The biggest question most entrepreneurs should be asking is: “is my venture fundable?” Of course, in the heart of every entrepreneur is an undying optimist. Pessimists can’t survive the emotional roller coaster ride of a startup. That kind of optimism leads to confidence that everyone sees your “baby” in the same light you do. Unfortunately, not so. Venture-style investing is a VERY rational business, at least for the professional investor. We don’t get caught up in the emotion of a market or business. We look for underlying team characteristics, market conditions, and established criteria to judge early stage companies’, who are often prerevenue, chances of success. This is not to say, the ones we turn down can’t be successful, or that we will only select winners. Clearly, neither is true.
So, let’s discuss what makes a venture “fundable.” We list our base criteria for consideration on our website. They were developed over the last 9 years of ACG’s life and experience in the market benefiting from hundreds of successful entrepreneurs, subject matter experts, and venture-style investors.
When you are asking for funding, the first thing to remember is people invest in people in markets they like and understand. If you approach the wrong investor, your venture is not fundable. Make sure you find and carefully review the investor’s criteria before approaching the investor. It will save you a lot of time and effort.
The second question you should ask yourself is: “is this a lifestyle business?” A lifestyle business is defined as a business that can’t scale except by cloning the Founder. In other words, if you run consulting business, then your IP and your ability to scale are directly related to the number of hours you can work. So, the only way to scale the business is to add more humans that mimic you. That means that incremental revenue is directly tied to incremental costs in a nearly linear fashion (i.e. there are no economies of scale). In other words, the business does not generate long term exit returns that justify the investment of a venture investor.
To that end, early stage investors, expect to see businesses that can realistically command a minimum of $15M – $30M in scalable top line revenue in 5 years and have a clear, viable exit plan to qualify for funding. In other words, angels and VC’s only make money when you are acquired (or IPO), which we want to happen within 5 years. We must believe you can reach a sufficient exit value to justify the risk we are taking with the understanding that we will be diluted one to three times by new rounds of capital before exit.
The third concern is the exit multiple of your business, or how your exit value relates to your industry. If exit multiples in your business are 5 – 7x on revenue, such as Software as a Service (SaaS) companies (primarily due to low overhead, proven replicatable sales, and recurring revenue models), then the investor can be more flexible with funding the business and the valuation. However, if you are in a pure service industry where exit multiples rarely break 1.5x on revenue, then we have to be very rigid in our analysis of your venture and post-investment management of the company growth. Which one do you think we choose?
The fourth issue is the point of pain you address in the market. If your product or service is “nice to have,” don’t seek venture investment, especially in tough economic times. Nice-to-haves are the first thing to go, if they were adopted in the first place. However, if you are addressing a clear and demonstrable point of pain in a novel way that creates barriers-to-entry for fast-followers, then you should consider seeking investment.
The fifth issue is whether your venture is simply evolutionary or revolutionary. Professional investors want to invest in companies that don’t compete. By that I mean, they sell products and services based on the value they provide, not on a price point. So, if you have a better mouse trap, don’t seek venture-style funding. It will be a waste of your time. Price points will always be driven down over time. We don’t dispute that. We want to identify the company that will set a new standard in a given industry and remain the market leader. If you have a revolutionary product or service and you can clearly identify a readily adopting market niche for it, then you should consider seeking investment.
There is nothing wrong with a lifestyle business, but they are not fundable by professional investors. Many are lower risk, but they are lower reward. That is now how our model works. We seek low risk/high reward opportunities, and we are willing to accept higher risk to get the higher rewards. If yours is a lifestyle business, you should spend time seeking friends, family, and partners that know you, trust you, and want to see your business grow while sharing the work load and the success.
Finally, before you spend money and time on preparing all the documents and spending the legal costs required to approach investors, ask yourself a few key questions:
- Is this a high-growth potential business?
- Can I generate enough revenue at a sufficient margin to be attractive to an acquirer?
- Does my industry have an exit multiple sufficient to make me attractive to an investor?
- Am I addressing a clear point of pain and creating hurdles for my competition?
- Is this a new standard for this product/service category or a better mousetrap?
There will always be more great ventures that money to invest in them. How you position your company is critical to being selected in this highly competitive market (we invest in 1% – 2% of all companies that apply to us). If you feel you have what it takes to be a high-growth company, you will have to prove it with a very compelling business plan and financial projections. And, you will have to identify and convey a demonstrable, sustainable competitive advantage in your market. In other words, the companies that get investment have an unfair advantage in their respective markets. Make sure you know your competitive advantage(s) and can articulate it before seeking investors! If it takes more than one sentence to convey, start over.
Copyright Eric L. Dobson, 2016