Raising Capital? Answer These Questions to Score an Investor's Check
Between listening to students pitch their startup ideas and reviewing business plans from more established companies, I encounter many attempts to separate me from my cash. I'm in the midst of weighing one such pitch from a business software company (I'll call it BSC) whose owners have already won some customers and who are hoping it will grow much larger.
The types of things I'm asking and trying to figure out are akin to the type of questions that have gone through my mind many times before in reviewing a pitch for money.
In an effort to save time for the entrepreneurs and capital providers who are reading this, here are five questions that should be answered about a startup's business model before anyone makes a pitch for investors.
1. What is the customer's pain? BSC was founded by a set of technical geniuses who have demonstrated their ability to get ahead of others in the industry. BSC's product improves on the state of the art, but its business plan does not make it clear whether that improvement removes the pain for any person of particular note.
To raise capital, start with a story of how a customer is suffering and why your product will relieve that suffering better than anything else. So be sure to start your pitch with a story from a real person who is grateful that your product made her pain go away -- unlike any other product on the market.
Related: Nailing Down the Perfect Price Point
2. Is the customer willing to pay more? BSC's business plan does not clarify how much it charges the typical customer or whether that price is higher or lower than the going rate for existing products of competitors.
To raise capital, be clear whether you're offering customers a much lower price for a solution similar to others on the market or a higher price than what competitors charge. If you're charging a higher price, potential investors need to know how your product's features translate into measurable economic benefits -- such as lower costs or higher revenue -- to justify that higher price.
If you're charging a lower price than the competition, be clear why you can make a profit at that price and how quickly you think your company will grow as a result of the better deal you're providing customers.
3. How long does it take to close a sale? To estimate a startup's future revenue and sales costs, an investor needs to know how much time will elapse between when the company gets a sales lead and when this results in a customer paying for a product. BSC developed a map of its sales pipeline but it was missing some key details.
To answer this question, figure out where the best leads come from and who within a potential client's organization is involved in deciding whether to purchase your product. From there, interview each person and find out their roles in the process and the factors that influence their decision.
With that map of the sales process, estimate how much time it takes to close the typical sale and figure out if you have the right strategy.
4. How will your company grow? These days it takes $100 million in revenue for a company to sell its shares to the public. Needless to say, some companies have been acquired for significant amounts with very little if any revenue. But if you are trying to raise money, make it clear that your company is going to get big in the next several years and explain how that will happen with convincing detail.
BSC portrayed significant growth -- but not at big enough a scale to go public and not with sufficient detail to be persuasive. One way to do this is to target a huge market -- bigger than $5 billion -- and show how other successful startups that have targeted similar markets have scaled significantly. My favorite thing to see is 50 to 100 interviews with potential customers that convince me that you know how customers buy, why they will buy from your company and how those customer counts will grow over time.
5. How will investors profit? Investing in startups is complicated. If a company is successful, it will attract big money as it approaches within a year or two when it will be of such size that it can go public or be acquired.
But that very success means that people who bet on your company before this happens will suffer because their share of your company will be diluted by later investors.
BSC estimated that early investors would end up with much more money if it achieved its modest sales targets, but it did not explain how much a better-than-expected revenue outcome might dilute the shares of those original investors.
To be fair, the odds of success for a startup investor are very long and there are plenty of things that can go wrong. But when you are seeking a check from an investor, present a model -- stating clearly a set of realistic asssumptions from credible sources -- giving an estimate of how much money an investor will make under optimistic, pessimistic and middle-of-the-road scenarios.
Though I still need to be convinced that you are a great startup CEO, providing well-thought-out answers to these questions will increase your odds of raising capital.