This guide is intended to help you with the process of getting your company investment ready, finding potential investors, and creating your capital raising road map.
Despite the advice in this guide, there isn’t any magic formula that ensures a successful capital raise, nor are there any hard and fast rules that must be obeyed. That said, the more you deviate from the norm, the harder you will probably have to work to get your fund raising off the ground. Subject to that health warning, here are some things that we think are likely to help you when you are looking to find investors for your company.
Raising capital for your company is not just about the money, and it is definitely not like getting a bank loan to buy a house, where the bank manager leaves you alone unless you miss a payment.
Involving external investors in your company, no matter how nice, experienced and/or successful they are, creates a close and personal relationship that will have flashpoints in times of difficulty and stress which are sometimes difficult to recover from. To put it another way, taking on external investors is like getting married. It’s exciting when the commitment is made but painful to get out of if it goes wrong. Actually, it’s usually easier to get out of a duff marriage than it is a bad shareholder relationship. Think carefully before you commit yourself to a capital raising process. Do you really need to raise capital? Can you find alternative means of funding your business through its current stage of growth?
If capital raising is the best way forward, our usual advice is to raise as much money as possible, as soon as possible, even if this results in more dilution than you think is ideal, because:
- capital raising is a high friction activity. It is time consuming (think months and months rather than weeks), expensive and often bruising. For these reasons, it is quite common for early stage companies to stall whilst raising money. So the fewer capital raises you have to do the better
- founders, bless their eternal optimism, virtually always underestimate how much capital their companies will need and how much time and effort it will take to raise it. Since you can’t be sure whether capital offered to you today will still be on the table tomorrow, it is usually better to take the money when it is on offer.
do your housekeeping
Keeping on top of legal housekeeping such as maintaining your company registers, due diligence files and Companies Office records will save you time and money when you come to raise capital. You will also impress potential investors and their advisers with your awesome organisational skills.
Our legal basics for startups guide has everything you need to know about keeping your startup’s house in order. Once you’ve mastered this topic, read on for more basics to sort out before raising capital.
appoint good directors
Boards exist to ensure companies are well run, and well governed so that shareholder value can be maximised and no ‘funny business’ goes on. – NZ Institute of Directors website
We think this is a particularly important role in the NZ technology sector, because so many of our tech companies are founded and run by great technicians (engineers, programmers, scientists, etc.) who are learning about business on the job. Certainly our experience is that companies that have independent and commercially experienced directors on the board tend to fare better in the capital raising process than companies with just founders on the board.
A good director, or directors if you can afford it, will help you:
- establish formal governance processes. Most investors will require regular board meetings and minutes, etc to be kept. Your company will look better if this is already in place
- hone your strategy and business plan
- make important commercial and management decisions
- develop a capital raising plan
- connect with good advisers and others who can help with the capital raising process.
Brad Feld, a high profile Silicon Valley investor and author, and co-founder of Techstars, put it this way:
In addition to functioning as a regular sounding board for the management team, board members can contribute substantially to the business, both as a group and individually. Board members can be incredibly useful during financings, merger and acquisition activity, general corporate strategy, and executive recruiting. Do not overlook the experiences and skills of each of the individual board members–they can often play high value, short term consulting roles as needed.
Ideally, your directors will have contacts with potential investors, but it is not always easy to find these sorts of directors for earlier stage companies. Even when directors do have useful investor contacts, the potential sources of capital are so diverse that you may be selling yourself short if you rely upon your directors as the primary source of leads.
Beyond personal contacts, the profile of your director will be important in helping you to raise capital. The a director’s profile, and the more relevant that profile is to your particular business, the better you and your company will look to potential investors.
Treat the appointment of a new director like any other key hire. Do your due diligence, including spending time with candidates to help you work out if they will be a good fit with you and your team. Do plenty of reference checking including talking to other entrepreneurs that have worked with the candidate and who are willing to provide you with some candid feedback. Also, check that your candidate has enough time to devote to the role with your company (good directors can quickly become over committed).
