Large and established companies typically have little issues in raising capital as they are highly sought after by conservative investors. Further, as previously discussed, raising funding for startups and smaller companies is primarily dictated by how much they can de-risk the opportunities for investors.
Here, we want to focus on the intricacies of raising capital for medium-sized companies, and the mistakes many companies make when seeking financing that may see them refused the capital they need.
What Kind of Companies are we talking about?
These companies are past the startup stage as they have some years of operations, financial performance, and track record under their belts. They tend to rely heavily on the CEO and the founding team for ideas and business development, they often lack a fully built-out succession plan and are typically funded by a limited group of private investors. Annual revenues for such companies usually range between 1 million and 25 million United States Dollars.
They are growth-focused, but the cash they generate is not always enough to make their expansion dreams come true. These dreams may include entry into new market segments, expansion into another geographic location, or hiring highly skilled and specialized resources. They are essentially bootstrapping their business, and need external funding to scale their operations.
Although they seem attractive and investible, they are often unable to convince investors of the credibility of their investment cases and are thus unsuccessful in raising funding through the capital markets.
If this sounds like your company, you might be making one of some of the following mistakes when trying to raise the capital you need to scale:
- Not crafting your business story in a concise and compelling way
- Approaching the wrong type of investor
- Not showing how your business survives without you
- Failing to credibly articulate sustainable competitive advantage or market positioning
- Not procuring and monitoring customer and supplier feedback/testimonials
- Not having financial information and other supporting documentation ready to provide to investors
- Being too aggressive and idealistic with financial projections
Not crafting your business story in a concise and compelling way
You lost me at “Hello”
This is about fine-tuning your pitch.
Your story is the hook. This is where you provide an executive summary of your purpose, mission vision, and growth plan for the business. The combination of your passion and focus are the key ingredients here as it is important to get the investor on your side from the jump.
There is a sweet spot for what is not too little information to generate interest, but not too much information to cause boredom and confusion. Sophisticated investors are less likely to invest in opportunities they do not find interesting, and ones they do not understand. CEOs of many mid-market firms struggle with this balance and tend to err on the side of over-sharing and providing too much minutia.
Approaching the wrong type of investor
There are various types of investors with different goals, levels of sophistication, analysis criteria, and attraction factors that must be evaluated. For this reason, it is important that your company seeks out the most appropriate type of investor given the current stage of your business:
- Angel Investors – Angel investors tend to be wealthy individuals with strong entrepreneurial backgrounds. Businesses seeking angel financing tend to be in the infancy stages of the business life cycle, and often have little to no profitability.
- Venture Capital Investors – Like angel investors, venture capital investors invest in early-stage businesses with little to no profitability. VC investors are often represented by institutions, including funds, corporate investment arms, and high net worth family offices. As such, VCs usually require a proof of business concept as a prerequisite to investing, which may not always be the case for angel investors who provide seed capital at the idea stage of a business.
- Banks – Lenders must be told clearly what and how much funding is being sought. It is also helpful to include your company’s plans, based on securing the required funds. In other words, the financial forecasts should include the effects of the cash inflows/outflows resulting from the funds being secured.
- Credit Unions – Credit unions are often regional-focused and smaller in scale than large commercial and corporate banks. As such, they can often be a viable funding option for SMEs.
- Private/Alternative Credit Providers – If your company is seeking to manage working capital by discounting your receivables, secure asset-based financing for equipment purchases, or flexible long-term funding for general corporate purposes, alternative credit financiers may be the best option if the strict lending criteria of banks and credit unions are prohibitive for your company.
- Private Equity (PE) Investors – PE investors acquire equity in established, profitable companies of varying sizes that fall within the growing or mature portions of the business lifecycle. They tend to be sophisticated, financial investors representing private equity funds, investment arms of corporations, and high net worth family offices. PE investors typically target an annual return of at least 20%, or at a minimum; to double their money within a 5 to 7-year period.
