Twice in the last week I found myself coaching founders on how to build a financing plan around value creation milestones so I thought I would share what I said here.
The idea of thinking about value creation milestones comes from the observation that the value that investors put on a startup is generally moves in a step function, even when the company itself is making steady progress. There are certain types of events that investors look to as evidence that a company has overcome certain challenges and has therefore reduced risk in the business and become deserving of a higher valuation. For new investors in a business it is often hard to assess the progress being made towards the milestone and hence little credit can be given until the milestone has been achieved. An easy to understand example of this is in the run up to a product launch – whilst the team has been working hard, can see the product coming on in leaps and bounds and becomes increasingly confident that they will launch on time and customers will come rushing to the door, for investors it is very hard know whether the product will work and be well received until it is in the hands of customers. Hence the value of a company is often relatively flat in the run up to product launch and then leaps up once it is out of the door and starts to get traction.
Typical value creation milestones for technology startups include:
- launching a product
- achieving first revenues
- breaking through revenue thresholds – e.g. run-rates of £1m, £5m, £20m and so on
- demonstrating a repeatable sales model (typically telephone sales, direct sales, or channel sales)
- for consumer internet companies, breaking through user based thresholds – e.g. successful public beta with thousands or tens of thousands of users, 1m monthly uniques and so on
- identifying a scalable customer acquisition channel
- demonstrating profitable customer acquisition (usually by analysis of unit economics)
- signing distribution deals
- demonstrating that signed distribution deals are working
- achieving first international sales
Given that the valuation of a startup increases when milestones like these are hit it makes sense to build a financing plan based on when they are likely to come in. Because it takes time to raise money and investors generally want to wait until the milestone has been hit before they will engage seriously in discussions about investing at the higher price point I generally advise raising enough money to last six or nine months after the milestones is expected to drop. That builds in time for delay and time for a leisurely fundraising. In his book The Second Bounce of the Ball, Ronald Cohen, one of the founders of the UK venture capital industry, is even more conservative – he advises raising enough money to get past two milestones.
However, raising lots of money to buy lots of time is great if you can do it, but for a lot of startups it won’t be possible, at least not without excessive dilution. In that situation I still think you need to stick with the discipline of thinking through when the value creation milestones will occur and timing your fundraising accordingly, but look for ways to compress the timescales. If possible bring forward the trigger events for the milestones, and in any case take your plan, including the milestones to investors before you have hit the milestones. Explain to them that you want to raise money quickly once the milestone has been achieved and ask whether you can keep them updated with progress and at what point they would like to enter into serious discussions. Hopefully you will find an investor or two who likes you and your story who will work to get themselves into a position to make an offer as quickly as they can after the milestone has been achieved.
In one of the conversations I had last week we ended up thinking that they should raise twice as much money as they had originally thought now in order to give themselves twice as long to raise the next round (twelve months rather than six). Our thinking was that with twelve months money the following combination of milestones and investor communications will be possible:
- July – pilot deal with a major retail partner goes live
- September – marketing support comes online
- November – retail partner decision to roll-out product to rest of stores
- January-March – anticipated strong sales months
Planned investor communication schedule
- October – first conversations on the back of marketing launch and early data from pilot
- December – tee up serious conversations for new year following positive decision to roll-out beyond initial pilot
- Jan-March – work aggressively to close another round in the momentum months
This is an early stage business and hence any number of things could change and/or go wrong but to my mind this is a pretty solid plan. The timelines are tight, but realistic, with two months contingency and the milestones will all be meaningful to investors and if the business performs I think the planned conversations will all be of interest.