Elements of a Fundraising Strategy

“While raising money for an entrepreneur can seem like a daunting task, there are actually specific steps you can take to make your company a more attractive investment.” 

An entrepreneur’s financing strategy should be grounded in a few key areas:

• Make sure that they understand when their cash runs out
• Understand what milestones have to be achieved to get a higher valuation
• Create the right plan to achieve those milestones in the right timeframe

1. How Milestones Impact Valuation

To understand why milestones are so important, let’s take a look at how startup valuations change over time. Like other investments, startup valuations are based on a calculation of risk and reward. Valuations increase as the level of risk goes down (or as the size of the perceived eventual reward goes up). In practice, risk is not reduced linearly over time, but instead changes in big increments when particular milestones are reached. These milestones could be things like customer traction; the hiring of a strong management team; or in the case of an internet business, when a monetization strategy is proven to work.

• The Most Important Milestone: Customer Traction. Usually the single biggest way to show that risk is being reduced is to show evidence of increasing traction with paying customers. If a significant number of customers are willing to pay for a product, that tells an investor many positive things:
  • The company has reached product/market fit
  • The monetization strategy is working
  • The technology works
  • The team has shown some ability to execute

However this can be a hard milestone to reach on one round of funding, so investors will look for intermediate milestones that help to tell them that risk is being reduced.

• Another Key Milestone: Repeatable, Scalable Sales Model. The second is a repeatable and scalable sales model. Reaching this milestone will greatly increase valuation, and attract growth stage investors who like to invest in companies that are ready to scale. Once a startup enters this phase, it will usually start to see its valuation increase linearly as a multiple of revenues or profitability.
• Additional Milestones. Other milestones that impact valuation are:
  • Hiring a great CEO with a proven track record
  • Hiring a strong management team
  • Reaching profitability
  • Becoming the clear market leader

2. Validate Your Milestones Increase Valuation

Validate with investor friends that the milestones you have picked to accomplish prior to your next fund raising will be good enough to warrant the valuation increase you are hoping for.

3. Mitigate Risks

If your company is about to raise funding, and you have very little time available, there are likely some quick steps you can take to decrease investor risk, and therefore increase your chances of success, plus get a higher valuation. In the early days of a startup, the nature of the risks can vary greatly from one startup to the next such as:

• Customer Traction Risk. The best example of this would be a company looking to raise a Seed or Series A round. Even in this early stage of the business, any proof of customer traction can greatly de-risk your startup and increase valuation.
  • Mitigation – Show Evidence of Traction. Demonstrate any of the following:
    • You have shown a wireframe mockup to a customers and they are willing to talk to investors and tell them that they plan to buy the product
    • You have shipped a beta of the product to some customers
    • Your beta customers are testing the product and reporting success
    • You have a large number of free users, and their engagement with the product is high
    • You have sold the product to a small number of paying customers
    • Your paying customers have put the product into production usage and are reporting success
    • Your customers are coming back and re-ordering, and recommending the product to their friends
• Technology Risk. If your startup is promising to deliver a new battery for electric cars that can hold 10x more energy, there is little risk that you will be able to sell the battery. Usually with this kind of startup, the major risk is whether the technology will work.
  • Mitigation – Bring in Technical Experts. A quick way to mitigate the risk (but not totally eliminate it), would be to get the top technical expert in the particular area of science to take a look at the scientific problem you were aiming to solve, and have them render an opinion that this technical approach should work.
• Execution Risk. Another startup might have significant execution risk, and their valuation might increase if they are able to hire proven executives that have a track record of great execution.
  • Mitigation – Consultants or Advisors. Bring in outside parties that have a track record of execution to supplement the team. For example, if a company is started by a strong business founder, but requires great software to be developed, that startup would become both more likely to get funding, and a higher valuation, if the business founder were able to attract a proven technical co-founder.
• Business Model Risk.Another type of startup might have shown great customer traction for its free product, but not yet have proven that it can figure out how to charge those customers. (e.g. the early days of Google, Twitter, and Facebook.) Proving that it can monetize effectively would increase valuation.
  • Mitigation – Third Party Validation. Get feedback and detailed statements from discerning potential customers or some other third party validation.
• Team Risks.You have an unproven team and it is not clear whether they can execute.
  • Mitigation – Advisors and Consultants. Bring in well regarded consultants or advisors that have a track record of execution.

Address these and other risks with specific tactics for mitigation.

4. Focus on Reaching Your Milestones

As a startup CEO, one of your key roles is to provide clarity and focus to the whole organization. The exercise above will bring great clarity to the milestones that the company has to achieve. Executing to these milestones should become the primary focus of the company. Don’t allow yourself to get distracted! The cost of failure is usually a down round, but can sometimes result in the closing of the company.

Valuations change based on milestones that significantly de-risk the business. Armed with this information, entrepreneurs should talk to investors to understand how they see the risks and milestones. Then plan and manage their business around achieving desired milestones before hitting their cash out date.