Raising a seed or pre-seed funding round can often be an entrepreneur’s first experience of raising cash for growth equity. Every deal is different, every cap table is different, and every investor-entrepreneur relationship is different. But understanding the key characteristics that define each investor “group” can help make the process of signing the deal and getting the cash, as quick and efficient as possible.
When it comes to raising your first round, it’s not just about knowing how, it’s about knowing who. Doing your investor “due diligence” is vital; but before that, asking some key questions about the type of money you want will help filter out the playing field when it comes to who to approach.
In this blog post, we look at three key investor groups offering growth equity funding at the early stages:
1) private angels or angel syndicates investing their own money
2) venture capitalists looking for the next unicorn (in the long term)
3) private equity houses deploying institutional funds.
Before considering which group suits you best, it’s worth asking the questions …
1. How involved do I want my investor to be?
2. How much and what kind of communication do I want with my investor?
3. What expertise do I need to support my growth ambitions? What specific experience would I like an investor to have?
4. How much flexibility would I like around succeeding/failing to deliver on my plan?
5. How fast and steep do I anticipate my growth trajectory to be? (And what kind of return can I expect to offer when?)
6. What, “loosely’, do I see as my “end goal?”
7. Do I want an investor who will continue in a follow-on round?
8. In a joint round, how many investors, with what share of the business would work for me?
Answers to these questions differ across each key investor category; private angels and syndicates, venture capitalists, and private equity houses administering VCT funds. Below, we explore what you can expect from each.
Involvement and Communication: Different angels will have different expectations on how much they expect to contribute. Some will keep completely hands off, while others may want weekly updates, or expect to have certain decisions run by them. If they are sat on the board, they might only expect to give advice once a month at the board meeting. Some will be happy to whatsapp, others might expect a more formal or distant approach. Establishing that from the outset will prevent confusion down the line.
Expertise: Some angels will have invaluable advice in a specific sector; often entrepreneurs end up accepting a lower valuation in order to bring in someone with a proven track record in a sector or vertical. Even if they don’t, their contacts or network will be useful at key decision points post raise.
Flexibility and return expectations: Angels will vary in their willingness to allow management to change tack or sacrifice growth/revenue to exploit new opportunities. This will likely depend on their time horizon for a required return. Demonstrating an understanding of, and having an open conversation around what you expect that return to be, will help inform opinions on how much flexibility they will be happy to stomach.
Follow-on round: Angels with varying ambitions and commitment may or may not be happy to consider a follow-on when the next raise comes around. If this is something you want, make it clear.
Involvement and Communication: Venture capitalists will likely take an observer or participating seat on the board and are focussed on supporting what is right for you, as the entrepreneur, and the business. They will likely provide input and advice where required on important decisions, and their communication style will usually be flexible and relaxed. Getting an idea of how the relationship will function pre-deal is important.
Expertise: Venture capital firms are often made up of professionals who have built and exited their own business. Research the backgrounds of the team at the firm, and where you can, reach out and speak to their portfolio businesses about what, as investors, they bring to the table.
Flexibility and return expectations: Venture capital firms focussed on early stage businesses typically invest smaller amounts for a smaller equity stake, and traditionally look for big returns over a longer time horizon. They will take a “portfolio view” meaning that of a certain number of investments, only 10% may need to make it big, with the understanding that the others may not succeed. For that reason, they are less wedded to a tight delivery of the business plan than Private Equity houses and can allow for sacrifices in growth or revenue in the short-term in order to make longer-term gains.
Follow-on round: Venture capitalists are often stage specific, with a key set of criteria on ticket size and equity stake. Where you can, get an understanding of what their limits would be for following on, and what their preferences are for leading or supporting on joint rounds.
Involvement and Communication: Private Equity (PE) houses, even with VCT funds, have a lower risk profile than Venture Capitalists. Their investment managers – who will likely be sat on the board - will be answerable to an investment committee behind the scenes. Understanding pre-raise of how much contact and answerability investment managers expect in between board meetings is helpful.
Expertise: Private Equity houses are usually generalists and their experience will most often come from working with their portfolio businesses. Investigating, and if possible speaking to a PE house’s portfolio companies (and those they have exited from), will help to understand exactly what PE houses will bring to the table other than money.
Flexibility and return expectations: Private Equity houses typically have an investment horizon of between 3 and 7 years, over which they will be looking to make a 3 to 5 x return. Because of this relatively tight turnaround, traditionally they will expect their portfolio businesses to deliver on their plan quarter to quarter. Where they fail to, investment managers will look to see an alternative plan to hit the numbers.
Follow-on round: Where you can, get an understanding of whether the PE house likes to lead the round, what their preferences are on joint rounds and whether they expect to consider following on.
We understand that raising cash for growth equity can be a daunting process, but we hope this blog post can help you set realistic expectations of each investor category to support you in the early-stages of your funding journey.
Written by: Eleanor Simmons, Consultant at Whitecap Consulting
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