Figuring out how to fund a startup is no easy task. Knowing how — and when, and where, and why — to pursue a formal round is one of the toughest questions a leadership team has to tackle. For entrepreneurs who have never been through the motions, funding your tech company can be all but exhausting.
We sat down with William Robinson, Marc Neri, and Dennis Grunt from Silicon Valley Bank, a commercial bank for tech companies and startups, and asked them all there is to know about startup funding throughout the various life stages of your startup. From finding your first investor to weighing the benefits of IPO, they gave us their expert advice on funding in all its iterations.
Seed Funding:
What are the key concepts and ideas you need to iron out for your first pitch deck?
I’m a proponent of milestone financing. So, a company raising an angel or seed round should have a clear understanding of how much capital it needs to get to the next significant milestone.
Investors tend to view companies as fitting into one of three risk categories: pre-product/market fit, at product/market fit, or post- product/market fit. Where a company falls on that risk continuum should influence the set of investors the company targets, which in turn should influence key elements of the pitch deck.
For instance, a company that is still developing its product would need to clearly define the size of the market opportunity – and not just the market as a whole – but the part of the market that its product will address.
Also, many pitch decks lack a clearly defined competitive advantage and sales and marketing strategy. To the extent that a presentation can hone in on early signs of traction as it relates to customers, paying customers, users, or any other key metrics will heavily increase the likelihood of receiving funding at a favorable valuation.
Is bootstrapping a really good choice, or are there benefits to raising an equity round?
Raising venture capital is obviously not the objective; it’s a tool that may or may not help the entrepreneur/founder achieve their business goals. If a company can afford to bootstrap and simultaneously find ways to generate revenue, that’s great. For example, many service businesses can generate significant revenue early and may not need to consider raising VC.
At the opposite end of the spectrum are capital intensive businesses such as medical device companies that oftentimes must raise large amounts of outside capital just to get through regulatory approval. For companies that fall somewhere in between the continuum of the aforementioned examples, the decision to pursue venture capital is very much a personal decision that is likely driven by the size of the market opportunity, total required funding, and personal objectives. Are you swinging for the fences and do you want significant oversight?
Cost of capital and access to capital are also factors to consider.
In short, if you’ve built a product, gotten early customer validation, and are swinging for the fences, then raising a round is a good choice.
If I secured a seed round, how much should I pay myself?
Again, the answer to the compensation question somewhat comes down to personal preference. But in my 8-plus years of banking startups, it seems that $50k - $80k is appropriate compensation for seed stage founders, depending on geographic location and personal circumstances.
Responses from William Robinson, Vice President, pictured left.
Seed through B Round:
What are the most important metrics that investors are looking at for your post-initial round of funding?
It ultimately depends on your business. For example, for an early-stage B2C start-up it is likely going to be around your user growth metrics, whereas an enterprise B2B startup will likely be more focused on product development, customer acquisition cost, and unit economics.
However, nearly all investors (especially here in Chicago) will ask themselves if they see product market fit (i.e., Is there a large market for this product or service?). The key is to determine early on with your current and potential investors what the key milestones are for the most recent round of financing.
Is it time for a round of venture debt, or should I raise another equity round?
Venture debt can be great tool for certain companies to extend runway, achieve additional milestones, and reduce dilution (i.e. own more of your company).
There are a number of articles out there on the topic including this piece by the Kauffman Fellows that explains how venture debt works. But at a high level, venture debt is nuanced in that it typically needs to be done in conjunction with a current equity financing. So if you’re more than 6 months from your last round and have less than 12 months of runway, you need to start evaluating other options.
Obviously, if your metrics are strong enough, then you’re going to want to fundraise soon when you have ample liquidity on the balance sheet. However, in a lot of situations, companies will look to current investors to provide a convertible note to push out that next round so that additional milestones can be achieved.
Do I have the right investors? What are my options if I don’t?
Ensuring you have the right investor(s) is a huge factor in determining whether or not your company will ultimately be a success. Outside of pure capital, a good investor will add so much value to your company, given their prior experience in your industry, a deep rolodex of customers, suppliers, and other investors, and general assistance with scaling the business (hiring, finance, legal, marketing, etc).
Taking an investment from a VC is often compared to entering into a marriage. You really need to take your time to get to know your future partner. That means spending time with them, asking for references (especially on investments that went south), and really determining if there is a good mutual fit. Because, just like a marriage, when a relationship goes south, it can become very ugly and costly to the company and to the investor.
Responses from Marc Neri, Vice President, pictured right.
Series C to Exit:
Weighing your options: how do I evaluate an acquisition versus going IPO?
The primary goal of most founders, outside of building a great business and creating jobs, is to realize a liquidity event via a successful exit. While the right path will vary company by company, there are several key factors that should be considered when determining whether an exit via M&A or an IPO is the best path for the company’s shareholders.
Some of the most important factors include the company’s long term vision, the sustainability of its culture post-transaction, and the ability of its leadership to continue to scale the business. An IPO, versus M&A, will better provide the company’s leadership team the ability to continue to steer both its culture and execute upon its founding vision.
Other key factors a company should consider is the ‘Risk/Return Profile’ as well as the ‘Time to Liquidity’ each route provides its shareholders. While culture and vision are extremely important elements of a company’s continued success, they should be balanced with an appreciation for the procedural and financial implications of pursuing each route.
While an IPO can better protect the founding vision of the company and can often provide the potential to yield a greater economic outcome for its shareholders (versus an M&A transaction), there is also greater volatility and uncertainty due to market fluctuations. This volatility can make it especially difficult for companies with more substantial private market valuations to realize a satisfactory return, especially given the time and expense involved in going/being public for its shareholders (versus a sale to either a strategic or financial buyer).
In addition to volatility, M&A typically offers shareholders immediate returns at close and a pathway to exit regardless of exit value, whereas an IPO can take years to exit especially for insiders. The investment horizons and expectations around exit value, which are likely to vary between key shareholders, will be a significant driver in a company’s decision as to which path to pursue.
It should be noted that the vast majority of companies — approximately 92% — that have exited over the past five years have exited via M&A. As companies have had access to larger sums of capital (and at favorable terms; Series C Private Valuations were up about 85 percent from 2009 to 2014), companies are able to stay private longer, helping to delay an IPO, sometimes indefinitely.
While the best route is tough to predict and will vary based on a confluence of unique factors, each company should focus on building a great business first and foremost. That way, you ensure you are building something that others – be it acquirers or the public markets – find of significant value.
What is the climate like in Chicago right now for late stage investments?
From SVB’s perspective, the ability for Chicago-based companies to attract late-stage capital remains strong. Obviously, a company’s ability to attract capital is based on a variety of factors, with the most important ones often being the strength of its product and/or service, the presence of a large and underserved market opportunity, and a steep trajectory in revenue.
Assuming a company possesses these characteristics and others, data suggests that the amount of capital invested in Illinois on an annualized basis will remain on par if not exceed total capital invested in the state for 2014. While total invested capital (specifically for later stage investments) is anticipated to at least be on par with that realized for 2014, the number of investments are forecasted to be down with fewer companies receiving more dollars.
Responses from Dennis Grunt, Director, pictured left.
Image via Shutterstock. Headshots courtesy Silicon Valley Bank.
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