Last week, we co-hosted a webinar with VentureBeat that took a deep dive into funding options for tech companies at different stages of growth. The panel featured BJ Lackland (Lighter Capital’s CEO), Claire Lee (Silicon Valley Bank’s Head of Early Stage Banking), and Erik Benson (Managing Partner of Voyager Capital). It was a wide-ranging conversation among three leading investment experts about the changing funding landscape and what entrepreneurs need to think about when deciding which funding path makes the most sense for their business.
We received about 60 questions from the audience during the discussion—too many to answer during the webinar. We’ve tried our best to answer the most common questions in five key topics. If you have anymore, feel free to ask us at firstname.lastname@example.org.
Topic one: funding path
Q: What are the key differences between a VC-backed funding path and a non-VC backed funding path?
VCs are looking to invest large amounts of money into companies that have traction and potential markets of more than $1 billion dollars. The VC path is really the only way to go if you need $20—$30 million dollars to grow your company, or if it will take two to three years to bring your disruptive product to market. The VC path means handing over a big chunk of equity and ceding some (or a lot of) control over the management of your business. This can be a good option if the goal of building your company is to have an exit via IPO or an acquisition in 5-7 years.
If you are building a company that has strong growth potential but doesn’t need to disrupt an entire market to succeed, or if you want to own and run your company for the long-term, then the non-VC path may make more sense. Non-VC funding includes a variety of debt-based financing options and will allow you to retain control over the life of the company. However, debt financing is hard to secure without revenue streams or hard assets. Traditional banks usually look at much more mature and well-established companies. Tech banks, like Silicon Valley Bank, extend financing to companies with $5M annual revenue or companies that are VC-backed.
Make sure your funding path lines up with what your goals are for the business. Investors will be with you for the life of the business.
Topic two: funding needs by stage
Q: Is there an advantage to raising money early in order to ramp up and take advantage of opportunities, or is it better to wait until the company has significant revenues?
One of the reasons entrepreneurs want to raise capital is to build a war chest of funding that allows you to take advantage of opportunities. This can be of huge value to your company, since launching your product more quickly than your competitors often nets you more market share, which can boost revenues and raise the valuation of your company.
But raising money early can also be difficult and expensive.
If you want to raise venture capital, the cost of securing capital early on will be higher. With an untested product or little to no revenue, you’ll have no leverage against low valuations and unfair term sheets—you’ll have to agree to huge bites out of your equity if you want VC money. If you go the debt financing route, you’ll find that bankers are cautious about lending to early companies with no concrete assets.
Once you start generating revenue, your options will broaden to include revenue-based financing, which is specifically intended to help a company grow and scale fast. It also helps companies position themselves for better valuations when they decide to seek VC. An owner of a more mature company can give up less equity for a bigger investment.
Q: What debt options are available to grow a SaaS company with recurring revenues through marketing and sales? Traditional banks don’t want to touch us.
We wrote a blog post earlier this year on why banks hate SaaS companies, so we understand what you’re going through. Banks really prefer established businesses with hard assets and/or a track record of bringing in millions of dollars of revenues over a long period of time. Specialized tech banks, such as Silicon Valley Bank, do become an option once your company has $5 million dollars of annual revenues, but what about before that?
During the growth stage, revenue-based financing is the only debt option we are aware of that fits the needs of entrepreneurs. Lighter Capital’s RevenueLoans are specifically designed for tech businesses with sticky subscription-based revenues and healthy margins. RevenueLoans provide the capital companies need to scale through sales and marketing or product development.
Topic three: capital needs
Q: Our technology is extremely disruptive with very high market potential. Should we aim higher than a $1 million dollar round of financing?
A $1 million dollar round is a difficult amount to raise. It’s too small for VCs, and probably too large for angel investors. When deciding on how much to raise, make sure to get enough financing to capitalize on the market opportunities you envision, but don’t raise more money than you need. Remember, the more money you raise, the more you need to return to investors—either in interest or sacrificed equity and control—and the longer it will take you to pay it back or extract value.
Also, make sure your company is ready to put all the money it raises to good use, and that your staff and infrastructure are ready to handle a fast increase in scale.
A well-thought-out business plan and capital-raising strategy can help you figure out how much capital you really need in the short- to mid-term. Your business plan should tell you what your growth milestones are in 6 months, 1 year, and 3 years, which will help you figure out what you need to do and how much it will cost you to go from one milestone to the next.
