How can founders better prepare their startups for funding success?
Investment preparation is usually associated with creating the investor pitch, compiling a list of target investors, and populating a data room. Founders then hope that the story of progress made and the exciting future ahead will be enough to attract big investors.
But we know that only a very small percentage of startups make it through the early stages of funding. For example, the graduation rate from Seed to Series A is just 1 in 5. To beat these odds, founders are constantly searching for new ways to prepare for investment so the proposition they bring forward is irresistible.
By inserting an investment readiness checkpoint a few months ahead of the funding campaign, founders can ensure they are on course to deliver the most compelling proposition to well-matched investors. This proactive step buys time to make any critical adjustments ahead of pitch deck preparation and align current investors with the funding strategy.
Timeline for an investment round
In early-stage investment rounds (Seed, Series A) investors typically look to provide sufficient capital to cover 24 months of expenditure. The idea is to give the startup around 18 months to demonstrate real progress, then 6 months to raise the next round.
Whilst timescales will vary depending on company circumstances, most boards usually begin discussing the funding plan around 9 months before the new round needs to close. Hopefully, some cash contingency is in place, so the target close date is not the same month the bank balance hits zero. Having a buffer of at least 3 months of cash burn is highly desirable.
With the funding objectives agreed, founders begin assembling the investor deck, listing target investors, and preparing the data room. Informal discussions with current investors then take place to test their appetite to participate. This can all take 2-3 months before the board finally approves the funding plan and ‘blesses’ the investment deck. The founder then begins reaching out to new investors.
The 9-month lead-in point can be a sobering moment. It may be the first time there has been a serious overall assessment of company progress. This usually incorporates a review of the key objectives agreed at the prior funding round. If things have not gone according to plan, this retrospective analysis - and what it implies for the forthcoming round - can lead to awkward discussions with current investors.
Out of necessity, a funding plan is eventually born. But it can sometimes feel like the product of an unhappy marriage if there is weak alignment between the board, the main investors (some of whom may be on the board) and the founder. A lot of haggling will have been required to converge on the amount to be raised, the use of funds, and a target valuation. By which time many weeks may have passed and the pressure to get out in front of investors will have become intense.
As a result, the investment proposition can often feel like a compromise compared to the founder's original ambitions.
But it doesn't have to be like this.
A framework for investment readiness
Founders can seize the initiative on the funding strategy by taking an important step ahead of this 9-month lead-in point: This is a review of investment readiness in the context of the next funding step and developing market conditions.
The power of undertaking this assessment before the board imposes a funding strategy is that it gives the founder time to consider funding options and address any critical shortcomings in the proposition.
To make this review as objective as possible, founders must step outside their normal operating perspective and look at the business through the eyes of an investor. In our earlier blog, Why VCs will ‘pass’ on your startup, we described a simple framework to help think about this:
The 2 major factors that will heavily influence funding success are:
1. the investors you approach (your audience), and
2. the investment proposition you present (what’s in it for them).
The order here is intentional.
The Right Investors are those that will be a true fit for your business. For example, they will be investing at the relevant stage (Seed, Series A, Series B..), they will be active in your sector, and they will be able to invest in your geography. Location is becoming a significant factor with the continued rise in cross-border investment, especially from US investors. There are other important attributes to consider, and we will cover more of these below.
A Strong Proposition is one that aligns with the needs of investors. It meets their investment criteria and is the reason why they will invest.
A "No" (a rejection) will either be due to a weakness in the investment proposition or pitching your story to the wrong investors, or both.
A “Maybe” is the general landing zone for founders that present a strong proposition to the right investor. If the stars ultimately align following due diligence, the final outcome should be a “Yes”.
The first rule of investment preparation must therefore be to ensure that you arrive at the start line of a funding campaign with a strong proposition and a well-qualified target list of investors.
Applying the Framework
At Duet, we call this early assessment of investment readiness, Investment Analysis. The focus is less about measuring progress against earlier objectives set by the existing investors and more about what new investors will be looking for and how close we are to meeting these.
This is a classic gap analysis and poses 3 key questions (in order of priority):
1. Who will be our target investor audience?
2. What criteria will they use to assess our business? and,
3. Are we on course?
The first step is to build a list of prospective investors based on their historical investment activity. Here we are seeking relevance. We don't want to waste time pursuing investors that aren't even a basic fit.
Relevance can be checked by analysing historic investments using the criteria associated with the company and the deal to be done.
In terms of company, we need to match stage of development, industry and sector, business model, and geographic location. In terms of deal, we additionally factor in funding stage (Seed, Series A..), and quantum (deal size). Finally, we refine the list down by selecting other preferences such as the type of investor, their location, assets under management (AUM), and dry powder levels within the fund.
The types of investors are a key consideration, and a founder may have particular preferences here. VCs, Family Offices, Corporate VCs, Asset Managers, Regional Funds, High Net Worth private investors, and other niche players can bring something different to the table in addition to cash. Each of these investor types will have different ROI expectations and will approach the process differently, so ensuring an alignment of interests is key.
With the target investor audience identified, a cohort analysis of the most relevant deals undertaken by these investors will provide insights into the investment propositions that have been successfully funded.
We then undertake a peer group analysis of companies operating in the sector. This reveals how competitors are positioned (via a market map) and also how they are funded. This is something that investors will undertake during due diligence, so forewarned is forearmed.
We finally look at the overall transactional trends, such as median deal sizes and valuations, that will inform our thinking on the funding strategy.
Through a series of collaborative meetings with the founder and key execs, we then compile an ‘investment scorecard’. This rates the company’s investment proposition across the key criteria we have identified.
The scorecard has a very similar structure to the analysis that investors will produce themselves during due diligence, ahead of their final Investment Committee meeting.
Our scorecard provides a top-level risk/opportunity assessment and is broken down into 4 key areas:
- The underlying Problem/Solution thesis (Is there potential to create a valuable business?)
- The plan to achieve Product/Market fit (Do customers love our product?)
- The Go To Market strategy (Can we efficiently scale?)
- The Business Model (Can we make money?)
From this analysis, a checklist of the most important investment preparation tasks to be addressed prior to the start of the campaign is then produced.
Based on these findings, founders can have greater confidence that they are creating the right funding plan. How much should we raise? When? Who from? What will be the use of funds? What milestone will it take us to?
Presenting such a considered proposal to the board on funding strategy, target investors, and the overall investment proposition - including new insights on competitive positioning - demonstrates leadership and puts the founder in a stronger position to deliver on their funding ambitions.
Founders that have undertaken Investment Analysis highly rate the experience:
“Investment Analysis provided a clear and insightful analysis of where our business was, and what we needed to do to deliver value, and grow. Those priorities are on my desk and the focus of my activities every week.”
“The Investment Analysis process provided great insight into the current funding market and an excellent critique of our investment proposition. This will assist in the further development of the funding strategy for the next round and to help ensure our state of readiness.”
"The investment analysis work that Duet does is first class, invaluable and worth every penny. I’d recommend it to any business looking to scale-up and seize every growth opportunity along the way."