How does a startup raise capital from investors? (V2)

Overview

The purpose of this document is to provide an overview of how a startup can raise capital from investors.  You must prepare a custom plan for your unique situation.

There are four major sections:

I Are you ready for your Round X investor ask?

II Raising capital is an ongoing process with investors, until the final exit occurs.

III Round X investor ask

IV Company Data Pool

 

I Are you ready for your Round X investor ask?

You’re ready when you have your:

  • Purpose and WOW1 statements;
  • Executive summary;
  • Pitch presentation;
  • Business plan; and
  • Due diligence material.

Meeting investors will be all consuming of your time.  Things may move very quickly.  If you don’t have all of the above ready, two things will happen: 1) it will take you time to answer investor questions 2) you will present an unorganized and unready impression.  Investors will worry that you’ll manage and protect your money in a similar fashion.

II Raising capital is an ongoing process with investors, until the final exit occurs.

First you have to get ready to ask investors, which includes identifying target investors as well as the steps in the “Round X investor ask” described below.  Then you spend a focused few weeks contacting investors.  Interested investors will conduct due diligence.  Then there will be a legal and financial closing process to actually get the cash from the investors.  Of course you’ll continue communicating and working with the investors which includes ongoing two-way communications.  Meanwhile, you’re communicating with those who did not invest, as well as the broader investor community as part of getting ready for the next round of funding

Layout a plan of the overall process, recognizing that many things happen in parallel and evolve over time.  This is not a case of complete step A before starting step B

Prepare to ask investors

The objective is to get ready to ask investors for capital, and be able to respond to their questions.

The key things to do are:

  • Have a plan, both for this ask and considering future asks e.g. at a seed stage you won’t want to sell control of the company.
  • Prepare all of the material noted above.
  • Be clear on what type of investor you are targeting and why e.g. venture capital, high net worth individuals/accredited investors, government loans and grants, etc.
  • Be clear on how much you want, what milestones will be achieved with the funding, and what type of funding e.g. Debt, promissory notes, convertible notes, SAFE (Simple Agreement For Future Equity), convertible preferred shares, common equity

Ask investors

The objective is to have engaging interactions with investors and building your long-term reputation.  Investors should become part of your network and may invest in future even if they don’t do so now.

  • This will be a focused, all consuming, few weeks of time.
  • Have your target list of investors.
  • Have your network do introductions to the investors.
  • Hopefully some of your target investors will do introductions to other investors.
  • Manage the investor engagement process, which including documenting key points from each investor phone call and meeting.
  • Use CRM (Customer Relationship Management) software as the foundation for your long term process of engaging investors.

Term Sheet

A Term Sheet outlines the key financial and other terms of a proposed investment. Investors use a Term Sheet

to achieve preliminary and conditional agreement to key terms and conditions.  Once negotiations regarding the term sheet are complete and signed, then the final legal documents will be drafted, which will involve additional negotiations.

The term sheet is not intended to be legally binding, with the exception of clauses dealing with confidentiality and exclusivity.  The Term Sheet will usually define certain conditions which need to be met before the investment is completed

Have your own point of view as to what you require in a term sheet. E.g. what is non-negotiable vs what negotiable, what you’d ideally like vs bare minimum you’d accept vs you walk away.

MaRS here in Toronto has a sample term sheet, which illustrates what investors may negotiate.

https://www.marsdd.com/mars-library/term-sheet-template-for-angel-or-venture-capital-investors/

Due diligence

The objective is to enable an investor to conclude that they should invest.  In the case of a VC, this could be an investment letter going to the partner meeting for approval.  You also have to do a due diligence of the investors, if this was not done as part of preparing the target list of investors.  The investor questions will be answered by you sharing some of the information from the Company Data Pool, described below.

The most important thing is to manage the process.

  • Do not just send data room access to investors.
  • Always ask the investor for a 15 minute call to understand what the investor is looking for, what analysis would be most helpful, and what the best format would be. If the investor say to send over the data and they’ll call in future, decline the request, because there is insufficient investor interest to for them to invest 15 minutes of time.
  • What you are doing is trading information in return for investor-engagement and learning more about the investor.
  • The data room is critical for your team to have an organized location for all information, from which you can
  • It will usually be junior people at the investor analyzing the data.
  • Do not just give customer contact information to investors. Always offer to contact the customer and get her ready for a 20 minute call with the investor.

