Be ready to answer questions before they are asked.
Congratulations. It’s a great time for entrepreneurs. Last year was a record year for venture capital investment, and this year promises to follow suit. 2019 is on track to be the second consecutive year that venture capital investment exceeded $100B.
But, make no mistake. Just because investors are writing more checks for bigger sums does not mean they are lowering their expected returns or cutting back on transaction due diligence. Quite the contrary. To find potential winners among the most robust startup ecosystem in recent memory, investors will be looking for those who distinguish themselves by providing the most important data before it is even requested.
Here are a few tips for entrepreneurs to ensure you have the right answers – and start out on the most confident footing when dealing with potential investors. Remember, you only have one chance to make a first impression.
The diligence process builds upon first impressions and shows investors not only that you have a viable concept, but that you and your team have the necessary skills to grow and manage a rapidly expanding business, where you fit into your industry or sector and how you will effectively manage your capital deployment. It’s crucial to show that the due diligence information/data room was not prepared hastily , but part of a process of ongoing self-assessment. Of equal importance, it shows that you are employing good governance and accounting practices for maximum transparency and compliance.
It’s wise to create a secure virtual “data room” through a service like Digify, that allows all required users to log in and view the curated documents in a setting, where confidentiality and security are highly valued
Due diligence information will fall into three broad categories:
A business should detail your product or service, how it is additive or disruptive, your competitive environment and competitive advantages, projected sources of revenue and a thorough understanding of strengths, weaknesses, opportunities and threats. Data providing evidence of the potential size of the market is also very important. Investors certainly like to invest in companies that are scalable in very large potential markets.
A complete overview of current expenses versus revenue and a projection of how, in a conservative scenario, that will change within the next five years or so — about the time frame for investors to decide whether to stay in or exit.
Make sure you populate your data room with documents that stand up to scrutiny. You will want to make sure you don’t sell the company short in your projections but at the same time do not paint an unrealistically rosy picture. A “hockey stick” earnings chart, with a sharp, consistent earnings spike would set off warnings for any experienced venture capitalist. Provide a vivid picture of earnings before interest, taxes, depreciation and amortization (EBITDA).
Make sure that your financial projections are realistic and achievable. You will not build a lot of confidence with your investors if you are constantly falling short of your revenue and earnings targets. Venture capitalists always advise their portfolio companies: if you are going to fail, fail fast.
A full disclosure of all regulatory issues facing the company, licenses and warranties and an inventory of intellectual and physical property, including computers and other equipment and real estate, as well as obligations under leases and other agreements.
You should also identify the executives who are essential to the company’s operation, whether they have equity in the business and how much, contract obligations and of course a detailed payroll breakdown with projected changes.
Make sure your data room includes a letter of intent and a term sheet, precisely detailing in bullet points the nature of the agreement with investors, with nothing left to guesswork or interpretation. Bottom line: What you hope they will give, what they stand to get back, and when.
The first question an investor will ponder is whether your company, marvelous as it may be at inception, is sustainable. You will need to convince them that you can adapt to fast-changing market forces, regulatory shifts and disruption from competitors. Does the company have a strong sales pipeline and the ability to scale up? What are the prospects for acquisition by a larger company? What are your customer acquisition costs and what is the lifetime value of a customer in current and future dollars? What kind of churn do you expect?
If you put in the hard work to provide confident, realistic answers to these questions, your reward in the end may likely be a higher valuation of the company.
Alan Wink, Director – Capital Markets at EisnerAmper LLP, assists clients with capital budgeting, capital structuring and capital sourcing. Alan has 20 years of financial and consulting experience, having served as Director of the Interfunctional Management Consulting Program at Rutgers Graduate School of Management, a program he helped build into one of the largest business school-based management consulting practices in the country. He started his career in accounting, spending six years on the audit staff of a Big 4 accounting firm and a Fortune 500 Company. Alan left the accounting field to expand his horizons in the area of Corporate Finance. Alan spent several years as Director of Financial Analysis for AmBase Corporation (NYSE), where he led approximately $2 billion of corporate acquisition activity. He is also a past Vice President of Capricorn Management, a $100 million private equity fund specializing in restructuring and turnaround opportunities. In addition, Alan is a leader in the firm’s Technology Group, providing a variety of industry-specific services to technology and life sciences firms, including business and strategic planning, marketing and competitive analyses, financing assistance, and operational and financial benchmarking. He has worked with many early stage and emerging growth companies on developing the appropriate capital structure for their position in the business life cycle. He maintains an active contact base with angel investors, venture capital funds and private equity funds. Alan also understands the level of returns private investors are trying to realize and devises strategies that allow both entrepreneurs and their investors to achieve desired return thresholds.