Q: My startup is making 500K in revenue and growing at a massive rate. What’s our best funding option?
At this stage in your growth, you will have to choose between a VC-backed path and a non-VC backed path, and the best option depends on the elements we discussed above.
Companies with strong, growing revenues in this range are great candidates for revenue-based financing. We will lend up to 1/3 of your annualized revenue, and we can lend you more as you grow. Strong revenue growth will also mean that you pay off the debt faster.
It may be worthwhile talking to angel or VC investors if you are looking for a large capital injection right now but otherwise, it may make more sense for you to hold off as long as you can and grow your valuation.
While you might have healthy revenue numbers, you may still find it difficult to secure a bank loan. Banks are not as impressed as entrepreneurs think by a stupendous growth rate. They look for established companies with slow but steady profits, or hard assets they can collateralize against the loan, such as inventory, your properties, or cash in your bank account.
Q: How much of my company would I need to give up for a multi-million dollar investment?
If you are looking to enter a crowded market and need millions of dollars to scale, the venture capital route is likely the only route to get you the firepower you need. Depending on the investment size and valuation, you will be looking at giving up 25–45% of ownership in exchange for $2–$5 million dollars in a Series A round. In Series B rounds, you are likely giving up 10–30% ownership in exchange for an investment of $5–$45 million dollars, depending on your size, revenue, and valuation.
Growing your company before pursuing equity financing will increase your company’s valuation, so many entrepreneurs first focus on growing through their own money, or friends and family rounds, before they raise VC money.
Topic four: attracting investors
Q1: What do investors specifically look for in a company?
Equity investors want to know what problem the company is trying to address and how they differ from other available options. Beyond product-market fit, investors look at the team to see if it consists of the right people to bring the product to market and execute the business strategy. Having 2–4 team members with startup experience and deep industry knowledge is important. Investors also want to see a good fundraising strategy, including a solid plan on how you’re going to use their money.
Banks, specifically, look for companies with longevity and stability. Compared to VCs, they have a much more conservative appetite for risk. While you might be able to secure funding with a VC because of you are a proven entrepreneur with a disruptive product idea, banks need to know how you are going to pay them back. That’s why it’s difficult for entrepreneurs to secure a traditional bank loan without a revenue stream, or hard assets they can borrow against.
Unlike VCs, revenue-based lenders are less concerned with funding a disruptive product or service. Similar to banks, they want to see solid revenues, but their threshold is much smaller, and no personal guarantees are required. Lighter Capital funds tech companies that have at least $15,000 in monthly revenues, 50% margins or better and aren’t burning through too much cash.
Q2: What are my funding options when my company is not located in one of the places that investors congregate?
If you’re not based in one of the dozen or so cities where the major venture capital firms are based, it can be difficult to raise funds. This goes double for angel investment, which tends to be a rather local phenomenon: angels invest in their community and take a more hands-on approach. If you live outside of an area that angels congregate, you’ll need to find ways to broaden your geographic range. Participating in online portals, such as AngelList, is a good way to reach investors on a national level.
While securing non-local VC or angel investment outside of these centers can be particularly challenging, it’s not impossible if you’re solving a big enough or sticky enough problem and tapping into a potentially large market.
Topic five: mentoring and support
Q1: Will investors give me guidance and support beyond capital?
Unlike banks, venture capital investors will give you guidance and support to help you grow your business. From business strategy to market definition, VCs are heavily involved in your day-to-day operations. VCs are well-connected in the startup community, so they are well-positioned to help you recruit new team members as you grow. This can be especially useful in major tech cities, where the talent you need is in short supply.
If you choose a revenue-based loan from Lighter Capital, you can expect much more mentoring than you would get from a bank, but not as much as the guidance from a VC. We are happy to help you as little or as much as you need. Lighter Capital can help you with fundraising, talk to you about your business strategy, or make introductions—but we have no formal control over your company in the way a VC or Angel might via a board seat, so you are free to take or leave our advice.
Q2: How can I optimize the support I receive from an investor?
Choose your investors carefully! Select your investor like you would your co-founder. Your investor will be a vested partner in your business for a long time, so be sure you have a strong relationship with that person before you sign on the dotted line.
Once you select an investor, you need to understand who the point-person from that firm will be. It’s also important to understand how they want to communicate. Do they prefer phone calls or in-person meetings? How frequent do they want to talk? Once a week or every other week is typical.
Clarity around communication and setting the expectation early allows you to focus on getting the most value out of your relationship with the investors.