The prospects for startup funding have changed dramatically in the past year. There's less capital from investment sources available, and many companies' valuations are plummeting. January was the first month since 2011 in which there were no IPOs.
But all those ominous-sounding developments may be a good thing--they may force you to get more realistic about your company and its prospects.
One person who has been watching the funding frenzy of recent years in Silicon Valley, which has created the species of super-valued private companies known as unicorns, is Mary Jo White. The chair of the Securities and Exchange Commission spoke during a keynote address Thursday night at Stanford University about protecting investors in pre-IPO companies.
The topic has taken on particular importance with SEC changes last year that affect the ability of private companies to raise investor capital. Generally speaking, non-accredited investors--retail investors who have less than $1 million in assets and earn less than $200,000 annually--can now put a limited amount of money into startups. White offered some insight into the new world of startup financing, where companies are likely to stay private longer. Here are four things to keep in mind.
1. Don't appear more valuable than you are. Nine out of 10 startups fail, White says, but more important, 70 percent fail within two years of their last financing, having raised an average $11 million. There is an enormous amount of pressure for funded startups to achieve the mythical unicorn status of private companies worth $1 billion. "One must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems," White says. The risk for startups is even greater, she adds, because unlike public companies they have fewer controls and governance procedures in place.
2. Be transparent with investors. Changes to fundraising rules in the last few months allow investors with less than $1 million in net worth to invest a limited amount in your company. For the time being, these investments will be managed through crowdfunding portals, such as StartEngine. But you should be upfront too. "It is important ... for this excitement not to be shortsighted by failing to keep the interests of investors paramount, which could quickly deliver a very damaging blow to the success of crowdfunding," White says.
3. Put controls in place. If you plan to be the next Uber and stay private as long as possible while raising money from venture capitalists and other investors, behave like a public company anyway, White suggests. As your board expands to include founders and VCs, bring in outsiders with experience in public companies, and include members who can provide sufficient regulatory and financial expertise. In short, make sure your company is being run and governed for the benefit of all of your investors, White says.
4. Be wary of alternative lending. While non-bank financing can be a critical source of loans for business owners, you need to exercise caution. White says regulators including the SEC, the Treasury Department, and the Consumer Financial Prortection Bureau are looking into so-called marketplace lenders for their potential lack of transparency to investors regarding the riskiness of the small businesses that borrow from them. While that seems like an investor problem, the risks can rebound on the small business financing market as such lenders experience more pressure to lend as the market grows.