We break down the stages of a start-up’s lifecycle, typical funding needs at each stage, and who to approach for capital
When should you approach potential investors? In this section, we help entrepreneurs think about the timing of raising capital
Valuing a start-up is one of the hardest and most contentious aspects of fundraising; we introduce the concept and examine several valuation methods
Here, we discuss what makes start-ups appealing to investors, which will allow you to better under- stand what funders look for when evaluating companies
Every entrepreneur needs to put together a pitch deck to present to investors; we highlight the most important components to include
Before we get to the fundraising, the following is a brief overview of the signs of a successful start-up. These are things that an investor will want to see when thinking about putting money into your company.
According to Sam Altman, one of the most experienced start-up mentors in the world, there are four essential components to a start- up: the idea, the product, the team, and the execution. Luck plays a big role, too, but that is clearly not something that is within the control of the founders.
Ideas are key to setting the company’s vision and to creating a com- pelling story around the start-up. While many companies end up pivoting as they develop their product, moving away from the company’s founding ideas and establishing new ones, creating a unified vision for the start-up is not only a good way to focus every- one in one direction, it also makes it easier to sell the vision of the company to investors.
Once you have a good idea, you build a product around it; this is what customers actually use or buy when they are interacting with your company. A successful company will be able to translate a good idea into a great product, and will listen earnestly to early users, taking into account their feedback and understanding how the product is being used (regardless of how it was intended to be used). Indeed, it’s not just the product that investors are examining. They also consider the product-market fit: does the product satisfy a demonstrable need in the market?
One of the most important success factors for any start-up is hiring the right team. The first few employees of a company will often make or break the company. Do look to hire only when you are desperately in need of new employees, and recruit from your personal networks first, asking your friends and acquaintances to put you in touch with high-performers they have worked with. Do not be afraid to give your first employees a relatively large chunk of equity, as they will be the ones who will make the company succeed, and do not be afraid to quickly fire people who are not working out.
Execution means putting everything together. This is the crucial aspect of the CEO’s job: making sure the team is focused, motivated and growing. It means managing the team in a way that maximises the employees’ efforts, and manages disagreements among team members. It also means setting clear, measurable goals so that pro- gress and employee performance can be evaluated. Keeping these four components in mind is useful for all start-ups, and especially those that are looking to raise money, as investors will organise their thinking around the same themes – is the idea any good? How about the product the company built around this idea? What about the team? And how focused and motivated is the company to exe- cute its vision?
One of the most important decisions you need to make is when to actually begin approaching investors.
Each start-up is different, but nearly every start-up should be boot- strapped for as long as possible; there is no point in giving outside investors equity, paying for admin and legal fees, and spending time (that could be spent working on your product) just for the sake of fundraising. If you can get your company to profitability without raising money from outside investors, you should.
The decision on when to fundraise also depends on the founders’ connections and experience in the start-up industry. If you have exited several companies in the past and have connections to inves- tors, then the timing of the fundraising process will be different than for someone who is a first-time founder.
Most, however, are not experienced entrepreneurs, and do not have the ability to bootstrap the company indefinitely. That means they will need to seek investors sooner or later. The good news is you can raise money fairly early on in a start-up’s journey. As long as you have a strong idea, and do some work around putting together a pitch deck that explains how this idea will become a viable business, you may be able to approach (relatively small) investors. It typically takes three to six months to raise funding from investors; sometimes, a lot less or a lot longer. Depending on how much money you have in the coffers, you will probably need to start looking for capital at least six to nine months before you find yourself strapped for cash.
One thing to keep in mind is that it is better to aim low and raise more than you had planned, than aim high and lose face when you do not quite meet your goal. Ideally, you will only need to raise funding just once from outside investors before you reach profitability; however, this is rare. More realistically, you are likely to raise money for the next one to two years, and will need to fundraise again after that.
The documents you will need depend on the stage of funding you are in, and who you are approaching. If you are looking to raise money from a grant-making institution or an angel investor, you are likely to get away with a one-pager articulating your idea and why it is important now, as well as a pitch deck. If you are going to a private equity firm or a bank, you are likely to need a detailed business plan, financial projections, etc.
As this guide is geared more toward younger start-ups and first- time entrepreneurs, we will focus on the documents they will need to show when going to investors.
