Startups Have to Prove Potential Worth when Courting Investors
By John C. Stevenson
Having a great notion for a business is no guarantee of success, or even a guarantee that the business will ever see the light of day. Entrepreneurs seeking investors to turn their ideas into realities need more than just a notion written on a paper napkin.
More often than not, they need investment capital.
Investors say that successful startups are most frequently those with management teams that have done not only due diligence to understand their proposed business, but who have also worked to understand the risks that potential investors face, and how investors pick their startups.
“It’s tough to be a startup founder,” said Kevin Meinecke, an associate with VentureSouth who specializes in deal flow and due diligence. “You’re going against extreme odds, and from an investor’s point of view, they want to bet on someone who can beat those odds.”
Indeed, according to Meinecke, more than half of all startups fail; he said that of the ones that don’t fail, most will manage a low return on the investor’s money, while maybe one out of 10 beats the odds and can return 10 times the value to the investor. Those startup successes are what enable investors to thrive despite all the losses.
“Understanding the math from an investor’s point of view is something that doesn’t get acknowledged very often, but it ties into proving your credibility,” Meinecke explained. “Building the credibility that you’re the one that can beat those odds – you’re the one that can succeed – is really the goal at every step.”
That’s why Meinecke urges startup founders to do their own due diligence when considering which investors to pitch to.
“Do your homework on the investors first,” he said. “That has two prongs. The first is what is the investor looking for, so do I fit the criteria of companies that they invest in.”
Meinecke advised that startups can often answer these questions by reviewing a potential investor’s website. Investors will often outline their guiding principles and philosophies, and may even list other startups in which they have invested.
“The other piece,” he said, “is researching what you want an investor to bring to the table. A lot of companies are looking for more than just capital. They’re looking for expertise, they’re looking for experience, they’re looking for connections. So you really want to do your research on [potential] investors, and that should narrow it down to a smaller pool of investors you’re approaching.”
Meinecke said an entrepreneur can build credibility by building a relationship with potential investors. He said it helps to have an introduction to an investor from a third party, someone who knows both the investor and the entrepreneur. And that introduction doesn’t have to be followed immediately with a pitch deck.
“Get to know those investors before you ask for money,” he advised. “You want to try to be on their radar before you ask. Even if you’re not ready to raise money yet, you want to get your ideas out there.”
Credibility can cut both ways, and the smart startup founder is careful not to overpromise when pitching to potential backers, according to Joel C. Stevenson, a senior lecturer at the University of South Carolina’s Darla Moore School of Business.
“The biggest pitfall is promising more than you can deliver,” Stevenson (no relation to the reporter) said. “Make the pitch believable. Be conservative; keep sales [estimates] at a minimum and deliver more than you promise.”
Stevenson said it’s important to keep a pitch focused; sometimes, he said, a startup founder “is so excited, they talk too much.” Stevenson said his rule is to keep a pitch deck at no more than 10 slides, with an emphasis on facts about the market you want to enter, what your business will sell or what service it will provide, your target goal for initial investment and how those funds will be used.
Meinecke agreed the pitch should be focused, and added that it should be designed to highlight the company and how it will make money.
“You want to sell the idea of your company,” he said. “You don’t want to go through and educate the person on every aspect of your business; that will come with due diligence. You want to give the high level [view] of the important aspects of your business.”
A growing trend is for startup founders to produce a video pitch, and while Meinecke agreed this can be a valuable tool, he noted that some potential investors might be more comfortable with a more conventional pitch deck than a video. “Send both,” he suggests: “You never can tell” what a potential investor might prefer.