Endeavoring to raise money for your startup businesses can be a tedious process. Creating your minimum viable product (MVP), building your team, and refining your pitch are just the beginning, and each can take months. And when you are ready to seek investment, your attention and energy will be consumed by a long and grueling investor road show. It is a tiresome process made even more frustrating when you ultimately find that early seed investors have all the leverage during negotiations.
It is enough to discourage any startup entrepreneur.
According to Ed Quattlebaum, founding partner at Polaris-Crux Group, a strategic advisement firm that focuses on helping early-stage innovation companies with capital raising and commercial scaling, one of the most effective strategies to better position you and your startup during negotiation is to acknowledge and address one anxiety that all investors loathe: risk.
"Entrepreneurs need to understand that the terms of all financing options at their disposal are based on the simple risk/reward principle," Quattlebaum says. "The greater the investment risk, the greater the expected reward. Thus, anything you can do to reduce the risk and/or increase the reward will improve the likelihood of getting a deal done and enhance the financial terms for the funds. In the end, developing your risk and reward profile is critical to establishing your company’s value to a potential investor.”
Quattlebaum suggests that entrepreneurs consider and embrace these inherent startup risks and be prepared to address and, when possible, reduce them for investors.
1. Founding team
The best way to reduce risk is to assemble a great team and demonstrate your ability to execute on your idea. Investors will look at everyone in the startup, from the management team to the board of advisors to the scientists and technicians involved, so vet thoroughly.
2. Minimal viable product
If your idea requires additional technology or innovation to be commercialized, it adds an additional layer of risk to the project. Before you even pitch your idea, make sure that you have a tested MVP that is or can be ready to scale quickly.
3. Freedom to operate
Your team and company should be free of encumbrances, such as existing patents or trademarks, supplier or distribution challenges, talent shortages, etc. Any needed licenses or additional innovation only adds potential problems and, hence, more risk.
4. Barriers to entry
Low barriers to entry -- the ease at which new companies can enter your market -- represent a large risk for investors. Ultimately, patents are one of the most effective barriers you can create for competitors, so pursue legal protection for any proprietary technology or product you develop.
5. Market adoption
If you are developing a new technology, especially one that is considered disruptive, it will represent a high level of risk to investors. Do your market research and leveraging crowdfunding to develop "proof of concept," demonstrate need and demand, and reduce risk.
6. Evolving industries
With products and technology changing rapidly, you need to look long and hard at your business and consider if there might be other companies or technologies on the horizon that could ultimately supplant your business. Be prepared to address these threats in your long-term strategy.
If your product or service is regulated or has the potential to become regulated, it will increase the risk to investors. Stay abreast of laws and other restrictions that may affect your growth.
8. Exit strategy
Demonstrating that your business has a viable exit for early investors is critical, either through acquisition by a larger company or via an initial public offering (IPO). You should do your research and be able to speak to the historical trends in your industry to show that your exit strategy is realistic.
9. Odds of success
No matter how awesome you believe your company to be, remember that three out of every four startups fail. Moreover, Quattlebaum, a biotechnology entrepreneur himself, estimates that only 20 percent of high tech or biotech companies ever generate revenue, and less than 10 percent will be profitable. The odds are stacked against you and your startup -- and investors know this -- so temper your expectations accordingly.
Getting to the negotiating table is always a challenge, so be prepared when your hard work gets you there. Put yourself in the shoes of your potential investor partners to better understand and address their concerns over risk and, ultimately, improve your leverage when negotiating.