October 2, 2020
What to Expect in Your Fundraising Process
Posted by John Kogan
Fundraising, whether venture, private equity, or private party (aka “friends and family”) is frequently written about, but rarely with the insight of those who have done it dozens of times, and in lay terms. This article will attempt to break down the steps from the perspective of a founder or CEO principally responsible for raising fund.s
1.) Build a Business
First, build a business. If you’re asking why that doesn’t come later, chances are you haven’t raised funding like this in the past decade or so (or ever). The fact is that much has changed in the last 20 or so years since the “dot-com” era where a founder could bring an idea to a venture firm and have at least some chance of getting funded. In those days it took massive amounts of capital in order to get a business off the ground, and you could legitimately expect to raise millions of dollars before going to market and seeing your first revenue dollars.
These days, the cost of the underlying technology to build a company is next to nothing. In fact, the biggest single expense to a truly early-stage company may be the founder(s) giving up whatever salary they made at their prior job. It is quick and relatively straightforward to develop technology and put it in the field to monetize in many industries. Of course, this is not the case in all industries. Sometimes you must create hardware-based technologies, which certainly requires investment, or invest in drug development or biotech precursors.
While all of those businesses may require significant fundraising before revenue, one still needs to go to funding sources with highly developed products or chemical compounds or a killer track record in order to have any chance to be taken seriously. Companies are expected to be further down the road these days than at any time in the past, and the expectation is that you will have gotten down that road on your own devices, frequently bootstrapping your way to IP development, early products and revenue traction
2.) Demonstrate Traction in the Market
If you are not on your first funding round but rather on some subsequent round, then you will need to have shown significant traction in product development, in go-to-market and in revenue. All of this needs to happen in order to provide the basis for the funding activity, which requires the valuation of something, some asset (product) or some going business. Real businesses have real intellectual property, real revenue, and very frequently these days, real traction in the marketplace, which provides something tangible for an investor to value and be the basis for your funding round.
3.) Research Possible Investors
Once you have built the beginning of that business or asset that has value, you can go about finding an investor. If you don’t already have access to investors who might have an interest in your industry or business stage, do your research. There are plenty of means to finding venture capital sources or related investors who might be interested in your business and industry.
Crunchbase is a good place to start. There you can find companies that are analogous to yours and look at who is funding them and who the direct competitors of those funding sources are in order to find a host of potential starting points. You can also go to other investor referrers, such as your law firm, your tax advisor, your CPA, or friends and family that you know have raised investor funds in the past. VC and private equity funds get too many bad ideas thrown at them to pay attention to just anything that comes in over the transom, so having a direct referral in, whether it’s from your own network or someone who knows and trusts you, is a major advantage.
4.) Draft an Executive Summary and Pitch Deck
In order to attract funders, you will need to be able to quickly and succinctly articulate your business idea, traction and future. You will want to build a one-page executive summary describing all of the above. There are plenty of examples of fundraising executive summaries out on the web. If you cannot pique their interest with the strength of your referral or your executive summary, you will not be able to get time on their calendar.
The follow-on to the executive summary is a pitch deck of no more than 15 slides. Like the executive summary, you can find many examples online. Your pitch deck has the same job as your executive summary, except it needs to go two layers deeper. You should be able to present the entire deck in 15 minutes, leaving 15 minutes for Q&A. It should describe your idea and/or your product, show traction in the marketplace or traction through analogs for your business idea, name top clients, give a sense of potential market size, and discuss your go-to-market strategy with solid ideas and reference points about how you will grow from where you are now to a truly massive, successful company.
You will also need a financial forecast that holds up under questioning. The forecast is the economic instantiation of the story you are telling. It must have revenue that makes sense, operating expenses that fit the go-to-market activities your company will need to undertake, show margins that are reflective of reality, and highlight the investment funds you will need and when you will need them. Investors read financial forecasts many times a day and are fluent in the language. Your forecast must be fully backable and the CEO and CFO must be fully conversant on all drivers in order to remain credible. That’s not to say you are expected to tell the future, just that you understand your core economics and what it will take to succeed. If you can articulate this, they will expect you can adjust as your business meets reality in the market.
5.) Value Your Funding Round
If you manage to attract some interest in funding your company, one of the more interesting dances in the business world will then occur, which is negotiating the valuation for your contemplated round of fundraising. The valuation is what determines how much of your company you will give away in exchange for some amount of money. Don’t let anyone tell you otherwise, it is a negotiation with guardrails. Those guardrails tend to be the broad-based investing parameters of whomever you’re speaking to.
