It might seem strange at first to hear that these are boom times for venture investing, but it’s true: Startups raised 30% more venture funding in Q3 2020 than in Q3 2019—$36.5B, according to CB Insights. Similarly, pre-seed and seed investments increased by 40% in 2020 compared to the same period, April to October, in 2019. As societies worldwide undergo radical shifts in a COVID-19 world, the companies enabling these shifts are poised for massive success. That kind of potential has VCs and angel investors very, very interested.
However, not everyone knows how to attract venture capital and angel investments in this new era. Here are my seven rules for startups eager to find—and secure—funding.
Rule 1: Understand the Current Service Addressable Market
Only serving business-to-business clients simply won’t cut it right now. One of the radical shifts is that businesses are tightening their belts. As more workplaces go fully or even partially remote on a permanent basis, the infrastructure costs normally carried by businesses will shift to employees.
Startups need to reassess their market opportunity in this new environment and act accordingly, even if the conditions for reaching the entire market have not emerged. Before the COVID-19 pandemic, newly minted videoconferencing juggernaut Zoom had been trucking along as a better version of WebEx used mostly by professionals connecting over long distances. However, the potential was clear: Zoom was robust, innovative, easy to use, and universally compatible.
Make it the startup’s job to know not only where the money is going, but also which sectors are overcrowded and which provide many opportunities for its product or service.
The company had a clear value proposition that, at the time, was geared toward businesses. When all those businesses’ employees began using the service for their social lives, Zoom was able to quickly conclude a deal with Oracle to scale its capacity. In other words, when nearly everyone had to move their lives online, Zoom was ready to take advantage of the shift. The company’s user base jumped from 10M to 300M within a few weeks.
Rule 2: Focus on Emerging Trends and Product-Market Fit
Not everyone can predict a pandemic, but the good news is that they do not need to. Investors are seeking forward-looking companies that dare to imagine the future and can quickly offer what consumers are looking for. Peloton was already riding the surge in home wellness and stationary cycling, then the mass closure of gyms quadrupled their stock price over the last year.
Make it the startup’s job to know not only where the money is going, but also which sectors are overcrowded and which provide many opportunities for its product or service. Before the pandemic, just under 19% of seed and pre-seed dollars went to IT startups, according to my own research. In the seven-month period leading up to US presidential election, that number more than doubled to 44%.
Rule 3: Be Adaptable
Nearly every startup has to pivot at some point in its journey. For example, Slack started as a game’s chat function, and PayPal was a way for Palm Pilots to send IOUs before it hit upon the $244B idea of allowing people to send money to each other via email.
Entrepreneurs need to be flexible and have an open mind to accept constructive feedback. They must show potential investors that they can respond to change, adapt, and thrive. Even better is having proof of past adaptability, either within the last year or in previous tough times. When the market presented a challenge, did the startup rely on its fundamentals to alter its approach and adjust the business’ value proposition to pivot successfully?
Rule 4: Have a Proven Management Team
Just as you wouldn’t want someone who’s never been on a boat captaining your ship during a hurricane, investors wouldn’t want someone who’s never led a company as the CEO of their portfolio company, particularly during a crisis like the COVID-19 pandemic.
VCs and angels don’t look at their investments as just pouring money into a company. They invest in people, too. To use another metaphor, investors don’t simply bet on the horse; they also bet on the jockey, who needs a firm grip on the reins. Startups should bring on talents with proven track records throughout the entire management team. This will be a strong signal to both angels and institutional investors that the team knows what it takes to take a company through to an IPO, or at least to a successful exit within three to seven years.
Rule 5: Be Scalable, with Hockey-Stick Growth Potential Even After the Pandemic
VCs and angels are not in this game for 5% year-over-year growth. They want to see fireworks on that balance sheet—doubling year over year at least, with the ability to exit at a substantial multiple in three to seven years. To truly convince them, startups need to demonstrate their ability to quickly scale to meet potential mass consumer demand for the new product or service.
A company should also have a robust post-COVID-19 growth plan that can adapt to unforeseen changes going forward. For products designed to address needs related to the COVID-19 pandemic, the million-dollar question will be how demand persists as the vaccine rolls out.
Rule 6: Keep the Burn Rate in Check
This uncertainty also makes a manageable burn rate and an 18-month runway with a realistic cash flow plan absolutely crucial. The initial funding might seem like it will last forever, but it often goes much more quickly than expected. A company that shows discipline in its burn rate early on is a good sign for potential investors.
Rule 7: Be Realistic About Valuation
For companies in hard-hit industries, it might be wise to explore government grants or debt financing before considering an equity round. It is almost certain that a valuation discount of anywhere between 25% and 50% will be applied to accurately reflect the uncertainty in the current marketplace. Investors expect startups seeking additional capital to have a realistic assessment of the business landscape. Even with vaccines rolling out, it will probably take another year or more for everyone to fully engage in those high-infection-risk activities.
Although entrepreneurs in the affected sectors might still be able to raise money from friends and family at pre-COVID-19 valuations, raising pre-seed money at too high of a valuation could hinder the company’s future ability to raise capital. Startups should avoid putting themselves in a Catch-22 situation, as most early investors are reluctant to go through a down round. It can be a difficult balancing act, but doing it correctly shows maturity.
Do Entrepreneurs Really Have to Follow All These Rules?
There are, of course, exceptions to every rule, but the best path to funding lies in following as many of these rules as possible—both now and after the COVID-19 pandemic ends. At times like this, sticking to the fundamentals is key.