Generally, they will want to see a comprehensive one pager that outlines a business idea and how the company plans to build a compelling product around this idea, outlining current and future challenges, and how to get around them. Entrepreneurs should also include a pitch deck – a set of slides that they can use to showcase their ideas, traction, and market opportunity to potential investors.
The one pager is an important document that every entrepreneur should spend time to get just right. This should be a mini-business plan, and should include a succinct overview of what the business is, what problem it is solving, and how you plan to turn your idea into an appealing product. Include charts, images (including your company logo), and graphs as much as possible; but, do not forget to clearly articulate, in writing, the purpose of your business and how you plan to execute it. This is a document you should be able to leave behind and have someone want to read, so do make sure to balance substance with visual appeal.
The second document every entrepreneur will need to prepare is a pitch deck. Singularity Investments, which invests in businesses in Africa and North America, recommends 10-12 slides in the following format:
Additional slides investors may want to see include: traction to date, use of funds and investment instrument sought, and exit route.
For both the one pager and the pitch deck, a small amount of customisation/tweaking to better fit the investor can go a long way. For example, if the investor is known for wanting to see how the investment may effect social or environmental change, add a slide (or at least a few bullet points) about how your start-up may do that.
Remember that as soon as you raise money, expectations will shift. It is no longer just your money and time. Investors will expect increased reporting and tracking, as well as formalized record- keeping and the like. Do not be unreasonable, and do not make empty promises, but do come across as optimistic, hopeful, hungry, and ready for the increased scrutiny of the business.
Valuing a company is a highly important part of the fundraising process especially when raising money through equity. It is also, however, imprecise and highly difficult. This is because many start-ups are in the ideation stage, and it is nearly impossible to value a company that has few assets besides an idea and the prom- ise of commitment by a few eager cofounders. One way to avoid this question early on is to consider convertible debt, a form of mezzanine funding mentioned above. At some point, however,
it will be necessary to determine your start-up’s value.
Valuation and why it matters is important for every start-up up to understand. This is because it affects not only the company’s short- term prospects, but can also have important ramifications down the line.
We provide a basic example to introduce the concept, and to explain why it is important.
Of course, one of the key questions is how does the investor obtain a certain valuation and, hence, the shareholding he or she accepts in the business. Many factors come into play to determine this, key among them being the cash flows a company expects to make, current performance, and even the number of investors interested in the deal.
There are various methodologies used to come up with a company valuation. The key ones include: discounted cash flow (DCF), multiples based, and assets-based methodologies.
The DCF methodology computes the cash flows the start-up expects to make in future and discounts this to the present. This means taking all the cash in the future and making adjustments for inflation and risk to find out the value of these cash flows as at present. The discount rate is a highly debated variable, and it will be set by the funder when evaluating the investment. It is a good idea to create several scenarios with different discount rates and therefore different net present values; make sure you can explain the reasoning behind the different scenarios.
The net assets valuation approach calculates the total value of the tangible assets it has. For start-ups, this would usually result in the lowest valuation, since most start-ups do not own a lot of assets – it is the intangible assets like the idea, the potential, and team talent that excites investors.
It is important for each entrepreneur to note that the final price in a deal is a combination of the valuation and negotiation between the investor and entrepreneur.
The multiples approach compares similar start-ups to obtain the valuation. This would mean if one start-up – similar to yours in terms of sector, size, business model, etc. – with sales of $20k is valued at $100k it implies a value to sales multiple of 5 ($100k/$20k). If the start-up is truly similar to yours, you can use this multiple to value your start-up. Assuming your start-up had sales of $40k its valuation would therefore be $40k x 5 = $200k.
Do not raise more than you can handle! Many investors we inter- viewed in Nairobi warned against raising too much money too quickly. If your valuation is high early on in your company’s lifecycle,
investors will expect you to show similar (if not faster) growth when you raise money again in the future. If you cannot justify a rise in value, you may need to settle for a down-round – an investment that results in a lower company valuation than previous rounds. That not only leads to unhappy investors, but can also seriously hurt employee morale.
– What you need to do before fundraising
– Overview of 10 investor types
– Mobile Lenders
– Accelerators & Incubators
– Angel Investor Networks
– Impact Investors
– Public Funds
– Venture Capital Funds
– Private Equity Funds
– Funding Cycles & Stages
– The Come-Up
– When to Fundraise
– Get Your Pitch Deck Ready
– V is for Valuation