For example, a venture fund may not invest in companies without being able to take at least a 10% ownership position, allowing them to have a meaningful equity stake a few rounds down the road once your company goes public or gets sold. That 10% is a firm barrier which they might not go below. Once you understand that the negotiable elements are valuation and ownership in exchange for capital, you will realize that the math around dilution for your company’s equity is actually fixed within a fairly narrow zone, with rare exceptions.
You should familiarize yourself with multiple fundraising round dilution math so that you can understand how critical it is to raise the right amount of capital at the right time, such that by the time you are done building your megacorp, you will still have enough ownership remaining to realize the financial part of your business building dream. Don’t forget that each subsequent round of fundraising will likely require you to expand your stock option pool in order to force the dilution of a stock option pool on you and existing investors so that your new investors do not need to immediately take the new stock option pool dilution once they have closed the round with you. This will definitely impact your dilution math and your ownership percentage.
6.) Sign the Term Sheet
Once you have negotiated the valuation for your coming round you will be presented with what’s called a term sheet. This will lay out all of the high-level funding expectations from your perspective investor, including the aforementioned valuation, the amount of money they expect to put into your company, whether they expect to have rights to put additional capital into future rounds, investor information rights, anti-dilution methodology and other factors. The real details will come later, once you have both signed the term sheet and the lawyers turn the term sheet into multiple funding documents that determine all of the rights of the investors and the invested company. This process can take many weeks or even a couple of months.
For the company, true leverage begins at the second term sheet. Once you have competitive bidding for your funding round you can play the parties off one another or, potentially, have them join forces and come in on a larger round together.
It is important to realize that either party can walk away from a (typical) term sheet. Term sheets are “non-binding”, meaning they do not have the force of a contract. Thus, both parties have to remain “in love” during the dating process that is due diligence.
7.) Undergo Due Diligence
Once the term sheet is signed and locked down, you will go through what’s known as due diligence. Due diligence is the process whereby your potential investors get comfortable with what they think they know about your business. Note that at any point in the due diligence process, they may determine they don’t like your business now that they know more about it or they like it less than they thought they did. This may lead them to reduce their valuation, thus costing you more equity in exchange for their investment, or they may reduce the amount of funding they want to bring to you, or they may simply walk away. Until the funding documents themselves are signed, either party can walk away at any time. Thus, the due diligence process is absolutely critical for the success of your funding round.
During the diligence process you will need to produce any number of documents describing your product, your go-to-market program, your customers, your customer support, and any and all revenue, go-to-market, or product information you have available. You will certainly need to provide some sort of business plan or company forecast. The further developed your business is, the more thorough this forecast is expected to be.
The very valuation of your company will, to an extent, be determined by how convincing your business model is. Not just convincing in terms of whether they believe it, but convincing in terms of does it make business sense, and does it show you building a massively scalable, massively profitable enterprise. A great business forecast can make the difference between a strong valuation and no round at all.
This is a learning process for the investor, and you will find that any VC or private equity investor will dig deep into your company in order to learn more and gain confidence in the investment they are contemplating. They may ask to speak with existing investors, service providers, employees and customers. It is an invasive procedure.
8.) Celebrate a Closed Deal
If you make it to the end of due diligence and documentation, which are frequently engineered to complete at the same time, you will hopefully get to a closed deal with funds hitting your bank on the deal closing date. That is an incredible day, celebrated by all. Everyone also realizes that the work is just beginning. Funding is not an end point at all, just the ability to continue your hard work of product development and growth on your long journey to a successful company.
Great finance partners help with steps 3 through 8 of this process. They should be right alongside the founder/CEO, helping with process, analysis and forecasting. The founder/CEO will be busy driving the front-end of the business and being the key person the investor is funding. A great finance team puts the founder/CEO in position to effectively present the business and close a successful round. That’s finance done right.
Have questions or want to learn more about how we can help you successfully navigate the fundraising process? Visit our FP&A page to see how our experts can help your organizations.
John leads the Finance Performance Improvement practice, where he helps clients with strategic finance outsourcing, executive search & finance technology solutions. He is passionate about helping CFOs become strategic leaders and make the finance organization a genuine weapon for their organizations.