Angel groups and crowdfunding platforms provide a range of options for startups seeking early-stage venture funding. Some have a lower threshold for listing than others, but all require compelling material for potential investors.
Competition for early-stage funding is intense, and high-net-worth investors are rightfully critical. They recognise that early-stage investment is a gamble, with multiple risk factors that could impact the future performance of a young company.
For this reason, potential investors will expect your material to address two key concerns:
- Compelling value proposition – Demonstrate the quality and scale of the opportunity, which includes a logical pathway to a sizeable (ideally 10x) return on investment
- Risk mitigation – External references should suggest that you have minimised important technical, people and commercial risk factors
Preparing a compelling information memorandum (IM) for investors is not a simple task. It should provide a clear and concise description of the business and opportunity in a presentation-style document of fewer than 20 pages.
The IM should cover the following:
Demonstrate that you know the market and your target audience. This includes clearly defining the market need you are addressing, the scale of the opportunity, the extent and quality of competition, the key barriers to entry and how your business can overcome them.
Commercial value proposition
Why will your idea be the clear winner functionally and commercially? Address why a potential customer will make the purchase decision at your price point and how the sale will be profitable to the business.
Possibly the most compelling argument for an investor is the level of market interest, because it immediately validates the technical and commercial value proposition. Market interest in pre-revenue firms may take the form of distribution partnerships or co-development arrangements with larger players.
Intellectual property protection
Investors would prefer that your core intellectual property is protected and that the IM describes the commercial advantage of such a monopoly. But many startups — especially those that are internet centric—may not have unique intellectual property, and thus should demonstrate a “first to market, create a dominant position” approach.
Investors want to see your business structure — how you plan to develop, manufacture, sell and distribute your product. The most important factor is a believable statement about how you will get to market, outlining the structure and channel partners.
Team and board
Some investors will only consider companies if those involved have already demonstrated commercial success. A critical component of the IM is demonstrating subject matter and/or commercial experience—or at least a pathway to achieve that expertise.
For businesses not yet earning revenue, a business value based on a future earnings projection can only be based on multiple assumptions and thus is not extremely compelling. For this reason, investors will compare your valuation claim against similar early-stage ventures.
If anything, what’s more important is the value of the business at the target milestone that the requested funding is meant to reach. Demonstrate that investing at the current valuation will provide at least a 10x return if the milestone is achieved.
Investment required and use of funds
IMs should include a clear statement of the amount of funds requested and how those funds will be used over a set period of time. The financial modelling should demonstrate that the requested funding will allow the business to achieve a milestone that will positively impact its valuation. Investors want to see that their funding is clearly directed to value-adding activity, which generally does not include repaying founder loans or inflated executive salaries.
Equity dilution is the fundamental enemy of the early-stage investor. The IM should state if further funding rounds will be required, with an explanation of how the business value is expected to grow with each round.
Pathway to exit
Most investors will not be seduced by the prospect of a dividend return in the distant future. The liquidity and flexibility of a future IPO is more appealing, but the resources necessary to meet the listing criteria may mean another funding round is necessary. It may be more impactful to demonstrate the acquisition strategies of large players in the sector and how that approach could benefit your shareholders.
In summary, an IM should address investors’ fundamental risk and return management needs—while also capturing their imagination.
Kim Walker is a Director of Prime Innovation, a division of ASX-listed Prime Financial Group. Prime Innovation specialises in helping innovative and rapidly growing companies navigate the commercialisation pathway.