Finance · 21 June 2016

What steps should startup founders take before a first-time investment?

investment
Startup founders should ensure to take the right steps before a seeking first-time investment

Going through the process of raising investment for the first time can be an anxious period for any small business owner. Here, Crowdcube CEO Darren Westlake tells startup founders what to consider. 

First-time investment for a small business can take many different forms, from pre-seed loans through providers like Start Up Loans and Smarta, to founder capitalisation and then seed equity through platforms like Crowdcube, encompassing angel investors, VCs, friends and family, customers and the wider crowd.

Prior to even considering fundraising, there are some basic steps that any founder should undertake.

Firstly, know your market and the competition. You should know what market you’re entering inside and out, who the competition is, what their weaknesses are, how much of this market share is realistically achievable in the short-term, and why you believe your proposition is different.

Secondly, making assumptions about how prospective customers will react to your product has killed many startups. It’s key that you only build rudimentary MVPs (minimum viable products) and test them as quickly and as many times as possible with iterative improvements, so you can see how early adopters react and then learn from them.

By building in these steps at an early stage, you will save a lot of time and capital that would otherwise be wasted. Eric Ries’ book “The Lean Startup” is well worth a read on this subject.

Thirdly, before rushing into raising finance you need to ensure that the business you’ve started is showing early signs of “product-market fit”. Ask whether the market is large enough, and whether customers in that market are satisfied with the product. And will they use it?

This can only be achieved with customer traction, alongside iterative testing. From an investor’s point of view, product-market fit is a key consideration when looking at the investment opportunity. Investors want to know whether a market will provide multiple returns?

Once you’re comfortable with your business proposition and you’re ready to raise your first round of equity investment, then look at something like the Crowdcube Sprint Programme as your next step. This is a fast-track fundraising method for seed rounds on Crowdcube.

Then, to ensure you have the very best chance of success in front of potential investors, consider the following carefully:

Assemble a winning team – Ensure the team you have in place is capable, passionate and thick-skinned. If possible, mitigate weaknesses in your team by using advisers and mentors. An investable team, ideally with exit experience, is one of the most common factors in successful Crowdcube fundraises.

Mitigate risk with tax relief – The key here is to obtain Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) advance assurance from HMRC and reduce the downside risk to investors. Investors can receive initial income tax relief of 50 per cent on investments up to £100,000 per tax year, as well as capital gains tax exemptions. You can find more information on how to qualify and get you application underway on the HMRC website.

Communicating your revenue model – When communicating your message to investors through your online pitch or face-to-face, they will expect you to have a robust understanding of your financials, and, in particular, your revenue model, when this will be realised and how it will be executed. Throughout your business plan and financial forecasts your financial proposition should marry up seamlessly.

Defined investment requirements – All investors will want to understand how much money you need and what you’re going to spend it on. Ensure you have clearly defined investment requirements for this round and a defensible explanation of where this will be spent and why. It’s also imperative that you raise enough cash, considering your cash burn rate and runway in your financial model. It’s useful to frame this in the context of 18 months of investment, which will typically last you 12 months.

Realistic valuation – Investors in startup businesses invest for many reasons, however, almost all of them are investing to make a financial return, so pricing this realistically in the early stages of your fundraising process is one of the savviest moves you can make. You will attract more investment interest on platforms like Crowdcube and mean that as the cool winds from Silicon Valley float over to the UK you won’t be in the position of having to do a down-round at Series A or B because you were over-zealous at seed stage.

Remember, fundraising is all-consuming – It’s very simple, you need to be prepared to give up between three to six months of your time, which you would usually spend running your company, in order to raise funds. Make sure you understand and prepare for this upfront, ensuring you raise finance at the right time and have spread various tasks between the founding team prudently.

Confused about crowdfunding? Read Darren Westlake’s expert advice on debunking some commonly-held myths about the process, here.

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ABOUT THE EXPERT

Darren Westlake is the co-founder and CEO of Crowdcube, an online platform that enables startup, early and growth-stage businesses, from a range of sectors, to raise finance with the added benefit of being backed by the crowd.

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