When Is Your Company Fleshed Out Enough for Investors?
When you are raising money from venture capital (VC) investors, you have to plan your major activities three years in advance. This is important because you have to communicate your plans to investors.
Although investors are often smart people, they can’t read your mind. You have to spell out your thoughts. Looking at the big three-year plan and visualizing all the development that needs to take place over that time can be overwhelming. Time passes quickly, and if you have a good plan in place, you’ll be ready to seek capital quickly.
When your company is in early, developing stages, you need to find a balance between the things you must complete before talking to investors and the things that you can save until later.
Use risk profiles to measure company stage
In the course of its growth, your company will hurdle some major milestones, like launching a beta website and securing your first paying customers. By achieving these milestones, you change the company’s risk profile and value.
The more you can reduce risk by making these accomplishments early on, the more value you add to your company, and the more attractive you become to investors. How many and what kinds of milestones need to be overcome before you become attractive to investors is unique for every situation. Your main goal is to demonstrate sufficient traction and execution ability to compete with other companies for venture capital investment.
Therefore, when determining whether your company is mature enough to approach VCs, you need to think about those milestones. Risk profiles are different for each company.
For the most part, investors — whether angel investors or VCs — are fair and understand risk. Generally, they’ll be comfortable with a certain level of risk, but the risk level changes the conditions under which they’ll consider investing in your company.
Many VCs won’t even look at your deal until you have a revenue run rate of $1 million per year or more. At this point, their risk is reduced because the company has demonstrated its ability to produce and sell its product or service. Seed stage investors will take on more early-stage risk, and their business model takes this additional risk into account.
By overcoming risk milestones, you are increasing the value of your company and the number of investors who may be interested in your deal. The trick is to approach potential investors when your company is in the investors’ favored risk zone.
Match investor type with company maturity
Who you talk to during fundraising depends on the development stage your company is in, because different types of investors invest during different stages. Venture capital investing is highly specialized, so some firms specialize in seed stage investing ($500,000 to $1,500,000), and others only look at later stage deals at $5,000,000 or more.
Furthermore, many VCs specialize by industry. You don’t want to talk to a VC in the healthcare space about a new solar technology. For that reason, knowing who to talk to can save you a lot of time and increase your confidence that you’re focusing on the right fundraising strategy.
A typical progression of funding rounds begins with bootstrapping rather than seeking outside funding and ends with multiple VC rounds. Here’s an outline of what you might expect at each stage:
Stage 1: Bootstrapped company: This is the pre-investment stage. Entrepreneur(s) work to develop a concept and may provide funding out of their own savings.
Stage 2: Friends and family round: First fundraising comes from people the entrepreneur knows because it’s too risky for professional investors. Entrepreneur needs to raise enough money to get to an angel/seed round.
Stage 3: Angel capital/seed round: In this stage, you’re building traction. The company has proven itself with early development and needs to raise enough money to attract institutional VC investors in 12 to 18 months.
Stage 4: Venture capital A round: Early-stage companies are raising money to possibly finish last touches of technology or product development and go-to-market strategy to prove market acceptance.
Stage 5: Venture capital B round and beyond: The venture-backed company will look to its Series A funders for B and C rounds. These rounds typically focus on capturing more market share and preparing for exit.
After a Series B round, a company may continue to raise money in additional rounds labeled C, D, E, and so forth. However, companies commonly experience a merger or acquisition before they get too deep into the alphabet.
If you know that your strategy will require multiple rounds, it’s a good idea to target venture capital firms that can grow with you rather than a seed stage fund that can only provide a few million dollars for early stages.