Start-ups often rely on their founder’s ambition and investment, however, there comes a time when outside capital is needed to finance further growth, execute a full or partial exit for owners, or optimise the capital structure.
Many successful fintechs looking to accelerate growth arrive at this crossroad and, whilst access to finance may not always be a challenge, determining which route to take, and when, can be.
Below we cover the 4 stages of the capital raising process and some of the key things you should keep in mind at each step.
- Seed Capital
You have a great business idea and when you put it to the test it’s a success, but you’re not sure if you have the resources to get it properly up and running – so what do you do?
Firstly, take a step back and consider how much you actually need. A common misconception – and one that can inevitably become a pitfall down the track – is that at the early stage, start-ups need large amounts of capital to grow.
Founders are surprised when they hear that they should be frugal at this stage of development, seeking funding in the thousands, not millions. Start-ups should layout and understand their minimum cost requirements before seeking any external investment as this will benefit you in the long run.
Key Characteristics of the Seed Stage:
- Valley of death
- Pre-revenue cash burn
- Valuation is at its lowest
- Family, friends, and fools
- Dilution is at its highest
- High-risk investment
- Back the person not business
- Investment in thousands (not millions)
- Angel investors.
Key things to keep in mind during this stage:
- Focus on fine-tuning the business concept
Investors are looking for two critical things: a great concept and a great founder. As investing in a start-up is high risk, potential investors want to see that the business idea is unique, scalable in the real world and is led by an innovative and charismatic founder who can drive it to success. At this stage, you should be proving concepts and developing your Intellectual Property (IP). This will increase your valuation and help in the next round of funding – it’s critical you capitalise on your intangible assets.
- Balancing your capital investment needs against ownership dilution
In the early stages when risk is high, business valuation tends to be at its lowest. As larger capital investments often come in exchange for a larger piece of the pie, this means you could be giving away much more of your business’s ownership and potential value than you’d expect.
When considering a seed capital investment, ask yourself:
- Ensuring the structure is right from day one
- What activities do you specifically need the investment for?
- What is the minimum amount you require?
- What other market opportunities are available?
- How much equity in your business are you willing to give up in exchange for funding?
- What grants and incentives are available?
Having the right structures, governance frameworks and processes set up from the beginning can save your start-up significantly in the long run. For example, a start-up with the incorrect tax structures for its growth trajectory can be faced with sudden and unforeseen tax liabilities later down the track.
Some questions you could ask yourself are:
- Are my systems and processes scaleable?
- What is my exit plan? Do I want to list or sell my business?
- If my business is to grow rapidly, do I have the skills, experience, and structures to support and run a much larger company?
- As the business grows, am I prepared for the new reporting obligations?
- Should I start the audit process early on?
- What type of governance framework do I need?
- Venture Capital
By now your business is up and running and you’re past the ‘valley of death’, however, you are still considered to be in the early stage. While you’re growing your customer base, to really scale up and accelerate growth you may require a substantial up-front capital investment in the millions.
This is where venture capital firms come into the picture. A ‘venture capital’ (VC) investment is exactly what it sounds like – a high-risk investment or punt into a promising, early-stage business. As VC firms seek businesses with significant growth potential, it’s vital you have a proven concept and a good understanding of your business model and profitability. It’s also important you ensure that the goals of your potential investor(s) align with your own. VC investors are often looking to be actively involved in the growth of the business for the long haul (up until the business is sold or goes through an IPO).
Key Characteristics of the Venture Capital Stage:
- Investment in millions
- Dilution minimised
- Moving into revenue
- Developed market (local and global)
- Minority stake
- Still early age
- Valuation improved
- Detailed information memorandum, business case & financials.
Things to keep in mind:
- Now’s the time to get on top of your numbers
Investors are now looking beyond a great concept or founder. They now expect a profitable and scalable business opportunity. It’s vital to build a detailed information memorandum, which includes the business case and detailed financials. At this stage, you may consider employing a CFO or an outsourced CFO.
- Know your investors
While Australia has a decent start-up culture, opening your mind to foreign markets – such as the U.S – may give you exponential growth at this stage. Internationally, the VC global market is very developed and sophisticated when compared to the Australian VC market.
