Many entrepreneurs are skilled at starting companies, and building successful small ones. Not a simple thing to do, but they seem to have a knack for it.
Growing a company into a big, growing, successful one is very different, and in many ways, more difficult task. And taking a company through a hyper growth stage is the most difficult part of all. That’s where many younger entrepreneurs fail. There are too many moving parts, unpredictable variables, and mistakes often go un-noticed until they have caused serious damage.
Which is why raising growth capital is of one the most important and defining steps for any company. It is at this point where experience, track record, maturity, timing, and a bit of luck come together. As Calvin Coolidge said, “All growth depends upon activity. There is no development physically or intellectually without effort, and effort means work.”
Growth capital is commonly defined as between $10mm to $75mm, and in absence of capital markets for smaller IPOs, raising institutional money has become the most common way to gain access capital for growth companies. Common questions around this subject include:
- Why would smart institutional money invest in such companies at what seems unreasonably high valuations?
- When is a company ready for growth capital? How available is growth capital?
- When do you raise growth capital?
- How do you find the right partner?
As always, I believe that no good decision is made in isolation. Let’s address these questions:
Institutional money is often referred to as smart money. The thinking being that they have the expertise and experience to have been able to raise the funds to play the game, and conduct appropriate due diligence and implement necessary changes for the portfolio companies. Which is also why so many commercial banks like to lend to companies backed by institutional money.
Smart money always backs the team. They prefer to back teams they have experience with, or have relevant track record, or industry expertise that is a clear differentiation. If you have the right team, they will make the necessary changes if plans are not on track, remove weaker players, and will manage the board’s expectations properly. A for that kind of risk mitigation, any smart investor will pay a premium.
Growth Capital Readiness
As Bill Gates famously said, “Intellectual property has the shelf life of a banana.” So when it comes to growth capital, institutional investors look to invest in companies that have a clear differentiation, scalability, execution capabilities, and a great team. There are numerous funds actively looking to invest, so there is usually no scarcity of capital for good opportunities. To get access to capital, key drivers include:
- Team: Does the team have the track record, experience, execution capabilities, and maturity to get the company to the next level? How well does the team work together? Are there any holes in the senior management team? Do they have M& A capabilities and expertise? Are their objectives aligned? Do they still own enough of the company to be properly motivated, or are they too diluted?
- Traction: Has the company refined and proven out its model? Is the capital going to be used for further proving the model, or will it be used to enhance the existing working one? What kind of clients, partnerships, and business development relationships does the company have? How referenceable are those relationships? How big is the customer base? How fast is it growing?
- Addressable target market: How big can this idea/company become? Will the potential outcome meet the investor’s IRR requirements? What are the growth potentials, geographical expansion opportunities, and adjacent or complementary verticals? Is there a rollup opportunity?
- Monetization Mechanism: Not every dollar is worth the same. Are the revenues transaction based, subscription, or revenue share? When to they collect the revenues? Is this a very cash flow negative business? What kind of information do we have on our customers? How much of the revenues are repeatable?
- Defendability of the IP: How difficult would it be for me to replicate this company with another team, some capital in a short period of time? Are there any barriers to entry? Any patents? How hard of an execution play is this?
- Business Model: Is this completely a new business model, an improvement on an existing business model, or creating a dislocation in an existing industry? What are the gross margins, customer acquisition costs, churn, LTV, etc? When will you reach breakeven or profitability? How strong and detailed are your financials models?
- Company Health: What are the valuation expectations? What does the cap table look like? How much preferences are there? Are there any existing debt and liabilities? Where is the company in its lifecycle? Have you shopped the deal? Are there any skeletons in the closet?
This is but a snapshot of what every investor would begin the discussions with.
Timing Is Everything
I often advise entrepreneurs that they should raise growth capital when they can, not when they need it. As Ellen Glasgow said, “All change is not growth, as all movement is not forward.” The best time to raise growth capital, assuming you are ready for it, is when the market conditions are ripe, market views your sector favorably, key competitors are being funded, or there is inbound interest.
If the sector is out of favor, key intuitional players have already made their investments, or you really need the capital, then you will be playing with a weak hand.
Finding the Right Institutional Partner
Raising institutional money is like marriage. Find the right partner, and life can be fantastic. End up with the wrong partner, and there can be misery!!! The right partner helps you grow with more than just capital, and grows with you.
Most smart institutional investors are always looking for good companies and teams to invest in. They often have tight relationships with the leading incubators, early stage funds, and investment bankers to ensure good healthy deal flow. However, they have specific criteria around sectors, geography, stage, revenues, EBITDA, and check size. There is, of course, the question of the vintage of the fund, and how much dry powder they have for new investments versus capital for existing portfolio companies. One last thing, do they have a portfolio company that they deem competitive or in conflict.
The best institutional investors act as partners in that they bring in other investors, open doors for business development opportunities, help in recruiting, are objective in their advice as the company grows, act like coaches, and guide you through the inevitable difficult times. That’s what with the right partner, valuation is less important because in the long run, everyone will do better.
The other side the coin is having a partner whose interests are not aligned with you, is not a value add investor, does not understand your business, and has completely different ideas about what the direction of the company should be. Just remember that horrible relationship you had difficulty getting out of …
So when you are raising growth capital, remember not all money is created equally. Talk to the CEOs of the existing portfolio companies. Talk to the bankers that have dealt with them in the past. Check the reputation. Look for the RIGHT partner.
Considering the fact that in most markets, growth is the biggest driver of enterprise value, focus on building a good team, a strong business model, a healthy company, and growth. So remember as Albert Einstein famously said, “Intellectual growth should commence at birth and cease only at death.”