Secrets of a Successful Capital Raise

When raising capital for your business, you as the CEO play the essential role. Talking to investors isn’t a delegable responsibility. If investors are going to put their capital behind your business, they must first believe in you.

On the heels of Axial’s Series C financing round, we talked to our CEO Peter Lehrman about his advice for other entrepreneurs raising money.

Even for the most successful companies, fundraising and M&A activity is a time of extreme scrutiny, uncertainty, and rejection. “As the CEO, you better gear up,” Peter says.

In this article, Peter discusses: 

• How to know whether now is the right time to raise money
• Why you need help
• Crucial investor questions to prepare for
• How to walk the fine line between humility and hype
• When to implement investor feedback, and when to ignore it

Diving In

“I started a business because I wanted to run it, not because I wanted to raise money for it,” says Peter. It can be extremely tempting to get frustrated by having your business, business model, and business performance picked apart at investor meetings, at a time when you feel you don’t have a spare moment to devote to anything other than operational items. But investors have to deliver performance too, so get used to this aspect of your job if you want to raise outside capital.  

If you just gave me the money, I could get back to the business, is something you may be guilty of thinking during more than one investor meeting.  

But to do the process right and get the best outcome for both sides, you need to be fully devoted to the process. “Investors really need you in the room,” Peter emphasizes. “You’re the person who can provide them with maximum context and insight into the past and future of the business.”

Is Now the Right Time?

If taking your eye off the ball in order to raise money sounds terrifying, join the club. That’s a normal and in most cases healthy feeling.

“That said, if you’re legitimately worried that you don’t have the time or resources to run a successful process and keep the business going, maybe now isn’t the right time,” says Peter.

He recommends every CEO ask the following questions:

• Who do you have supporting you in running the business?
• Who do you have supporting you in the financing process?

If the answer to both questions is “no one,” that’s an awfully bad place to be. Your options vary depending on the current financial state of your company.

• If your business is break-even or profitable… and you don’t have the right support system, put the financing process on hold. First, get at least one key executive into your business who can handle some core operations, and consider hiring an investment banker to support you in the financing process.

• If your business isn’t profitable… the choice is less clear. You either have to dramatically cut the expenses of the business, or you have to go out and raise money. “Either option is a huge risk,” Peter admits. If you go with the latter, you’re taking your eye off the business — which any banker will tell you never to do. It’s going to be a grueling, risky period, but as an entrepreneur, you’re in the business of finding a way over, under, or around. This is no different.

Getting Help

A note on investment bankers — there’s a reason that they’re still in high demand, even in the age of LinkedIn, Google, online deal sourcing platforms, and crowdfunding. Running a financing process requires specific expertise and takes an enormous amount of time.

This isn’t to say that you shouldn’t do your homework. You’re going to be selling yourself to people that do nothing but M&A all day, everyday. They have a sizable advantage when it comes to deal-making. “Learn as much as you can before diving in,” Peter recommends. “Talk to as many people as possible who’ve sat at both sides of the table.” Then hire an expert of your own.

In a sense, a banker is a little like a real estate agent. No one’s stopping you from selling your house without one. But if you do, you’ve got to be home every time a prospective buyer stops by. In addition to educating yourself, you have to devote time to market research, advertising, communication, negotiation, and paperwork.

Alternately: you can hire an experienced agent and take the kids to the mall while he or she is showing the house.

“Most middle-market businesses become profitable by keeping a close eye on costs and expenses. The idea of spending the cash to hire a quality investment banker or senior managers who can serve as your surrogate while you raise money might feel reckless,” says Peter. But investing in a team will pay dividends down the line.

“During a capital raise, the frugality that drove success for your current business could prove pennywise and pound-foolish.”

Investors want to see a strong team. Having your company’s value excessively tied up in the CEO can hurt your financing success just as much as high customer concentration.

There also comes a point in time when it’s important not to have dependency on yourself for the business to function effectively. Good lieutenants are required for your business to grow in value as it matures.

“Having a healthy and experienced team in place at Axial while I’m out — whether for investor meetings or other external responsibilities — is a milestone in the company’s continued progress,” Peter says.

Preparing

There’s no overemphasizing the importance of preparation in a capital raise. Most fundamentally, you need to have a clean and clear presentation of financials. “It’s stunning how fast messy numbers can kill a transaction,” Peter says. “Unless you’re a seed stage business, there’s no quicker way to ruin your credibility and your business’ prospects.”

“It’s stunning how fast messy numbers can kill a transaction.”

