Your ideal financing strategy is closely connected to your milestones.
This is an example of milestones for a startup, this does not represent how funding rounds take place in all situations. Funding depends on a variety of factors.
It‘s also possible to have multiple smaller seed rounds, as it‘s happening now in the market, and larger rounds once sufficient revenue is generated.
As you give away shares at different rounds, naturally your shares and mostly those of early-stage investors, get diluted.
Depending on your stage, different financing sources will be available, but there are many more factors that determine what kind of funding is available to your company.
These options are also not available under the same conditions in all locations, and actually vary greatly from country to country depending on liquidity, knowledge of startup investments and the economy. On top of milestones and stage, the main factors affecting the level and funding available are: Sector, Location, Market trends, Competition, Strategy, Timing and Investor role.
The size of the funding rounds we‘ve seen before might be typical for a platform. Sector determines the funding amount needed for each expansion or for product development: for example, a hardware startup easily needs millions before entering the market.
Location is fundamental. The early-stage financing market, including grants, determines the number of companies that will be funded, the sectors and the stakes given away, and ultimately determines the success of many companies. The sophistication of investors also helps in the way funding contracts are structured and also the exit possibilities. Investors‘ rights and protection, which are not guaranteed everywhere, as well as transaction costs, tax breaks for investors and of course the business risks connected to the location have a strong effect on investment flows. You, as the owner, can also decide where your company will be based, to take advantage of this.
Market trends also change financing flows. Funding rounds requirements, specialisation of VCs and other financiers on earlier or later stage companies, the life cycle of sectors from inception to maturity, change the size and characteristics of funding rounds.
Do not underestimate competition: if you want to compete with well-funded companies, you need a somehow comparable level of funding, or a fantastic competitive advantage that money cannot acquire.
Your strategy is of course relevant too: how big do you want to grow, how fast and in which direction you want to expand, determines how much money you will need.
Timing refers to how you structure your different financing rounds and your timely preparation. You can choose bigger and more rare funding rounds, or smaller rounds, when you have the possibility to choose. Raising funds when you have no money left, in addition, may force you to accept the first offer on the table at unfavourable financing conditions.
The investor role affects your financing strategy. They might help you grow and influence future financing rounds, or push for a faster growth that would lead you to adjust your strategy.
What factors will then affect the possibility of being financed the most when your company is early-stage (and also increase your valuation)?
An Investment Readiness checklist includes:
- An Active customer base and large market
- Having a First-mover advantage in the market or Disruptive business model
- Receiving Interest from different investors and operating in a Popular sector
- Having intellectual property or a proven technology
- An Experienced and responsible team
- Ensuring that the Company in the future can be easy to integrate in a potential acquirer and can become independent from its founders
- Having a focused strategy, but with a variety of future expansion possibilities
Do we need financial plans to measure investment readiness?
The development of technology is uncertain: new industries can be created by the market leaders, the commitment and implementation skills of the team are difficult to foresee, and much of the investment decision comes down to negotiations. Considering all this, why bother looking into the numbers? Many believe that creating realistic financials for early-stage companies is not useful.
Especially for those with purely a technology and marketing background, trying to lay down financials may seem like a senseless activity. And the valuation may be just a vanity number to repeat to investors with no real meaning behind.
However, all of these factors that form part of a company’s potential can be measured, not precisely, but they are observable. The potential of the technology, industries and product-market fit not only can, but should be analysed, and different scenarios should be considered. Also, not all startups are Airbnb or Uber, many do not create new markets, but they may still grow to become strong and profitable companies. Investment decisions are taken under some specific return expectations of the fund.
As for the commitment and skills of the team: this is one of the most unpredictable risk factors in startups, and the one that takes longer, often months if not years, to assess properly. And even though there will probably never be a certain framework to predict which characteristics will determine success, many are looking into the subject, and every investor with experience has their own framework to select the right founders.
Financial projections, even at seed stage, can be done by the right people, and sometimes they can even come closer to reality than you might think possible. But what is more important is that they are not just senseless numbers, they can determine the success or failure of the startup. Projections can help in a variety of strategic decision, in finding investments or selecting the right investments.
The main purpose of the valuation, instead, is not just to provide you with a number. The process of valuing the company gives you fundamental information about your company’s future, when to plan fundraising rounds, and how to present return possibilities to investors. By understanding your financial projections, you can choose a suitable financing strategy and plan the timing for fundraisings where possible. Understanding that your value is a function of future profit, growth and risk (for you or your future acquirer) can shift your attention towards validating future strategies and potentials markets, and towards reducing risks, instead of focusing only on what has been achieved so far, or on how good your idea is: it creates more realistic expectations and leads to fairer negotiations on both sides.
Preparing your financials, first, helps you have a more structured approach to your startup, measure your ideas and progress as you develop your product. New ideas can be translated into numbers to measure their viability or to understand how to adjust new ideas to make them profitable or valuable to future buyers.
Your strategy is also relevant to your exit strategy, as you can choose whether you want to focus on maximising profits, on an early exit. Understanding what brings value according to your chosen strategy helps you focus on the right factors from early on, instead of getting off track. In fact, some markets and some expansion decisions carry some risk that may deter some investors, so an option that might look positive in the short-term could potentially be detrimental to the long-term strategy. This is not in contrast with the lean startup approach, but rather aimed at key strategic decision that may end up turning investors away and complicate a possible exit.
If you are ever planning to sell the company, you can prepare yourself in advance by reducing your risks, simplifying your structure and therefore maximising the company’s value over time. In this instance you can analyse your competitive landscape by determining the timing at which it is worth selling and by understanding how your valuation changes with time.
You can also understand your competitors better by assessing whether they are building value with branding, users, technology or other processes, and by observing their fundraising rounds or potential exit strategy. Then you can compare your USPs and measure whether what your competitors are doing affects your future strategy or exit potential.
Identifying suitable investors also means figuring out what type of investors can recognise the value that you see in your company. If you understand your financial strategy and landscape you can understand whether a rejection depends on your business‘s low potential, whether it‘s just too early for receiving funding, whether it’s not the right investor for you or whether it just depends on how you sold yourself. This is important to understand, as it’s typical for founders to overestimate their potential without even considering the need for investors to achieve a positive return, and blaming others for not understating this potential. It is also typical for others to get demotivated by rejections when they might be simply targeting investors not suitable for the company.
Of course, the first interest of the investor will not just come from the numbers that you present, but rather from different interests such as sector experience or sector popularity, referrals, market possibilities, team experience and so on. However, the financials will form part of your startup story and will be one of the main factors in the final decision-making. In fact, a good startup story is confirmed by numbers, and it is even more convincing when accompanied by thorough research.
Therefore, securing funds not only depends on showing how amazing your product is, but also on turning your company into a great investment.