Most start-ups need to seek funding at some point – and many have to do it more than once. It can be a long and daunting process, but we’re here with everything you need to know when preparing for a round of funding to grow your business.
We’ve written this article with businesses at the seed stage of funding in mind, however it contains helpful information for businesses at every stage of their funding journey.
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Why seek funding?
When is the right time to seek funding?
How can you raise your first round of funding?
How to plan for a funding round
How long does it take to raise funding?
The different types of funding
How much money should you try to raise?
Why seek funding?
Need initial capital to get your business up and running? Already been trading for some time and looking to expand with new office space? Ready to grow with new hires? There are numerous reasons why a business might seek funding, either before launching or when they’re already established.
Very few start-ups are fully self-funded, so you’ll inevitably have to take the leap and get investors on board at some point. A study by CB Insights analysed the top reasons for business failure. The number one reason for failure, cited by 38% of businesses surveyed, was that they ran out of cash.
Businesses understand that cash is crucial for business success, and almost half (45%) of SMEs applied for external financial support in 2020 according to the British Business Bank. Of these businesses, 89% applied for funding to help them deal with the impact of Covid-19, and 75% needed help with cash flow. A further 8% sought finance to pivot or change their business model and 7% wanted to invest in their digital assets and tools.
Whether it’s to deal with cash flow issues in times of crisis, grow your start-up or develop new product offerings, there are myriad reasons to seek funding. It’s all about recognising the need for your business and timing it right.
When is the right time to seek funding?
If you’re keeping track of your start-up’s burn rate, cash runway, cash flow and forecasting your cash, you should be able to spot in advance using scenario planning where there may be cash gaps in the coming months, or where you need to start scaling up due to hires, asset purchases, or other activity.
Once you’ve identified the need for funding, and the right time to look for it, you should take stock of the situation. Raising capital for your business can be a difficult task – and it’s a big commitment, so you need to be certain that this is the right thing, for you, your company and, if you have them, your staff. Are you ready to dedicate yourself to your business for the long haul? If the answer to both questions is yes, then you’re ready to seek funding.
When you’re ready to take the first step into looking for funding, you should ensure that your company is incorporated. You can technically seek funding before your company is incorporated, but it’s unlikely that investors will be comfortable with this arrangement. When you incorporate your business, it separates your company from you as a person. That means that it has a legal status in its own right and any debts or liabilities belonging to the organisation can’t be reclaimed from you as the business owner – that is, you’re protected by ‘limited liability’.
Whilst you’re seeking funding to ensure your business is a success, sometimes things do go wrong, and incorporation means you are personally less likely to have to lose your savings or house if you do have to repay your investors for whatever reason. Any investor funds you receive should only ever be deposited in your business account and kept entirely separate from your personal cash.
What’s more, it makes your business look more established, which can only be a good thing when you’re reaching out to potential investors.
How can you raise your first round of funding?
Getting funding for your business requires a lot of self-promotion, so be prepared to put yourself and your business out there.
Go to investor events and talk to as many people as possible. These events are a great way of getting the word out about your business, and they give you a good opportunity to practise your elevator pitch. They cost little or nothing, meaning you’re getting low-cost exposure whilst making connections.
As well as speaking to investors, be sure to speak to other business leaders who have recently been through a funding round. Find people in your local area who are where you want your business to be, and ask them questions to learn about the process – and to get introductions to their investors.
How to plan for a funding round
Preparation and practice are key to securing investment. You’ll want to ensure you’ve done the following before any funding round:
Research your investors
First and foremost, do your research about exactly what your investors are looking for from a funding pitch. Most will want to see evidence of cash projections, your burn rate and your cash runway.
As a business founder, it’s important to understand the lingo used in your industry too. For example, investors looking to fund a burgeoning SaaS business will want to know that the founder understands important metrics such as Customer Lifetime Value (LTV), Monthly Recurring Revenue (MRR), Annual Recurring Revenue (ARR) and Customer Acquisition Cost (CAC).
Prepare your pitch
Investors are much more likely to put their cash behind your business if you offer them a compelling reason to do so. Share a compelling story and an exciting product or opportunity that’s going to be difficult for them to refuse. Even if they love your idea, sometimes that’s not enough if it has no market potential, so make sure that you can also demonstrate traction and growth potential for your business. Show potential investors that you’re going places – and give them a reason to come along for the ride.
Hone your pitch deck
Investors see hundreds of pitch decks every year, so you need to make sure that yours is memorable for all the right reasons. Start with an executive summary showing what you’re looking for and why, as well as a comprehensive slide deck – but not too comprehensive.
You want to strike that fine balance between giving too much information and too little. Remember you may have a limited amount of time to present and you don’t want to have to skip any parts. Include easy-to-read graphs, charts and screenshots – remember that you may not be presenting to people who know the ins and outs of business finance, so the easier your content is to understand, the better.
You should look to cover the following basic points in your deck:
- Your vision
- The problem you’re trying to solve
- Who your customer is
- The market landscape
- Current traction and future acquisition plans
- Your business model, including revenue and actuals
- Information about your team, and any new hires on the agenda
- What capital you’ve already raised, if any
- What you’re hoping to raise
Remember to leave plenty of time for questions!
Prepare a cash flow forecast
A cash flow forecast is important for investors. Firstly, it shows that you’re on top of your business and are actively planning for the future, making a potential investor more likely to trust your business.
Secondly, investors often look for fairly aggressive growth. After all, they want to see a swift and significant return on investment. If you have a cash flow forecast available, it shows them exactly where your money is going, and how much you’re investing into growth.
