THE INNOVATION GENERATION AND THE NEW FUNDING LANDSCAPE

Spencer Trask Perspectives is an interview series discussing unique insights and expert opinions on several topics relevant to startups from the firm’s CEO, Bill Clifford.

John Essick, Contributor

As we emerge from the COVID-19 pandemic, there will no doubt be a new wave of entrepreneurs and start-ups that we might call the “Innovation Generation” looking to capitalize on evolving or even brand-new technology markets. Fortunately, even before the pandemic, the avenues available to early-stage companies for raising capital had already expanded beyond the traditional to include new sources like crowdfunding and other internet-based communications channels. On the other hand, most of these newer companies have created products or services at a time of uncertainty, based on market forces that may not exist a year or so from now. That doesn’t mean the idea may not be a great one. It’s just that quite often that isn’t enough. A company also needs to find the right partners, get excellent guidance and, of course, move forward with the right funding source.

Bill, I would like to discuss how, or even if, you think the funding landscape for startups will be altered as a result of the events of the past year. How can the “Innovation Generation” take their ideas from “seed stage to the world stage”?

John Essick: This might likely be the first time what we are calling the Innovation Generation will start raising capital for their businesses through outside sources like VC and PE firms. Can you share some of the key things that investors will want to know about their business to help these startups focus on what will bring investment?

Bill Clifford: As VC’s, PE firms and individual investors perform due diligence on companies post-pandemic, the rules of engagement and investment will remain very much the same as they were before.

· The ability of the company to understand their buyers’ needs and translate these needs into products and services.

· The highest degree of vision and commitment to listen to and understand they buyers’ wants and needs.

· A marketing strategy that presents a clear, differentiated set of messages consistently communicated throughout the organization and publicized through an online presence, advertising, customer programs and positioning statements.

· A sales strategy for selling products that uses an appropriate network of direct and indirect sales, marketing, service and communication affiliates to extend the scope and depth of a vendor’s market reach, skills, expertise, technologies, services and customer base.

· An approach to product development and delivery that emphasizes differentiation, functions, methodology and feature set in relation to current and future requirements.

That these same criteria are the basis for Gartner’s Magic Quadrant should only reaffirm that these fundamentals are the measuring sticks by which all investors, sophisticated or not, will judge the investment thesis of each company post-pandemic as the Innovation Generation comes calling for investment capital.

JE: As a semblance of normality begins to reappear, there must be thousands of entrepreneurs who have been chomping at the bit to get their business model in front of investors. Is there a word of caution you may want to offer these eager entrepreneurs regarding the new funding landscape they may encounter?

BC: While we all hope and expect that the world will return to some form of normalcy during the remainder of 2021 and beyond, the fundamental financial metrics will also remain the same, and the scorecard for new and emerging companies will likewise remain the same. New companies will be judged on the strength of their revenue growth, their ability to control and manage costs, the size and growth potential of their marketplace and their management teams.

Those eager entrepreneurs would be wise to remember that as long as valuations are determined by the time-honored formulas and methodologies using revenues, revenue growth, market size, competitive position, and cost control, no amount of hand-waving or smoke and mirrors is going to win the day with a smart investor.

JE: How do you see the advent of the virtual world that has evolved as a result of COVID-19 impacting the capital raising journey for entrepreneurs and startups?

BC: Over the past year, startups were forced to become tech-savvy fast. Overnight, it seemed the business world grew virtual. As a result, in many ways, things have become wonderfully productive and beneficial. Despite a few bumps during the early months of the pandemic, things quickly carried on without significant disruptions. Employees worked remotely. Customers watched product demonstrations from the comfort of their home office. Board of director meetings were still held and collaborations amongst sales, marketing and development teams continued.

By adopting and adapting to new technologies, particularly ones enabling virtual communication (e.g., Zoom, Microsoft Teams, Google Meet), a startup can now present a crisp, high tech interface to the investment community during every pitch book presentation. These technologies allow rapid, real time responses to any questions posed during the presentations.

JE: Do you think investors will be looking more closely at the ways supply-chain disruptions can affect a company’s bottom line? Should this new generation of entrepreneurs be more cognizant of the issue than companies in the past?

BC: The COVID-19 pandemic may have done a lot of things to reshape the world in which we all live, but it did not change the fundamentals underlying sound financial investing in early-stage companies. Naturally, VC’s and early-stage investors would want to clearly understand the supply chain risk profile associated with the company and what contingency plans exist to mitigate this risk should the primary or secondary suppliers fail to deliver components in time to meet production commitments.

The issue of supply chain sensitivity was the focus of a previous Perspectives article entitled Thanks to COVID-19, the Startup World Has Changed Forever. In it, I opined on the importance of understanding why the supply chain risk issue was so important, not just to emerging early stage companies but also to all product-based companies as a whole. I also suggested that the FASB should include a supply chain audit as a mandatory aspect of every audit done on a publicly listed company in the U.S. as a part of their annual financial audit and made available to every shareholder.

JE: Do you see either reward-based or equity-based crowdfunding platforms becoming a viable alternative for start-ups or are they niche investment players?

The answer to that question is yes — a little of both.

Reward-based crowdfunding is a novel approach to kick starting a new venture in which the company offers to provide investors with a sample of the offering of the company — say a copy of their new record or a free cell phone case — in exchange for an investment in the company. The investor does not receive any equity in the company therefore the company suffers no equity dilution and retains 100% ownership of the company.

These platforms are viable alternatives to traditional VC funding for startups and early stage companies. They can get enough seed capital to establish a foothold in their chosen markets, and demonstrate to VCs and early stage investors that they have a viable set of products or services that meet some set of customer requirements. They can show other investors that there is a waiting market for their products/services and that the company can deliver to this market at price point that the market will accept. With these fundamentals under their belt, the company can then approach the venture community for round one venture funding without too much damage to their cap table.

However, multiple rounds of equity-based crowdfunding — each resulting in multiple small unit investors each owning small units or fractional shares of the company’s stock — becomes a nightmare for the venture company to deal with when consolidating shares in preparation for initial public offerings. Additionally, this approach is painfully slow and results in a very gradual ramp up in funding of the company. It’s simply not a realistic funding strategy for companies seeking to grow rapidly. It’s a difficult path for getting on the radar screens of legitimate venture capital firms that want to make significant investments in early-stage companies, and manage them through their growth stages to initial public offerings.

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