Learning to Avoid the Pitfalls: Seven Common Fundraising Mistakes
An expert is a person who has made all the mistakes that can be made in a very narrow field. – Niels Bohr
If I had to live my life again, I’d make the same mistakes, only sooner. – Tallulah Bankhead
To avoid situations in which you might make mistakes may be the biggest mistake of all. – Peter McWilliams
In our experience, here are the top mistakes clients of ours have made when seeking capital for projects and ventures. Does one of these have your name on it?
In a nutshell:
- Underestimate time commitment necessary for fund-raising
- Mediocre presentation skills
- Vague (insufficient detail) use-of-funds statements
- Poor understanding of cash flows and exit
- Not doing your homework on prospective investor partners (targeting the wrong audience)
- Being uncertain of your value (to the right target audience) or accepting the opinions of others as your own
- Ignoring outside feedback
#1. Underestimate time commitment necessary for fund-raising. With such a winning idea, team, and market, how hard could it be to raise needed capital? There are exceptions, of course (stories of hot-shots with an elevator pitch and a PowerPoint that hit it out of the park on the first try), but in the current economy, most companies vastly underestimate the time commitment necessary to successfully complete a financing. Turns out that if you invest the time in learning and preparing a winning proposal, you will save time later. If you ignore this all-important time to properly prepare, you’ll either waste considerable time (3x-10x what would have been required to do it right in the first place) or, more likely, simply not receive a funding commitment at all. We seen some developers take many years and come away empty-handed.
Thus, we recommend that a company seeking equity financing budget between 200 and 500 work-hours (depending on urgency, ~15 hrs/week minimum) to the capital-raising process, spread out over a 3-9 month time period. The key processes include:
- Hone and polish the package — the business plan, offering memorandum, letters of support, references, and other company due diligence materials — investment of your time and best efforts here pay dividends. You want to go faster, sooner? Go slower at first.
- Develop a comprehensive, targeted prospective investor list (see mistake #2, below). Heard of KYC? Know Your Customer. How about KYI — Know Your Investor. Take the time to read their online materials, ask clarifying questions about their focus, their process, their expectations for returns, … and show them that you are listening when you make your proposal to them. “Because you invest in XYZ, …”. This also reveals that you have business relationship and communication skills. Even loans (impersonal compared to equity partnerships) require that you and the lender get on the same page.
- Prioritize and contact a select few candidates from your list within a “closing funnel” process, allowing time to get to know the investor, so they can be approached based on facts of what they are looking for in the “ideal situation”, and to be diligent and responsive to the investor’s concerns, questions, and (if you get this far) due diligence requests. Be sure to act like you only have eyes for the investors you contact, just them, one at a time, and nobody else. If you are fortunate enough to be found credible and your deal within their “wheelhouse”, then …
- Negotiate the transaction (or attempt to recover, politely, if they decline to pursue further). Seek mutually agreeable terms and how to reach closing. For early stage venture investments, disagreements about valuation are the most common problem, but can be side-stepped with the right preparation and skillful use of the right tools and structures (such as convertible/bridge instruments). Making a fixed offer works well, so long as it isn’t framed as “take it or leave it.” Always negotiate in good faith, what you think is fair, using facts more than opinions to increase bargaining power. If you have a written offer from a different investor, talk about that only if or as needed in an effort to persuade the investor you prefer (tell them so), and never say generically “We have interest or offers from several funds …” unless you are prepared to show your hand. Generally, saying this will backfire. Investors don’t like competition, and don’t need your deal, so will typically respond with “Good for you! Congratulations … go and ahead and pursue that, instead. We’ll wait until you are ready to commit.”
To see how easily the preparation time adds up, our experience is that only about 25% of prospective investors showing an initial interest in a transaction actually progress to engaged dialogue and due diligence questions. Only about 10-15% of this 25% actually progress to a bona fide offer of funds (preliminary terms), of which only a few are likely to actually agree to consummate an investment transaction. So completing an early stage “risk capital” financing transaction (different than risk-mitigated project finance transactions, for example) requires, on average, contacting at least 20-200 pre-qualified prospective venture investors. What stage venture deals? Certainly seed stage, extended founders round, pre-Series A, and Series A (whatever establishes a share price and valuation).
