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How to raise capital during a market downturn

Tips for businesses that are relying on new equity to launch, scale or enter new markets during an economic downturn, such as the current COVID-19 environment.
3
minute read

An economic downturn can rear its ugly head out of nowhere and, in some cases, like the COVID-19 pandemic, the global impact is – dare we say it – unprecedented. We’ve heard this word bandied around a lot in recent times, alongside ”pivot”, “crisis” and an overarching theme of “uncertainty”. 

So what do these perilous phrases and their associated challenges mean for businesses that are relying on new equity to launch, scale or enter new markets? How do you raise capital during a recession?

To better understand the scenario, we need to first look at the market impact. After all, COVID-19 has affected individuals and businesses in many different ways. 

Understand the COVID-19 market impact

Throughout every economic crisis, there are winners and there are losers. The COVID-19 pandemic is no different. It would be unsurprising to people that health care, consumer goods and liquor have all seen solid market growth. And the technology sector is booming – who doesn’t wish they had Zoom shares right now! But, as we know, retail and entertainment have been hit hard, hospitality is struggling and tourism has come to a grinding halt.

While some listed companies are doing better than others, the only certainty right now is the uncertainty. As a result, venture capitalists are investing less in startups and new series A financings, company valuations are decreasing, and we’re seeing a significant drop-off in mergers and acquisitions. It’s a tough market in which to raise capital.

According to Forbes, as well as the usual challenges that start-ups face in an economic slump, COVID-19 will significantly impact 2 types of businesses in particular: those within affected industries (like hospitality, entertainment and retail) and those that depend on direct sales (for example, through distributors).

But as we know, with every crisis comes opportunity. Investors are seeking to diversify their portfolios and market demand is shifting towards products and services in unexpected ways. Consumers have new needs. As Geoff Wilson, chief executive of Wilson Asset Management (WAM), says: “It’s really not about losing money in bear markets. It’s how quickly you make it back in the bull market.” 

So how can founders and business owners take advantage of the current market conditions to obtain funding and grow their businesses?

Make sure you’re investor ready

When it comes to investors, you get one chance – so make sure you’re ready. Consider your value proposition and the draw cards for investment. Practise your elevator pitch and how to tell your story in a way that makes people sit up and take notice.

Make sure you’re clear on what problem you’re solving in the market and how that problem or opportunity has changed during recent times. Hopefully it’s a big problem because big problems need big solutions! So where is the revenue coming from and is it scalable?

Include in your business plan your team, network and company structure, ensuring all your legal documentation is in place to support these relationships.

And finally, consider what your ideal investor looks like and whether you’re chasing strategic investments, such as potential suppliers or ambassadors, or just cold, hard cash. Given the current market, rather than one family office or a small group of venture capitalists, you might explore a broad capital raise via your customers using a crowdfunding partner like Birchal. There are a lot of different options available.

Get your financial modelling right

Our recent experiences have shown that traditional capital raising rounds are proving difficult, with lower valuations, scepticism around future recession and risk aversion on the part of investors and founders. 

To instil confidence on both sides, it’s never been more important to get your company valuation and financial model right.

For founders, robust financial modelling allows you to test the commercial validity of your business and its sources of revenue. This should include core cost assumptions and importantly, consider a strong go-to-market plan and customer acquisition forecast to support income projections. This gives investors a much clearer picture of your growth model and their potential return on investment over time, as well as an understanding of the potential burn rate and funding needs in the early days.

It’s important to build out your financial model using assumptions that can adapt to changing market conditions; for example, slower than anticipated growth rates or increased capital expenditure, which ultimately affect the cash flow position of the business. This forecast can help determine the value of the business but also any future calls on investors to support subsequent funding rounds. More on this below.  

Reconsider your company valuation

Given the current market conditions, you need to consider how your valuation might change over time and what opportunities there are for raising capital in the future. This will help you work out what sort of capital raise you want to do. 

For example, if you were planning a series A or series B funding round, you might consider a bridging round. A bridging round is essentially a smaller funding round at a smaller valuation, so that businesses can get cash in the short term and work towards a larger valuation and capital raise round down the track when the market has picked up. Hopefully that’s soon!

Rather than a traditional equity raise, it might also be worth looking at a convertible note structure as a flexible, simple and cost-effective option for raising a seed round. A convertible note is a form of short-term debt that converts into equity, typically with a future financing round in mind. It effectively delays the valuation of your business until there is more market certainty or you have better data on which to base the valuation. As with traditional equity plays in the current climate, convertible notes can also provide special anti-dilution rates to mitigate the risk of down rounds in the future. 

As you get closer to making the deal, a term sheet can help you to streamline and simplify the negotiations with investors, without having to create all the formal documents upfront. Term sheets can be legally binding or not, so make sure you understand the difference and the obligations.

While times are tough, there are definitely some solid options for start-ups and businesses wanting to raise capital in the current climate. In fact, there are lots of exciting opportunities out there! The next challenge is to stand out from the herd.

Invest in your brand to stand out from the crowd

Once you’re confident in your market viability, you’ve forecast your finances and verified your valuation, you’re almost ready to start talking to potential investors. It’s time to sell your story.

To do this, you’ll need some supporting collateral to present your ideas and financials in a way that is clear and engaging. Investors are busy people and they receive a barrage of new opportunities all the time. So, how can you stand out from the crowd?

The answer: build a strong brand. The language you use, the way your visual identity makes people feel and the format through which you convey your concept are all crucial when building authority in the market. While money is tight before the capital comes in, it’s highly advisable to prioritise investment in your brand strategy and visual identity, prior to going out to investors.

You may have started pulling together a pitch deck and information memorandum for presenting to investors to support their due diligence. But is it right for the new market conditions? The current COVID-19 environment means it’s not easy to network in person, meet potential investors for coffee or host events. You need to do things differently.

With a reliance on online communications, some founders are turning to digital information memorandums as a great way to reach investors. A digital memorandum is a website version of a traditional information memorandum, hosted and accessible via an internet browser. 

Because of its digital format, you can make your information memorandum look sleek and professional, which is great for progressive or techy brands. You can easily make changes to content, which is cost-effective and quick, plus you can access digital analytics on how investors are engaging with the content: who is opening it and what they’re reading. 

It’s a snazzy alternative to the traditional PDF that gets emailed around and it can plug into other digital platforms for tracking and communicating deal updates. You can see why we’re a fan.

Keep learning

While raising capital during a market downturn is certainly challenging, with the right team and a few tips under your belt, successful entrepreneurship can still be rewarding and achievable. Remember that fortune favours the brave. Now go get ‘em!

Our BlueRock team is experienced in helping businesses to raise capital. Feel free to reach out if you’d like to discuss your opportunity and options.

You might also like to learn more at our upcoming webinar, Capital Raising in a COVID-19 Climate, to be held on Wednesday 3 June. Book your free spot now!

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