Future profitability is the promise every growing startup founder holds on to, but investors aren’t so easily swayed these days. In this time of economic uncertainty, funds will be awarded only to the most recession-resistant young companies.
Most investors (68%) believe the COVID-19 pandemic will have at least a negative impact on investment activity in the early stages in 2020, according to a survey of 500 Startups, a leading global accelerator and risk fund of seeds. However, most companies are still investing, especially in industries like healthcare, logistics, and remote work solutions.
Even before the coronavirus crisis ravaged the world economy, investors became more cautious about financing. In February, direct-to-consumer mattress company Casper became the latest high-growth startup to price its initial public offering well below initial expectations, following high-profile failures of the likes of Uber, Lyft. and, perhaps more infamously, WeWork (which never even made it to an IPO).
As investors backtrack against the growth model at all costs that has been a Silicon Valley staple, more entrepreneurs will be forced to rethink their business plans and investor arguments. The founders of the early stages will no longer be able to sell the hope of making a profit one day in exchange for large sums of cash. Even relatively risk-tolerant venture capital firms will want to see proof of profitability now rather than waiting until the distant and uncertain future.
Show me the money
Investors at Green Cow Venture Capital, an early stage hedge fund, have always evaluated startups based on their abilities to thrive in an economic downturn. Strong fundamentals, profitability targets, stable cash flows, and a solid business model are indicators that a company can weather a recession, making them strong candidates for financing.
“Don’t panic,” advises Maggie Sprenger, co-founder and CEO of Green Cow. “As much as the transition to a different business cycle may seem puzzling, there are many opportunities in a recession. And with that said, don’t be complacent either. There are always unintended consequences, and we are at the beginning of understanding the impact of COVID-19. “
To prepare for a Series A funding round in today’s investment environment, founders will need to have more than a well-rehearsed elevator pitch; They will need a comprehensive business plan and the foundations of a sustainable company. In other words, they should start managing their businesses as monetizable businesses, not projects with potential.
Unlike a seed round, which is primarily based on the founder’s experience and investor sales in the company’s history, a Series A generally requires that you provide metrics as evidence of an early adjustment in the product market. Without an established user base and an identified source of continued revenue, it will be difficult to find these metrics. That may be the reason why less than half of startup companies will raise Series A funds, according to Investopedia.
Your young business doesn’t have to be running like a well-oiled machine for you to feel confident in getting Series A funds, but it must be making planned and consistent progress toward profitability. As you prepare to meet (virtually) with investors, here are three steps you need to take to make sure they’re impressed by your speech.
1. Identify your sales strategy.
You will need to show investors the components of your sales plan: how you will sell your products, the team you will need to hire, the presentation you will make to customers, the channels you will use to market, and so on. They want to know exactly where their income will come from once they have funds. Otherwise the funds will run out and have nothing to show.
Paint a detailed picture of your vision for the funded business. “Investors must be convinced that the money they bring in will create all of this, that they have a sound plan and have identified what they will do with the money they raise,” says Jeff Erwin, who has been a founder of startups and CEO at the technology industry for over 30 years. The best way to show them that you can sell successfully on a large scale is to have already done so on a small scale. Test points include pilot customers, strategic partnership lineups, or advance posts you’ve received.
2. Articulate your commercial projections.
Often an interesting product is enough to get you noticed during the seed rounds, but securing Series A funding requires a concrete business plan. This includes identifying customer profiles, your total addressable market, and future financial projections. You need more than passion at this stage.
In a seed round, you can raise money by captivating investors with a vision of what’s possible. In a Series A, you must show them what is possible and what is realistic. They will want to know what a reasonable growth path might be. Sure, they’re interested in knowing all the money they could make, but mostly they want to see you understand the finances and key metrics of their business. Additionally, it is helpful to show an understanding of potential legal, regulatory or other risks to the business and how you might mitigate them. The VCs want to know that you are ready to captain the ship.
3. Plan your investors’ exit strategy.
The reasoning behind all of this is that investors ultimately want to make money. Whether you are eventually hoping for IPOs, being acquired by a larger company, or merging with a competitor, Series A investors will want you to show them a plan for your exit strategy. Keep in mind that the goal here is not to guarantee a certain output, but rather to demonstrate that you will find a way to get a return on your investment.
Your investors are likely to be able to make money in various ways once you have reached your profit target, but if you are hoping to get financing, don’t tell venture investors that you intend to keep your company private. Similarly, don’t go into a Series A meeting with the wild idea that an IPO is imminent. Have a realistic plan that shows them the reward they can expect to receive in exchange for giving you money.
The days when investors would be willing to wait years for a tech startup to become profitable are over. For every Tesla that produces cash but continually rewards investors, there is a WeWork that simply produces cash, and which is not sustainable during a recession. The environment for entrepreneurs is very different today than it was a decade ago, or even a couple of months ago. If you are a founder at an early stage, focus on profitability and see how the money comes to you.