Last but not least, test early on in the process whether you and your candidate have similar expectations about the remuneration for the role and the level of effort you expect in return. Some general observations we make to our clients are:
- when hiring directors, generally speaking you will get what you pay for, both in terms of the quality of director you are able to attract and the time they will put into the role. g., if you pay independent directors $750 per board meeting (which is at the low end of the fee scale for early stage companies) those directors are not going to be keen to put in much time outside of board meetings working for the benefit of your company. At that level, you can expect your directors to turn up prepared and to make a contribution at short monthly meetings. It would be unrealistic to expect anything more though unless you are able to offer additional compensation, e.g. share options
- despite the previous point, be careful with candidates who propose fee arrangements that are much higher than market norms. There is no problem if it is clear that the value the candidate brings justifies the fees proposed. However, if it is not clear, it doesn’t make sense to pay up front for value that may not be delivered. Also be cautious about fee proposals that look like a consultancy engagement. Consultants tend to have a short term, transactional focus, whereas you are likely to want directors who are focused on the growth of shareholder value over the medium to long term
- early stage companies can find it hard to attract experienced directors, not only because the compensation offered is limited but also because the level of effort involved is often higher than is the case with more established companies. For this reason, we suggest that early stage companies initially focus on the commercial and financial expertise of potential directors rather than specific board experience, on the basis that more experienced directors (and ultimately professional directors) can be added to the board as a company matures.
It is relatively common for independent directors of early stage companies to be remunerated with share options rather than by payment of board fees. An allocation of options equating to 2% to 3% of a company’s equity pre-capital raising, vesting progressively over 2 to 3 years, would be relatively standard.
hire good advisers
Having good professional advisers (accounting, legal, IP and tax) will give potential investors comfort that your affairs are well managed. It will also help you to develop an investment proposition, including proposed deal terms, that align with investor expectations. This can make a big difference to how smoothly your capital raising proceeds.
Professional advisers that are active in the early stage space are also a good source of introductions to potential investors, to intermediaries who can access potential investors, and to other advisers who may be of benefit to your business.
If you wish to raise capital from professional investors, you will need some or all of the following documents:
- a 1 to 2 page summary of your company and the investment proposition (often called an executive summary). Many investors want to see a summary document before agreeing to meet with a company, so your executive summary is key to getting you in the door
- a longer form document that describes your company, your business plan and the investment proposition in more detail. Some NZ companies (or their advisers) provide investors with a formal Investment Memorandum or Private Placement Memorandum, but this level of formality is usually not required for early stage companies (and many investors are turned off by long or glossy offer documents of this type). A good power point deck can be more effective than a text heavy document
- historical financials and a detailed forecast financial model (including forecast cash flows and balance sheet). It is essential that you know your financials intimately and can answer questions about your model and its key assumptions. You will lose credibility if it becomes apparent that you don’t understand and own your financials
- a narrative business plan that describes your company’s plans to achieve its forecast numbers.
Although this may seem blindingly obvious, you would be surprised by the number of companies that start looking for capital without any of these documents in place.
We recommend getting started on these documents at least 6 months before you think your company may need capital because:
- you may end up needing money earlier than expected
- you may get unsolicited investor interest that you need to respond to in a hurry, and
- it will be helpful for strategic discussions, e.g. if a trade party approaches you regarding a joint venture, partnership, or acquisition.
Tech investors see a lot of investment propositions. They tend to quickly reject deals that are pitched at an unrealistic valuation. This isn’t simply because the potential return from the proposed investment is unattractive. Investors can also be put off by high valuations because it suggests the entrepreneurs involved are unrealistic and may be difficult to work with on future capital raisings. In addition, the higher the proposed valuation the more likely it is that your investors will seek preferential terms in order to limit their downside risk. Even if you say you are willing to negotiate, investors favour deals that are easy to do rather than deals that are difficult, and negotiations over valuation tend to be difficult.
For these reasons, when investment capital is hard to come by (which it often is) we suggest you think about pitching at the low end of your realistic valuation range. This should increase the number of investors who are willing to look at your company, and it should then be easier to get one or more of them over the line and onto your share register.
A lot of the capital raised in NZ for tech companies is influenced by personal connections. This is important when raising overseas as well, although it is much harder for NZ companies to take advantage of this.
