Taking on capital has a cost and an inherent risk. Specifically, when you take on capital, you’re giving up equity and entering into an agreement with your shareholders to ultimately work towards delivering value back to them. There are risks associated with raising more capital than you can return that could materially impact the health and longevity of your business. That’s why understanding what taking on capital will cost versus what returns you may expect is so critical.
We recently worked with investment bank and venture firm First Analysis to educate our own portfolio companies about preparing for a capital raise and evaluating the returns associated with pursuing more rounds or seeking exit opportunities. Our work together inspired us to put together this framework for assessing the costs and risks of taking on capital, and how these should impact the way you consider exit opportunities.
Clearly Evaluate Your Growth Trajectory
To accurately assess whether you’re in a position to raise more capital, you must understand your company’s growth trajectory. If a raise will get you to the next level in your business, one in which you can return more value back to your investors than they originally put in, then the logic holds that another raise may make sense.
However, you may be in a position in your growth trajectory where another raise does not make sense, either because the returns won’t meet expectations, or because there are other ways to achieve your key milestones. For example, if a strategic acquirer has the resources to blow out your sales and ramp up your growth, acquisition could be the right path. There are also a number of ways to achieve growth without either fundraising or pursuing an exit event, including reducing your burn and ramping up sales.
Essentially, you must understand what milestones you need to hit to continue growing and if you can realistically hit them. From there, consider how you can hit those milestones, and if taking capital will change or affect their scale.
Fully Understand What the Capital Markets Will Bear
The capital markets matter because they set themselves based on the assets with them. In other words, once you know your own growth trajectory, you can match your company’s patterns against the markets and get a better sense of your position within them.
For example, if you are operating a SasS startup, understanding that public markets look at historical performance and investors focus on the growth curve is critical to knowing where your business falls relative to others and what the market is demanding. If you can’t meet those demands, then you need to take a hard look at your business and consider whether a capital raise is even a viable option for you.
Similarly, the capital markets also look for specific patterns and metrics in SaaS companies, which will in turn dictate their demands and expectations. For one, your Total Addressable Market (TAM) analysis needs to illustrate a large growth opportunity. Without that, you are not in a competitive position for a capital raise, and you don’t have high exit potential. Similarly analysts and partners evaluating SaaS companies are looking closely at cost of customer acquisition (CAC), especially in relation to revenue per customer, gross margin, and churn rates. This relationship determines the underlying value of a SaaS company. To get even more specific, companies with high recurring revenues, moderate growth, and low churn make strong candidates for investment and eventually consolidation.
It’s important to note that while these considerations in the markets in this SaaS example can be transferable across many other industries, there are always exceptions or unique circumstances associated with different verticals. You must understand your space above all else to make the best decisions and put your business in the ideal situation.
You should also be ascertaining your risk based on the markets. Where are they headed? How can they affect future fundraising, investment, or acquisition opportunities? You should never just think about fundraising in terms of what you need to do to get it, but what makes it worthwhile to pursue in the first place, otherwise you will lose sight of the inherent costs and risks of capital.
Evaluate Your Capital Needs Against the Fundraising Market
So much of whether you can take your business to the next level and achieve those milestones that will make it easier to return value back to your investors, essentially de-risking the capital you taken on, depends on what you need to grow versus what you can realistically get in the fundraising market. You should always be thinking of what your company’s value is and what its needs are. From there, know that time is key during a fundraising, and you will need to give yourself 6 to 12 months to undergo the process.