6 Numbers You Must Crunch to Win Capital
BY Peter Cohan
Looking to raise money? Here's exactly what you need to ask yourself before you try to win capital.
There is one sure thing when it comes to start-ups; you can’t get investment without crunching numbers.
And you can’t do that unless you ask the right questions of yourself. These six are on the mind of investors listening to your pitch for their hard-earned cash:
1. How big is your market?
You’ll lose if you say “huge” but have a shot if your convincing answer is “bigger than $1 billion.”
Most likely, you’ll have to create a reasonable estimate. You can do that by collecting data on what you know for sure and by making some reasonable assumptions for the rest.
Consider the example of Nimble. It sells storage that’s a hybrid of traditional spinning disks and arrays of flash memory.
Nimble targets a segment of the $20 billion network storage industry--and the figure excludes add-on software. EMC and NetApp are the market leaders. Nimble’s segment, including software, is worth $5 billion and it’s growing at 15% annually.
That’s big enough to get tens of millions in capital.
2. What’s your quantum value leap?
But that’s nowhere near enough. Your next step is to convince investors that your product gives customers much more value than the nearest competing offer--what I call a quantum value leap.
To do that, ask your customers how much they pay for competing products. Also know how much better than competitors your product solves the problems that drive your customers to buy it.
Nimble also figured out that QVL. In the two years ending August 2012, it got 600 customers. Among the five reasons Nimble wins is that it gives customers two to five times more storage capacity and five to six times greater performance for the same amount of capital spending.
If you can’t measure your start-up’s QVL--no capital for you.
3. What share of the market will your start-up snare?
To win capital, you still have to prove you can get a decent share of your target market.
As a general rule, investors figure that the maximum share of a market you’ll be able to get is 10%. Although after the fact, some winners have gone on to snare 80% of a big market that they created. To come up with a realistic estimate, it helps if your start-up grows faster than the industry.
Nimble, for example, is growing much faster--193% annually since the end of 2010 -- than the industry’s 15%. So it should come as no surprise that Nimble expects to get grab enough market share to generate revenues of $35 million a quarter by 2014 when it anticipates a public offering.
While that would represent a mere 2% share of what is forecast to be a $6.7 billion market, it reinforces how important it is for investors to know what share your start-up will get.
4. How much profit will you get from each sale?
Start-ups almost always lose money for years before breaking even. But you must prove to potential investors that your start-up has a path to profitability.
To do that, calculate your fixed costs (the ones like salaries, benefits, rent, and utilities that do not change with each new unit you sell). Next, figure out how much profit your start-up makes on each unit it sells by subtracting your cost to make it from its price.
From there you have to show that at some point--ideally in the next two or three years--you will sell so many units that the profit they generate will exceed your fixed costs. If you can’t do that, your investor will have a much harder time getting a return--and your capital prospects will dim.
5. How much money do you need?
With that number in hand, you still must estimate how much money you need and how you’ll use it.
For example, let’s say you’ve sold as much as you can in your home market and target future growth from Brazil. You must decide how many people, factories, warehouses, and trucks you’ll need to get a decent share of that market.
Then calculate the capital you’ll need to pay your new hires and build and operate the new assets. If you can’t give investors the details of how you’ll use their money, they are sure to pass.
6. How long before you deliver a big exit?
Finally, you have to show your investors how you’ll further enrich them.
But if you have good answers to the first five questions, that should not be too hard. For example, Nimble raised $25 million in a Series D round in July 2011. If the company was valued at $250 million, then those investors now own 10% of the company.
Suppose Nimble generates $140 million in 2014 revenue when it goes public. Using a stock market value to sales ratio of six to account for its fast growth, Nimble would be worth $840 million at its IPO, yielding those series D investors a stake worth $84 million--more than tripling their investment in three years.
If you can convincingly demonstrate that kind of return for your investors, they will line up to write you a check.
Strategy consultant, start-up investor, teacher, corporate speaker, pundit, and author PETER COHAN has invested in six start-ups, three of which were sold for a total of $2 billion. Before founding Peter S. Cohan & Associates in 1994, he worked with HBS strategy guru Michael Porter.