Not showing how your business survives without you
We delve into this in another article, but for now, here are the main points to consider:
- Skillset and autonomy given to your company’s executive management
- Depth and breadth of experience of your board of directors and company advisors
- Reliance on the CEO for day-to-day operational activities and decisions
- Level of onboarding and ongoing training given to your staff
- Existence of a succession plan for the business’ leadership
Failure to credibly articulate sustainable competitive advantage or market positioning
A company not understanding its market and its competition lacks credibility and provides a potential risk to investors.
Sophisticated investors perform detailed due diligence before arriving at a financing decision, and companies should know all the answers and then some. When seeking investment, a company must be an expert in their industry, and must certainly know more than the investor.
Companies that do not display full knowledge and appreciation for their competitive landscape seldom advance to the next stage of investor due diligence. Remember that you are asking someone to give you money to run your business, so you better know your business inside out and be able to spot changes in market trends and advancing competitors before they negatively impact your bottom line and your investor’s returns.
Your company’s competitive advantage can be displayed through:
- Product differentiation
- Barriers to entering your industry
- Wide variety of customers with no customer comprising more than 10% of your annual revenues
- Wide variety of suppliers that reduces your reliance on any particular provider
- Strategic partnerships – arrangements between companies, organizations, or persons of influence within particular industries or geographies to help each other or work together to make it easier for each to achieve their desired goals
- Intellectual property protection
Not procuring and monitoring customer and supplier feedback/testimonials
An investor’s job is to evaluate how you generate revenue, how you source and provide the goods and services to your customers, and the likelihood that you will be able to continue to do so in an increasingly profitable manner.
For this reason, it is crucial to continuously monitor and address feedback from your customers and suppliers and be able to use this feedback to enhance your credibility with investors.
Consider this example: A company is trying to raise financing in the capital markets, but its customer reviews on Facebook are negative. The company is not monitoring its Facebook reviews and therefore appears to be unresponsive to these clients. The investor is concerned by the negative reviews and moreso by the lack of awareness of the company. They are unlikely to win that investment.
Another company, however, demonstrates how they use logs, documents, and records to isolate feedback and data from every customer phone call to determine what they are doing well and what they need to work on. This company is more impressive to the investor as they are seen to be more agile and responsive to customer needs and opinions.
Not having financial information and other supporting documentation ready to provide to investors
This affects confidence by making you look unprepared.
This is common with younger firms who do not yet have their internal financial and governance controls firing on all cylinders. Requests for information from financial institutions are sometimes met with resistance and delays which can cause loss of investor momentum and interest.
Funding requests usually do not progress to the next step of due diligence with an investor until this is resolved.
Impress your investors and save yourself some time lost to back and forth by keeping your financial information and records up to date, even with a smaller or younger company.
Being too aggressive and idealistic with financial projections
When dealing with investors, the adage “It is better to under-promise and over-deliver” comes into play. Many companies want to impress investors with their figures and projections, showing how they are going to create amazing returns. However, it is better to project conservatively and then deliver the pleasant surprise of even better returns than predicted.
While projections are not a crystal ball, the practice of stress-testing your company’s financial projections enables you to have a clear picture of what the company intends to accomplish and the costs to do so. This reduces the likelihood of missing your projections. Also, important to note is that investors prefer to invest in the company as it actually is, and not based on a possibly overstated projected value.
For example, consider a company with a significant market share in its industry and multi-year contracts with established corporate clientele. The company has had linear growth over the past five years but is convinced that it will grow exponentially over the next five years.
The linear growth projections would make this company highly attractive for conservative investors seeking stable and predictable cash returns. Those same investors could be spooked by aggressive forecasts that cannot be upheld by past performance. For this company, it is a better bet to rely on more conservative projections. If exponential growth happens, everyone wins, but if it does not, the investors will not be disappointed.
Not engaging a professional to perform a valuation of the company by clinically assessing the key value drivers and detractors in the business.
Third-party professionals add credibility.
Typically, when clients submit their own financial projections and valuation, they are extremely aggressive with an underappreciation of the risk of achieving such projections. A valuation professional should be consulted to challenge the company’s projections and valuation assumptions before approaching investors.
Further, the equity offering should be priced attractively considering this company valuation. The valuation should be used as a starting point for negotiations, not the end goal.
The business of raising growth capital is the business of credibility. In a future article, we will discuss what is needed to correct these mistakes and present a credible investment case.