantage, but also a very specific strategy and forethought about an exit scenario. After assessing the chances of implementation, the investor will decide to enter the project and support the company at this crucial moment. So what elements will convince a strategic investor?
We do not bet on horses we bet on riders
You don’t have to convince an investor about the importance of the team that runs the company. It is truly the passion and conviction for a project that are actually important. The first question always concerns the team’s competence, which any investor will expect to be comprehensive. Although “hard,” aptitude is important here, business competence will be equally important at this juncture. Thanks to this, the company will be able to substantively contribute and partake in financing and sales negotiations thus allowing for the future commercialization of their solution.
The illusory impression is that business competencies are not important for an industry investor who is buying technology because the, to be acquired company, is to become a piece of some larger puzzle for them. We imagine that from their perspective, business acumen is not necessary because the investor possesses these competences and can support the company with this skillset if the need arises (smart money). Mostly this assumption is made when a technology is purchased which is a necessary component for a greater synergy of already owned businesses or technologies in the investor’s portfolio or operational construct.
However, great attention needs to be paid to the negotiation process. Thus, business competences in a young company are invaluable on several levels. First, they assist the company in not making mistakes during negotiations. They also insulate the interests of founders and current shareholder when dealing with a much more experienced investor. Additionally, this expertise allows for the founders to traverse the investment process in a conscious and mindful manner instead of haphazardly.
Finally, it should be remembered that another critical factor is the presentation of the founders, and the fact that in such conversations one needs a universal language of professional communication: most often this will be English. If the founders have an investor to convince, they must be able to not simply communicate, but communicate thoughtfully and skillfully.
Preparation of the company and appropriate presentations
In preparing the company for the investment round, market knowledge is crucial, particularly in regards to both local and global competitors. New technologies are global businesses.
It is essential to know exactly what the company needs funding for and how they will utilize these funds; the next “milestones.” Preferably this is communicated with a clearly defined plan (down to an accuracy of a month by month implementation/deployment of funs plan) that should include non-financial goals to be executed as well.
The company should personalize prepared material. The same teaser will not be suitable for every investor: particularly with new technologies. When a company plans to raise funds from a venture capital fund, it is necessary to create materials emphasizing market potential. This material must specify the value-add that the solution offered by the company provides. It has to clearly illustrate the optimal trajectory that this technology should take in order to significantly increase its value and thus achieve the desired valuation for exit.
However, when an investor comes from the same marketplace, we only need to allude to the market but there is no need to explicitly define it, as our investor already knows it very well. We should focus on the particular technology or service and the advantages offered over other competitive products in the same arena while also differentiating team strengths.
When we talk to the investors from the same branches of business, and there is a friendly atmosphere, it can be helpful to negotiate with a few comparable investors at the same time. This is possible particularly with very specialized and innovative technologies. In this manner, the entire negotiation process may be expedited. However, it should also be taken into account that in the case of more advanced negotiations and research, an industry investor may request temporary exclusivity during the process in order to protect their own interests. In these situations, it is worth specifying the important conditions of exclusivity so that they do not block parallel negotiations with other investors in case that particular conversation does not prove fruitful, so that several months of valuable time are not wasted. Remember that it is important to have various investment options so that the ideal investor is chosen.
Finally, when choosing an investor, we have to be sure that we really want to work with them and that we understand each other well before solidifying the agreement. Let us keep in mind that this investor, especially the ones that we are writing about here, will stay with the company for long time, so we want cooperation to be well thought out and fluid.
By: dr. Anna Maria Panasiuk, Private Investor Adviser, Co-founder of BE THERE, Managing Partner of Panasiuk & Partners