The lifecycle of a startup is quite akin to growth as we all know as human beings.
Series A/B rounds of equity typically get invested on the basis of potential (team and market) and therein starts the fun. Depending on the nature of business, the focus of growth stage companies can vary from getting profitable and becoming self-sustainable to an accelerated market/user grab and several variants in between.
It is absolutely critical to match the company’s trajectory to the investor psyche as early as possible.
Most early stage investors don’t have a mandate to continue investing through their company’s lifecycle and hit a ceiling with one or two rounds of funding. It could also be a function of where the venture capital investor is placed on their fund horizon as there could be pressure for a faster exit for some, more than others. While many investors have shown intent and ability to help companies tide through tough phases, it is more likely to be based on expectation of a medium term revival in the absence of which, there could be little support around the table.
Takeaways for growth stage companies
Early stage fundraising is a very different experience compared to Series C and beyond. It will no longer be possible to explain away suboptimal or nonexistent operating performance through the lure of potential. It also takes a whole lot of time as due diligence phases tend to stretch and the market is heavily skewed towards investors currently with a paucity of equity capital for this stage of investment.
Private equity investors look keenly for profitability and there are not many venture capital investors who have deep enough pockets to continue supporting their companies through growth periods even after the company enters ‘adulthood’ and is expected to fend for itself.
In some cases, companies seeking to expand internationally or grow inorganically have found support but it is not frequently forthcoming for regular burn.
Some aspects to keep in mind
- If the business value hinges on sustainable profitability, it needs to be evidenced as early as possible. Scale is useful to build the story but growth stage fund raising is going to be tough without demonstrating that the model really works. In many cases, it needs to extend beyond just showing gross profitability so that there are no hidden devils lurking in the numbers.
- If the business is predicated on market share or other operating metrics which can potentially provide a disproportionate outcome, it will be better to have the appropriate investor syndicate tied up as early as possible or at least get their input, if not funding. It will also be helpful to have folks who have seen similar models globally and understand gestation periods and monetization avenues.
- It can be absolutely frustrating to be at the cusp of profitability or a big win and run out of cash. Even if there is support from existing investors, it proves to be a major distraction in achieving business goals and can even end up killing promising businesses. This scenario eliminates any chances of going out to market for a fresh fund raise given the timelines for such an effort presently.
- Entrepreneurs need to strike a balance between dreams and reality (aka growth and survival) with the latter emerging as the bitter pill to be tasted sooner rather than later. The planning needs to be several quarters in advance rather than being reactive unless there is an exceptional opportunity to be capitalized which came out of nowhere.
- Entrepreneurs have to understand the investor position as well. There has to be an alignment of motivations and expectations which actually is applicable for all rounds of fundraising.
A few years ago, the oft heard lament was that there is no appropriate funnel development at the very early stage (angels, incubators, accelerators, seed funds, etc.) and we witnessed an explosion of activity on that front. After a couple of years, there has been rationalization in this space and the truly serious players have been separated from the rest.
Today, it feels like the funnel is more like an hourglass where there is reasonable traction at the seed and early stage as well as robust interest to deploy capital in the private equity segment but the bridge between these two seems to be weak.
Many a time, it demands a private equity investor to compromise on their requirements or a venture capitalists to over stretch, both of which may not be ideal in the long run for the ‘teenage’ company. Strategic direction for companies can get into significant conflict between entrepreneurs and investors at this stage as there is a visible tradeoff between profitability and growth in most cases.
Ultimately, the optimist in me believes that like all promising teenagers who go through a fair bit of pain, they turn out to be successful adults eventually. We need more such stories to help expand the hourglass into a full blown funnel and also attract the right set of investors to help bridge this visible gap!