29 Aug #Founders – what you ought to know before raising your #SeriesA from #investors
First, a word of caution. Raising your Series A from a venture capitalist is complex, time-consuming and tends to depend on who you know. Plenty of businesses succeed without founders selling their shares to institutional investors. Raising funds is essentially a sign of a founder’s ability to convince investors that their vision will be expected to reap more than 10-20x returns. At a very basic level, you should only consider this path if you’ve created something that works, and cash is your primary constraint to scaling. If your vision for the business simply cannot be attained through revenue, then the most common way of attaining your goal is by raising venture capital and selling between 15 and 25% of equity in your business.
The venture capital industry is high risk. In fact, the French put it most bluntly; ‘Venture Capital’ translates to ‘capital-risque’. With risk, comes the requirement for high returns, and with over 3 out of 4 companies failing before Series B and even more failing to repay their investments in full, investors are always on the lookout for their next fund returners.
In 2017, £1.46bn of venture capital was invested in UK companies at the Series A stage. There are a number of factors to consider to maximise your chances of being included in next year’s statistics.
Are you ready?
Raising investor capital means being answerable to other people, and losing much of your independence. You need to be prepared to relinquish control over some decision-making impacting your company such as its direction, governance and operation. The style and intrusiveness of investors may lead to further pains down the road, yet, obtaining VC money is also a first step towards an exit or IPO, where you’ll need to deal with much more stringent due diligence and regulatory transparency requirements.
OK, but is your business ready?
✓ You have proven that what you’ve built works via product-market fit
✓ You have a compelling growth story to date and an even bigger vision for the future, including a clear international strategy
✓ A cash injection will generate over 10-20x returns in 3 years
✓ Your addressable market is > £500m and there is an opportunity to take advantage of it
✓ You work in an un-crowded space and you can sell your product against real competition (the existence of well-funded competitors is often a reason for rejection)
✓ You have a committed team who are sufficiently incentivised to make the business a success
Put yourself in a VC’s shoes
Understanding how VCs make their decisions explains a lot about their behaviour. If you’re going to be partnering with them, it makes sense to understand how they work.
Partners spend most of their time fundraising from LPs (“Limited Partners”, including family offices, pension funds, insurance companies and government). Once a fund’s capital has been fully deployed, it can no longer invest until its next fund has been raised. As well as a 1-2% management fee, VCs make money by taking a share of future profits (typically 20%) after returning its invested capital back to its LPs. This upside is only crystallised once all the capital has been returned.
They have a fiduciary duty to return capital to their LPs within a fixed period of time. If a fund has a 7-year cycle, and it’s currently in its 3rd year of deployment, investors will consider your business’ returns within a 4-year time frame. The size of a fund often dictates the ticket size. If a VC deploys its capital into 20 companies, and you are looking for £5m, you would need to target a £100m fund. The generous tax incentives for private investors means that some VCs, specifically, Venture Capital Trusts, will only be able to invest if your business meets certain criteria.
In its simplest form, investing in scale-ups is just another form of speculation. VCs are structurally incentivised to maximise the chances of finding a fund returner. If the fund acquired 20% of a company’s share capital for £5m, it has valued the business at £25m. In order to return the £100m fund, the scale-up must create value of at least £500m, a 20x return on investment. Once you’re in, your business is then competing with other portfolio companies. If you don’t meet expectations, it may decide to pull the plug and focus on other companies.
Choosing your investor
In most cases, you will be wedded to your investor for at least 5 years. Founders should therefore spend time researching and getting to know their potential investors, as early as possible, in order to be in the best negotiating position possible. Specifically, consider the following factors:
- Criteria: Industry sector and investment stage
- Fund details: Size, fund date and available capital left to deploy
- Number of investments per quarter, including recent investments
- Value-add: Many VCs market themselves as providing smart money, but often the ‘value-add’ is overplayed so don’t rely on them to scale your business. You need to do it yourself
- Ability to follow-on in later rounds
Make a list of your top 20 investors and start from the bottom to ensure that by the time you reach the top, you’ve nailed your pitch.