Negotiations will continue, based on the findings of the due diligence.

At this point, you must do your own due diligence of the investors, if you did not do so when you prepared your target list of investors.

Close financing

  • This will be a set of negotiations (based on the signed term sheet) regarding the final legal contracts.
  • The lawyers will have a closing agenda.

Work with investors

  • If you have investors that are providing more value than just cash, then you need to work with them to extract this value.
  • You have to update investors with the objective of ensuring no surprises to them. The updates can include: issues, talent changes, answering questions, press coverage, new sales and partnerships, milestones achieved in the past quarter, milestones for the next quarter, growth in customers and revenue, potential new challenges, any financial changes, include burn rate, working with the investor regarding their requests.
  • Communicate with investors who decided not to invest.

Prepare to ask investors for the next round of financing

At this point, you’re keeping the Company Data Pool up-to-date, than creating from scratch.

III Round X Investor Ask

Each round of asking investors for capital is similar in process and structure but the messages, material, and perhaps presenters, will be different.

Reaching out to investors with messages, is like a pyramid with every increasing amounts of information, as the investor spends more time engaging.

The top of the pyramid is your statement of your company’s purpose and your WOW statement.   The objective is to generate immediate intense investor interest within a few seconds by communicating the essence of your company.  You can use this when you “bump” into an investor, leave a voice mail message, beginning of your presentations, etc.

  • Your company’s statement is a memorable sentence or two that is positive and outwardly focused on how you benefit customers and society (e.g. Nike’s “authentic athletic performance” rather than “sell lots of shoes made in China.”)
  • Your WOW statement has four sentences. What do you do better than anyone else?  What is your unique advantage and who benefits?  How are you different from the competition?  A wrap up sentence concluding with a call to action with the investor.

Then comes the 1 (at most 2) page executive summary.  The objective of the executive summary is to generate sufficient interest to get a meeting with the investors. You only have at most 30 second of reading time to persuade an investor to take the next step with you. The executive summary will be sent to potential investors.

The purpose of the executive summary is to:

  • Provide a written quick reference guide to your business.
  • Generate investor interest by demonstrating the clarity of your thinking and written communications skills.
  • Enable the investor to talk to others about your business, using your executive summary.

The content of the executive summary should include:

  • Immediately grab the investors attention with 1-2 sentences that state your unique solution to a big problem. This could be you WOW statement.
  • Describe the problem or opportunity and how the customer will benefit.
  • Outline your solution, as the target customer perceives it.
  • Outline your solution from an internal company operating perspective.
  • Summarize the team (founders, critical staff) and what is their relevant experience. Include total number of employees.  Be clear on who is accountable for sales and who is accountable for building and operating the solution.
  • List your unique technology, intellectual property, and patents.
  • State your target market size.
  • Describe your pricing model e.g. yearly subscription per user.
  • Identify the competition and your unique competitive advantage?
  • List your current key customers and outline sales funnel.
  • State the investment ask. e. funding needed to reach the next milestone, and what will be done with the funds. Include short cap table. List current investors and total current investment.
  • Show the current monthly recurring revenue, and burn rate.
  • Show the website name and year/month of founding.

The format will be text and tables, not charts and illustrations.

The pitch process

The pitch is a face-to-face presentation and discussion by the founders with investors.

The objectives of the pitch are:

  • Convince investors why the company must exist.
  • Be memorable – the investor must remember you the next day. Otherwise you won’t be called back.
  • Be professional – look and speak as if you already are the CEO of a successful company. This includes your body language, how you stand, and how you speak.
  • Create a trust, confidence, and emotional connection between the investor(s) and presenters.
  • Create the excitement and interest in the investors to learn more, while demonstrating your oral presentation skills and ability to have a Q&A dialogue.
  • Be able to communicate with an audience that has no previous information about you. Assume that the investors are not experts regarding your customers, your industry, or your technology.

The objectives of the pitch deck are to:

  • Support your presentation. The pitch deck will have little value if its is read as a standalone document.
  • Help you tell your story and vision in simple human terms.