You should offer different scenarios for growth in your cash flow forecast. Scenario planning shows investors that you’ve thought through multiple different scenarios – the different routes your business might take, pinpointing strategic decisions along the way and highlighting where you might, for example, take on new business or hire new staff. What’s key here is showing that you have thoroughly considered potential different scenarios for your new business.
Include a capitalisation table
A capitalisation table – or a cap table – shows who currently owns how much of your company. They may be sceptical of cap tables with too many investors, particularly if they’re looking to invest a large chunk of cash in exchange for a bigger proportion of your company. Investors will also look carefully to see if there are any well-known or influential investors as this may positively sway their decision.
Companies House filings
Ensure your filings are up to date so your investors get a full and true picture of your accounts and shareholding history.
How long does it take to raise a round of funding?
As with most things in business, funding can take longer than you might think. You should be flexible and plan well in advance for your funding round, as it can take 3-6 months on average to raise a round of funding – and often longer if it’s your first round.
The different types of funding
You must know what type of funding you need before you start chasing it – and there are a few different types to get your head around.
Pre-seed funding
When a company is just getting started, it’s often funded by the founders themselves, known as ‘pre-seed funding’ or ‘bootstrapping’. On average, start-ups in the UK budget £5,000 to get themselves off the ground, which usually comes out of the founder’s pocket.
Alternatively, you may want to investigate joining a start-up accelerator. Accelerators support early stage start-ups, offering funding in exchange for equity in your company. Typically, start-up accelerators are fixed term, lasting up to 6 months, and is an intensive period of learning where you’ll benefit from mentorship and networking opportunities. Many accelerator programmes culminate in a ‘demo day’ where you may have the opportunity to pitch your business ideas to a group of active investors.
Seed funding
A business’s first round of funding is known as ‘seed funding’, which is usually significantly larger than the pre-seed round. RLC Ventures has found that its seed rounds typically range from around £350,000 to £1.5 million.
This usually comes in the form of either convertible debt or future equity.
Convertible debt – often called a convertible loan note, or simply a loan note – refers to an investment that’s initially given as a loan, but is later converted either in whole or part into shares. This type of investment can usually be put in place quickly, and the associated costs are far lower than with equity round investment, so it can be a good way of securing much-needed cash in a relatively short time frame.
Another option is ‘simple agreement for future equity’ (SAFE), which is an investment contract between your business and the investor that gives the investor the right to receive equity upon specific triggers, such as the sale of the company or future equity financing.
Future equity financing is an altogether more complicated approach to funding, requiring your company to be valued and a per-share price to be set, with shares then issued and sold to investors. This type of funding is more complicated, expensive and time-consuming and isn’t particularly common for seed rounds.
You should also understand the type of investor you’re looking for, as there are several different types including angel investors, angel syndicates and venture capitalists (VCs).
Angel investors are private investors who are usually high-net worth individuals investing their personal money into small businesses, and an angel syndicate is a group of investors who agree to invest together on a particular project.
A venture capitalist is a professional investor that provides capital to companies with high growth potential in exchange for an equity stake.
Series A funding
Series A funding is the next stage, and companies seeking this type of funding are usually more established, with a consistent track sales record, established user base and high revenue. Investment at this stage is often by VCs, and the purpose of funding is typically to expand to new markets or develop the company’s user base and product offerings. In short, series A funding tends to focus on turning moderately successful companies into high-performing, money-making businesses. The average Series A funding, as of 2020, is £11.6 million.
Series B funding
Series B funding is fairly similar to Series A, with a focus on taking businesses to the next level, meeting the new levels of demand generated by the Series A funding, and expanding market reach. The average Series B funding, as of 2020, is estimated to be £24 million, and the average valuation for Series B companies is £43 million.
Series C funding
Series C funding is usually for already established companies, looking for fast growth. As well as VCs, investors at this stage tend to include hedge funds, investment banks, private equity firms.
Alternative funding
Of course, many start-ups today use alternative funding methods as well as, or instead of, the traditional funding rounds described above. The most popular of these is crowdfunding, with the total annual volume of crowdfunding in the UK growing from under £30 million in 2013 to £550 million in 2020. You’ll usually give customers something in return for donating to your business venture, such as a free product or shares in your company. Some start-ups prefer this method of funding as you can see great success without having to go into debt or give up collateral – although it can be hard work and time-consuming.
Whichever method you choose, remember that you shouldn’t just jump on the highest offer of cash. Your investors can become trusted business advisors, so it’s important to think carefully about who you approach for funding and the future relationship you might have with them.
How much money should you try to raise?
You want to neither overfund nor underfund as both could cause potential problems for your business. If you raise too much money too soon, you may be tempted to scale up your business before it’s reached maturity, or expand into new markets without proper research.
There is a delicate balance to strike – the more money raised by investors, generally, the more you have to answer to them. But you also want to make sure you ask for enough money so that you don’t have to get the investors involved in a second round too quickly.
However, if you don’t raise enough money, you may run into cash flow problems. Ideally, you want to raise enough to help your business reach profitability, or to get you through to your next funding milestone, which is typically 12 to 18 months later.
Dilution
Dilution refers to the process that every business owner must grapple with when seeking funding: when you raise money, the percentage of the business that you own starts to go down. Generally, most rounds of funding will require up to 20% dilution – but you should be prepared to negotiate with your investors. Ideally, look to avoid any more than 25% dilution as in your best interests to retain as much as possible.
Seal the deal
Once you’ve secured your funding, it’s time to seal the deal and get back to running your business! Funding rounds typically take place every 12-18 months, and you’ll need to provide evidence of your company’s progress between rounds to convince future investors of your worth.
That’s where cash flow forecasting comes in handy, helping you to manage cash shortages and surpluses, scenario plan for future ‘what if’ questions and track your spending to ensure you keep to budget.
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