- It’s not just about the money
Partnering with the right investor is crucial. Not only is it a long-term commitment, but choosing a good VC investor can bring many benefits to your business outside of capital, including, greater business expertise and experience, and access to new customers, markets, industry groups, and talent. It’s essential to remember that the relationship needs to be mutually beneficial – you should seek a savvy investor who can offer you more than capital.
- Private Equity
Similarly to VC investors, private equity (PE) investors are looking for businesses with a strong growth trajectory. However, the difference between them comes down to risk. VC investors will take a punt on a good idea, whereas PE investors will be looking for businesses with a proven track record and the opportunity to continue significant growth.
The general goal of the PE investor is to invest in a private business where they can rapidly grow its value in around 3 to 5 years, then sell the business at a higher price, maximising their return on investment.
In Australia, the private equity market is very developed with investors particularly interested in businesses within the technology, healthcare and food and agriculture sectors. The major challenge for tech companies is that PE firms are looking for the top 3 in any segment and they rarely invest sub $30 million – where many tech firms sit. However, as more family offices and high-net-worth individuals are looking to invest in tech, there may be more opportunities on the horizon for smaller businesses.
Key Characteristics of the Private Equity Stage:
- Strong management teams
- Profitable requiring growth capital
- Partnering for growth & exit
- Sophisticated markets
- Global market
- Typically controlling stake
- Family office entering PE market
Things to keep in mind:
- Set your management up for success
Private capital and equity investors’ level of everyday involvement within the business will be limited. However, they do want to back an experienced and driven management team who can quickly put their invested capital to work.
It is important to:
- Identify gaps in skill-sets and knowledge, and rectify them
- Overcome the tunnel vision of founders
- Find incentives to motivate management
- Cash is still king
At this point, you need to ensure cash flow is optimal and take steps to ensure it is correctly managed. This influences everything, from your tax structures, financing abilities, to your everyday viability. At this stage, investing in forecast financial modeling is necessary to demonstrate your current and predicted value and it adds to your credibility.
- Identify and mitigate risks
Make sure you address any potential risks that your business could face later down the track and mitigate them. These could include, improving information systems to prevent data breaches, regularly reviewing your management and governance structures to detect and mitigate organisational risks and maintaining good relationships with suppliers and external stakeholders.
If you’re a tech company with more questions about dealing with private equity, please see our guide for software companies here.
- Equity Capital Markets
While equity capital markets encompass more than just initial public offerings (IPOs), they are typically the ‘end goal’ for many founders to exit – opening up a whole new world of capital. The IPO process is a long journey that involves complexity at all levels – from stringent regulations of the ASX; to needing buy-in throughout the organisation; right through to managing perceptions of suppliers, customers, and the wider public. There are alternatives to an IPO, including a trade sale, which comes with its own pros and cons. We recommend seeking advice at this point in the process, as shareholders often run a ‘dual-track’ trade sale and IPO process to create competitive tension and increase exit value.
Key IPO Characteristics
- Access to capital growth
- Higher public and investor profile
- Secondary marketing for the company’s shares
- Greater operational efficiency
- Reassurance of customers and suppliers
- Aligning employment and management commitment
- Institutional investment
- Valuation improved
- Currency for external growth.
Things to keep in mind:
- Due Diligence and internal controls
Companies listing on the ASX will go through a due diligence process, which is made easier with robust financial record keeping and internal controls. At this stage, it’s imperative that financials are audited.
Some other things to consider:
- Is my CFO able to handle a public offering? Sometimes, legacy CFO may not be equipped to deal with an IPO.
- Do I have the right internal financial systems in place?
- Do my current board members meet public company requirements?
- Are all my contracts and previous equity agreements correctly documented?
- Operational Efficiencies
Operational efficiencies go hand-in-hand with due diligence. An entity must be fully running like a public entity well before it becomes one. The extra layer of scrutiny means that having the right systems and processes, as well as policies and procedures – such as I.T, and cybersecurity is critical. This includes streamlining technology for greater efficiency and removing any obstacles to growth like human error.
- Corporate governance
Strong corporate governance is key and the board must act in the best interests of the organisation. They should also be able to articulate and understand their value drivers and present them to the public in a transparent way.