REBLOG: Seeking Capital For Your Startup? Remember: It’s About Returns For Your Investor by JD Morris from Forbes
One of the most daunting tasks you are likely to face after having successfully founded a growing startup can be securing enough capital to pay the bills until the expanded operations begin to pay for themselves. Startups seeking funding for their expansions have a number of options for securing capital, but you still need to convince investors that your business is worthwhile as an investment. An understanding of the funding landscape will help hone your sales pitch and increase the odds of a successful capital campaign.
Unfortunately, the American business ideal of steady growth over the long term has been replaced in the minds of many entrepreneurs by dreams of founding a unicorn company that explodes onto the scene and cashing out through an initial public offering. Startup founders need to keep in mind that the likelihood of founding a unicorn is incredibly small, but there are other successful strategies for rapid growth using outside capital. Those strategies should be centered on producing a high company valuation and creating significant wealth for yourself and your investors.
Few modern startups succeed without outside capital.
The Fortune 500 list features a few companies that made it to the top as startups and by expanding the family business. Bill Gates was lucky enough to have a product IBM desperately needed. Jeff Bezos got his seed capital from his parents’ savings and raised $8 million through a series A round from Kleiner Perkins in 1996. Both companies also benefited from fantastic support from advisors and investors. For example, Amazon’s investment bankers played a crucial role in raising debt for them during the dot-com collapse, which resulted in Bezos retaining a large share of the company. When looking at the success of the founders of Facebook, Google, Microsoft and Amazon, you should know that this type of success is even rarer than the unicorn model.
Of course, there is still the chance your company will succeed without the help of outside capital. The bootstrap model, where an entrepreneur can entirely self-fund operations until the company is financially viable, can still work. With luck and products that offer high profit margins, the founder can take home a considerable paycheck. However, bootstrapping is unlikely to land you on the Forbes 500 list of billionaires any time soon. About half of businesses fail within five years, and capital is always needed for rapid growth.
If you are lucky enough to get capital from SoftBank, Sequoia Capital or other mega-funds to stay solvent until an IPO, then you are one of the very rare unicorns. The great IPOs of today tell a unicorn success story. However, there are significant failures. Jawbone’s pivot to health-tracking devices did not keep it from its 2017 liquidation. Dream of a unicorn, but remember, most investors are not looking to deploy capital to develop a unicorn.
Investors know the odds are against you.
Startup investors generally use a high-risk model where they spread their capital among numerous startups, knowing that it only takes one or two to be successful enough to pay back the initial capital investment. Companies that produce such returns are called dragons. Unicorns are more based on valuation. A dragon is one deal that pays the return for a fund after investing in many deals.
Normally two to three startups will provide enough of a return to make a venture capital fund successful, while the others fail to make any return for the fund. Based on this math, startup investors are generally looking for an exit when a company has achieved a valuation that is roughly seven times greater than their total investment in a company, in my experience. Sure, an investor could buy into an existing unicorn, but a high return after the B round is unlikely and often will not cover the losses from their other investments. Most investors need high valuation that will be supported by acquisition valuation versus the longer and riskier path of an IPO.
Laying out a realistic exit strategy is key.
Venture capitalists and startup investors know that most of their bets will be on losers, so if you think your idea is going to be a surefire unicorn that will dominate its market, go ahead and pitch it that way. Investors love to see enthusiasm in a startup, because it lets them know you believe in your company and are willing to put in the work necessary to make it successful. However, you should also lay out a more realistic exit strategy for investors, such as selling the company. I earlier suggested that “entrepreneurs should stop dreaming of the shiny IPO” and focus on being attractive for an acquisition.
Remember, investors are looking for a dragon to show their limited partners (i.e., 700%-plus return). A unicorn can be helpful for venture capital funds to show their investors should they want to raise more money for future funds, but the bottom line is the return they get from investing in you.
ABOUT JD MORRIS
Mr. Morris (JDM) focuses on serving on the board of advisors and board of directors of several private companies. His family of Special-Purpose Vehicle (SPV) invests in a wide range of businesses. JDM has helped close more than $91 billion in deals—leading more than $7 billion in enterprise value of these deals.
He has been a speaker at various industry forums, has been quoted in numerous leading publications, and has made several appearances on Bloomberg, CNET, CNBC, ESPN, and many media outlets. Mr. Morris hosted an educational radio show about financing deals and other hot topics after Bloomberg morning news.
Mr. Morris received a B.A. in economics with mathematics from Hampden-Sydney College in Virginia, where he worked in the development office to pay his way through college. He is an Omega Rho Honor Society student in Washington, D.C., with The George Washington University (GWU). JDM is currently working on finishing a program under MIT Sloan Business School, as well as the MIT Computer Science & Artificial Intelligence Laboratory (CSAIL).