How to develop your investment strategy
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Photo Credit: Shutter Stock

Photo Credit: Shutter Stock

In this article I wish to provide you with an overview of fundraising terminology, concepts and initial strategy. Understanding it is one of the most important lessons to learn when entering the world of investment.

Photo Credit: Shutter Stock

Photo Credit: Shutter Stock

In this article I wish to provide you with an overview of fundraising terminology, concepts and initial strategy.  Understanding it is one of the most important lessons to learn when entering the world of investment.

Understanding the investment process

If we map out a standard successful growth of a company, we can usually find 3 main stages:

The seed– when an idea begins to form shape.

  1. The growth– when the company begins to show growth, usually in terms of user-base or early revenue.
  2. The exponential growth – a stage in the company when it reaches the next level of growth with a substantial user-base and/or substantial revenue.

 The basic form

Although the following may substantially vary from case to case, it is agreed to be the standard concept of investment terminology:

Getting started:

The initial: pre-seed/family and friends round. Pre-seed investment should get you to a working alpha or to an initial proof of concept stage. Depending on the amount, such money can come from the founders themselves their friends/relatives or even angles that would like to get an early start in the game.

Next: a seed investment. Such money should take you to a working beta stage or proof of concept. Seed investments are normally obtained from angels or super angles (refers to angels investing over $1M of their private money).  Various VCs also invest seed money.

The growth of the company:

Round A investment is designed to grow the company into a serious business. Such money is normally institutional in nature. A serious business may be defined in terms of user-base or revenue.  Each company should set their realistic goals in accordance with the invested amount.

Round B and C are designed to further grow the business into a substantial business.  Same goes for any further rounds.

In very successful companies, where no additional funds are needed for the business operation, there may be a round of investment for the point of establishing a private company’s valuation.

Prior to approaching fundraising and preparing your Excel it is very important to prep the groundwork for your company’s phases.  The reason is that savvy investors wish to allocate their money in stages in order to minimize risk.  Moreover, it would be easier for you to know which investors to approach and whom to avoid.  Repeat investors mostly know their preferences and patterns.  Some will invest in early stages while others will only get it later on in the game.

How much should you raise?

The overview:

You should raise enough to get you to the next stage. It used to be that the rule of thumb was for an investment amount that would last for 18 months. The reason is that at early stages of a start-up, each year the company would undergo a serious change in its phase: i.e: from an idea or concept to a beta stage, from beta to growth, etc.  And since it takes roughly 6 months to obtain an investment, you should 18 months would cover one growth span.

However, times have changed and phases are evolving more rapidly.  While the above strategy still holds true, investors now are accustomed to rapid phase changes.  Companies can now show very fast growth within a very short amount of time, even within a beta stage.

So in general, you should raise the exact money you need for each stage with a 6 month cushion for the next round.  Understand that smart investors will like to see a proof of your businesses growth and will invest in stages.  Thus, it is imperative to map out early enough the timeframes with which you would like to reach each of your phases.

The Hands on approach

  1. Seriously break down the phases of your company.  Set goals for yourself – what you believe you are able to reach and at what point.  This is the most important initial financial process. If you misscalculate (which happens in many cases), then you may find yourself out of fuel when you haven’t reached your goal yet.  By doing that, you will find yourself fundraising again, having to explain why the initial money given to you did not get you to the promised land. This is not a happy place to be in.
  2. If you have the knowledge and required skills to design the proper financials – great.  If not, this is a good time to hire a good consultant. It will serve you well in the long run.
  3. You will be ready for a meeting with an investing partner if you are able to answer the following questions: How much do you need and how far will it get you?

In early investments (pre-seed/seed- valuation does not matter.

You may be astounded at this statement, but there is logic behind it. As a rule of thumb, each round of early investments takes between 25% to 35% of the company.  The purpose is to maintain an equilibrium of power and a proper decision-making mechanism. Basically, a constitutional balance.

For example: If three founders initially hold 100% of the company (i.e 33.33% each), then a smart seed investment might see an investing partner obtaining 25% of the company, leaving each partner with a remaining 25%.

In the next stage, round A, an investing VC may obtain 30% of the company, thus leaving the remaining partners with 17.5% each.  The founders still maintain a collective 52% of the vote.

It is imperative to sustain a balance of powers for many reasons. Here are a few:

1)      The entrepreneurs/founders are the heart and soul of the company and steer it with love, intuition, knowledge and vision. However, they may lack the vast experience it takes to run a growing, large scale company.

2)      An investing partner brings in knowledge, talent and connections, but may get into emotional battles over the company’s financial decisions.

3)      It is simply unhealthy to have the shame shareholders as board members and as partners throughout the growth of company, as they are often locked into a particular perspective and would do well to have the occasional fresh outsiders take.

Under some dictatorships, leaders may be very successful (Mark Zuckerberg for example). Such cases are extremely rare however and should be discussed separately.

Thus, it is not the valuation that should drive you, but rather the basic allocation of power and the decision-making process within the company.

Photo Credit: Shutterstock/ Watering money plant 

 

 

 

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Emma Butin

About Emma Butin


Emma Butin is a technologically challenged geek. She loves everything that that is served in a no brainer effort. Emma’s obsession is to take big ideas and compile them into one button. That’s why she is working with start-ups right from their early stages distilling products to one button. In 2008 Emma Founded Kryon System, an international award winning software company with patent pending technology. In June 2013 Emma released her first book (in Hebrew) "About Economics and Love.” Today, Butin also teaches “strategic entrepreneurship in hi-tech” at the IDC Herzliya and engages in speaking around the world.

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