Creating a level playing field in private equity
This is not an easy time for start-ups. With the economic downturn, gone is the time of speedy due diligence and crazy overvaluations. With a lower risk appetite, investors are more than ever looking for sturdy business fundamentals and are less willing to take a chance on riskier companies.
This is arguably beneficial for the start-up ecosystem overall, and for you as a start-up founder with a strong business idea. But let’s begin with the basics, with a beginner’s overview of a start-up’s fundraising journey.
Private equity investors can be seen as individuals or organisations that ‘bet’ on start-up companies in a bid to help them grow into global leaders. While most start-ups “bootstrap” as long as they can – finding ways to fund their company without external investments, through their own credit card or from friends and family for example – in order to minimise early capital dilution, there comes a time when the amounts required become too large for bootstrapping. This is when private investors usually come in. They invest funds in a company and, in return, receive shares of the company’s capital.
This is how the world’s biggest firms – Facebook and Google, for example – started, initially needing a business angel funder to input personal investments, before moving to a private equity investor for larger funding.
If the company succeeds, the investor gains a lot more than what they initially put in, whereas if the company doesn’t do well, the investor stands to lose money – so it really is the investor taking a bet on whether they believe the company will thrive or not. For this reason, the investment process is very thorough and can be drawn out over extended periods of time.
The beginning of the start-up journey
At the early stages of private investment, otherwise known as seed, start-ups usually look for funding from public grants or by seeking out angel investors.
Angel investors are typically people who have created companies before or have experience investing in companies, and are looking to further invest in organisations and businesses that they believe have potential. At this stage, beyond the usual business criteria, the business angel’s gut feeling and personal belief in the entrepreneur and their vision are key factors in their decision to invest. For this reason, entrepreneurs must carefully pick the business angels they pitch their clearly articulated vision to: those who have a track record in investing in similar sectors, and share the same vision, will be more likely to invest. Investors can become mentors of sorts for entrepreneurs, so it’s always best to choose an investor that truly believes in the start-up and its vision.
Moving from seed to Series A and B
As your business progresses, you'll need more funding than an angel investor can provide, so you’ll move on to Series A funding – roughly €10mn.
At this point, entrepreneurs will visit venture capitalist (VC) firms. VCs attain their money from limited partners (LP) who are usually institutional investors – so, for instance, they may receive their money from pension funds, who also set the broad vision for the VC’s investment thesis. The general partners of VC funds then allocate that capital into companies that they deem to be most promising investment-wise, following that investment thesis. Platforms like EuroQuity provide a major help to start-ups at this stage by increasing their international visibility and by putting them in touch with the most relevant investors. It has helped start-ups raise over €515mn since its creation.
VC firms will regularly need to raise new funds from LPs to fund their next rounds of financing in start-ups.
Many start-ups go through several “follow up” seed or Series A rounds before moving on to series B. Once you’re ready to move to Series B, you’ll follow a similar process as outlined for Series A. It’s important throughout that time to make the most of your board of directors – made up in large part of your current and previous investors – they may reinvest in the next round, and/or help you through their large network to find the right investor to top up the needed amount. At each of those stages you also have the option to go down the corporate VC (CVC) route, the strategic venture funds of big companies – such as the likes of L'Oréal – that invest in start-ups in their sector, and provide start-ups with the additional benefits of their existing network and expertise.
What to consider when looking for an investor
One of the most important things to remember is that fundraising is a two-way street. The investor may be taking a chance on your and your idea, but you are also giving them an incredible opportunity to make money in the future through their return on investment.
Throughout the fundraising process, you must evaluate the investor, too, to ensure they’re a good fit for your company, as they will be a part of your board of directors for years to come. Women in particular tend to ask for lower amounts than what they should, so I always advise to go high, then you can negotiate a lower offer.
Not only does this reflect what you’re worth, but it will cover additional unforeseen expenses while also extending the period of time before you have to resume fundraising again.
Women in private equity
VC firms tend to still be very dominated by men. In Europe, only 5% of venture capital managing partners are women, and in the US, this figure is only slightly higher at 15%. This has repercussions on the gender distribution of start-up funding, as VC firms that have women as managing partners are three times more likely to invest in women founders.
LPs have a key role to play in making the VC world, and by extension the start-up world, more gender balanced. For example, few LPs (25%) currently include gender in due diligence questions for General Partners and their funds’ portfolio companies. Tying this data to performance and payouts for investment managers would be a major incentive. Re-engineering their investment process is another way forward. For example, constraints such as check size and track record requirements can block women out (few female investors can provide 1-3% of the capital in a new fund). Expanding the track record requirements to include GPs’ past performance as start-up operators, executives, and ecosystem players would open up the door to more female players.
In turn, VC firms should ensure that more women are hired and promoted within their organisation to ensure they progress to the managing partner role. Unfortunately, that’s something we’re not seeing enough of yet, and women entrepreneurs are paying the price for this lack of diversity.
Of course, the lack of women investors and entrepreneurs is not fair, but it also doesn’t make economic sense. A report by the European Investment Bank showed that female funded companies actually delivered twice as much revenue per dollar invested, compared to their male counterparts. That's a pretty huge difference, right?
Words: Fannie Delavelle