10 Reasons Investors Don’t Invest in Start-Ups
For many early stage businesses in Australia, access to funding is the number one barrier to growth. With most young businesses having little by the way of tangible assets, heading down the bank path often leads to a dead end. Investor sentiment suggests that money isn’t the problem; the common challenge investors face is finding suitable businesses to invest in. With little done in Australia to educate small business owners on becoming investor ready, it’s no wonder so few entrepreneurs access the level of funding they require.
So what’s the problem with investing in start-ups and how can entrepreneurs ensure their business is investor ready?
1. Inexperienced Management Team
Often start-ups can’t afford a good management team. The smart investor realises, however, that clever entrepreneurs will have three or four mentors who make up the company’s “Advisory Board”. An Advisory Board offers the “grey hair effect”, bringing experience and intelligence to a team that may otherwise lack both.
To Do: Engage mentors and construct an Advisory Board with experience in what you are trying to achieve.
2. No Proof of Concept
Business owners don’t go to the trouble of proving the concept of the business model, prior to asking for money. Even though this can be achieved with a free blog, through Facebook or with an inexpensive market research campaign, it’s hardly ever done.
When Nikki Durkin, a 19 year old, decided to launch www.99dresses.com.au she created an Event on Facebook explaining the concept and inviting people to join the Event if they liked the concept. Two weeks later she had 40,000 people saying, “Do it”. Concept proven. It’s for this same reason that acquisitions are often easier to raise money for than a start-up. There is a proven business model that is hopefully demonstrating profitable performance.
To Do: Find inexpensive ways to test and measure each layer of the business model before investing excessive amounts of money.
3. No Cash-Flow
Often start-ups go to market asking for $100,000 before they’ve made a sale. This means that the valuation (see point 4) an investor will come in at is going to be significantly lower than if there are historical sales. Rather than raising $20,000 now, getting some sales, and then raising the rest later (perhaps from the same investor), business owners will often go after the whole amount now. Meaning they either don’t get an offer, or they do and it’s going to cost them 75% of the business.
To Do: Raise as little money as possible in the beginning. Prove the concept, establish a higher valuation, and then raise more for less.
4. No Understanding of Valuation
Entrepreneur: “I want to raise $100,000 and I’m happy to give up 10% equity.”
Investor: “So that values your company at $1m?”
Entrepreneur: “Um…yeah…Yes it does.”
Many business owners think valuation is an outcome of how much money they want versus how much equity they want to give away. Both these factors are, in many ways, irrelevant to the investor. The business owner needs to have a clear indication of what the business is worth and this needs to be backed up by a clear valuation methodology.
To Do: Engage an advisor who understands how to value a business and understands business strategy.
5. No Clear Path to Exit
The investor wants a return. However most entrepreneurs fail to outline how the investor is going to get their money back. Having shares in the business is not a return for the investor; it is simply their security so that when the business reaches a certain trigger point, or goes to exit, the investor can see a monetary return. If this path is not clearly defined, it’s obvious to the investor that taking their money is more important to the business owner than giving it back.
To Do: Decide what your end game is and communicate this to the investor.
6. The Business in its Current Form is Not Scalable
Investors need growth. If the business is dependent solely on the business owner, or has a very time intensive way of generating revenue, it will not be an attractive growth opportunity. The best businesses are ones that make money whether the owner is there or not. Although this may not be achievable in the early stages, there needs to be a clear growth path that allows the business to make money, even while the owner sleeps.
To Do: Systemise, productise and automate your business where possible.
7. No Strategic Value
Cash flow is important. What’s also important is strategic value. Strategic value is the asset of the business, which may one day be saleable. An example of this is Facebooks valuation of $15 billion while they were still losing $1m each month. Their strategic value? Their database. Strategic value might come in the form of a technology, a patent, a database, a brand, an exclusive client list or a first to market brand.
To Do: Identify the components of your business which are valuable beyond the cash-flow they deliver.
8. Lack of Focus
Many start-ups look at industry leaders who are doing several activities and try to replicate a diversified business model. If we look at Virgin for example, they have over 400 companies operating in a diverse range of industries all over the world. What is often not recognised is that from the time Virgin began in 1970, they were solely focused on making and selling records for 10 years. It wasn’t until 1981 that they began to diversify into other markets. Start-ups that stick to a niche have a much greater chance of dominating. Once you own that space and are operating profitably, diversification may be worthwhile.
To Do: Focus on your core business and only your core business.
9. Growth Path not Heavily Identified
Often the entrepreneur will have a vision but little data or support material to add weight to the proposed growth path. As entrepreneurs we need to make the future real. Any well researched and projected marketing strategy, that outlines specifically how the company plans to grow, will go a long way to making the future real.
To Do: Think about what sort of supporting evidence you can provide to investors to demonstrate you know where you’re going.
10. No Understanding of Points 1 Through 9
Capital raising like any other business strategy is a skill and therefore education is crucial. One book that was recommended to me by Siimon Reynolds, who has raised tens of millions of dollars, was Enterprise and Venture Capital by Christopher Golis.
To Do: Keep learning.
One of Jack’s Companies that teaches these things is www.mbeeducation.com.au