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This article was contributed by Mike Fey, CEO and cofounder of Island.
It’s a fortunate time to be a technology startup. Global venture capital investments reached over $157 billion in fiscal year 2021 alone, a record high. Despite the unpredictable economic landscape brought about by the pandemic, or perhaps because of it, investors have demonstrated a nearly insatiable appetite to back technology companies —searching for the next unicorn. But while there is currently a surplus of capital available to technology startups, the onus is on founders to not only successfully engage with financing partners, but the right financing partners.
As cofounder of software startup Island, I have seen firsthand how partnering with forward-thinking investors with sterling reputations can radically change a startup’s trajectory, and even attract like-minded financing partners. While there’s no shortage of playbooks out there on the basics of fundraising, the guidance I received from my fellow founders proved to be invaluable during the financing process. Below are five pieces of advice that can be leveraged by technology entrepreneurs in the early stages of funding to attract top-tier investors.
Build a peer advisory group to improve your technology startup
While there is cash available to startups, investment firms receive on average 1,000 proposals each year, meaning there is stiff competition when targeting a specific venture capital firm. Before a start-up ever approaches an investor, they need to validate their idea and take a game theory approach to their funding strategy. They must anticipate every possible question, objection, or suggestion they could receive during the funding process to ensure they are bringing forth a fully formed vision. The most effective way to do so is by building a peer advisory group.
By consulting the best and brightest minds in their network, startup founders gain access to a host of objective perspectives that can help them solidify, or in some cases completely reimagine, their businesses. Founders must enter these meetings with an open mind, and be prepared to listen and pivot quickly based on their advisors’ feedback. For Island, we spoke with over 100 industry experts to validate what use cases and core functionality was essential to our early design partners.
During this consultation process, it’s critical that founders avoid the mistake of confusing “peers” with “buddies.” Their advisory group should be made up of respected thought leaders who will challenge the founder’s ideas when necessary, and who genuinely wish to see the industry improve. Founders must also resist the urge to treat their advisors as future buyers. The guidance they provide in a start-up’s infancy can be infinitely more valuable than any potential sale down the line.
A technology startup’s founding team matters more than you may realize
There’s a reason it takes some startups approximately six months to hire an employee. A founding team is the engine of a new technology company and can make or break its success. However, many startups fail to realize how much impact the team’s makeup can have during the funding process. In the early stages of a company, before there is even a tangible product, the founding team is a startup’s greatest asset when approaching investors, and every team member should be selected with this partially in mind. Technology vision and products naturally morph over time, but a good founding team can be relied upon to succeed through these changes. In some of Island’s early funding meetings, investors spent more time reviewing our founding team’s backgrounds and expertise as they did to evaluate our offering.
Having the right founding team gives investors confidence. Therefore, it’s important to take a people-first, roles-second approach. Founders can start with a list of everyone in their network who has proven to be rock stars with the passion and selflessness to build a company from the ground up. They should then cross-reference that roster with a list of needed skills and expertise that will complement founders and speak to investors. The overlap will provide a solid prospect list with which to start the recruitment process.
Strive to demonstrate market fit
Post-mortem studies by CBInsights found that 38% of startups fail due to a lack of cash flow or capital, while 35% of startups never deliver a positive return for investors due to insignificant market demand. Unsurprisingly, these two causes of new business death are linked, making it vital to demonstrate a high likelihood of market fit to potential investors early in the funding process.
Technology startups must first establish what market fit and demand look like for their company. Is it displacing competitors? Is it producing tangible results for a key customer set? Or, in the case of Island, proving demand for a new category based on repeatable use cases? Once a startup has set a goalpost for market fit, it’s much more evident to potential investors how and when it has been reached. To further assuage any hesitation, founders should come prepared with the customer data to prove to financing partners that there is a market need. By defining their total addressable market (TAM) and then demonstrating step-by-step how they will penetrate that TAM and monetize their product, startups will tangibly illustrate a market need through hard data.
Discerning investors will be looking for market fit red flags during the proposal process, including a low barrier of entry. We found investors were less concerned with whether we could build what we were pitching and more focused on whether the market would be there if we did. Top-tier investors are comfortable funding hard problems; in fact, they welcome it. They understand a high barrier to entry creates a sustainable advantage. Building a great new company is packed with risk, but if you succeed, the win is worth it to everyone who took on the risk with you.
Identify and engage with investors thoughtfully
Startups must identify the investors who are not just willing to fund them, but can actively help shape their technology company with their unique knowledge and experience. In the early stages, too much emphasis is often placed on the terms of the money and not enough on the firm you are receiving it from. While economics matter, they mean nothing if the company is not successful. So partnering with the investment team that raises your chance to be successful should be at the forefront of the decision process, ahead of valuation. After all, owning a larger percentage of a failed company does not pay well.
Performing an internal audit, founders can identify their strengths and where they need support, allowing them to partner with the investors who can augment any weak points. Each founding team is different — for instance, I, personally, wanted investors that could collaborate with us on building our category and provide guidance on how aggressively we should apply funding against the efforts. Other founders may need help in building out their team, product design, or messaging. Firms may have different expertise, but the board member who joins you also adds to the dynamic and should be in consideration.
As the startup engages with investors, it is tempting to treat it like a common sales process, but the reality is, it is a team-building process. The goal is not a round of funding. Rather, it is to find the partners who will make your company successful, especially in early rounds where hundreds of decisions will be made at the board level that could make or break the company.
Early alignment makes a difference
In my experience, different founders can have completely different experiences with the same investors. The difference was one of alignment. Not just picking the right investor but the right board member can have a dramatic impact on the value that can be delivered to the startup. During the process of selection, we discovered that the best firms actually add value with great feedback and insight from the first meeting on. The line of questioning they engage in is often a clear indication of their expertise and a harbinger of your future collaborative process.
After the term sheet is signed, both parties are now on the same team. As such, expectations must be aligned before a cent is invested. For example, some technology products can go to market in six months, while others may take years. Without setting expectations early on, it’s easy for both sides to get frustrated. Firm leaders should share the returns they expect, while startup founders must propose when and how they can deliver them. Through a frank and open conversation, a timeline and KPIs can be reached to ensure all parties are satisfied with the business strategy.
The right strategy attracts the right investors
With the market seemingly saturated with firms ready to invest, there’s no shortage of capital available to today’s technology startups. The challenge no longer lies in scarcity, but in engaging with the right investors through the right channels. By taking the necessary time to deliver a refined offering and approach every step of the funding process with intention, startups can reach the investors who are true believers in their vision and have the capacity and capability to help them achieve it. As founders, we can never lose sight that the goal is not just to fundraise, it’s to build a successful business. Each step we take should be measured on that progression.
Mike Fey is the CEO and cofounder of Island.