No one ever said entrepreneurship was easy. Sometimes it seems that for every financial hurdle you overcome, a new one awaits.
This is particularly true when funding a start-up. Many business owners find that there are several cycles of fundraising: even after a large initial investment puts you on the right path, your ability to take business to the next level is, frustratingly, just outside of your financial reach. And there lies that familiar hurdle: you need more capital.
While there are many strategies to help determine the best source for raising capital, it’s just as important to take a strategic approach so you’re poised for success before engaging in fundraising discussions with potential financiers. Whether it’s an angel investor, bank, or venture capital or private equity firm, a successful outcome can hinge upon how prepared you are in the diligence process. I’ve found that the closer you adhere to the following five rules, the better your chances of getting the funding you need, when you need it.
Rule 1: Don’t Move Ahead Without a Valid Business Model
Have you evaluated your business model since its creation? If not, now’s the time. Chances are, your business model was originally built in either Microsoft Excel or a similar type of tool. But is that model still viable? Is it coherent, and driven by key variables and assumptions? A static spreadsheet lacks the ability for a potential financier to change assumptions and variables to truly gauge your business’s viability.
Here’s another reason to have a well-built business model in place before engaging in discussions with prospective sources: If you lack a proper model, the third parties looking at your business may create their own model of your business based on their interpretation. Transferring ownership in this way diminishes your ability to control the process, especially as you walk someone through your key levers and variables. Not only that, but your business model can (and should) be the best tool for your own education; helping you evaluate all the facets of your own business and how they influence your funding decisions.
Rule 2: Cash is King – So Prove It
Your prospective financiers will essentially want proof that you have a controlled and calculated approach to cash management. Tighten up your short- and long-term cash flow forecasts to make them accurate and presentable and be sure to include the following key elements:
- What’s your true cash burn? Determine how much cash you need, when you will be needing it and how you’ll apply it.
- Map out your projections, month by month. A monthly cash flow schedule that forecasts out about 36 months is recommended.
- What’s the optimal amount? There are many ways to approach how much cash is needed. For example, this may be based on immediate need and stage of product development as well as desired dilution levels by founders and investors. Whatever your reasons, back them up with a well-defined cash flow forecast to use as a foundation for decisions.
Rule 3: Don’t Wait to Get Your Books In Ship-Shape
Are your books in order? Are your accounting records clean and closed? For rising business owners, it’s easy get stuck in forward-thinking mode before giving attention to the financial occurrences that have happened to date.
Keep in mind, those early-stage issues don’t just disappear. This includes technical accounting issues that need to be resolved and implemented, or other accounting rules that may have been overlooked in your company’s early days. For example, let’s take the handling of software development costs for a technology company. Is this expensed or capitalized? Are there other specific rules that should be in place for your industry? Before engaging in discussions with potential funders, it’s a good idea to correct and close the loop on lingering issues to ensure your records are accurate and current.
Rule 4: Organize Your Documents and Procure a Data Room
Building on the rule above, you must be organized before approaching third parties for capital. For small business owners or sole proprietors who may not have sufficient internal controls in place, poor record-keeping practices can resurface in a way that negatively affects the diligence process. Be sure you locate any missing documents and have all of your revenue and vendor agreements available and in one place.
Essential to your organization is the procurement of online data rooms to house and manage your diligence items. Many early stage companies are not aware of electronic data rooms and go the route of emailing schedules back and forth with the parties making the diligence requests. Such a process is inefficient and leads to version-control issues and missing requests. Online data rooms not only solve for this; they offer another distinct advantage during the diligence process: they allow you to track who is looking at (and when they are looking at) your documents. This provides insight on how things are progressing, and gives you a sense of what a diligence party is focusing on.
There are many companies online that offer electronic data rooms, with fees as little as $100 per month. Here are a few set-up tips:
- Use multiple electronic data rooms. It may be common for larger or public companies to have one data room for sharing – but for smaller businesses at this stage, it’s best to have separate data rooms. Why? Each prospective financier may have slightly different diligence requests, and having separate data rooms will help you manage and fulfill each “customized” request list. This strategy also helps you avoid sharing extraneous data that may be applicable to one source but not another.
- Load permanent documents first. Start with static items such as incorporation documents, legal documents and prior-year financials. Then, to avoid duplicating your efforts, hold off on loading the documents you know will change on a constant basis leading up to the actual diligence request. For example, if you plan on raising money in a few months from now, it’s best to wait to load your current month’s YTD schedules as they will need updating.
- Designate a point person. Too many hands in the cookie jar leads to miscommunication and multiple versions of responses. Without a data room gatekeeper, potential financiers will be supplied with differing information — or worse, no information at all. Having one designated person as the official tracker of all requests helps avoid this.
Rule 5: Too Much to Manage? Raise Your Hand for Help
It’s a bit of a Catch 22, really. Far too many start-up companies are focused on obtaining more funding yet are insufficiently prepared for the fundraising diligence process. Most new business owners lack the time, resources and tools needed to gather and prepare critical financial items; the very necessities upon which a funding decision may be based.
In these cases, seeking outsourced help — prior to initiating funding — will likely be a worthwhile investment. An outside perspective can also provide valuable insights on key business elements that can help your business grow, such as your cash flow forecast, a sound business model and books that are clean and orderly. Is outsourcing finance and accounting the right move for your your business? Here’s a few tips to help you decide.
Like I said, entrepreneurship isn’t easy. I hope these tips help put you on the right track to procuring the funding you need to take your business to the next level. And keep in mind, 8020 Consulting is always here to assist you throughout the fundraising process and beyond, so don’t hesitate to contact us at any time. And don’t miss our follow-up blog post: Business Fundraising Success! Now 5 Things You Should Do Immediately.
About the Author
John Woolard is a CPA with over 25 years of diverse, hands-on financial and operational leadership experience in entertainment, technology, retail and distribution environments, including CFO, VP of Finance, and Controllership at companies ranging in size from early start-up through middle market as well as Fortune 500. He has worked very closely with Venture Capital firms and the raising of multiple rounds of financing and negotiation of lines of credit with banks, and has helped grow companies from early stage to maturity.
Categorized in: M&A Due Diligence and Transaction Support