On Wednesday I was invited to mentor 66 startups that have been shortlisted by the London Co-Investment Fund (LCIF) as their top candidates looking to raise rounds of between £250k and £1m. A room full of eager-eyed entrepreneurs who have built good products and are supported by strong teams, and now need that next boost of capital to set them on their journey to commercial success. All of them have the same problem: unanimously the question they all asked was, “where do I find investors who will invest in my round?” (and more acutely in the lower range of £250-500k)
The market for bridge and seed-extension rounds has always been tough. Startups get caught between not having enough proof points to qualify for VC investment, but having built a team and operating model whose burn rate requires 6-figure investment to keep going. But is it getting worse?
Anecdotally I’ve had many a conversation with investors who claim that SEIS (which offers a better tax incentive than EIS) has encouraged angels to target smaller, earlier seed rounds in search of reduced overall risk. And entrepreneurs have fallen into the trap of capping their seed rounds at the £150k SEIS threshold, which for most businesses doesn’t provide enough runway to get the proof points you need to maximise their chances of funding at the next round.
There are less than 10 funds in London who targeted £250k to £1m rounds in 2014. To give you a cross section of 5 of those I know well:
- the first fund is very active and has remained so, but as this post will show, is increasingly having its pick of the very best startups as other sources of capital dry up;
- the second fund was very active until the tail end of last year, when it reached the end of its investing cycle;
- the third fund who backed a number of highly impressive and immediately recognisable success stories is now in the last year of its investing period;
- the fourth fund over-extended itself at the sub-£500k level and now needs to balance the portfolio by focusing on later stage (larger ticket) deals;
- and the fifth fund wrapped up its seed operations in 2014 and is focusing its new fund on Series A.
So where else can entrepreneurs turn? Particularly as this points to a growing list of entrepreneurs chasing ever fewer sources of capital.
Some VCs operate (smaller) early stage funds on the basis that there will be a handful of businesses who exhibit such impressive metrics that the VC wants optionality ahead of the Series A. Another model that follows the same thinking is VC Partners who invest personally in a business before it is mature enough to meet the criteria of the VC fund they manage. I’ve just seen this with one of the portfolio businesses I support, Reedsy. But it took the founders 5 months, well over 50 meetings and a lot of heartache before they raised the £250k they needed.
Angel networks continue to provide a stable base of capital, but they present challenges that most entrepreneurs want to avoid. Most require the entrepreneur to pay to pitch, which presents a significant obstacle for cash-strapped businesses when there’s no guarantee of a successful outcome. You also have to understand the mentality of angel investing – most angels invest because they have a personal interest in the sector, the idea or the entrepreneur themselves, which makes them hard to find. And if you’re lucky enough to find the right angel, they typically won’t write a cheque for more than a few £10,000’s.
Finally there’s grant money and crowdfunding, both of which can be an excellent source of capital, but typically only apply for certain types of businesses. As a general rule, crowdfunding works best for B2C businesses or businesses with wide marketable appeal. Grant funding typically requires the entrepreneur to demonstrate genuine technical innovation, but even then the process of applying can prove challenging.
So where does that leave the 66 Green Light startups hunting for investment from the LCIF partners? And what can other founders learn to maximise their chances of fund raising success?
I’ve already touched on the fact that in “hindsight” most startups fail to raise enough in their Seed round, which might otherwise give them the funds to jump to Series A with no bridging required.
But that doesn’t help those already in this situation…
I take it all the way back to the fundamentals of why you became an entrepreneur in the first place. Are your here to build a business? Or are you here to play a game of hop-scotch jumping between funding rounds?
Business is about optimising an operational model to deliver quality product/service for maximum cash inflow while minimising cash outflow, and if all goes well you might generate a nice wedge at the bottom that can be reinvested or used to reward staff and shareholders.
Building successful businesses requires an operational model that can be self-sufficient, no matter what stage of maturity you’re at, and doesn’t compel management to continually go back to the markets to cash-flow their operations. Building a business is a marathon, not a sprint, and if you break the marathon down into its individual one mile stages, are you designing an operational model to achieve the individual goals at each stage with the minimum amount of external assistance? This is what the investment community refers to as “execution” and invariably sets the best entrepreneurs apart.
I accept that there are businesses, particularly in the B2C space, social media and network businesses whose success is predicated on scale and requires a hard-and-fast approach to growth. But most businesses are not like this.
When I assess any startup for investment, not only do I want to see the entrepreneur’s vision, passion and commitment to their game-changing idea, I also want to see that they have a clear roadmap of how to get there.
So, for those entrepreneurs struggling to raise funding, can you force yourself to reshape your mentality and revisit your operational model to drive cash into the business by other means?
Getting your clients to pay for development can be the easiest way to bootstrap a business. But this requires the business to remain agile while it develops product-market fit while ‘live’ on the shop floor. Here are some ways to achieve this:
- If my ambition is to build a self-service low-touch SaaS platform, I could consider selling high-touch one-off projects to a small number of clients to fund my operations while I develop the features needed for a self-service platform;
- If I’m building a marketplace business, there may be a paid-for product/service I can offer to one side of the market (usually the supply side) to fund operations while I build up liquidity;
- If I’m building an enterprise software business which typically requires long sales cycles, I might consider offering paid consultancy to my prospective clients to keep myself afloat;
- I might even consider shortcutting the build of a tech platform by executing the service myself.
None of this precludes you from trying to raise money from investors. But this type of bootstrapping activity can benefit the business long term in 3 key ways:
- It will force you to rationalise on what is essential expenditure and what is discretionary, which is a quality most investors like to see;
- It will push you towards product-market fit quicker than you would otherwise, because every £1 of cash generated will only be followed up with another if you’re satisfying customer need;
- It will give you the time and space to build the metrics you need to better meet an investor’s criteria.
Who knows – it might just give you the additional proof points you need to beat your fellow entrepreneurs to securing that hard-to-find £250k to £1m round.
The evidence of the last 6 months suggests the market in London in the £250k to £1m range will remain challenging for some time to come. Does this call for a new approach from entrepreneurs? Moreover, is there a responsibility on accelerators, incubators and mentors to prioritise bootstrapping and “business building” rather than focusing on how to win favour with investors? If we can achieve it, we’ll probably be building better businesses with a DNA that breeds long term sustainable success.