I recently prepared a pitch deck with one of my start-up clients and we decided not to commit to a specific funding requirement. Facing investors with different investment mandates and strategies, some of which were unclear, we opted instead to present funding scenarios. This approach has consistently proven to be effective and is beginning to be endorsed by major VCs.
This method challenges the traditional belief that companies must specify a fixed funding requirement. In most cases, there is no valid rationale for committing to a predetermined round size. High-growth businesses and start-ups are usually better off presenting two or three funding scenarios instead.
The outdated approach imposes unnecessary constraints on what is often a fluid situation, solely to appear more appealing to certain investors. Moreover, it compromises the authenticity and quality of information while unintentionally deterring potential investors who might have been a good fit.
In a pitch deck or information memorandum, one of the essential pages outlines the required funding and its intended use. The traditional approach here is to reference a specific amount. But there is little consensus on how that figure should be calculated. Instead of a generally accepted formula, there are merely different approaches. As a result, many tend to goal-seek an amount that is considered ‘right’ for their stage of growth in the belief that it will appease investors.
Unfortunately, this leads to an artificial funding requirement with expenses and other inputs being adjusted to reach the desired number. This taints the financial model with inauthentic assumptions and ultimately undermines the investment case. It's important to avoid doing this because it will likely spell your doom.
Let's take a step back and remember the purpose of presenting a funding requirement: to provide transparency about the company's financial needs. Goal-seeking strategies, where one contrives expenses and revenues to reach a certain funding amount, are counterproductive to this purpose.
It is not sustainable to have one financial narrative for investors and another for reality. Reality will catch up. Hoping that they will converge at some point in the future is extremely naïve - a strategy known as “fake it until you make it”.
You might be desperate to raise money. And yes it is difficult but it must be done right. Raising too little can lead to investor mistrust and compromise the success of the business, while raising too much, without a strict financial strategy for it, can lead to unnecessary dilution and wasteful financial management practices.
By dressing yourself up to suit a specific type of investor (that is, an investor with a mandate to invest a certain amount at a certain stage) you, by definition, are alienating investors who are not part of that group.
In principle this isn’t unacceptable. But when you get into discussions you’ll find that the investors you thought were your perfect fit reveal themselves to be a poor fit. This can play out in a few ways but the most common I’ve seen is what I call the misbranded investor problem (I probably need a better name for it). It is where, for example, a so-called Seed investor is actually more inclined to invest in deals that are Series A, or vice versa. You could also have a different understanding from them of what Seed or Series A actually means. Either way, it’s common for investors to tell founders that they’re ‘too early’ for them.
This can have huge implications in your process, especially if you’ve set yourself up for a type of round that you cannot achieve. You would have to revise all the funding parameters (model, sources and uses, pitch deck). Doing so loses you credibility with those who have already received your materials. Not to mention the waste of time.
The worst part is that investors aren’t always honest about their decline reasons. They might tell you that your offer doesn’t stack up but in reality they have other issues behind the scenes. For example, they have run out of capital and haven’t closed a new fund. Inauthentic feedback is actually fairly common.
You can do a perfect job of investor profiling and you will still run up against these issues. That’s because, in reality, strong forces conspire against you. Here are the usual suspects:
You are biased about your investment readiness (this is why we are building a comprehensive VC readiness test at The Venturesmiths). In any case, whether you use industry nomenclature or not, your readiness to raise a certain amount of money is highly subjective (location, industry, team, and simply who you’re talking to). Ask a few people or run a poll on how much money you can raise now and I bet you'll get divergent responses.
There is no clear standard for investment readiness and the standards keep moving. For example, Series A, and your readiness for it, is different to different people.
Investors cherry-pick. In trying to invest in the ‘best’ deals, investors tend to prefer companies that are almost ready for the next type of round (Seed investors want to invest in companies that are almost ready for Series A). This is why we see the meaning of the terminology shift over time.
Lastly, some investors are vague or inconsistent about what investments they are willing to make and you will not know their actual and current preference until you’re in conversation with them. Sometimes this happens because they're trying to balance their portfolio (overweight in a certain type of investment). Other times because they just haven't figured out what they want.
So, while good preparation can mitigate the problem, it can be largely avoided by not coming in with a rigid position. If you simply incorporate flexibility, these issues can arise but they will not break your process. You can roll with the punches and you will not need to change tact and lose time and credibility.
Instead of presenting a single sources and uses, present two to three scenarios showing what your uses of funds and roadmap would be under each.
The convenient side-effect of this is that it signals to investors a clear path to a larger round of funding. And that you will very soon be ready for further funding.