How to plan a successful funding strategy
Startup Investment Manager at #CPHFTW, Danny K. Malkowski, guides you through the four stages leading to succes for funding your startup.
No matter what type of startup you are trying to fly all the way to success, there are many questions and uncertainties that need to be addressed on your journey. One question most startups are facing more than once is: How much money do you need in order to lift off the runway and reach the next level?
Imagine that you have just finalized your Minimum Viable Product (MVP) and launched the first beta version last week. But you only have a 3 month runway left (the time until you run out of money) in which you have to show some traction while simultaneously raising the money necessary to sustain and scale the company.
Most Venture Capital (VC) funds will not invest less than 500.000 EUR per ticket and also never invest unless there is at least some proven traction of the business. This leaves you with more risk willing Business Angels (BA) or early investment funds, typically partially funded by the government. But since you do not have any users yet, the valuation (the price an investor is willing to pay for shares in your company) will be significantly lower corresponding to the higher risk and business uncertainty for the investor. And the valuation will likely stay low until you have at least 4–6 months of data showing user interest and giving an indication of the business potential of your startup. It’s a shame that your runway was not 6 months longer on your previous funding round, eh?
This example illustrates that your funding strategy requires proper planning and continuous readjustments. In order to do proper funding strategy planning we need to look at the four major stages a startup will go through during its first few years: Proof of Concept, Proof of Technology, Proof of Business, and Proof of Scale.
1. Proof of Concept
In the Proof of Concept stage you develop your initial business approach, identify unique selling points, market entry barriers and your competition. During this phase you typically modify your concept and technology quite often as there is lots of learning and discovering involved. During the initial months of the Proof of Concept stage you are financing your time yourself, either with savings or by simply starting out in your spare time. Maybe you haven’t even legally established your company as a business yet! However, this quickly becomes crucial since it makes it a whole lot easier to bring on potential new co-founders and also potential initial investors. These investors are typically your friends, family and closest network, which could also include a few BAs. The Proof of Concept stage should not take more than 6 months.
2. Proof of Technology
In the Proof of Technology Stage you develop the MVP of your solution. This stage usually overlaps partially with the Proof of Concept stage. During the Proof of Technology stage accelerators, incubators as well as governmental innovation and investment funds also become interesting to talk to. The Proof of Technology stage should not take more than 12–18 months.
3. Proof of Business
Once you have developed your MVP you launch your first beta and start getting some real user feedback and hopefully revenue as well. You now have to proof that your business is viable and this is unfortunately where quite a lot of startups make mistakes in terms of funding strategy planning. The big mistake is when you don’t plan for at least 6 months of beta testing where you iterate and improve your product constantly, which allows you to gather crucial data in order to attract institutional investors. So plan for a Proof of Business stage of around 9–12 months. This gives you time to prove your business and raise money from institutional investors, which sometimes can take up to 6 months.
4. Proof of Scalability
Once you have a viable business, the institutional investors such as VCs start to show interest. At this point in your startup timeline the technological risk barriers are now much lower. You have now also successfully defined a market and made the users aware of a pain they have, which you have proven yourself able to solve. This calls for increased competition — and once you enter the Proof of Scalability stage a new race begins. Here, you need to take over a substantial amount of your identified market within 18–24 months.
Between each stage certain risk factors are identified and reduced, which means that the valuation of the startup goes up. Let’s go back to the example in the beginning: The startup does not have enough money to prove their business before new capital is required. VCs are currently not interested and they are running out of cash in 3 months. What should they do?
Instead of raising for both Proof of Business and Proof of Scalability, they should split up their budgets in two. The best possible outcome is that the initial investors that are already on board will invest in another round, giving the start-up 6 months of extended runway. Alternatively, a new BA could also enter the company, bringing a new network which could prove to be useful when scaling the company later on. Either way, the startup should not focus on raising funding for a scalability plan of 18–24 months before they have successfully proved the business.
In conclusion, proper and continuous planning of your funding strategy is crucial. Make sure you always update your funding strategy if a milestone becomes delayed, even though you don’t necessarily run out of money within the next 12 months. The ideal funding strategy is to raise your initial funding round so that it can finance both your Proof of Technology and Proof of Business stages, meaning approximately 24 months. Remember, you planned for that runway in the beginning. An airplane which starts to roll from the middle of the runway might not be able to take off even though you cannot see the end of the road yet. So better start paving early before it is too late.
You can discuss your own specific business approach and funding strategy with Danny. Sign up here for our recurring Open House Weekly Check-In each Thursday from 10–12AM located at Founders, Skelbækgade 2, 5th Floor, Copenhagen. You can also reach him at firstname.lastname@example.org.