You need to answer the key investor questions:

  • What will you do?
  • Who are you?
  • How will you make money?
  • How much cash do you need and what will you do with it?
  • How will you manage the risks?
  • How does the investor feel about you? Do they like you?  Do they think they might be able to trust you with their money?

Your approach is:

  • Engage the investors emotionally with the story about the startup.
  • Make a great first impression. The first 2-3 minutes can make or break you.
  • Describe what’s been a great relevant experience for each member of your core team (10-15 seconds each)
  • Use charts and illustrations.
  • Maximum of 10 slides, which support what you are staying. What is critical is what you, and how you say it, during the presentation and during the Q&A.

 The following are the 10 slides.  The bulk of the investor impact will be due to what the presenters say, how they say it, and how they deal with Q&A.  The pitch deck supports the presentation and only contains a small part of what the presenters say.  This is why multiple dry runs of the presentation are required in front of a challenging audience to ensure that the presenters have a detailed understanding of their future business.

Slide #1 Cover slide

  • By the end of this slide, the investors have some idea of what the company does.
  • State your company purpose and WOW statement.
  • Show company name, location, presenters names and titles.

Slide #2 Company overview

  • By the end of this slide everyone knows what the company will do. The remaining slides show the details of how to do it.
  • State any brand names (customers, partners, investors, advisors) associated with the company.
  • What is the target customer need, problem, or opportunity?
  • State your value proposition: what types of customers will perceive what types of benefits to address which of the customer needs or opportunities.
  • What’s your target market, your unique solution (technology and intellectual property), your customer traction (launch date, current customers, revenue rate, pipeline).

Slide #3 Market opportunity

  • This draws upon your market analysis.
  • You are demonstrating that you understand the customers and the marketplace.
  • What is the size of the opportunity ($, # of customers)
  • What are current customer success stories and testimonials?
  • Are there trends which support your statement of market size?

Slide#4 The team

  • The objective is to have the investors feel that the existing core team can achieve the next set of milestones.
  • Who are the key members of the team and what their relevant experience and accomplishments?
  • Those milestones may include attracting additional talent.
  • If there are any existing major talent gaps, identify those as well as the actions to close those gaps.

Slide #5 The solution

  • What will the customer perceive? Hardware?  Software?  Services? A combination?
  • Do the customers need to change their processes, talent or technology or does your solution complement?
  • Don’t use acronyms and lingo.
  • How will you deliver the solution to the customer?

Slide #6  The business model

  • How do you make money?
  • What is your pricing model? Cost-of-acquisition? Gross margins?
  • How long does it take to make a sale?
  • What are your costs?
  • What are your assumptions?
  • What do you do if there are major variances from your assumptions?

Slide #7 Unique technology and intellectual property

  • You are demonstrating that it is not easy to copy your solution.
  • This can include unique team expertise and unique partnerships with others.
  • Illustrate how the technology will enable you to scale your business at low marginal costs.

Slide #8 Your competitive advantage

  • You need to demonstrate: why customers will change what they are doing today. There is a cost to change.  Often the status-quo is better than the costs and benefits of changing.
  • Why will customers buy from you rather than competitors? This is very different than pointing out all the problems that competitors will have.
  • Why do you have a sustainable and profitable advantage? Competitors will respond to you.  How will you deal with their response?  Competition and the market place are not static.
  • A check box matrix can show why customers will choose you over the competitors.

Slide #9  Go-to-market strategy

  • Who has already paid you?
  • Who is in your pilot program?
  • What your prospect pipeline? Letters-of-intent?
  • What’s unique or disruptive about your strategy?
  • What are your critical barriers and how will you overcome them?

Slide #10 Key Milestones and financing requirements

  • What have been the accomplishments to date, with the historical financing. This directly ties to the metrics in your financial projection.
  • What is your ask?
  • What milestones will the ask achieve?
  • Restate the purpose and WOW.
  • Restate the customer problem and your solution.
  • What are the key points you’d like investors to tell other investors?

The Business Plan

Let’s assume the investors are excited by your pitch and believe that your company must exist.  Then the investor asks for your business plan.  If you don’t have one at this point, the investor will not move forward and will believe that you weren’t prepared.