Once you’ve identified your preferred investors, there’s still a choice within the organisation. You’ll need to find a lead partner within the fund to champion you. Choosing this person will depend on their sector expertise, how many portfolio companies they are currently managing and your relationship with them. The answers to the first two questions are typically listed on the fund’s website and the answer to the third is dependent on whether you think this is someone you can trust and can work closely with.
Ask portfolio companies for references. Are they still enjoying working with their investor? How did they find the fundraising process?
Getting your foot in the door
Before pitching to investors, ensure that you know your numbers and presentation inside out. Find a friendly audience, and practise your pitch in front of them in plain English. Practise the following pitches: your 20-second elevator, your 3-minute sale and a longer 15-minute presentation. Record yourself, replay it and give yourself a mark out of 10 for fluency, impact and enthusiasm. Repeat until you reach an 8 or above.
Getting an introduction is often the best way to approach funds, as it relies on you being able to use your existing network effectively and they will expect the introducer to believe in the business. Some funds opt for direct applications on their website, but this is still uncommon.
Aim to line up all your investor meetings in a similar period. Given that investors will typically ask for an exclusivity period, receiving multiple term sheets will put you in a better position and you will be better able to decide to whom you want to commit.
The fundraising process
The fundraising process is similar across all funds:
- A deal is sourced via an introduction or initial meeting;
- Your business will be pitched at the next weekly pipeline meeting;
- You and the team will be asked to pitch to the fund;
- After further meetings, including partner meetings, and some basic due diligence, the partners may decide that they’d like to proceed and issue you a term sheet which will include their key investment terms, what they expect in return and what if scenarios, if things don’t go as planned. At this stage, you should instruct an external financial advisor (including lawyers) who will be best placed to help you negotiate good terms;
- The investor will perform further due diligence; and
- You’ll then negotiate the terms and eventually sign your term sheet. The lawyers will draft the suite of deal documents, typically comprised of new Articles of Association, the Shareholders’ Agreement and the Subscription Agreement.
Getting your documents ready
Having a business plan, including a one page executive summary, a pitch deck and a financial model ready in a virtual data room will ensure you’re better prepared and help you review your business through an investors’ eyes so that any issues which are at the bottom of your to-do list become a higher priority. You’ll also need a number of due diligence documents. (I’ll discuss examples of these in my next article).
Consider your valuation as an output of the fundraising process, not an input. Valuing your company is an art, not a science, and will often depend on the competitive pressures surrounding your raise, i.e. whatever the market will pay, rather than a pre-agreed revenue multiple. Ensure that you only go out to fundraise once you’re comfortable that you’ve done what you can to maximise your prevent and future value.
Spending your investment
Decide how much money you need and how you’d like to use your funds, and ensure you’re able to articulate clearly where you are now and how the use of proceeds will get you to where you want to be. Incorporate the use of proceeds within your financial model, showing the growth of your business with (and without) the suggested funding level.
Investors prefer the use of proceeds to be channelled towards growth levers such as new hires to increase outbound sales, or marketing spend, rather than used to develop unproven technologies.
Use your existing team or board members with investment experience or find an advisor. Find out here how PwC can help you on your fundraising journey. If you’re not sure whether institutional funding is for you, my colleague has written a blog looking at your other options for funding.
I’d be really happy to hear from you if you have any comments on this article, if you have any queries about fundraising, or if you’d just like a chat! You can reach me via email@example.com or on twitter @jhj_hollis
Jonathan is a founding member of the Raise team at PwC and is responsible for developing our new Raise Series A programme which supports a cohort of enterprise companies looking to raise their first round of institutional funding, and for growing PwC’s Scale proposition in London and across the U.K. He has worked with over 70 SaaS companies, many of whom have gone on to raise their Series A, and has a broad investor network, which has contributed to this article. Having set up his own company whilst studying Economics at the University of Cambridge, he subsequently qualified as a chartered accountant with PwC, before moving to his current role. He currently manages PwC’s entrepreneurs’ network and runs Tech London Advocate’s SaaS Working Group.