Alex Douzet is CEO of Pumpkin, a pet insurance and wellness care provider founded to help ensure pets live their healthiest lives.
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Some of the top reasons I've seen startups fail are running out of cash or not securing the additional funding needed to continue their growth.
As a three-time founder, I have experienced all the challenges of raising capital. Overall, fundraising is a high-stakes, high-stress endeavor where decisions have far-reaching consequences for you and your business.
Seasoned founders all advise being skeptical at all fundraising stages, both internally within your business and externally with investors. I've found that building a network of trusted advisors and mutually beneficial relationships is key in this process. It's also crucial to have a fundraising framework or guiding principles that can help you avoid some of the mistakes many first-time founders have made along their journey.
1. Determine the correct funding source for you.
Venture capital (VC) funding is most suitable for businesses with high growth potential and the ability to generate substantial returns on investment. In my view, technology, life sciences, e-commerce, AI and machine learning startups often benefit from VC funding. However, it is important to note that VC funding is not a one-size-fits-all solution.
Each funding option has pros and cons; only 0.05% of startups raise venture capital. Around 77% of small enterprises get their initial funding from personal funds, and the most popular financing method for startup costs in 2023 was "love money"—aka friends and family. If your business does not have rapid innovation cycles or high scalability, these alternative paths, as well as bootstrapping, angel investment or strategic minority stakeholders, might be a better fit.
2. Don’t accept more or less funding than you need.
Once you have determined that VC funding is appropriate for your business, it is crucial to accurately assess how much money you need. The emphasis here is on utility, not ego. One of the top reasons startups fail is they run out of cash or fail to secure new funding.
Refrain from underestimating your capital needs to avoid running out of funding before reaching your next milestone, causing potential setbacks and losing investor trust. On the other hand, overestimating your funding needs can result in dilution of ownership, unrealistic valuations, pressure to spend unnecessarily, misalignment of incentives and limited exit options. Striking the right balance is essential.
3. Assume any business information you share is public.
The sanctity of the information you share during fundraising cannot always be guaranteed. Confidentiality agreements and NDAs have limitations. The investing world is highly interconnected, and information is often traded among individuals.
While this can work in your favor by increasing exposure, it can also lead to opinions being formed before you even have a chance to pitch. Expect that investors will collaborate, share insights and discuss potential deals within their networks. Guard the information you share and ensure its accuracy in representing your business.
4. Scrutinize your potential investors.
When seeking investors, a targeted approach is more effective than a shotgun one. Take the time to interview and evaluate potential investors just as they evaluate you. The quality of investors is as important if not more so, than the amount of capital they offer. Look for investors with 15 to 20 years of experience, even if they are difficult to find. Allow at least six months to identify and secure funding sources. Beware of investors who want to move too quickly, for this can be a red flag.
Conduct thorough due diligence of any potential investors. Examine the companies they have previously invested in and their standing in the business community. Look into their history with companies that are similar to yours, paying particular attention to their successes and the outcomes of their investments. Specifically, evaluate their track record of successful exits, where they have made significant profits upon leaving an investment.
Understanding the distinction between nominal paper performance and tangible financial returns is crucial. Paper performance refers to the theoretical value of investments on paper, which may not represent cash that can actually be realized. This value can be artificially enhanced through new funding rounds, especially when they are internal rounds led by existing investors.
In contrast, genuine performance is evidenced by actual profits returned to limited partners (LPs) beyond the initial investment. I've found that real success is measured by an investor's track record of converting investments into liquidity for LPs, typically through exits like IPOs or mergers and acquisitions rather than mere impressive numbers on paper. It is essential to know that a potential investor has a history of delivering substantial returns to their LPs through such exits.
Closing Thoughts
Securing funding is a slow and patient process that requires careful evaluation of your capital needs and thorough vetting of investors, often taking six months or longer from start to finish. Founders can flatten their learning curve and increase their chances of success by researching and seeking out seasoned, trusted advisors.
Lastly, it is important to remember that the investor who supported your first venture may not be the right one to invest in your fourth. I urge you to develop the skill of vetting new investor relationships to adapt to the changing dynamics of the startup world and your industry. With the right approach and mindset, fundraising can be a stepping stone to new levels of success for your startup.
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