Walking up a mountain is never easy. Walking up a mountain with weight on your back is even more difficult. Walking up a mountain with weight on your back and no markers to the summit is scary and nearly impossible.
While walking up mountains, instead of focusing on the scenery, people usually focus on how tired they are. Instead of focusing on the smell of the fresh air, the thoughts of “Why am I doing this?” become the focal point. But after a while, if you keep going, the journey and the climb – not thoughts of reaching the summit – become the focal point. The journey up the mountain is where the learning takes place; it's what makes the summit enjoyable.
So what is the process for first time entrepreneurs to raise funding ?
One of the first things that entrepreneurs need to do is make a shortlist of who the 'right' investors or evaluate “mix of sources, cost & timeline of alternative funding mechanism” would be. For raising let's say equity round :
- To begin with, you need to decide if you are ready for angel investors or for VCs.
- When applying to investors, check their websites and see if they have invested in businesses similar to yours and if your domain is within their interest areas. E.g. if you are a life-sciences company, there is no point in approaching investors whose focus areas are Mobile & Internet and Consumer Businesses.
- Check if there are synergies between any of their portfolio companies and your business, and if there are, then evaluate highlighting the same during your presentation.
- So in a way, entrepreneur need to play a role of match maker with clear defined investor target and need to be sure about this marriage outcome for a long term partnership with right inclination for incentivisation in favour of founder's team.
Estimating the market size with cash burn around measure of capital efficiency
Estimating the size of the market, and then predicting how much revenue the startup can achieve and at what growth rate is indeed a tricky exercise. But going wrong on this could either kill your company, or if in a rare case you have underestimated your revenues, you may end up raising more capital than necessary and thus diluting more equity at an early stage of the venture.
It is therefore very, very critical that entrepreneurs focus on working and reworking on the market size and revenue potential based on sound assumptions and with minute detailing.
Differentiator in the market place
It is very important to have unit economics around pricing or revenue models to bring various matrix under various phases of start-up market evolution phase from scratching a market with prototype to building customers receptiveness to product/services. Also, an investor would like to visualise how scaling level challenges in business will be mitigated with a clear differentiator to create significant level of entry barriers in the market to competition.
Another important aspect is to address the measure of capital efficiency to market place while building up the business block. In one of the start-up, as a finance professional, we had guided the allocation of raised capital to more rapidly evolving market segment with reduced outflow on sales/marketing investment rather than addressing market which looks promising over a long term but has high level of cash burn initially on sales/marketing set-up with higher level of risk reward. An analysis of “cash burn” as an expense or investment need to be clearly arrived at to address the measure of capital efficiency.
Therefore, it is important to have points below to Consider When Estimating Market Potential around business model.
- Clearly define what problem you are solving… and for whom – this will give you a good idea of the number of customers with that problem in the geographies that you plan to be available. A clear traction building up roll out on execution side of plan. After all every idea is as good as its strength of execution backed up with strong organisation & management to be developed by founders team.
- Estimate the practical reach e.g. while there may be a 100,000 people in your target audience spread across 50 cities, you may want to take the top 5 or top 10 cities and see how many people you have within your target audience. This of course gives you the total market potential, if 100% of potential customers were to buy.
- Now, apply some filters i.e. ability to pay, ability to reach via media, etc. E.g. while there may be 60,000 potential customers in the top 10 cities you identified, and you may be planning to use a combination of media, if the total reach of these media vehicles is 50%, the total potential of the market is really 30,000 customers.
You could also apply some price filters to test the elasticity of the demand in comparison to price. I.e. work up alternate scenarios to reflect the increase / decrease in demand in case the price were to be moved up or down; and then evaluate which scenario makes a better business case. [Note: For different situations you may have very different parameters for a good business case. In some cases, rapidly acquiring customers, even if margins are lower, would be a key criteria (often relevant in categories; it is important to achieve scale to be relevant – e.g. e-commerce – lock in potential customers on whom profitability can be increased later)].
Now, if the product is of a repeat purchase nature, you would need to make some assumptions on the number of times the customers would buy the product / service in a year. In doing this, it is critical to map the reality or in case of new product categories, to do some qualitative and/or qualitative research to validate your assumptions on the number of repeat purchases within a year.
Another way is to figure out how market has evolved over a period in other advanced geography and replicating the same evolution in other emerging geography with some set of broader maturity level number comparison, will give reasonably good insight on the market size evolution and revenue traction.
All the above will need to be worked and reworked at different levels of assumptions often to arrive at what seems like a practical market estimation.
Valuation v Dilution :
Venture Capital/Private Equity is needed to boost business growth either organically or inorganically. Raising capital is a long process, coupled with structuring around right controls, having need to set the valuation & dilution norms for investor & management.
Smart VC/PE fund Investor will always keep in mind adequate incentivisation in favour of drivers of business with strategic structuring around key norms. An important driver for investor, in the current context of emerging businesses around internet economy, will be to bet on current “drilling-mining” of market forces to "create a business model". Hence, Investor would like to have clarity on current capital injection tranche requirement and corresponding phase evolution of full fledge business model over a period of time with future participation. So to this extent, capital injection is function of betting on team rather than betting on a business model. In true sense, Investor is gearing up to start “mining” the market forces for creating “sensible business model” having defined revenue & profitability linkages, at an appropriate factor of time duration.