Startup companies: the challenges of raising investment

Embarking on a startup involves more than innovation and vision; it requires navigating legal and financial hurdles that can significantly impact investment prospects. This article explores the challenges startups face in securing investment and outlines what investors consider before committing funds.

Colleagues recently had the benefit of attending a ‘flip the script’ event hosted by KPMG. The investors in attendance discussed how they evaluate founders, what founders should do to enhance their chances of securing investment and their top tips for success.

Founders should be passionate whilst showing a solid commercial understanding of how their ideas solve real world problems and have the potential to be profitable. Over-promising in their pitch decks, or setting unrealistic expectations, were to be avoided.

An expectation for a founder to understand their weaknesses and show a willingness to learn from others and be challenged by their peers was encouraged. Many founders have a rigid vision of how their business should grow, however, a founder must be comfortable being challenged and accepting an alternative approach.

Challenges for founders

Valuation

Startups often have limited financial history, all are very often pre-revenue, complicating the valuation process. Founders may overvalue their business due to their vision, while investors rely on financial analysis and experience to determine a realistic valuation. Disagreements over valuation can delay or even derail investment.

Investors assess whether a startup’s structure supports future growth. Most startups are established as limited companies, which provide limited liability and transparency in share structure and governance — key factors for investors.

In 2023, the number of new technology companies incorporated in the UK increased by 22%, underscoring the resilience of the UK tech sector.

Equity

Founders must also contend with equity dilution when accepting investment. Negotiating investment terms involves balancing the need for capital with retaining decision-making control. Investors often request that an investor-director be appointed to the company with certain controls if the company fails to meet its objectives.

Additionally, startups typically undergo multiple rounds of investment as they scale, often requiring further equity dilution to secure additional funding. While this is not

always the case, it is prudent for founders to consider how much equity they dilute initially to ensure they retain flexibility for future investment rounds.

Challenges for investors

When evaluating a startup, investors will assess if there is a viable market for the product or service. An active market, such as with AI, increases investor confidence that there will be a profitable exit, should the market maintain its activity.

Investors seek a scalable business plan, outlining realistic steps to achieve profitability whilst also ‘keeping it as simple as possible’. It is important that the business plan sets out clearly how the investment will assist with the growth of the company.

The investor will scrutinise the founders to ensure that they are confident that the plan can be carried out to the term provided, utilising the investment monies, whereby they will look for an exit.

Management team

The management team’s experience, cohesion, and ability to execute the business plan will be key for any investor. A founder must understand the market and surround themselves with the right people.

Investors need to ensure they can work effectively with the team, particularly since founders generally retain day-to-day control, and investors may need to step in if issues arise.

Intellectual property

It is crucial for investors to see that founders have proactively protected their intellectual property (“IP”) if applicable, or if they plan to. This ensures that the startup’s products or services are safeguarded against replication, which could undermine their first-to-market competitive advantage and jeopardise potential profits and exit opportunities.

Exit strategy

The exit strategy is key for securing investment; investors need to understand how they are going to get their return on investment, and they look for clear plans to achieve this, whether through a private sale of the company or through an initial public offering (“IPO”).

A well-defined exit strategy makes the business more attractive and demonstrates that founders understand how to scale the company effectively and, critically, that investors expect to get a return on their investment.