Fundraising activity has stalled over the past few months as investors have remained uncertain around the path/timeline to recovery from the coronavirus pandemic. Despite the state of the market, as a principal at Bling Capital and the founder of a seed-stage venture capital firm, I have seen several founders who have successfully raised large checks at pre-coronavirus market prices.
I wanted to share what set these particular pitches apart and how you can potentially increase your fundraising chances in today’s economy. These founders were able to gain an edge by specifically addressing and in some cases even turning the current macroeconomic climate in their favor.
Have Cash Burn Under Control:
Most VCs are prepping their portfolio companies for 18-24 months of runway and will likely want to invest in a founder who has the same mentality. This starts by showing a good grasp of burn mechanics, which entails creating a financial model that breaks out major cost items for the next 24 months.
Doing this exercise shows that you have a good understanding of the various levers you would need to pull under different downside scenarios. There are several ways to evaluate burn but I recommend looking at Bessemer’s Efficiency Ratio, which measures how much the company is burning for each incremental dollar of revenue. Definition and benchmarks highlighted in the table below:
Net New Annual Recurring Revenue (ARR) here is how much additional revenue you have added in a given period. Net Burn is how much you have burned in net dollars (taking revenue into account) in the same period. For example, if your company reported that you added $1M in ARR this month but burned $3M, that would be a 0.3 Efficiency Ratio, which would be risky.
Distribution Strategy During Covid-19:
While most sectors are underwater, there are several key distribution channels that have remained resilient during this environment. A founder who impressed me recently ran a modern health clinic that was able to pivot to converting all their customers to digital appointments within two weeks because their physical locations were on lockdown.
Generally, channels that have a higher mix of “card-not-present” payments, or transactions made without physically needing to swipe or insert credit a card, will fare better during the lockdown. I have included a general framework around thinking through Covid-19 impact by sector and payments type below.
Looking at how your distribution channels are being affected also may provide insight into which customers are at risk. For example, a tech startup that is selling software to restaurants will probably experience an uptick in cancellations. This startup might find it better to pivot to selling software to cloud kitchens (delivery-only kitchens which have seen an acceleration in purchases) instead. Taking some time to understand how COVID-19 impacts distribution channels will provide better direction around adjusting your customer mix or product use case.
Profitability Gives You Leverage:
Investors today have more power during negotiations because they know the fundraising environment is a lot colder. If your startup is cash flow positive, you will have a considerable amount of leverage because the company’s immediate survival is not dependent on the investor’s capital. Investors also love investing in profitable startups because economically, it is the same as investing in a larger round minus the dilution. You have essentially derisked the investment for them while keeping the cap table clean.
For companies that haven’t reached profitability, don’t fret. If you are able to show incremental margin improvement from the past few weeks, even that would help make a case that the company has a path to profitability and show investors that the business is not just another cash-burning machine.
Key KPIs to Focus on:
COVID-19 has changed consumer purchasing behavior, which leaves pockets of opportunity for startups to disrupt. Founders who can convince investors that they can not only survive but thrive in this environment will be able to seek more attractive terms. A well-known example of this is Peloton stealing away market share from physical gyms like Equinox during the lockdown period. I encourage highlighting a metrics-driven strategy that quantifies to investors how your company can grow even faster than before.
These are several KPIs that indicate a well-positioned business:
- A decrease in customer acquisition cost (CAC) means you are able to acquire more customers for a smaller sales and marketing spend in today’s environment. You might be seeing a lower CAC because of a shift in consumer spending behavior or because you have identified a new, more efficient marketing channel.
- Inversely, showing an increase in retention and usage translates to higher customer lifetime value (LTV). A good example here is mobile games showing higher engagement and spend during lockdown.
- Ability to increase prices with little impact on retention. Having this pricing power means a business is able to achieve higher gross margins and scale considerably faster.
- One last “KPI” that is often glossed over during pitches is talent level. The team quality matters just as much as quantifiable metrics to the investor (especially at the early stage). Given the rounds of layoffs over the past two months, talented operators who otherwise would have been difficult to recruit are now available at startup budgets.Showing that you were able to upgrade your team at attractive prices (“We just brought on a former senior product director at Airbnb for $x and x% of equity”) speaks volumes to your ability to effectively recruit.
Investors Respect Hustle:
Like many businesses today, if you are in an industry that is hit hard by COVID-19 and there is very little room to pivot, the KPIs highlighted above might not be within your control. If every metric is in the red, one other angle to take is putting on display your team’s hardcore hustle.
Investors respect entrepreneurs who have grit because they know that tough people outlast tough times. Utilizing all available resources to keep your business afloat, whether that is enrolling in a government stimulus program (i.e. PPP) or taking advantage of corporate perks (i.e. free Facebook ad credits) shows resourcefulness. In addition, building complex products with very limited resources is an alternative way of showing your resourcefulness.
I was recently impressed with a two-person team that was able to get a HIPAA compliant system up and running within a few weeks by leveraging existing software like Google Forms. Under the average management team, the same product would have taken months to build with a larger engineering team.
Optimize on Speed, Not Price
Finally, I have seen valuations in today’s markets cut 20-50 percent, so if you do have the opportunity to close a term sheet at a fair price, this is likely not the best time to play hardball. I encourage founders to get through the fundraising process as fast as possible so that they can navigate the company’s operations during these trying times.
Optimizing on speed in order to return back to day-to-day execution sends the right signal to both your existing and new investor base. In addition, if you have received multiple term sheets, consider pocketing the extra money. It’s not clear when capital markets will recover and how things will look tomorrow.
Fundraising today is tough but addressing points above may help better position your company for a successful raise. Best of luck to all the founders out there.