Note that project finance, by contrast, can be programmatic, or even formulaic (cookie-cutter deals) to investors who are well aligned with the performance expectations of the project or pipeline (portfolio) of projects. Much more straight-forward to find project investors than early-stage venture capital (the former is In3’s current focus, while the later now has crowdfunding and “Lean Startup” approaches to help somewhat), but this still take more preparation time than most developers realize.
If you don’t like these odds, consider changing the risk/reward profile (the purpose of the aforementioned preparation) via In3’s “alternatives” toolset, which is a tailored conversation we can have under NCNDA. It’s all about the investor’s perception of risk, not to eliminate all potential risks, but to grapple with and offer solutions (contingency plans) for the ones that could conceivably “go wrong” to avoid having a negative impact on “triple bottom line” (or at least financial) performance. See glossary
Examples: identify and systematically eliminate risks (and perception of risks), use creative deal structures such as quasi-equity or other tried-and-true contractual techniques, or shift to asset-based project finance, deal aggregation, portfolio optimization, … using deal sponsorship and capital guarantees as leverage.
#2. Mediocre Presentation Skills. Far too often, investment discussions go astray because of lack of rapport and inadequate questions initially asked by the presenting Company. Active investors across the risk spectrum (startup equity to secured debt) are literally inundated with investment opportunities, so companies must be prepared for this “short attention span theater”. It is not unusual for a principal at a high profile VC firm or impact investment firm to review dozens of otherwise qualified prospective investments every month. As such, it is imperative that your investment presentation be extraordinarily brisk, to the point, and delivered with flair (a touch of personal style such as a sense of humor can come in handy) and great “positive energy” and enthusiasm. Do not let that enthusiasm blind you to your audience’s non-verbal signals, however, as you may be missing the opener to exactly the conversation that’s needed to overcome objections, confusion, or skepticism. If the key presenters on a management team do not have these skills, proven to be rock solid even under intense pressure, then our recommendation is to either invest in getting some presentation coaching, or to substitute the company principals with more impressive team members as presenters to open the door. It is that important. (See related article Top Three Mistakes when Presenting to Prospective Investor Partners).
#3. Vague Use-of-Funds Statement. Too often a young company will get stuck on the simple question, “How much money are you seeking and why?” Answering this satisfactorily is at the heart of the proposed investment. More mature companies can present sober and credible use-of-funds and drawdown forecasts based on multiple funding scenarios, built from “the bottom-up,” with specific revenue and costs estimates garnered from the company’s historical financials and from forward-looking surveying of vendors, salary bands, property leases, etc.
Our experience is that the most credible and impressive entrepreneurs will have a detailed scenario of Use-of-Funds presented with a willingness to discuss specifics without defensiveness. Family offices, angels and super-angels, in particular, like to use this topic to better understand how the management team sees this future scenario playing out, anticipated time horizons, management’s ability to respond to change, defend their numbers … but still keep an open mind about contingency plans, risk factors, and “what if” scenarios. Perhaps needless to say, but use accounting standards (GAAP or IFRS) to categorize, show proportions and summarize this information so it is immediately understandable. Do not make the investor dig for answers to basics like how much is for tangible capital expenditures versus working capital, raw materials, services, contingency, etc. Here’s a guide, with several examples, to ensure you avoid making this mistake: How to Create a Sources & Uses Statement
#4. Poor Understanding of Cash Flow and WIIFM. Profit matters. A lot. Even in most so-called “impact investments” or for the sake of sustainability, with social and environmental benefits. Totally obvious to you? Great! But, believe it or not, most entrepreneurs have a relatively strong grasp of the marketing and operational components of their business, but tend to be weak in projecting and communicating the specifics of how they actually make money. And by making money we mean generating liquidity, usually in the form of cash. Before an investor will place their own cash into a company, they must be reasonably certain that this cash will be transformed into a systems and infrastructure that will eventually (and sooner rather than later, from “quick turnaround” to “patient capital”) create much more cash than originally invested. Creating cash requires a rock-solid revenue and cost flow business model. Among others, key variables in the model include customer acquisition costs, pricing and gross margins, accounts receivables aging, realistic administrative costs, and taxation and depreciation. The better that a company understands and communicates these cash flow variables, the stronger and more credible will be the investment offering.
