How do I access funding for my start-up? If you’ve asked yourself this question, you’re not alone.
At one point or another, most businesses hope to access funding. When asked what the biggest challenge start-ups and small to medium businesses face, the answer is the same, whether you’re in the United States, Europe or Asia: funding.
Here’s the kicker though. While businesses say access to funding is a challenge, funders say they’ve got the cash – they just can’t find the right businesses to invest in.
So, how do you become a business that funders will back? More than that, how do you become a business that funders are clamouring to give their money to?
Here are three key questions you need to be able to answer if you want to score investment funds.
1. What is the funder’s mandate?
This is an area that many business owners don’t consider, but it’s an important one. Just like start-ups, funders and investment firms are not one-size fits all. They have specific mandates they follow, industries they favour and returns they are looking for.
For example, an impact investment firm will only invest in businesses that are solving a social need or challenge. A tech-focused venture capital firm will not invest in a manufacturing business. Understanding the fund, their mandate and their industries they focus on is critical.
Simply approaching any investors without knowing if your business suits their focus will give you a reputation within the market that you’re a time-waster.
Key questions to consider:
- Have you researched the funder and gone carefully through their website?
- Do you know exactly what they’re looking for in an investment?
- Does your business suit their mandate?
- Have you researched the other firms in their portfolio?
- Have you reached out to those firms and asked them their experiences with the funder?
- Are you only interested in capital, or the network and mentorship that comes with investment
2. What different types of capital are available to you?
There are many different types of capital available to businesses and start-ups, starting with bank finance all the way through to venture capital and private equity capital.
This is known as debt finance, which means you need to repay the loan and the bank makes its return through interest payments. It’s often called the cheapest form of finance because you do not give away any equity in your business to access it.
When you apply for a loan, understand that the bank will need some form of surety against the loan, and they will want to see your financials to ensure you can meet the loan repayments.
Accessing finance should help you to grow your business and is therefore part of your ‘cost of sale’. It should not be used to cover debt – using debt to cover debt will end up in a debt cycle.
There are many alternative funders that focus specifically on small and medium businesses. They can be slightly more expensive than bank finance, but they are specialised. They understand specific sectors and small businesses in a way that banks often do not, which means you may be able to access finance when other avenues have been unsuccessful.
Just like banks, alternative funders will want to see your financials to ensure you can repay the loan.
Many fintechs are alternative funders – they use algorithms to determine your finances and whether you can afford the loan. If you want to utilise an alternative funding product, it’s important for your financials to be in order.
Angel investors invest in their personal capacities. They are more likely to invest in start-ups within their networks and they aren’t always as concerned with high returns as more formalised investment houses are, such as venture capitalists and private equity firms.
Angel investors, like venture capitalists and private equity investors, are equity investors, which means they give capital in exchange for shares. This is often considered more expensive capital, as giving away equity can amount to significantly more down the line.
Venture capital firms
Venture capitalists (or VCs) invest in businesses that they believe will give them a 10x return, or ten times their investment. The aim is to exit the business within five to seven years at a significant return.
This means that VCs focus on businesses that have the ability to scale, or grow quickly to a much bigger and more profitable business. If you cannot demonstrate how you will scale, it’s unlikely you will be able to access VC funding.
Many very good businesses that are profitable and sustainable don’t suit the VC mandate because they lack this crucial aspect.
While private equity firms are also interested in the growth potential of businesses, their capital tends to be more patient, which means they are willing to wait longer before they exit. They also invest in firms that they will be directly involved in. Many PE firms install board members and even executive managers in the businesses they invest in.
Key questions to consider:
- Do you want to access debt funding or investment funding?
- Have you considered the pros and cons of the different types of funding available?
- Are your financials in order?
- Can you show how your investor will make their return?
- Can you prove how you will repay your loan?
- Have you carefully evaluated all of your options?
3. Is your business investable?
Having an investable business means that you have built a business that funders can invest in. You check all the boxes according to their very specific criteria.
This means two things. First, you need to know what those criteria are – what do they care about, and what are they looking at.
The good news is that most funders list their criteria on their websites and investors themselves will often write or speak about the things that are most important to them when choosing to invest in a business. In other words, the data is out there, you just need to do your research.
Second, you actually need to check the boxes. Build a pitch deck that speaks to their key concerns, but more importantly, ensure that all those concerns are addressed in your business. If they aren’t, it could be one of two things.
Either there isn’t a good match between your business and the funder, but there is a better match for you out there, or your business isn’t investable – yet. Start addressing those key components and relook your investment plans down the line, when your business is ready.
4 Ways to Become Investor-Ready
There are many different components that investors look for, but here are four good places to start.
To determine all the different elements you should address over and above these, research each specific fund, the individuals in the fund and speak to other businesses they have invested in.
