Raising capital is hard, even if your startup has high profit margins and strong growth. In the best-case scenario, you secure financing after a months-long marathon of wooing investors, talking to banks, and collating reams of paperwork. But more likely, your months of work will leave you empty-handed—even if you have concrete numbers to back up your business’s trajectory.
Competition for funding is intense—less than 1% of American companies ever receive VC funding. Even traditional bank loans, considered by many entrepreneurs a fallback option, are hard to get for companies working with intangible assets like software.
Here are five problems with raising capital the old-school way, and one solution that’s starting to gain traction among tech startups.
Problem #1: In VC, pedigree is everything
How well-connected are you? Venture capitalists aren’t likely to bet millions on someone who hasn’t been vouched for by a VC they trust. A lot of entrepreneurs use connections they forged during their MBA. If you’re not an alum of a top-tier business school, you’ll need to find a way to get connected to potential investors. If you’re a scrappy and self-made entrepreneur—or if you’re not located near the Bay Area—getting a foot in a venture capitalist’s door can be a real challenge.
Problem #2: Your idea needs to be PowerPoint-friendly
Can you do justice to your business idea in a single slide? Can you give potential investors a detailed overview of your business model, competition, market and future plans in an hour-long presentation?
One hour is usually all the time you’ll have to convince VCs that your startup will be wildly successful and that they’ll be able to grow their investment ten-fold (or more). This can be very tricky if you’re carving out a new market niche that investors aren’t yet familiar with.
Problem #3: Pattern recognition is different for everybody
Venture capitalists look to their experience to decide how to invest. When they review your company, they’re trying to discern whether your business concept fits the mold of past successes. Maybe they had good luck funding a new trend like VR. Or maybe they’ve funded too many of those recently and fear the trend is passing, leaving your novel VR content marketing startup in a lurch.
Venture capitalists can seem clairvoyant, but as an entrepreneur, you don’t want to cross your fingers for a match between your business and a VC’s idiosyncratic beliefs. It’s like a roll of the dice—with much lower odds.
Problem #4: Fundraising takes time away from the most important thing: your company
If you’re like most entrepreneurs, you started your company to make money—but also because you’re passionate about what you do. When you start pursuing VC money, however, you’ll be running from coffee meeting to lunch meeting to pitch meeting without seeing any progress. It’s like a hamster wheel: you run and run and run, but you never get anywhere. Pretty discouraging when those VCs end up deciding their money would be better invested elsewhere.
There’s the issue of miscommunication, too. On the East Coast, the absence of a “no” may indicate potential interest. If they’re absolutely not interested, they’ll tell you. Out west, though, investors are less likely to give no for an answer. This means you may be spending your time wooing VCs who have already decided against funding you. That’s time you could use to court other investors—or, even better, to run your business.
Problem #5: Bank underwriting methods are prehistoric
If you decide to go for a bank loan, expect bankers to live up to their reputation for being numbers people. Bankers don’t understand the software industry and may insist that your company has no value, despite growing revenues and satisfied customers. Banks are still stuck in the days of inventory and asset-heavy businesses, back when real estate was still a safe investment. In addition, an over-reliance on factoring in company history means that your young but promising—or even profitable—company’s chances of securing a loan are lower.
A lot of startups earn a bank’s stamp of approval because of a metric that matters a lot to bankers and not at all to the company: the founder’s personal credit score. A personal guarantee—also known as risking your life’s savings—may get you a line of credit for your fledgling company. The downside is steep: if your company fails, the bank comes knocking on your door to recoup their losses.
A solution: data-driven alternative lending
In contrast to the finger-in-the-wind, qualitative methods of venture capitalists and the outdated approach of traditional banks, many new online lenders are determining a company’s potential using quantitative analysis driven by machine learning, API integrations, and proprietary risk algorithms.
Some online lenders, like OnDeck Capital and Funding Circle, target main street businesses and use information such as credit card receipts to evaluate the creditworthiness of the business.
Lighter Capital, where I work as CEO, funds emerging tech companies. When we look at a company, we want four main pieces of information:
1.Profit and loss statements and balance sheet
2.Last three months of bank transactions
3.Major customers and sales pipeline information
4.Information on your team
We gather as much of this information as we can through automation, scraping information directly through QuickBooks, bank accounts, LinkedIn, and Salesforce.
Having data allows lenders like Lighter Capital, Funding Circle, and OnDeck to determine quickly if your company is a good fit for their model. And they can fund you quickly so you can get back to doing what matters most: building your business.
BJ Lackland is the CEO of Lighter Capital. Before he joined Lighter Capital, he was a consultant to early stage technology companies, an angel investor with Element 8, and the CFO of Power Efficiency Corporation. Earlier in his career, BJ spent five years as the Vice President and Director of Summit Energy Ventures, a VC firm focused on investments in energy technologies.