Startup businesses are grappling with significant challenges as they seek to raise small capital or debt rounds.

With the equity market experiencing significant constraints, primarily due to economic uncertainties and cautious investor sentiment, securing business funding from angel investors and venture capitalists (VCs) has become increasingly difficult.

This necessitates a more strategic approach, focusing on critical metrics that can enhance appeal to potential investors and lenders.

Challenges in raising capital

Raising capital has become increasingly challenging for startups in today's economic climate. Factors such as global economic uncertainty, heightened investor scrutiny, downward valuation pressures, and intense competition for limited funds have created a more demanding environment for securing business funding.

Economic uncertainty

The global economy's instability, marked by inflation, supply chain disruptions, and geopolitical tensions, has led investors to become more risk-averse. Angel investors and VCs are now more selective, favouring startups with proven business models and clear paths to profitability. NZ seems particularly hard hit from this perspective.

Increased scrutiny/expectations

Investors are demanding both clearer plans to self-sufficiency and more rigorous due diligence. They seek detailed financial projections, robust business plans, and evidence of market traction. Startups must present comprehensive and transparent data to build trust and showcase their potential through a lens of realism which may have not been as evident in the 2022-bull market.

Valuation pressures

Startup businesses more often face downward pressure on valuations. With a reduced appetite for risk, investors are less willing to accept high valuations, making it harder for startups to raise the desired amounts without diluting ownership significantly. Although valuations are slowly recovering from the 2023 crash, the multipliers being paid today are significantly less than previously, resulting in “down-rounds” for many businesses, which disappoints current shareholders and promotes greater dilution.

Competition for funds

The pool of available funding has shrunk, while the number of startup businesses seeking funding continues to grow – many seeking follow-on investment. This increased competition means that only those that can distinctly differentiate themselves are likely to secure investment. Funders may also be prioritising follow-on rounds, even though at times this could be good money after bad.

Key metrics for attracting investors and lenders

Attracting business funding through investors and lenders requires startups to demonstrate key metrics that highlight their financial health and growth potential. Essential indicators include real revenue growth, favourable customer acquisition cost-to-lifetime value ratios, controlled burn rates with extended runways, solid market traction, and high gross margins.

Real revenue growth

Demonstrating consistent and sustainable revenue growth is crucial. Investors look for evidence that the company is scaling effectively/efficiently and that there is a growing demand for its products or services. Historical growth rates and future projections should be clearly outlined and justified.

Customer Acquisition Cost (CAC) and Lifetime Value (LTV)

A favourable ratio between CAC and LTV indicates a sustainable business model. Startups should aim for a high LTV relative to CAC, showing that the long-term revenue from customers outweighs the cost of acquiring them. This supports further capital being growth focused, versus survival.

Burn rate and runway

Investors are keenly interested in a startup’s burn rate—the rate at which it spends its capital. A lower burn rate with a longer runway (the time a company can operate before needing additional funding) is attractive, suggesting prudent financial management and operational efficiency. The days of annual raises are over for most.

Market traction

Evidence of market traction, such as user growth, customer testimonials, and partnerships, can significantly boost investor confidence. It indicates that the product or service has a viable market and is gaining acceptance. If very early stage, then the quality of market validation (vs surreal TAM/SAM statistics) is equally important.

Gross margins

High gross margins indicate the potential for profitability. Investors prefer businesses that can generate substantial profits from their operations, even if they are currently reinvesting in growth. This is particularly challenging for hard product companies to sustain early on.

Conclusion

In this constrained equity market, startup businesses must strategically navigate the funding landscape by emphasising solid financial health and operational metrics. By focusing on revenue growth, customer value, financial prudence, market traction, and (at least gross) profitability, startups can enhance their appeal to cautious investors and secure the necessary capital to drive their growth ambitions. But it is pretty noisy out there.

Register for the next Dunedin FoundX meetup

For further insights and practical strategies on raising capital in today’s economy, register for the next Dunedin FoundX meetup on Tuesday, 25 June at 5:30pm – 8:30pm where our expert panel will share their experiences in raising business funding, trends in the startup space, and provide valuable guidance for navigating the current funding challenges. Don’t miss the opportunity to connect with peers and industry experts to enhance your funding strategies.

Register now

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex.

The title 'Partner' conveys that the person is a senior member within their respective division and is among the group of persons who hold an equity interest (shareholder) in its parent entity, Findex Group Limited. The only professional service offering which is conducted by a partnership is external audit, conducted via the Crowe Australasia external audit division and Unison SMSF Audit. All other professional services offered by Findex Group Limited are conducted by a privately-owned organisation and/or its subsidiaries

4 June 2024