So after reading the first post in this series, you’ve now learned about what mistakes to avoid when you’re seeking funding. But you must be thinking, OK I know I need to pitch to investors, but is my company investable?
You’ve decided you need to pitch to investors; that’s great. One of the first things I work with clients on is their overall “investibility”, i.e how attractive will your deal be compared to other investment opportunities? Hopefully, this work doesn’t involve putting “lipstick on a pig” and that your product, market, etc. are all strong. Anyway, assuming this is true, let’s discuss how we can structure your investment opportunity.
After years of business coaching, and sitting on various boards, there are always a number of considerations to take into account. I’ve compiled a list of the top 5 considerations you should make about your company’s investibility.
5 considerations about your company’s investibility.
1. Founder Shareholdings Should Be Reasonable.
Clearly, this varies situation by situation but at the end of the day the investors that are putting their hard-earned cash into your business and (hopefully) making your dreams come true, actually deserve a “fair” deal.
Sure, you came up with this amazing business and you have invested thousands of unpaid hours getting it to this point, but that’s not the same thing as cash. Does your work have value?
Absolutely! Every investor understands and recognizes that the founder’s sweat equity and genius, there would be nothing to invest in. But the ratio has to be reasonable and fair, for now. And here’s another thing to consider: You may be the founder but you may not be the CEO forever. Often times—particularly with high-growth startups—the founding CEO will not be the CEO who scales the company beyond the startup phase. Investors want to make sure you don’t have “founderitis.”
Founderitis is what we call a founder’s ego getting in the way of the company’s growth plus the founder refusing to step down/step out of the position they hold. Admit that you know what you don’t know and be prepared to be replaced for the benefit of all of the shareholders – including you!
2. Who’s Got The Chequebook?
I heard a wonderful/terrible story years ago about an investor that made a substantial (mid-6-figures) into a tech company with three founders. He loved the tech, the market, and the guys behind the story.
He was happy to write them a cheque, certain that this would propel them forward and make everyone a lot of money. That is until he came over to the office the following week and saw three brand-new BMWs parked in front.
Sure enough, the “guys” had gone and celebrated their “success” by leasing new toys instead of spending the investment money on moving the business forward.
Needless to say, the leases were cancelled right away and the investor now insisted on personally countersigning each contract and cheque over $500. Adult supervision required…
3. Control Isn’t Just About Shares.
Make your capital structure simple and easy to understand, with one or two classes of shares and simple rules for investment. Transparency and simplicity.
Given such experiences such as the one above, investors are justifiably nervous about how their money is spent. So, in order to be transparent about finances and alleviate any potential concerns up front, I usually recommend we set up a structure that contains most of the following elements:
- an independent CFO,
- an independent Board,
- a third-party countersign on all material contracts and expenditures,
- agreements in advance about milestones and rewards, and
- frequent check-in meetings.
4. Can You Be Successful with Less Money?
All investors, of course, want to know how much money you need to scale your business, but you had better know:
- what you intend to spend it on (also called “use of funds”)
- and whether you could grow your business with less money.
Can you scale with less, and what would you be sacrificing as a result? It’s actually a very good idea to have multiple budgets and financial forecasts developed in your business plan so that you can address different growth models for scaling your business.
Investors want to see their money used to move the needle for the company – achieving revenue, key hires, new technology investments, growing sales, making profits, etc.
What they don’t want to see (in general and there are always exceptions) is their money being used to retire old debt, especially if any of this money is going into the founders’ pockets!
This makes all sorts of sense when viewed from the investors’ perspective.
5. Anti-Dilution Protection.
Most venture financings will, at some point, include a negotiation about anti-dilution provisions and will likely include a weighted-average adjustment in case dilution occurs after the investment is made.
Why would dilution happen?
The most common reason is that you, the business owner and your Board, decide you need more financing. This isn’t always a positive event.
Future financing sold at a price lower than in the prior round is called a “down round”. Therefore, many investors will insist on protection via anti-dilution provisions in the event of a future down round.
According to a US private-company financing source:
“Up round financings dropped significantly in Q2 2018, falling from 81% in Q1 to 68% of all financings in the quarter—a low not seen since 2013. The share of down round financings in the quarter went up sharply, from 7% in Q1 2018 to 18% in Q2 2018. Flat rounds were also more common in Q2 2018 than in prior quarters, up from 11% in Q1 2018 to 15% of all financings in Q2. An increasing number of later stage companies that have failed to meet investors’ high expectations have had no choice but to raise money at flat or lower valuations.”Source: Entrepreneurs Report
The question that many entrepreneurs haven’t thought about is: My investors are protected from dilution in a down round, but what happens to the rest of the company? Unfortunately, the holders of common shares are the ones who will be impacted the most and are actually diluted twice in a down round — first the normal dilution from raising additional funds and then additional dilution to cover the dilution for the last group of investors that got the anti-dilution provisions.
If you want any more information about any of this, or you are thinking about financing your growth-stage business, please contact us for a no-obligation introductory meeting – we would be happy to help!