Funding is a tool for accelerating growth. But it comes at a cost.
Not raising it to accelerate growth also comes at a cost.
Many factors drive the decision to raise or not raise funding. In the instance that you do want to raise growth capital, you have 2 primary options, debt or equity.
Listen to Pavlo Phitidis discuss how to approach and secure the right funding partner in this podcast from The Money Show:
In the case of equity, this requires you to value your business. How you value and defend your valuation and thereafter, negotiate the terms of the equity funding carries long term consequences.
Equity funding has two components for any business owner. Money and strategic value. When seeking to raise equity funding, a business owner must consider whether they want money alone or money and strategic value. How you negotiate with a funder will be determined by this need.
Understand your strategic intent
Why you want funding should guide your choice of funder. If you simply need money to accelerate a growth strategy that’s working, then your funder choice is a pricing negotiation. If you want more, then it’s a relationship negotiation. If you are not sure, then you need to do more work.
Understand your equity investor
In all markets, there is always more money than viable investable businesses. If you are not experiencing that, your business is not investable.
An equity investor has two objectives, to use their money to generate a return in line with the perceived risk and then to repeat the process. See it as a lever of growth. They understand that their money is a lever to shift and carry the higher load on a business looking to accelerate its growth. With their lever, your business can lift a higher load. Without it, you might be able to lift that load, but it’ll take a lot longer doing it on your own. Because time runs out and the market waits for no one, you might even lose the opportunity to grow completely.
Helping an investor to see how their money will accelerate your growth and through that generate their return is your responsibility. To reduce the risk of their money not being returned or growing, they will test the validity of your business and yourself. It’s not personal.
To increase their return, they will look to reduce your valuation to, for the same investment, secure greater equity to accelerate and increase their return. The return for them offers more opportunity. They can invest it further in businesses and they can raise more money from other investors to build their fund to invest in more businesses. To secure your business, they will use pricing, their reputation, the resumes of their team and offer a range of intangible assets like connections, introductions and more. This helps them negotiate your price down by increasing their equity portion up.
Setting your valuation
To set your valuation, you need to do so against the free cash your business can and has generated. An investor is not interested in your stock, equipment and land. These assets are of interest to a debt funder who will lend you money against them. Equity valuations are driven by the velocity and quantum of free cash and the certainty of it.
Growing a business eats your free cash so for many, you need to talk about the future you can promise to support a decent valuation.
In addition, you need to consider if you want a strategic investor or just their money. Defining the strategic value of your investor is critical if you believe that they can, beyond the money, bring it to the table to accelerate your growth.
Getting this right means splitting out your valuation. The portion that their money will accelerate and the portion their relationships/skill will accelerate. They will not want to pay for that portion.
Getting this right requires you to have a deep understanding of your business, the market you are playing in, a clear growth strategy and evidence that it works, and, to show how money alone can accelerate it.
In the case of strategic value, you need to understand your investor, speak to others that he or she has invested in and confirm that they can and will bring the strategic value to accelerate your growth.
Raising funding is an emotional exercise the first time round. It’s a bitter exercise the second time round if the first time it failed. I’m yet to see where both parties don’t over-estimate the value they bring to each other. This creates expectation gaps and disappointments. To get it right, understand your business, be clear on your growth strategy, know what you need to make it happen and then do your due diligence on the investor, just as they will on you.