Further, the clearer the investor can see how they will benefit financially, the “what’s in it for me” (WIIFM) consideration, including their likely exit or partial exit, the more you will have their attention.
#5. Not Doing Your Homework. Why waste precious time and money contacting unqualified and inappropriate prospective investors? Before an investment offering is undertaken, either you can target a pre-existing short list of sources, with known criteria, or … a comprehensive prospective investor list must be created, and all of the investors on that list must be qualified as to track record of investing in financing stages (private, public, equity, subordinated debt, senior debt, etc.) and market sectors similar to the company in question, country (or countries), size and asset class(es) of the deal. Since conditions change, you probably want to ask if they actively investing or just sitting on the sidelines? (See mistake #1 as possible root cause … doing your research and preparation before sending email to your list — we would recommend that you call first, in any case — will at least enable you to get proper attention by referencing what you know about the fit between their investment focus and your investment opportunity.)
How do you know there’s a fit? Contacting prospective investors that have not recently invested in a company or project “like yours”, no matter how compelling the deal, does not usually bear fruit. If there are natural tie-ins to deals they have done before, mention them; if not, you should simply ask, right away, if this — one sentence description of your deal — fits with their investment thesis or strategy.
Asking this question (or any others) also reveals that you are taking time to discover their interests, their focus, their history, … a sure sign of respect and professionalism. This is also a way to show your social skills — asking questions from a place of curiosity and genuine interest in what they are about tends to get them to listen to what you have to say, in kind. Be sure to actually listen, verify and clarify what you hear — that is, play back what you think it means and ask “Do I have that about right?” When you reveal what you know about their interests (particularly important with impact investors, who tend to be more thematic and purpose-driven than pure financial investors) you make a connection that sets you apart from almost everyone asking for money — you show that you have a genuine interest in other people, other companies, are good “partner material,” not just fixated on how brilliant and important your deal is. Its importance to you may or may not translate!
#6. Being Uncertain About Your Proposal’s Value (to the right audience). Capital-raising is a long and often arduous process that requires patience and persistence. Getting to early “no” or “yes, we’re interested” or “maybe, but we have questions” is the golden standard. As discussed above, the vast majority of investment presentations will result in some form of rejection. But in addition to rejection, the company will also usually receive — either solicited or unsolicited, direct or indirect — advice and feedback on the “flaws” of their business proposal. This will only occur is there is rapport (avoid making mistake #2), and signs that you are truly interested in improving your pitch, learning, listening.
In some ways worse than being uncertain about your proposal’s value is being overly confident, deflecting constructive feedback (even if you disagree with it), borderline arrogant and obnoxious. Confidence is good, but is there a 2-way street and basis in your relationship with the prospective investor for give-and-get? Get your ego out of the way and theirs may also take a breather. :>) Be sure to take feedback seriously, but not personally. See Mistake #7.
While feedback is sometimes valuable, it is critical to very carefully filter and evaluate this feedback before revising the business plan and presentation. Impose structure on making any revisions for long enough to garner feedback from diverse perspectives. By the time an investment offering (or similar structure) is provided, company management should be extraordinarily convinced and committed as to the validity and solidity of its plan. Be sure to measure all feedback, no matter how well-intentioned, against this conviction and commitment.
It bears repeating (advise to my American brethren): being impervious to outside feedback, being overly stubborn or pig-headed, or just not interested in what others have to say, … also ruins chances for success. Right? Keep reading.
#7. Ignoring Outside Feedback. This is the opposite of #6. Just as wrong as accepting the views and opinions of others in place of your own, so too would it be a mistake to ignore the feedback you will receive from qualified sources. But before evaluating the feedback, you have to “let it in” (hear and understand it … so suspend your reaction long enough to be curious and interested in what they mean, are trying to say to you, or otherwise wish to convey). Then, once you grasp their intended meaning, definitely consider the source, any “hidden agendas” (existing investments causing “portfolio bias”), or criticism born of lack of understanding. Try not to sound defensive. Rather than arguing, saying “Let me tell you why you’re wrong” (in so many words), use the misimpression as leverage, stating “What if I could show you that XYZ isn’t a gating factor” or “If we have a way to mitigate that concern, would you be interested?” or countless other ways to not show that you are offended or frustrated by the fact that they didn’t fully grasp the efficacy of your plans. For more, see our problem-solving guide to gaining investor or guarantor commitment.
