7 Deal Breakers While Raising Capital
Raising Capital is one of the most important tasks a founder can accomplish. Startups have become a lucrative option of investment too for angel investors and venture capitalists. But, while raising capital, you might run into some roadblocks just when you are getting close to a deal.
So, in this article, we are going to navigate through the complex world of fundraising for you. Here are some common deal breakers while raising capital that you should avoid.
- Not Knowing Customer Acquisition Cost
No matter the type of business you are in, this particular term fascinates the investors more than ever. Customer Acquisition Cost (CAC) is the money you spend to acquire each customer. Initially, it is hard to calculate for any founder how much he/she is going to spend to acquire each customer. But, as the business grows, you will gain insight into your customer base and will be able to predict your CAC much better. This is a crucial factor for investors in determining the viability of your business.
CAC depends on the nature and type of the business you run. Some of the factors that determine CAC are the length of your operating cycle, purchase value, product impact, etc. If your CAC is constantly reducing, it shows that you are spending on marketing and advertising more mindfully. This would make investors see that there are high profits for them in the future. You can reduce your customer acquisition costs by making people aware of your product’s problem through blogs on your website, taking testimonials and reviews from happy customers, improving quality, addressing customer complaints immediately, etc.
- Outsourcing your Core Competencies
Investors study your business model to understand the core competencies. It is these core competencies that are going to attract an investor while raising capital. If these are being outsourced to another company, then it confuses investors that in which company they are investing, yours or a third party. They have no control over this third-party company and yet the success of the company in which they intend to invest would be dependent on it. This serves as a deal breaker for investors.
Therefore, it is important to identify the core competencies and build resources for them internally. For example, if you are a fintech company, then having an in-house tech team is more beneficial than completely outsourcing it and relying on a third party.
- Not being aware of your competitors
Not being aware of the sea you are sailing on is the most common red flag for investors. No matter how unique your idea is, there is always competition. Sometimes, the competition might not seem direct but even a substitute to your product is a competition. Netflix CEO Reed Hastings says that the biggest competition for Netflix is sleep. People work all day and they get free time at night in which either they could sleep or binge watch Netflix. This makes sleep a competitor of an OTT platform.
When you are aware of your competitors, you can always strategize to make your product stand out from your competitors. So, a very obvious question an investor asks is ‘Who are your competitors?’ and ‘How are you dealing with them?’. These questions look easy but the trick is in your answers. To answer these two questions impressively, you need to first find out the following:
- Do thorough market research on the customers’ demand.
- What products people were using before your product was launched?
- What problems did they face earlier?
- How did your product make their life easier?
- Why are people ready to shift towards your product?
- What makes your product hard to replace?
- High Cash Burn rate
It is a no-brainer that investors evaluate sales and profit margin but it is the Cash that keeps any business running. The Cash Burn rate measures the rate at which cash is reduced from the business. No matter how powerful the engine is or how aesthetic your vehicle looks, once there is no fuel, no one cares about the flashy details. Similarly, investors would not want to invest in a business that would be out of cash in a few years. If the cash burn rate is too high, then this would act as a deal breaker for investors while raising capital.
So, before raising capital, keep a tab on your cash flow. If your cash is decreasing at a faster rate without any corresponding sales, then it shows that you are not being prudent in your spending and are burning money without a proper business plan. You can track your monthly cash burn rate and build a strong revenue model so that money keeps flowing consistently. Some of the ways to do this are by extending less credit period to your customers and negotiating for a higher credit period from your creditors. This would give you a cash window if you are just starting your business and need time to grow.
- High Customer Concentration Risk
If you are in a B2B business, then you have to scale out this risk before you go for raising capital. If a customer contributes more than 10% of the total revenue of the company or if two or three customers account for 25% of your total revenue, then your customer base is highly concentrated. High Customer concentration poses a risk that two or three large clients can bog down a company. It gives a chance to your competitors to copy your product or service and present them to your clients with more favourable terms. It also gives low bargaining power to the company and thus less scope to increase the prices in the future.
Again, here the power of the success of the company is shifted to third-party players and Investors are afraid to place their bets on something over which they have the least control. So, before walking into a pitch meeting, try to expand your customer base or at least have a plan to expand it in the future.
- Do not flash dividends.
Investors are looking to run a marathon and not a sprint. That is why they are not those who are looking to generate monthly or yearly returns from your business. They are patient people and are here to build business for the long term. They value growth in a business more than its profit. Every investor wants to spot the next Amazon or Facebook. So, they do not care if you distribute them profits every year. Rather, they would be happier if you reinvest this profit in the business and grow its value in the long term. Generally, the goal of investors is to sell their stake in your business after it has multiplied its value by at least 10x.
So, while raising capital if you are thinking of promising dividends to investors, then, this could be a deal breaker for you. This might look like your business does not have enough growth opportunities or investment avenues and thus you are returning the money.
- Financial Hodgepodge
Last but not least. No matter how well your pitch goes, you will get the funding only after due diligence. Therefore, your Financial Statements should depict a clear picture of the state of affairs of your business. Presenting the financials of your company in a manner that is just favourable in form and not in substance gets caught in due diligence. This raises a question about the integrity of the people running the company. While raising capital, your financials should give a clear picture by following a detailed approach so that investors decipher your business correctly. You can depict segment-wise revenue by customer, products, geography, etc. While pitching the sales projections, you can show three scenarios viz. Pessimistic, Most likely, and Optimistic. This would also give confidence to investors that you know your business well.