THE CHALLENGE: ‘Two guys with no revenue’ learn a venture-capital lesson
Customers carry a card or keytag and scan it to earn rewards. The company also offers a quick-pay component with auto-reloading capabilities. Business owners receive detailed information to track usage among customers.
Mr. Bailey says the business is doing well, drawing “millions” in revenue. What he isn’t so certain about, however, is when a young business like his should seek outside funding.
To date, Spoonity has raised about $500,000 through self-financing and government grants, including the federal Scientific Research and Experimental Development tax credit and the Industrial Research Assistance Program.
“We’re now at a stage where we could take it to the next level,” Mr. Bailey said.
But after having tried and failed to secure venture capital financing in early 2013, Mr. Bailey thinks it might still be too soon to try again.
In retrospect, he believes Spoonity wasn’t ready to demonstrate its financial viability on the first go-round. “We didn’t have a sufficient customer base, and there wasn’t enough market validation. As a result, we spent a lot of time and energy unnecessarily. Instead of selling investors, we should have been selling clients,” he added.
But things have improved, Mr. Bailey said. “Back then we were two guys with no revenue trying to raise money. Now we’re ten people with millions in revenue and a much bigger opportunity for accelerated growth. The product market is there.”
Nevertheless, Mr. Bailey needs to know that Spoonity is at the right stage for seeking cash.
“To ask someone for a fairly sizable investment requires a lot of planning and preparation on both sides. They’re going to have to do a lot of due diligence on the company, and a lot of investigative work. And we have to do a lot of preparation in order to provide them with the material,” he added.
The Challenge: When is the right time for a startup to seek outside funding?
THE EXPERTS WEIGH IN
Paul Rhodes, partner in the audit and advisory group Crowe Soberman LLP, Toronto
There is no cut and dried, one-size-fits-all timing. But at some point a company will feel constrained in its growth plans because of a lack of financing.
When that happens, ideally the business owner should have a road map for where they are heading using forecasts or some sort of modelling. It should also articulate how much funding is required for that next stage of development, such as introducing a new product or breaking into a new market.
The first thing a venture capitalist is going to look to – aside from the historical results – is what the future looks like. They will want to know how this infusion of cash being sought is going to be put to work. They will also look at governance issues such as how organized and effective management is, along with its expertise.
One point to keep in mind is that there is a big difference between debt financing and equity financing. Equity financing, such as venture capital financing, involves taking an ownership stake in the business. A big question for the entrepreneur of an early stage business, therefore, is, “At what point am I willing to dilute my interest in the business, in exchange for an infusion of cash that I can put to work in improving returns and increasing the scale of the operation?”
Ari Pandes, assistant professor of finance at the Haskayne School of Business, University of Calgary
At some point you make the decision: Do I want to grow this company to compete with the larger players? Or do I just want to maintain the status quo? If you want to maintain the status quo then internal financing might be enough. But if you want to grow beyond that, then you’re going to have to consider seeking external financing.
When to do that really depends on the circumstances of the company. For example, a high tech firm would be different than an oil and gas firm that requires significant capital-intensive investment, tangible assets and that sort of thing.
Have you grown to such a point where you have a little bit of a track record, and you can pitch a really strong idea? Venture capital likes to see sales and at least some earnings. An external investor will also want to see prudent mechanisms in place to generate internal financing and growth. Other factors such as prudence in cost management and receivables and in generating investment cash for growth are also going to be on a venture capitalist’s checklist.
Make a mistake and venture capital financing is tough to get. They’re very choosy whom they’re going to allocate money to.
But you also have to be careful because you’re going to lose some control. A venture capitalist is going to want to call a lot of the shots. So it’s not for everyone.
Michelle Lawrence, founder of Prelude Music, Winnipeg
There are certain circumstances where you could be harmed by waiting too long to try to get venture funding. But you should also consider whether there will be a big difference in waiting, say, another six months before seeking investors. How much might the company be able to grow internally in that period of time? Would the company be more marketable to a potential investor if it delayed seeking funding until that time?
One thing to watch for is there can be a big difference between how much prospective investors value the company at, compared to what entrepreneurs think their business is worth. Therefore an accurate, realistic financial evaluation should be done ahead of time, and you can hire professionals to do so objectively. Try to put yourself in the other person’s shoes and take the emotion out of the valuation exercise.
THREE THINGS THE COMPANY COULD DO NOW
Prepare a road map
If you have your plans mapped out, you will know the optimal time to seek external financing. You will also know how much you need for your next stage of development.
What’s your worth?
Prepare an objective evaluation of how much your company is worth. An outside professional, such as a chartered business valuator, can help.
Know your terms
There is a big difference between debt financing, such as a bank line of credit, and equity financing, such as from a venture capitalist. The latter involves taking an ownership stake in the business.
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