The dos and don'ts when you raise money for your company

Nov 25, 2021 Finance

 

Why do people start businesses? For the money and the chance to control their own companies, certainly. Every year, there are dozens of business ventures that entrepreneurs launch, but many of them find it difficult to acquire investors.

As such, HoloBase invited Wu Jiang, an investor from VarCapital, to share his insights on what should startups look for when raising money. Mr. Wu Jiang is the Managing Partner of VarCapital and was the Editor-in-Chief of GeekPark which is one of the most enthusiastic communities of innovators in China. Up to now, VarCapital has successfully invested in great companies such as XPeng Motors, Lian Coffee and Unitree Robotics.

 

Maintain rationalize capital structures when raising funds

As we all know, sufficient capital is essential for a startup to become successful – but as companies go through the process of financing, many founders find it difficult to balance the capital structures when raising funds. So how do you create a new capital structure that leaves everyone in a reasonable position and the company with a rational capital structure moving forward?

As for this issue, Mr. Wu Jiang shared his insights: "Generally, as you raise more money, the more investors you have, the more your shares will naturally be diluted. If you want to attract more investors in and you don't want to release more equity, it is imperative that you make the company valuable enough and that more investors want to invest in you. Historically, there have been companies that existed that raised very little money before going public, and the founders maintained sufficient control of the company."

He also gave an example that happened in China. "There is a drone company in China, which is very famous all over the world and is not publicly listed yet, but his valuation in the last round of financing has been very high, and there are very many investors who want to give him money, so he chose to give up a very small amount of shares and selected some institutions that he recognized from the investors."

This example illustrates the need to maintain a rationalized capital structure when financing a business.

Of course, sometimes, this balanced structure may be upset. Some investors gain control of the company, which ruins the focus of the founders on the business.

Mr. Wu Jiang explained, "Such a situation does exist, but the core of this deal is whether the value of your company is recognized by the investors and they are willing to invest in you. The percentage of shares depends on their assessment of your company's value, and if your value is high enough, they will take the money out and only take a small percentage."

Therefore, he thinks that the founders can convey to investors the value of their company and their understanding of the business to get investors' buy-in.

 

Keep those things in mind when raising money

Many founders believe that as their business scales, they need to give control to stakeholders. It's simply not true.

As Mr. Wu Jiang mentioned, there are several things that are very important to keep in mind when raising money for a startup:

The first is the need for the founders to maintain control of the company.

The second is that the founding team needs to be given a reasonable allocation of equity to ensure that they are putting the value of the company first at all times.

The third is that for the first round of financing, try not to give away too much equity, or at least ensure that the founders or founding team still have sufficient control of the company after multiple rounds of future financing.

So for a company raising money for the first time, offering 10-20% is a reasonable range, while also ensuring that the company has enough option pools to reserve for future colleagues who join the company.

 

Be aware of what venture capitals look for

The risk is very high for VC investing in seed stage, especially when many things are uncertain. Investing in early stage projects, most of the references come from understanding and trusting the founders, and investing in early stage projects in such a high risk situation also prefers to get more returns.

But usually the probability of success for early stage projects is very low, and many VCs also invest with the intention of letting the founders try or explore a bit, and they have a higher tolerance rate for failure in very early stage projects.

As for this point, Mr. Wu Jiang combined the case of his investment in Unitree Robotics.

When we came into contact with Unitree Robotics in the early days, we also looked at many teams in China at the same time. In the field of quadruped robots, almost no one in China had successfully developed this product at that time, so Unitree Robotics was the first company in China that could really produce quadruped robots, and from this perspective it had certain technical advantages.

From the robot's point of view, in the past, we all looked at wheeled robots, and we are used to robots with wheels, but in some specific scenarios, wheeled robots are not very convenient because they have extremely high requirements for the ground, while quadruped robots can travel on uneven roads and even go up and down stairs, so they have great commercial value in the scenario.

In the past, we have been thinking that robots will not become the emotional companion of people in many cases, and many human emotional companionship is done by pets today, so we will also be thinking that four-legged robots can one day become our companion pets, which is also our future expectations for Unitree Robotics.

In his view, what a VC is looking for in a startup to provide funds is not whether they have raised a lot of money or not, but rather whether their technology has real business value in the long run and provides social value.

 

Pay attention to those sectors in Africa

China began to invest in African countries in the 80s, however, since the year 2000, China's investment in Africa has been growing more rapidly.

In the first nine months, China's foreign direct investment in Africa went up 9.9 percent compared with a year ago to $2.59 billion, according to the vice minister. The growth rate was 3 percentage points higher than the country's overall foreign investment and exceeded the level of the same period in 2019 before the COVID-19 pandemic.

Chinese companies have shown increasing interest in investing in the continent. More than 3,500 Chinese companies have been set up in Africa, of which private companies account for over 70 percent. China's foreign direct investment stock in the region was $43.4 billion, and it has become the fourth largest investor in Africa, according to CGTN.

There is no doubt that many Chinese VCs are also targeting this huge market. From the current stage, the main areas of their investment in Africa include the following aspects: games, tools, short videos, travel, e-commerce, hardware and Internet finance.

Finally, this is a personal suggestion from Mr. Wu Jiang: When you are young enough, spend more time exploring what you love. Don't mind whether what you are passionate about is recognized by the world or not. It's more about whether you love the things and participate in creating or renewing them. Beyond that, be bold enough to try out instead of just watching.