What Investors Focus On When Funding Early Stage Ventures
If your startup is looking to raise money, please be mindful that investors will undertake thorough due diligence before parting with any funds. Allied Legal sets out some of the key issues investors focus on when investing in startups.
There are various methods used to establish the value of companies and their assets. In the case of established companies, traditional methodologies such as discounted cash flow are adopted. However, in the context of startups, which have minimal sales and potentially little in the way of cash flow, valuations are more problematic. Accordingly, other factors such as the following are given importance:
- The quality and experience of the founders and management team (Key Team).
- The openness of the Key Team to accept coaching and mentorship and their potential to execute on plans.
- Customer validation of the concept.
- The “go to market strategy” and the potential size of the market.
As you can see from the above, "people" can be a key factor in an investor’s valuation of a startup.
Investors will always seek to confirm that the startup owns its intellectual property (IP). In most cases, a startup's value is going to be based almost entirely on the value of its IP. As a result, startups must ensure that their IP is safe. Certain IP can be protected by way of registration. Alternatively, intellectual property can also be protected by way of contract including non-disclosure agreements and proprietary rights agreements.
While this point has already been made above, we can’t stress the importance of people to an investor’s funding decision. Early stage ventures can often be nothing more than one or two people, an idea and ambition to turn that idea into a profitable business. Accordingly, funding a startup can often amount to an investment in its people. For this reason, investors spend a lot of time getting to know the founders and their key team members.
Investors will inquire about the founders’ professional and educational background, their roles and responsibilities in the startup and whether they have passion for their idea (i.e. it always helps if you can demonstrate that it's about more than just the money!). Investors seek confidence that the founders have the talent to get their business from where it is today, to where they believe it will be with the benefit of additional capital.
Validation of idea
Investors seek comfort that the startup’s product or service has received some level of validation. Letters of intent, pilot programs, customer contracts and / or early sales all provide investors with confidence that the startup’s idea can be commercialised. If founders are able to demonstrate some level of market appetite, the risk profile of funding the startup is far more promising from an investor’s perspective.
In-house "dev" team
From an investor’s perspective it is looked upon favourably if your development team is “in-housed”, as opposed to outsourced pursuant to a software development agreement or otherwise. This effectively means that your key intellectual property is in your control as opposed to reliant on a third-party arrangement.
Have your house in order
Investors will come to you with a shopping list of requirements in the lead up to their due diligence process. This will include key information and company documents such as:
- The company books (including your cap table).
- Key agreements.
- Details of grants and incentives.
- Financial statements.
- Details of employee incentive schemes.
- Customer arrangements.
- Details of any key risks including litigation.
Ensuring all such information is up to date and easily accessible will provide investors with confidence that you are an organised team that has its act together. The key takeaway here is that you must not give investors a reason to doubt you. Looking organised can add value!
Allied Legal’s commercial and startup lawyers regularly advise startups on capital raises. We work closely with startups and their founders to ensure that such transactions are professionally and expertly handled. If you have any questions please reach out to us on 03 8691 3111 or email us at firstname.lastname@example.org. We’d love to help you and your team.