Not every startup can or should be backed by venture capital, and not every business hits a milestone with enough capital remaining to fundraise. Below is a simplified categorization of the 4 buckets an early-stage investor might place you in, each with its own likelihood of fundraising success.
Bucket 1: Everything is up and to the right
This is the ideal case for venture capital. Your growth is up and to the right and you are demonstrating good early profitability (unit economics, gross margin, positive revenue retention).
In this case fundraising should be the fastest and easiest of all the buckets, assuming you are able to validate the results, demonstrate confidence and competency as a founder, and have your data room ready (financials, compliance, cap table, etc). Here founders typically have a lot of leverage, and sometimes investors will even waive diligence if things are growing really quickly, or there are a lot of term sheets.
Bucket 2: You are growing but need to improve unit economics
If you fall into this category, you are still in a good position to raise venture capital, but you will need to articulate a compelling vision to how your growth and improvements to unit economics will translate into a profitable business in the future.
This may involve making changes to your pricing strategy, reducing costs, or increasing customer acquisition and retention. You will need to have a clear plan in place for how you will improve your unit economics and be able to demonstrate early progress towards those goals, ideally with supporting evidence.
A few examples of how this could work are:
- Economies of scale. Some operating costs are known to come down at scale. Is this enough to demonstrate profitable unit economics.
- Market share. Some companies artificially lower prices in the early days to capture market share, but can demonstrate that in the future they will be able to increase fees to overcome a hurdle of poor unit economics.
- New markets. Some companies build a playbook and show positive unit economics in one market, but are rapidly expanding into new markets. If you can demonstrate that the new markets are showing improving similar trends.
- Product expansion or loss leaders. Sometimes giving away something for free can get people in the door to then upsell or cross sell to a more profitable business.
Bucket 3: You have profitable unit economics but cannot achieve escape velocity
This is one of the most frustrating fundraising situations to be in, because you know the business works. If you fall into this category raising capital will be a challenge, but not impossible. You have a functioning business at the core, but either cannot start the growth flywheel or your business is directly tied to marketing or sales. As a founder, I have found the biggest challenge in getting funding is a disagreement between the founder and investor around valuation. Don’t let your ego get in the way of a capital - owning 10% of $1B is better than 100% of $1M.
To increase your chances of success of raising capital:
- Prove that the risk in your business is not the market, team or product, but (mostly) the capital
- Consider raising a smaller amount of capital to start the growth engine, and then raise a larger amount in the future.
- Build validation that growth can come with capital - LOIs, marketing tests, partnerships
- Tie your current business to a larger, more ambitious vision and nail your story.
- Build up a network well in advance of you needing to raise capital
The other viable alternative here is to see if you can get it cash flow positive, and keep it as a lifestyle business, a side hustle or sell it to a larger company that has distribution. There are 3 key ways to get your business cash flow positive: increase revenue, decrease expenses, raise capital. The longer you wait, the harder it is.
Bucket 4: Your business is flat or down with poor unit economics
If your business is not demonstrating profitable unit economics or growth, it is likely because your business model is flawed. This will make it nearly impossible to raise capital, as investors seek asymmetric returns on their investments, and you are not demonstrating the potential for a viable and scalable business. While you may have a good product, it may be too costly to distribute or there may not be a sufficient market demand for it.
In such cases, it is advisable to either sell the business or wind it down. Continuing to invest time and effort into a business that is not working is not worth it. It is important not to get emotionally attached to the idea of persisting with what is not working, as the dream may be over.