The marketplace itself is your most important and trustworthy source of “feedback” (results don’t lie or have egos or agendas), so implicit in correcting or avoiding this mistake is ensuring your business plan and proposed investment is aligned with the current realities of the capital marketplace — for example, neither too small nor too large an ask (if too large, break into rounds or other incremental approaches, and if too small, such as the case with project finance ever-increasing ticket size, aggregate and optimize a portfolio of planned assets). This alignment, plus market timing, are key — don’t focus on a sector that’s in decline (fossil energy, pesticides, conventional agriculture, large-scale hydro …) while all the new money is going into the alternative that happens to be grabbing significant market share.
Most investors won’t tell you why your opportunity isn’t for them – strangely, the unvarnished truth is rare and a standard responses like “We’ll pass” or “Not in our space” or “Wrong stage for us” are most common. They might fear an argument (which can get unpleasant or even heated/stressful) more than their “fear of missing out” (yes, FOMO is a real and pungent thing with most moneyed people). But for those who understand your situation but also remain objective enough – and generous enough – to share their feedback or “candid” (unvarnished) perceptions, by all means take advantage of learning all you can from them to round out your knowledge of what’s expected, desired, and “de rigeur” (or other fake-sounding words of choice) in the intensely competitive marketplace for capital.
You may decide to reserve judgment when hearing points of view that seem unique to that person or organization, and ideally, allow a pattern to emerge from multiple, diverse sources. Just say “Thank you” and “I’ll take that under advisement.” If you hear the same feedback from multiple investors, then you would be wise to listen and adjust, at least in how you are presenting the opportunity, if not your actual deal facts and focus. This is tricky, as you have to decide how you will manage the boundary between yourself and capital markets. Just because they “don’t get it” doesn’t mean you should be impervious to that implicit feedback — somehow, they do need to “get it” in order to offer constructive feedback at all, so re-consider how you are sourcing prospective investors (change your methods, team, venue, … something!). If you do not receive constructive and helpful feedback as a result of a pitch, ask for it. If they give you a blank stare, ask simply “What would help?” or “What did you want to know about this opportunity?” or even (if they seem a bit confused) “What would help you make clearer meaning out of this so we could learn how to improve?”
In the age of distance communication, we often seem to be connected (such as online via email or voice/video conferences) but in truth we really are not able to benefit from the full, unstated, non-verbal and well-concealed truth of what others actually think and feel. If there is basic interest, ask for an in-person meeting and you will indeed learn much more. At least that will serve as a catalyst for figuring out whether or not you can do business with that investor.
Take your time, once prepared. Reserve making changes to the opportunity itself — something akin to a “pivot” after reconsidering fundamental assumptions, such as business, marketing or product strategy, deal structure, or business model — until after data is in hand to inform decisions and defend those decisions. Investigate and validate new assumptions before making the pivot. But then, once changes are made, you can go back to earlier sources and explain what has changed and why. In many cases, showing that you have sound business judgement is an important proof point — and arguably more important than the content of the business plan itself.
Raising money is a big challenge even under the best of circumstances. The pitfalls and hazards are everywhere, and the consequences of failure can be devastating, but so are the opportunities to learn and evolve into a more investible business. Focus on a capital campaign intensively for relatively short bursts then cycle back to building strength, value, and further proof points before returning to the well. Stake out your milestones with evidence of accomplishment and keep building relationships even when not actively raising money. Capital is like oxygen. Without sufficient oxygen, your venture will sputter along, gasp, wheeze, and eventually stop (or be abandoned). With the consequences of failure so dire and the challenge so great, it only makes sense to seek out professional assistance to maximize your chances of financing success. That’s where In3 Group’s “power tools” may be able to help. Contact us to discuss your situation.
Here’s to your success!