Discussions About Preparing Your Financing Strategy
We discussed the importance of finding out what works in your business model and then creating an operating plan with a detailed cash budget. In this discussion we help you determine the capital you will need for financing the growth strategy you outlined in in a previous Article.
– But, exactly, how much money do you need?
– When do you need it?
– How do you value your venture and structure a “good” deal?
– Who are the best investors for your deal?
– And what are your financing alternatives?
A concise financing strategy threads these important elements together.
If you are looking for outside funding, you are not alone. We found that 49 percent of the CEOs leading the Inc. 500 companies, who raised later-stage financings, got it from venture capitalists or other private-equity investors.
But entrepreneurs leading an emerging growth venture face a myriad of challenges: an ever-increasing pressure for recruiting and retaining skilled workers, the need to defend against new entrants, and shortened product life cycles that demand higher investments in R&D to continually pioneer and introduce new products.
As a result, today’s average venture-backed company needs to raise some $16 million of venture capital during its first five years, and complete five or six financing rounds to get from start-up to a liquidity event. This is a 129 percent increase from the amount raised by the average five-year-old venture capital-backed company in 1985. And the median number of months between financing rounds is about fifteen months.
The fund-raising process can ruin a venture’s prospects if it is not prepared for the harsh realities inherent in the process itself. It cannot be done casually nor can it be delegated to another party. The process can drain the entire venture team’s time and energy. In fact, about 25 percent of the CEO’s time and 20 percent of the time of those reporting directly to the CEO will need to be dedicated to raising capital during the first four years. Not knowing this critical fact, many of the venture teams and entrepreneurs we have worked with over the years first show us their business plan, and then ask us to help them with their financing strategy.
It could not be more backwards. You need to have a financing strategy before you do the business plan, but you don’t actually start to seek financing until you have your business plan complete. In fact, your business plan communicates not only your vision and business strategy but should also complete and support your financing strategy. You need to be prepared and take the necessary steps to ensure that you get the capital you need to fund your growth strategy, when you need it, and most importantly on terms that do not sacrifice your future upside.
Steps to Preparing Your Financing Plan
Complete your projected financials. They will be used to analyze and model the effects of integrating the operating plan you first created in a previous Section and your sales forecasts and revenue model from a previous Article.
Determine the funds needed to support a 5 to 7 year growth strategy we discussed in Article. This includes funds for capital investments in property, plant and equipment (PP&E), and working capital investments for inventory, human capital needs, and marketing and sales expenses.
Forecast funds available to you over the next five years. This involves the funds that your venture will generate internally as well as those which must be obtained from external sources like venture capitalists, strategic partners, founders, and board members.
Establish a system of controls for governing the allocation and use of funds within your venture, making sure that the basic financial plan is carried out properly. This often includes the hiring of a Chief Financial Officer (CFO) to develop procedures and practices.
Establish the field-tactics and timeline. Utilizing your advisors’ connections, develop a list of potential investors, prioritize that list and begin knocking on doors. Bring your advisors into the feedback loop and discuss potential investors’ objections. Revise the financing plan, while expanding the networks and contacts as needed.
Is Your Financing Strategy Realistic?
First, do you truly know how much is needed to finance the long-term growth of your venture? Knowing the answer to this before you meet with investors is key. As Michael Hirsland, a general partner with Boston-based Polaris Ventures, says, “We are more interested in the total capital needed for the life of the company.” And is it realistic? For example, the typical average sought by entrepreneurs from angel investors is about $750,000, with a range from $50,000 to $5 million.
Also, consider the fact that Cisco Systems got launched with $1.8 million and Yahoo was launched with some $1 million. How much can you capture from your retained earnings? eBay was self-funded from day one; it did not need outside funding but needed the credibility of being venture-backed. When the $5 million check arrived from Palo Alto-based Benchmark Capital, co-founder Pierre Omidyar proved this by depositing it in the bank, “where it remained untouched.”
Second, although bad things will happen to your business overnight, be advised that good things take time. Desh Deshpande, chairman and founder of Sycamore Networks, advises entrepreneurs to set a deadline—decide to spend six months raising money and make sure to go all out: “If there are no investors that you pick up along the way then you should probably reconsider the venture and maybe even try to come up with something new.”
Finally, understand that the path to getting financed is neither clear nor predictable. The financing strategy should be driven by corporate and personal goals, by financial needs, and ultimately by the available alternatives. However, it is the entrepreneur’s relative bargaining power with investors and skills in managing and orchestrating the venture drill process that actually govern the final outcome. So be prepared to negotiate with a financing strategy and complete financials.
As James Stancill writes in a classic Harvard Business Review article, “It’s impossible to know exactly how much a new business will need during its first five years, but it is possible to come up with realistic estimates.”