1. Your numbers
Do not even set up a meeting with potential investors unless you know your numbers like the back of your hand. Your financials reveal a few key things about you, your team and your business that investors are evaluating.
- First, it proves you understand how your business is going to make money, when you will breakeven, and how much it’s going to cost you to get there.
- It shows you understand your market and what they are willing to pay for your solution
- Investors want to know that your business is financially stable. A founder that does not know exactly what is happening in their organisation down to the cent does not inspire confidence in this area.
- In order for investors to get the returns they are looking for, your business needs to grow financially, in terms of top-line and bottom-line growth. If you don’t have a firm handle on your numbers, how are you proving this growth?
Top tip: You don’t need to be an accountant to have a firm grasp on your numbers. You can take a course and upskill, but the most important thing is to be reviewing your financials daily until it becomes second nature to know exactly what is happening in your business at all times.
2. Your team
Here’s how you can review your team. On a scale of one to ten, rate everyone according to these five Cs: Communication skills, courage, the ability to cut it, everyone’s level of conviction and how much they care. The higher their scores, the more you know you have a team that investors will gravitate towards. And investors do care about the team – they know that success doesn’t just rest on the founder, but on everyone’s ability to execute on the vision, together.
- Are there leaders in the business who can lead and manage people?
- Are there a range of necessary skills across the business? (remember, no person can be everything to everyone)
- What is the background experience of the team and who has domain experience? (ie who has intimate knowledge and experience in the industry you’re operating within?)
- Do you have a range of technical skills and commercial skills? (ie who is building/developing your solution and who is selling it?)
3. Your traction
Traction is all about whether your business is making sales (and therefore money) at an increasing rate. Investors will look for whether there is a reasonable amount of money coming into the business and if the figure can be grown. They will be looking for revenue growth each month, proving that the business is on an upward curve.
- Do you have traction?
- How can you encourage or support further growth in the market?
- What are you currently doing to drive sales?
- These are all key areas funders will look for – traction is an important aspect in any business, but for investors looking to 10x their capital, it’s one of the most critical figures they will examine. Without strong traction the business cannot scale, and the investor won’t make the returns they’re looking for.
4. Target addressable market
Also known as TAM, a target addressable market is the sum total of the market you can focus on. The rule of thumb is to first find a market you can dominate. It doesn’t have to be a big market, it just has to be one that you can own.
For example, for Facebook it was the university campus – one single university campus. Facebook is what it is today because it focused on the niche first, and the broader market after it had dominated niche markets.
- Audiences are select. You need to prove you understand this. Target audiences need to be broken down by groups, subsets of groups and even subsets of those groups. The more specific you can be, the better.
- This is a short-term and long-term play, and you can unpack both for the investors in the room. The long-term play is the whole target audience once you put all your dominated subsets together. It’s this vision that the investor is interested in. The short-term play is that you can prove that you understand your audience well enough that you can target a niche rather than a broad market.
Funding red flags and how to avoid them
The 5% trap. This is a strategy that most investors have seen more times than they care to count. A key element of the 5% trap is looking at target audiences with broad strokes. For example, assuming that everyone who has an Apple iPhone will be interested in downloading your app. In 2018, more than 217 million iPhones were shipped worldwide.
5% of this is 13,5 million – if each of those users bought your app for $1, that’s more than $13 million dollars. On paper it sounds great. The reality, however, is that you haven’t taken anything into account regarding who those users are, and why they will care about your app.
Are they English speaking or Chinese speaking? Male or female? Millenials or boomers? What are their hobbies and where do they live? What do they spend their disposable income on? Investors are far more interested in hearing those details than being told you can capture 5% of a huge market with zero details of who makes up that market.
Focusing on your solution instead of the problem
As an entrepreneur, you’re not only passionate about your idea, you believe in it with every fibre in your being. This is an essential ingredient in your ultimate success (never lose that passion), but it’s not what customers will pay you for.
What they care about is what you can do for them. In other words, what problem do you solve? When you lead with a solution, you’re not painting a picture about your end user. You’re not placing your business in the real world, solving a real problem that will earn real revenue.
Not calculating costs versus revenue
You can sell a product or service for $500 and make 1 000 sales a month equalling $500 000, but if it cost you $495 to product and sell the product, the you are only make $5 per item sold – which is a 1% margin, and you don’t have a sustainable business. Your costs are as important as your revenue projections, and investors will want to see everything.
Before you approach funders, keep this in mind – not all businesses are built for funders. There are hundreds of thousands of very successful businesses that serve their founders, employees and customers well, but cannot necessarily scale in the way that investors are looking for. If your business is in this category, enjoy it – but don’t tie yourself up in knots trying to access something that will never be.
Similarly, if your goal is to access funding, take these tips seriously – they will give you the foundations you need to build a scalable business that funders will back.