As technology companies mature, founders and CEOs often have to acquire outside capital to fuel their business’ growth. When attracting investors and negotiating rights, business owners should understand how their companies are valued and what that means for fundraising. Here are 10 considerations to keep in mind when valuing your tech company and determining the capital you’ll need.
The first step is to evaluate the size of the market in which your company operates and determine if there is sufficient demand for your product or service. You should then consider your product’s unit economics, which include production cost and profit margin. After determining these factors, you can begin to project how quickly you can grow your company.
At first, it may not be evident how much outside capital you need to take your company to the desired next level. To help define those requirements, put together a long-term financial model. This explains the “use of proceeds” to investors and how they’ll be deployed to support growth plans. You’ll want to seek out advisors and mentors early on who can offer feedback and challenge financial model assumptions before presenting to potential investors. Their input can help ensure your financial model is sound because once that model is shared with investors, you won’t want to make major revisions.
A clear financial model and use of proceeds determines how much capital you need to reach your objectives. With this, new investors project growth and set tech companies’ valuation. Remember that the company’s capacity to achieve or exceed investors’ expectations will then drive future equity value.
There are always competitors, even if it’s unclear at first who they are. Financial advisors can help you understand the competitive landscape by talking with their network of investors to gauge the level of interest in a certain sector. If interest is high, the landscape is often more crowded with defined competitors; and when courting investors, you’ll need to focus primarily on how your product or service sets you apart. However, if interest is low, you’ll likely need to first educate investors about the industry and explain why now is the best time to invest in your tech company.
As your capital table expands, later-round investors will want to protect their investment with contractual rights, and they’ll want, at minimum, the same rights as those granted in prior rounds. As a result, the rights you negotiate during early funding rounds take on additional importance because they set a precedent moving forward.
Generally, business owners can issue two types of equity to new investors. Common equity is typically issued in early rounds, often to friends, family and seed investors, and it provides limited rights. On the other hand, preferred equity is usually issued in later rounds, providing minority investors with protective rights, which can include: board representation, liquidation preferences and drag-along rights that prevent the company from selling without the preferred shareholder’s approval.
Valuation and liquidation preference are largely driven by competition among investors who are trying to lead the round, as well as the perceived value of your tech company and the risk assessed in reaching financial targets. The more investors compete to lead the round, the more leverage your company has during negotiations. Generally, drag-along rights, protective provisions and board seats are negotiated venue rights, with specifics that vary among companies and investors. Negotiations are largely driven by the interests of the company and investors, and what each values most.
One of the protective rights sought is liquidation preference. This gives preferred shareholders the right to receive proceeds from a sale, wind down or liquidation before any proceeds are granted to the tech company’s founders and common shareholders. Essentially, this is a right that provides new investors with downside protection. It’s often helpful to keep the terms simple during negotiations.
Rather than relying on a single investor, there are advantages to attracting a diverse pool of investors who are prepared to weather any storms your business or the market may experience. Another reason to diversify your investor pool is to leverage their unique expertise and market insights. However, it’s important to consider each investor’s interests and whether they’re aligned or competing with others. Determining how many investors to bring on also depends on who will be the lead and what you must give up in order to attract others.
In addition to capital, investors can offer expertise, experience and access to large networks. When evaluating which investor can best help you reach your goals, you should first determine the area where you need the most help—whether it’s sales and marketing, engineering and product development, or expansion abroad. Research how potential investors have helped other companies in the past and solicit feedback on any benefits or challenges those companies experienced.
While navigating the process of finding investors and raising capital can be complex, the journey of growing your business is an exciting endeavor. We have dedicated technology bankers who specialize in advising companies throughout their expansion efforts. To speak with an industry specialist, get in touch below or email us: firstname.lastname@example.org.
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