The plan must convince investors why they should make an investment.  The plan can be read by itself. It is not intended to be presented and looked at on a screen.  The document contains large amounts of information, which answer many of the investor’s questions.  This plan can be 30 to 50 pages long  This demonstrate that you understand in detail what you are going to do with the investors money.

BDC (Business Development Corporation of Canada) provides a business plan kit for startups, available for free download.  The following is a link to it:

https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/pages/business-plan-template.aspx

IV Company Data Pool

The company data pool contains all of the key information to launch your company, operate it, and raise capital.  From this data pool you can extract the information needed for due diligence. Founders, management, staff, board directors, and advisors may have access to select pieces of the data pool.

The data pool does not contain “working copies” of material.  It may contain draft versions of material

The contents of the data pool include the following:

The plan to raise money.  This includes the definition of the target investor, list of target investors, who will do the introductions, status if each investor.  Set up a CRM (Customer Relationship Management) process to manage the ongoing communications.

  • The executive summary.
  • The pitch presentation and supporting material.
  • The business plan and supporting material.
  • Ongoing sales, operating, and financial plans and reporting
  • The CRM process for customers, suppliers, etc.
  • Shareholders Agreement
  • Term Sheet
  • Due diligence material

The due diligence material will include:

  • Corporate records and charter documents
  • Intellectual property documentation
  • Securities issuances and agreements
  • Information regarding disputes and potential litigation
  • Information regarding employees and employee benefits
  • Equity Grants

What is an ideal investor?

  • Do they have the same values and interest in growing your business as you do? How soon do they want to exit?  What is their reputation?
  • Are they easy to work with? What do other founders say about them?
  • Do they have a relevant network: of other investors? Of potential customers or partners? Of talent that can help or join your team?
  • Do they have relevant industry expertise?
  • Do they have relevant business model expertise?
  • Do they have relevant functional expertise?
  • Do they have the financial capability to keep investing in future rounds?

You can download a due diligence template for planning and managing the creation of due diligence documents from https://www.fintelligent.com/virtual-cfo-services/due-diligence-checklist-raising-venture-capital/

You can download a due diligence checklist from Y Combinator

https://blog.ycombinator.com/ycs-series-a-diligence-checklist/

Who will be carrying out your ongoing financial and operational reporting? What software solution are you using?  Do you need audited financial statements?

What is your term sheet?

  • Common terms include: Who is issuing stock or note. Type of collateral. Valuation. Amount being offered. Shares and use of proceeds. What happens on liquidation or IPO. Voting rights. Board seats. Conversion options. Anti-dilution provisions. Investor rights to information. Founders obligations. Who pays for legal expenses. Nondisclosure requirements. Rights to future investments. Who signs.
  • Capital options: Debt. Convertible notes. SAFE (Simple Agreement for Future Equity). Equity. Consent to sell, first right-of-approval, tag-along.

What is your investor and company governance structure?  What decisions require shareholder approval?  What is in your shareholders agreement?  What decisions require board approval?  How are directors appointed?  How are disputes resolved?  What documented policies do you have for regulatory and legal requirements?  What documented policies and procedures do you have?

 What do you do if you are a SME (Small Medium Enterprise)?Z

This article is applicable to SME’s raising capital from investors.

 Conclusion

A lot of work must be done before the first investor ask.  Planning, organizing, and team communications are critical.

 Your next steps

To enable discussion with your team and advisors, download the following one-page slide:

How does a startup raise capital from investors 2018 12 20

Footnotes

1 Bill Reichert, “Getting to WOW.  How to create a value proposition that will dazzle investors”, Garage Technology Ventures, https://www.garage.com/resources/getting-to-wow/

2 SME Industry Canada definitions (2018 May 9): Small business: < $5 million in revenue, < 100 employees; Medium business: between $5 million and $20 million in revenue, 100 to 499 employees.

Further reading

There are many types of potential investors.  Tom Koor, “How can a private company sell securities in Ontario?”, Koor and Associates, https://koorandassociates.org/points-of-view/how-can-a-private-company-sell-securities-in-ontario/