Raising Money in a Recession

About a month ago we decided to raise a small round of capital for Skyrove.  We decided to shorten the business plan to an Executive Summary/Investment Proposal of a few pages and to distribute it to potential angels, rather than VCs or larger acquisition partners. 

We weren’t sure that we were going to be successful, considering the the current depressed economy, but we felt that we had value to offer and that savvy investors would recognize it.

Within days we signed our first investor. 

4 weeks later we have 3 new and 1 old investors putting in a few million Rand. All the investors will add significant strategic value to the business. All the investors are ‘sophisticated’ investors with established track records. 

So how did we do it? 

Business at the Speed of Trust 

I’d say trust was the single biggest factor in raising this round of capital. 

One investor didn’t even bother talking to us! He stated simply: 

“I met Henk last year some time at East London airport, and he has good references from very good mates of mine, x* and y*. Executive summary is self explanatory and I have no questions at this stage. I just need your banking details and subscription documentation so that we can deal the formalities.”

* Not their real names 😉 

The new investors were people we already had a strong trust relationship with or were close to people in our “trust network”. 

In a recession, investors are much more likely to invest in people they trust. This is a natural protection against risk. I could cope with losing my own money, but I’d have a much harder time explaining to friends why I lost theirs. 

Entrepreneurs for Entrepreneurs

All the new investors have very strong entrepreneurial backgrounds with two of them active in the ICT space. They understood the product and could clearly see the potential for growth. 

I’ve often been frustrated in the past when people start asking questions such as: “How big is the internet going to be 5 years from now? Is your business still going to be relevant?”. 

Anybody who’s ever started a high-tech business realises that nobody really knows whether your current model will be relevant 5 years from now.  

For example, let’s say you’re selling anti-virus software. 5 years from now, Microsoft may have open-sourced Windows and added a security layer that makes anti-virus software irrelevant. It’s possible, though highly unlikely.

But even if it did happen, you’d have built up a team, a strong brand and a client-base. You should be ready for any challenge.

Either way, I think any business model that solves a customer’s problem right now is worth more than one which might take off in a few years. 

Looking into the future brings me onto my next point:

Cut the Crap 

If you don’t know something, admit it. I don’t know how much money we’ll make 5 years from now.

Ater 4 years of running this business I have a pretty good idea what’s possible in the next 3 years if we continue to grow organically, but even then I’d say the margin of error is 50%. Beyond that, it just gets murky. I start to thumbsuck variables. I say things like: “If we raise R50M in year 3, then we can…”

That’s not planning. That’s speculation. I think in general, computer scientists struggle to speculate. And I think in times of high economic growth, this could count against you, as everyone is looking to make speculatively high returns. 

I think in a recession, you’d find everyone is less likely to believe any hyperinflated projections, especially if your projections are dependent on further investments in the future at higher valuations.  

It’s About Value

During high economic growth, investors will take risks by backing bad ideas and throwing mud against a wall. They can’t do do that when money (and exit opportunities) are scarce. You have to invest in value, in companies that are going to be cash-flow positive before running out of money. 

This is especially true in South Africa where there aren’t nearly as many exit opportunities for startups as in Silicon Valley. 

So What Can You Do?

Admit that your company’s valuation is probably too high. We dramatically lowered our valuation from what we previously pegged it at. Although P/Es are irrelevant for startups, there are also fewer exit and trading opportunities for investors.
Be profitable within the next 6 months. It doesn’t matter what stage your business is in, if you can’t be profitable within the next 6 months, you’ll have a hard time raising money. If your startup is already a few years old, now is the time to make some tough decisions if you’re still burning cash. 
Add real value to customers right now and bill them for it. Now’s not the time to build pie-in-the-sky projects and hope that you’ll figure out the business model when you have millions of users (and paying millions for server infrastructure).
Look for investors who will add strategic value. The best investor is someone who’s been through what you’re going through and in the process built up a team, a brand and a large network of advisors that you can also tap into. 

Most importantly, don’t give up on finding investors just because we’re in a recession. There are many people with money looking for good investment opportunities – we sent our investment proposal to just over a dozen people, and have another 4 interested to invest – and investing in a startup could be a better bet than putting money into the stock market.