See if anyone has already built the same business you are set to pitch. In our experience, it is rare for a proposition to be unique. Companies with competition don't phase us as long as they have done their homework. Competitors can help a company define its market positioning and develop a strong USP. They can also show that an idea is feasible and there is demand. But if a startup looking for investment is oblivious to any existing competitors, it suggests they are not well connected to their market which could be a reason not to back them.
We recommend picking a firm with a history of venture capital deals. Your lawyer should know what is negotiable in a term sheet and what is not. The minimum requirement is a top-drawer regional firm, which helps you avoid London prices. They need a corporate department (for investment agreements) and a commercial department (for your supplier and customer contracts). Do not use the person that helped you buy your house! Ideally, the firm will also have an IP department. You may still prefer to use a patent agent if you have a lot of self-developed tech. Do not be seduced by law firms with international practices unless you have a real need for this as they are a lot more expensive.
As an early-stage business, your accountant is not as important as your lawyer because as soon as you have funding, you should bring financial management in-house asap by hiring a CFO. However, in the early stages, several tasks are much cheaper if done by an accountant rather than a lawyer such as filing EMI and EIS forms. A local firm is OK or better still a regional firm with Venture Capital-backed clients. If you are lucky enough to be profitable, then you also need tax advice. Get this from a separate specialist firm. Whatever you do, do not hire one of the Big Four Accountants, they are too big, and you are too small.
Bootstrapping, where an entrepreneur starts a company using their own money or the operating revenue of the business to fund it, means they keep 100% ownership for longer. Startup software and most hardware businesses can develop a demonstrable product on boot-strapping and could be the stronger for it as it demands discipline, focus and cost-control. Some companies in, for example, the biotech or semiconductor space, will need a big slug of capital up-front and will not show revenue for years so bootstrapping may not be an option. While bootstrapping means you keep complete control, there is a downside. Without equity-based funding, you can only build the business as fast as your pockets are deep or if you can generate margin. Slow growth will quickly become a problem if others with more money can steal an advantage.
A Venture Capitalist’s traditional focus is on highly scalable and defensible propositions. They want businesses with the potential for rapid growth and high returns. Lots of early-stage businesses will fail to deliver the return on investment that the VC requires. They will need to seek out alternative funding arrangements.
VCs can back startups at the idea stage, but they need to be started by serial, successful entrepreneurs or have experienced management teams. Venture Capital funding is not a chance for recent graduates to learn about business on the job.
We filter out companies that can’t demonstrate they can deliver a product, show some happy customers or provide a sustainable business model. However, we are not a typical VC as we go further to ensure our investees succeed. They get a substantial cash injection, and a host of support services to help them accelerate their growth. We call this Active Operational Investment. This approach works well with companies that have innovative technology, experienced management teams and whose product solves a real-world problem. Once engaged, we want to use our resources and expertise to increase the speed at which their product gets to market so they can start making money.
The most prominent mistake is to over-value the business in the early funding rounds. Each round is priced on a forward-looking basis. Investors are negotiating in a price window that delivers them good uplifts on the value of their investment in subsequent funding rounds. If you succeed in negotiating a high price at an early funding round, then any mistakes in execution will mean the valuation will stay flat or even fall the next time you return for more funds. Your original investors will be unhappy and might start thinking about new management.
The other mistake to avoid is being too conservative and raising too little money. As an early-stage investor, we would advise: never leave money on the table. It is better to have your stake diluted a bit more in an early round and hold more cash than you initially think you need. You will be grateful for the financial cushion if you need extra time to close a sales agreement or finish the product.
Take care to make a decision armed with the full-facts. A VC relationship can last longer than the average marriage! Our investees typically come to us, because they get extra support to fast-track their growth. Make sure your early-stage investor can help you deliver your business goals.
We are always happy to hear from innovative early-stage IoT companies looking for funding. Click here