The current climate is really challenging for a large amount of early-stage businesses. Not only have many found it difficult to continue operating as normal, but for those looking to fundraise, the landscape has changed pretty much overnight from what was a bullish market, to a now very cool market. However, at Seedrs, we’re here to help fundraising startups during this period in whatever way possible. So if you are looking to raise capital in the near future, this blog post will outline a few key challenges to expect whilst fundraising at this time, and how best to set yourself up for success.
Not only can your business survive this pandemic, but you can set yourself up to thrive. It’s a testament to your entrepreneurship – leaning into the obstacles and finding opportunities in places that others have missed or written-off. History has shown us that market leaders have been born out of a recession – Disney during the Great Depression as well as Apple and Amazon during the dot-com bubble burst. So, here’s how we can help you weather this storm and address the challenges you face head-on.
Top Challenges Facing Founders During Covid-19 Pandemic
Angels Getting Cold Feet
It’s an uncertain time for everyone right now, and angel investors are likely to be more tentative to part with their cash. Angels are likely to have been heavily exposed to the stock market turndown and more hesitant to take risks, particularly when no one is sure when things will go back to normal. Further, VCs are focusing on their portfolio rather than making new investments – a market signal that angels seem to follow. According to Beauhurst’s recent blog, Q1 2020 saw the lowest number of equity deals into private UK companies since Q3 2014.
Unfortunately, the power lies with angels in this situation, as they anchor your round and the crowd follows the large anchor investment at the beginning of a campaign.
So, if deals are falling through with institutional investors, it might be worth turning to those you trust instead of looking for new investors. From their point of view, they want to see their investment in your business make returns and mitigate further losses, so their continued support would increase the chances of survival and eventual returns.
Knowing How Much Money to Raise
Cashflow concerns for startups mean that short term takes precedence over the long term, and increasing your runway becomes critical. Growth rounds may have to be postponed due to the uncertainty, so we suggest you consider cash to see you through the short term over growth capital to get you through this period.
You might be in a position where you can grow during this period. If so, it might make sense to raise more capital to propel that growth. If your revenue has dropped and customer numbers have plateaued or reduced, perhaps look at a bridge round to take you to where you need to be to raise more for growth later down the road.
As the demand for investment opportunity decreases as anchor investors shy away, the price of an investment is likely to decrease too. So, how can you make your funding round more attractive to investors? By lowering the round price and accepting more dilution. A lot of founders will be pitching on the backfoot, and you need to take this into account when pricing the round.
The bull-market for startups is likely to decline, ceasing the valuations that have been skyrocketing in the last few years. If you’re calculating your startup’s valuation based on quantitative measures (e.g. revenue run-rate multiples), this current climate will likely impact your run-rate revenue, so you need to take this into account as the business will have decreased in value since January.
Right now, cash is king – if you can strive to improve your cash position at this time, you will give yourself more breathing space, meaning investor conversations will be easier. As well as being conservative in your valuation, be conservative in your runway and how the business and its cash is managing itself.
Attracting Further Investment
Many founders may be wondering how realistic it is to attract further investment in their campaign. We strongly believe that it is realistic, given that you set the right foundations for your round.
The Cheeky Panda, a bamboo toilet roll product, has been fortunate enough to face unprecedented demand in the current crisis, which has been reflected in an incredibly successful pre-registration campaign. As for the other three companies, they wouldn’t obviously benefit in the same way as a toilet roll manufacturer, but they are successfully attracting further investment on top of their angel investment. Fully Charged raised £500K in two weeks, Big Drop raised £200K in a single week, and GUNNA Drinks have seen their convertible round reach 168% in overfunding.
3 Steps to Successfully Raising Capital During the Covid-19 Crisis
Firstly, consider your options and identify the strategy that best suits you – should you hunker down and hibernate, keep a lean team and continue operating or do you take this opportunity to pivot and grow? Each of these comes with different budgetary requirements and strategies.
You don’t need to create complex financial models to understand your cash position and determine the capital you need to the nearest penny. Just carefully consider the runway you need alongside your monthly burn rate to determine whether you need to raise capital, and if so, how much – it impacts which investors you reach out to and demonstrates that you’ve thought about it prudently; they will want to see that you’ve thought about all of these things.
Prioritise cash – there are several ways you can do this, which will depend on your situation and business. However, consider adjusting compensation where possible to reduce cash spend. For example, don’t be afraid to renegotiate contracts and leases, and evaluate if there are any fixed costs that you can turn into variable costs.
Readjust your focus to ensure you address market demands – how can you provide your product or service to consumers who are likely to have different demands and react to their behavioural changes. For example, moving forward, consumers are likely to be more cost-conscious and value businesses that enhance a sense of wellbeing, community and reduce anxiety.
Make use of the support that is available – there are several Government measures that might help you.
- Job Retention Scheme – allows businesses to put staff on furlough at 80% of their normal pay (up to £2.5K per month), which will be reimbursed by the Government. This means that your staff won’t be allowed to work for the coming months, but that might suit a ‘hunkering down’ strategy.
- Cash grants and Business Rate Holidays – £25K cash grant for retail, hospitality and leisure. £10K cash grant for small businesses receiving small business rate relief.
- Coronavirus Business Interruption Loan Scheme (CBILS).
- VAT deferral and time to pay.
- Changes to insolvency rules.
- Self-Employed Income Support Scheme (SEISS).
Every week, our Executive Chairman and Co-Founder, Jeff Lynn, is sharing his thoughts on the current resources for startups, so check out his notes for useful resource summaries and updates.
Structuring The Round
Be realistic and be prepared – account for the following considerations.
- Target raise – by considering whether it’s a growth or bridge round, as well as your budget, how much do you need to raise to make this round worthwhile?
