6 more lessons I have learnt about raising capital from VCs [Part 2]

The following is an adapted version of a talk done by Clive Butkow from Grovest at the Gordon Institute of Business Science at the University of Pretoria, South Africa. Butkow boasts 28 years of management consulting experience at Accenture. Currently non-executive director of Grovest, he is also supporting and mentoring technology businesses, assisting them in driving growth.

I want to share with you what I have experienced from sitting on both sides of the table on how you can increase your chances of raising capital for your business. In part one, I discussed the myth of insufficient capital in South Africa, the importance of having a team and other key things investors look for in a startup.

In part two, I look at what investors are looking for, how to prepare yourself for a pitch and the importance of knowing what you want.

1. Keys to the investors vault — investor hot buttons

What do your investors look for? There any many ingredients required to make a startup successful. For me, the most critical three ingredients are: Firstly, having good people — have the best team on the planet. Secondly, make something customers want by confirming product market fit. Thirdly, being able to sell and make getting and keeping customers your number one priority by adding more value to your customers lives than anyone else is adding.

Your product/USP needs to be 10X better than anything else on the market. Ask people for money all day long — many entrepreneurs think that marketing and sales is the same thing. Until you have asked people for money, you have not worked. Most startups fail because they fail at one or more of these three ingredients. We see less and less people funding ideas and decks.

Investors want to see early traction — some sort of indication that not only your idea is great, but that you talked to customers, built a minimal viable product and have some kind of traction — proof that you can do it and it may work. Other hot buttons for an institutional investor, include:

1. Ability for high growth.
2. Large market potential when you scale.
3. High margin business.
4. Repeat customers and annuity revenue.
5. Viable risk reward relationship.
6. Obstacles to competition, the size of the mote.

The prototype or traction, not the business plan is one of the most critical step in raising capital. Get sufficient traction with paying customers. This does not mean perfect product market fit. It means early evidence that there is a problem and your solution or product is going to have a shot at addressing it.

2. Lack of preparation and make your forecasts realistic

Same as if I can sell toothbrushes to one percent of the Chinese population then I will sell 15 million toothbrushes. Do not use top down but bottom up when calculating your numbers. Validate your financial figures and show that you have achieved product market fit — build bottom up estimates not only top down (sell the product to one percent of the Chinese population). Your forecasts are a bunch of hypothesis or guesses — for a startup it is more about market research, initial traction and the team.

Read more: VC to pump $10m into South African, African startups [update]

To be ready to fundraise you need to have the following: strong knowledge of the problem you are solving, the reasons you started this business and your customers, market opportunity, competition, distribution channels, break even and burn rate, runway that the capital injection will provide and many other things.

It’s important to explain to the investor exactly how you will use their funds, on product market fit, customer development. But do not ask for high salaries as investors will not fund your lifestyle.

You are going to be asked a whole lot of questions and then some by potential investors. If you are not prepared it will come through and will be a big turn off. The keys to the investors vault requires an enormous amount of skill, time, effort, persistence and commitment.

3. Begin the discussions for money before you need the money

Investors don’t want to meet you, they want to be introduced to you. Get a soft introduction to an investor if you are serious about raising money. This is about relationship capital by developing the relationships with VC’s before asking for money. A soft introduction to an investor is the most effective (leverage your network for access to investors). Grow your network at every opportunity. An entrepreneur’s network is their net worth. The best way to manage your VC is to meet your projections.

Remember VC is not for everyone as every VC wants to fund huge next Google. Don’t assume your VC can always add value — they have numerous investments and board positions and don’t always have the time for your company. Have realistic expectations of venture capital.

They like different verticals. They write checks of different sizes. Just because they are an investor does not mean they are the right investor for you. Doing research, understanding what a particular investor likes and why you might be a fit is important.

Read more: Survey: South Africa’s Venture Capital industry is now worth a massive R2bn

Sell the deal to the investor and know when to start the conversations. Begin the discussions with an investor before you need the money: raising money is about selling. Develop relationship capital. Like a dating game hot or not — people will decide quickly and the first couple of minutes is key to winning over the VC. Don’t spend 15 minutes on the background.

4. Not all money is the same

I always like to under promise and over deliver so I have one more lesson. Not all money is the same. You want smart, not lazy capital. There is no shortage of money looking for a home. Why do I say this? There are four types of capital every entrepreneur needs to grow a successful scaleable business.

Firstly, mentorship capital. The exposure to experienced entrepreneurs that you will meet and will provide mentoring though the training provided through the pitching and judging process and many other interactions. Secondly, social capital. The access to the networks of these entrepreneurs to open doors to help you start and grow your business. Thirdly, human capital. Every business needs the best people on the planet and you will through this network have access to the right people to help you scale your business. Lastly, financial capital. The capital awarded to the finalists as well as opening doors to other institutional capital like Angel and venture capital.

5. The five lies entrepreneurs tell VCs

• My forecasts/projections are conservative.
• I have no competition – no-one else can do what we are doing – if there are no competitors you are most likely building something no one wants : can’t even use Google to figure out that ten other companies are doing the same thing.
• Gartner says it will be a R10 billion industry in 5 years and all I need to get is one percent of the market.
• I have secured 10 of the top JSE 100 companies and they are ready to do business with us.
• Hurry up because other investors are about to do the deal.

6. And the five extra lies VCs tell entrepreneurs

• I liked your company but my partners did not.
• If you get a lead investor I will follow too.
• We have lots of bandwidth to dedicate to your company.
• This is a plain vanilla term sheet that guy can sign quickly.
• We love to co-invest with other firms.
• Show us the traction and we will invest

The difference between these two sets of lies is the investors have money. The most important question you need to ask when building or scaling your business is not “How do I raise venture capital?” It is rather “Do I need to raise venture capital?”

Image by Paul Saad via Flickr