Funding And Investors Explained

Darren Rogan

Darren Rogan is a Tech Entrepreneur, repeat Founder, Lean Advocate and a Startup Techie with high scale aspirations. He has been involved in startups as Founder, early stage Employee and Advisor both in Australia and the US. He runs a startup pitch event StartupBragger and Co-Hosts technology-based podcast Hack and Heckle. His involvement in funding rounds has seen him successfully raise hundreds of thousands of dollars in capital and he is the perfect guest to give us a lesson in Funding 101.

I'll let Darren take it from here:

When we talk about funding; it can come from certain types of people. We've got;

  1. Friends, family and fools. These are people who invest because of you, not because of what you're building. They're the people who are going to tell you that you're a special snowflake so don’ t expect brutal honesty from these people. Full Disclosure: If you take money from family members, your family barbecues turn into board meetings and they all think they're getting pay slips while they give you stellar advice like; “Have you tried marketing on Facebook? It's awesome.”

  2. The Angel Investor. This is someone who has independent wealth and they're normally trying to pay that forward. It's like the people who go to the TAB to bet on horses but instead these individuals like to bet on startups. Most of them are dealing with five to ten percent of their net worth and they're investing in companies where they understand there's a high failure rate, but they want to give forward rather than it being purely about a financial return. Angels are typically willing to take more risk. It’s their money and the only other person they usually have to justify their investment to is their better half. An important point to note is that there are considerably less people to consider for an Angel to invest in you versus the considerations a VC (Venture Capitalist) must undertake.

  3. The Venture Capitalist. The VC market is very different to the previous two. We've got micro VCs and we've got major VCs but both are money managers. They manage money on behalf of other people called their LP’ s (Limited Partners). The LP’ s are the people who own the wealth and they give it to VC’ s to manage. This is similar to people who manage index funds and stock market investments, but in this case it applies to people investing in businesses. The VC market is a tough one as there are significant risks associated with these investments. An expected high return is needed to combat that risk. It’ s critical to remember that VC’ s are dealing with other people's money therefore are generally more analytical as they have to justify their investment to their partners.

Now we have covered the different types of investors, we can talk about funding rounds. The first round is often referred to as a 'seed'. This seed round is usually to help your business get off the ground. Then follows an A, a B, and a C round, then generally an IPO (Initial Public Offering) or a Trade Sale. You rarely see a D or E round prior to the IPO or Trade Sale but they can happen in some circumstances.

Most companies who manage to stay in business go to a B or C round and then get acquired or hold an IPO. The idea behind naming these ‘rounds’ is supposed to give a snapshot of the age and expected traction of these companies taking investment. The early stage seed often comes from the Angel Network and the investments that you'll find during this round are from people trying to put their money into high risk-high return opportunities.

Then we move towards the VC from the A round onwards who are applying portfolio theory and looking at considerably higher growth. To quantify, the returns that are expected from a VC are supposed to be ten to one. Are you a ten to one business? Capital markets are not necessarily the right place for everyone, they are for a certain type of business and if you don't fit that type of business, that doesn't mean you're not a special snowflake, it just means that you're not the snowflake they’re looking for.

I liken taking on VC to getting a mortgage. You're selling a part of your business and it's like trying to build a house from the plans. To fund this you would go into the Bank and say, “Give me some money and I'm going to build something of value”. You don't find many property developers celebrating getting a mortgage from the Bank but without other information, we use valuations in Startup Land as definitions of success to try to prove that we are indeed valuable and to try to build hype.

I believe we shouldn't celebrate raising capital as much as we do but it does allow us to put a discrete valuation on how well a company is doing. Generally, a lot of internal company information is very private and companies often wouldn't want to disclose this unnecessarily. A valuation is an accepted public way to articulate how well the investors participating believe a company to be worth at that point in time.

But funding is not for everyone, when you take a VC or an Angel on, most of them will want a board seat. In fact, the common expectation is that at every round you give away a board seat. There's normally a representative from each investment entity assigned a board seat to look after the commercial interest of their party at each round. This is because the VC has a fiduciary responsibility to his/her LP's to look out for them above anyone else. They are obligated to do what is necessary to get their LP’s a return on their money and this is why they usually require a board seat so they can have a say in what direction the company takes.

There are plenty of companies that have achieved significant success without external funding. 37Signals are a famous tech company that has never taken any money; they bootstrapped their entire business from day one. Even the companies that receive significant investment typically bootstrap for a period of time in the beginning anyway. They start by building something useful and then decide they want to take over the world. The problem is that at the current rate of growth they will be old and decrepit before they can do so, so funding is often used as a way to accelerate those world domination plans.

There is a lot to consider when taking on investment. I have taken money in the past and I believe that if you are to do so, then it should be for very specific reasons. Maybe you are after a land grab? If you desperately need to be front and centre and your company doesn’t have a lot of defensibility it can make sense to take money on because of the marketing aspect.

Take money only if you know exactly what you're going to do with it. What are you going to spend that money on? Have you truly got a hole in your business that you can't fill with current cash flow? Is raising capital really necessary? We can’ t forget that all investors want their money back and then some. A VC wants his money back and an Angel wants his money back so how are they going to do that? Well, they're going to sell your business. Do you want to sell your business?

An average VC fund has about five years in it before they're looking to start liquidating and then they often have another three years before they need a return on their money. As a general rule, you can expect to have an eight-year window if you are at the very beginning of your capital-raising journey. Is this how you want the next 8 years to look like? Fundamentally, the success of a business is how much money it generates from its products and/or services and how valuable it is to its customer base.

It's not the hoodie; it's not the tech crunch article or the PR Stunt featured on channel nine. None of that makes any difference. Even being on Shark Tank won’ t be the be all and end all to your success. Investment may be one piece of the puzzle and it may be for you, but don’t expect it to solve all your business problems.

You can find Darren on Twitter or at Cerebro.com.au

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