You should also be prepared to answer a wide range of questions from investors about the past, current, and future of the business. Peter recommends every CEO think carefully about these two in particular:

1) What metrics do you use to run the business?

Notes Peter, “Your answer will signal to investors how operational you are. How much structured, critical thinking have you done around measuring inputs and outputs? What metrics do you obsess over? How do you determine success or failure?”

Investors want to see that you’ve done the hard work to develop frameworks to evaluate the business’s operations and financial performance. They also need to hear the answer from your perspective in order to effectively corroborate it with answers from senior management and signals from inside the business. Your answer doesn’t necessarily have to be identical to that of your CFO or VPs, but there should be a clear narrative for investors to pick out.

2) How would you use $100,000 vs. $1 million vs. $10 million?

The numbers here may vary depending on how much capital you’re looking for. What investors are trying to get at with this question is how you think about investing capital in the business.

• How fleshed out are your plans?
• Is your orientation around spending in line with theirs?
• Do you know who would be in control of those resources and have the ROI hypotheses been built out rigorously?

“Investors want to hear your plans and priorities for the company firsthand, and feel confident that you would manage growth and allocate capital in a way that feels aligned,” says Peter.  

Managing Expectations

Success in a capital raise requires two things:

• A clear plan for the business
• Effective communication of that plan

Think carefully about how you present your vision, to whom.

“Investors have different levels of risk tolerance. Equity investors aren’t interested in being paid back with a 5-6% coupon,” says Peter. But depending the type of investor you’re targeting, they may be solving for 2x, 5x, or 100x.

Similarly, where one investor may be drawn to a more measured, deliberate CEO, another may be turned off by a CEO who doesn’t seem ambitious or audacious enough to create a breakout company.

Think carefully about how you present your vision, to whom.

“Be true to who you are, but be ready to flex a little bit in one direction or another depending on who you’re talking to,” says Peter. “I’ve been coached by colleagues that I can be overly worried about being credible at the expense of being fired up, so with investors, I know I need to make sure my conviction and passion about Axial’s transformative potential comes through loud and clear.”

Your presentation style can have important implications for the nature of the offer. “A big vision might get you a higher valuation, but investors may add more downside protection into the way they structure the term sheet. If you hit your mark, everyone wins. But if you miss, they’re protected and you might not be.”

Plus, if you sell an investor on a pipe dream, your job is going to be pretty stressful after the deal closes.

Doing Your Homework

“I met most of Axial’s investors through referrals a few years before we announced funding. The more lead time to build credibility and rapport, the better,” says Peter.

Talking to as many people as you can (as discreetly as possible) is the best way to learn bad actors, weaknesses, or other information that investors won’t trumpet on their websites. Ask tactical questions like:

• Who are their investors (a.k.a. LPs), and what are their expectations?
• How do they underwrite investments?
• What returns are they looking for, in what timeframe?
• What’s the average tenure of their investments? How long do they typically hold companies?

This is information you can corroborate with investors directly during meetings. Don’t be afraid to have a peer-to-peer conversation. “I know from experience it’s easy to get unnecessarily deferential in these environments. Be respectful, but assert yourself as an equal immediately in order to calibrate the alignment of the partnership,” Peter recommends.

(It goes without saying that you should be mindful of your tone and approach. Posing thoughtful inquiries in the course of conversation will be much more effective than firing off a line of non-stop questions.)

Gathering Feedback

In the course of a financing, you will hear “no” more than once. Rejection can sting, but don’t let it cause you to overlook one of the most interesting and productive parts of the process: feedback from expert critics.

“I really appreciate those investors who were willing to spend 20 or 30 minutes explaining why they passed in more detail,” says Peter. He asked every investor who passed one question:

“What would you need to have seen in order to move forward right now?”

“This isn’t a last-ditch effort to get them to change their minds,” says Peter. Instead, it’s a technique to get an investor to bring down her guard so you can learn why she passed in a more honest way.  

Good investors don’t pick their investments based on whether or not they like a business. Even if they love your company, they have to evaluate if right now is the right time — given the market, their current portfolio, your outlook, your weaknesses, trends in your industry, the state of your customers’ businesses, and a million other factors small and large. “A would-be investor’s answer to this question may help improve your pitch process, target more appropriate investors, or see the defects in your business more clearly.”

As you gather feedback, remember that it’s OK to set some of it aside for now. There’s a huge amount of insight in investors’ concerns. But they also have a tendency to overanalyze the current business, even though what they expect from you is a vision for the future. If you react to every investor criticism, you’ll always be a step behind.

Instead, use their thoughts as starting points for business improvements. Keep a steady head, listen without judgment, and keep moving forward.