- Valuation – what’s an acceptable minimum and an achievable maximum? There will be undoubtedly a level of dilution that you and your shareholders won’t be prepared to bear. Note that starting with an unrealistic maximum valuation sends a bad signal to investors, so make sure it’s achievable.
- Timeline – not only is it important to understand how much time you have to raise funds, but it gives investors a sense of urgency and a deadline to commit.
- Who are your target investors? Message appropriately based on how much you’re raising and your business proposition. Ideally, look to have a few different options to create a sense of competition between investors as it not only creates some breathing space in negotiations, but it acts as validation to investors.
- Don’t forget about your existing shareholders! Keep them informed, and onboard; you never know when they might be able to make an introduction.
- Equity or a convertible? We offer Advanced Subscription Agreements (ASAs) to founders (labelled as a Convertible Equity campaign on our platform). In its simplest form, it’s an investment made now for shares following a trigger event at a later date (typically a business’s next funding round), and there’s a discount of the valuation for the investor as a reward for investing early.
An ASA is similar to a SAFE (in the US) or Convertible Loan Note, but it is S/EIS eligible to increase attractiveness for investors. Why should you consider it in the current climate? Well, one of its key benefits is that it defers valuation discussions to a later date when your business might be in a better negotiating position. Currently, you might feel the pressure to raise at a valuation below what you feel you could have achieved in a normal market. So, by deferring these discussions to a later date, you might be able to negotiate a far more attractive valuation. Further, it benefits an investor as it’s probably quite difficult for them to gauge what a reasonable valuation should be right now, so they can rely on a valuation set later down the line by an institutional investor in the next big funding round, plus then benefitting from a discount.
ASAs: Key Considerations and Parameters
- Valuation Cap – this is the maximum price the ASA will convert at, to counter a scenario of runaway growth before conversion. So, if a company does particularly well after the investment, it allows the investor to benefit from the upside of their investment as they would have done had they invested in shares normally.
- Valuation Discount – the discount that you apply to the future valuation as a reward to early investors. Typically, the discount has been about 10-20% depending on the terms of convertible and business. However, in this current climate, the discount is likely to be higher, which will be expected by investors.
- Longstop Date – if the trigger event has not occurred by this date, then the ASA will convert at a pre-agreed default valuation. So, you need to be realistic about when you’re likely to raise that next round because the pre-agreed valuation will likely be a lot lower than if it were to convert on a trigger round.
- Trigger Event – this is typically a future funding round that is a lot larger than the ASA bridge round, and you’d outline a minimum round size. The conversion will also be triggered if the company is sold either before that next larger funding round or before the longstop date.
- Default Valuation – the price the ASA would convert at if there is no trigger event before the longstop date. Historically, this has been the valuation of the company during their last raise, or a reasonable estimate of what it’s current valuation is. Given investor sentiment at the moment, it’s likely that you’ll need to apply a discount to this default valuation to make the proposition more attractive.
ASAs are a great way to avoid taking a down round or a lower valuation in terms of equity, whilst keeping a good investor story. A great example of this is GUNNA Drinks, who recently raised a convertible note on the platform, pulling together a campaign very quickly, anchored by existing investors. They now sit at 168% funded, and they’ve offered investors a 30% discount on the growth round that they’ve had to push back 6-12 months. It was well thought out, and it was received well by investors as a result. It’s an excellent example of a business that has understood a great way to fundraise through this crisis and offer a good deal to investors that also suits the founder and the business.
Executing The Round
Lastly, let the structure help the execution of the round. Initially, approach people that you trust to anchor your round. Given the high levels of uncertainty, investors will be looking for validation through pre-commitment in a round even more than they would before. So, you’re more likely to attract further investment if you’ve achieved anchor investment from people you can trust.
Use the scarcity principle to your advantage – if you limit the supply of the product, demand increases with fear of missing out – just take the pandemic’s toilet roll shortage as an example. If you decrease the amount you’re raising and the time you’re raising it in, you create more fear of missing out on your round.
You should also advertise your campaign as a unique opportunity – after all, it is! You would not be thinking of raising a short round or a convertible round right now if it wasn’t for the pandemic. Most investors will be aware that this is a time of opportunity, so if you play to that narrative, it’s likely to produce very good results.
Further, don’t forget to talk about future rounds you plan and the potential investor uplift (and discount if you’re doing an ASA). Reassure people by saying that you’re still planning growth once you get through this period. By talking about the exciting things that will happen once you’re out of it, it’s a great way to get investors excited about the long-term opportunity.
Get the Selling Points Right
- Don’t neglect the elephant in the room – you should have dedicated COVID-19 communications. Don’t avoid talking about it – you will be asked about how you’re dealing with the crisis anyway, so take control and pre-emptively answer those very questions.
- Startups should be more agile and better placed to get through the crisis than incumbents, without the significant costs of employees and office spaces etc. So, you’re in a far greater position to pivot quickly; use this to your advantage.
- There are, and will be, several businesses benefitting from this crisis. Find the ways this might help you benefit and play that into your narrative. For example, Big Drop Brewing supplies kegs to pubs, and pubs aren’t operating at the moment, which is an obvious negative against the investment opportunity. However, Big Drop found that their online orders have increased dramatically during this period, so they pivoted a lot of their operations to ensure online orders could be fulfilled and then communicated this agility throughout their campaign and reassured investors that they are making up for their revenue in other areas, which has been received very well as a consequence.
These are unprecedented times, but we’re open for business, and we can help you raise capital in these difficult circumstances to emerge stronger than before. As we’ve outlined, by carefully considering the challenges ahead, as well as the key options available to you, you can raise the funds you need, and we can weather this storm together.