If capital raising is or could be on your road map, even if it could be several years away, make an effort to build your network in the NZ tech community, including amongst potential investors, by treating every conversation as a subtle sales pitch. Your sales pitch will be most effective if you’ve got an interesting story to tell about your business, particularly around recent successes and your plans for the immediate future. If you can tell your story in a way that generates excitement about your business you will start creating interest in your company from investors and people who can assist you to land investors.
Make a point of getting along to local events for your industry so that you become known by your peers, who will hopefully have good things to say about you around town. If you can, attend several industry wide events each year – e.g. Morgo, which are attended by entrepreneurs and some investors. Awards nights can be good for networking too, e.g. the Hi-tech awards and KEA’s World Class New Zealand awards.
Get to know the managers running your local accelerators, incubators and angel investor groups, and go along to their networking events. Follow up with people of interest – or better still, do something useful for them, like making connections that could be useful for their business (paying it forward).
As a general rule, the better known you and your company are in the NZ tech and wider business community, and the more positive the public image, the easier it will be to raise capital. Investors are much more comfortable backing people and investing in companies that are known to them and who are positively thought of by people they respect.
Successful capital raisings (particularly if a high profile investor is involved) and exits are two of the best opportunities for profile raising, because they provide tangible evidence of success. Good profile building around these two events will set you up for better capital raisings in the future. Rod Drury’s self-promotion following the sale of Aftermail is a great example of how tireless profile building can create an opportunity for multiple successful capital raisings in later ventures (at ever higher prices).
If you’ve taken care of all of the pre-work discussed above, you will hopefully have created a buzz about your company in the NZ tech scene, and will have some warm leads to follow up amongst the investment community.
While it’s tempting to jump in and start chasing down all those leads, a more structured approach will usually be better. We suggest you plan your activities along the following lines.
identifying suitable investors
Identify the types of investors that are likely to be interested in your company and try to rank them in terms of their attractiveness to you as investors, so that you can focus your efforts on those that are most attractive, for example:
- an early stage company is likely to want investors with relevant industry and investment experience and/or networks, who are willing to roll up their sleeves and help drive the company forward. Ideally, it would be great to involve investors who have already chalked up some experience in the early stage space, as they are likely to have more realistic expectations about this type of investing activity, in turn reducing the risk of future conflict
- at the other end of the spectrum, a more mature company is likely to be able to buy in most of the expertise it needs, and may not have an immediate need for capital. However, it may make sense to have high profile tech investors as shareholders and directors as a prelude to bigger and better things (e.g. an IPO or a large, high value, funding round).
You should tailor your investment collateral (investment summary and pitch deck) to fit with the investor(s) you are seeking to snare.
make yourself compelling
Work out what else you can do to make your ask more compelling to your target group, and see if you can pull this off. E.g., if you have a high profile independent Chair and he/she is willing to commit to invest in the round, this is great validation of your company, your valuation and the terms.
Create a list of investors to contact and work out who will make the initial contact. It is best not to cold call, so for investors you don’t know see if someone in your network can make a warm introduction (e.g. one of your directors or a professional adviser). This is especially important in NZ due to our small size, but it’s also how deals are done everywhere – even in the US.
getting the right lead investor
Focus your initial efforts on securing a high quality lead investor. This should be an investor who is putting in sufficient money, and who has sufficient credibility, that other potential investors will be happy to accept the terms that you and this lead investor have agreed.
This last point is extremely important. A lead investor is in effect endorsing your company, your investment case and the agreed terms. This endorsement should make it much easier to get subsequent investors on board. Keep in mind that if you are targeting high net worth investors (HNWs) they tend to not want to be the lead investor, as this involves a lot of heavy lifting. However, once you have one HNW committed to your raise, it is far easier to add each successive HNW investor. This herd effect applies to some degree to all investor classes.
For our latest take on NZ’s tech investor landscape, including where each investor type plays and the pros and cons of each type, see our summary of active New Zealand tech company investors. We will update this table periodically, so do let us know if we’ve missed out any potential investors, or if you think we’ve mis-categorised anyone.