Raising capital for startups – what’s new following the burst of the bubble?

By Prof. Liora Katzenstein

Background 

Throughout the western world it is becoming very difficult for startup ventures to raise capital. After the crisis of 2008, there was a significant change in attitudes to raising capital for startup ventures. During the happy bubble years, in the mid 1990s, we experienced the dream of every entrepreneur. It’s only a slight exaggeration to say that investors stood in line to put their money into young high tech companies, particularly in the field of communications, internet (especially social networks) and media in all its forms.

For example, one day two young entrepreneurs came to the offices of ISEMI, two students from the Technion who were interested in studying entrepreneurship at ISEMI in order to promote their venture. They told us proudly that they had come from one of Israel’s largest law firms, where one of the partners was interested in investing in them, and after our meeting they would be going to present their wares to a VP of one of the three largest banks in Israel. They reported that they would give these investors until midnight to make up their minds, because “there are lots more waiting in line”.

Now, after the latest global crisis, the situation is completely different, and in my opinion, that’s good news, for entrepreneurs as well, and I’ll explain it in this article.

Raising capital for startup and high tech ventures has changed:

Following the unimaginable amounts of investment, in the billions of dollars, that went up in smoke at the end of the last millennium, investors are now looking for startups that can show a clear business model and generate income even without investment. This is even more marked in a period of severe crisis, when the stock of cash is running out. When any liquid cash is very expensive, only companies that can demonstrate a professional approach and even some initial results will tempt investors. In the current investment climate, entrepreneurs must show a business, not just an idea. That means a lot more than a hypothetical business model. In the past, investors were prepared to gamble on a brilliant technological idea, improve its business model and build a winning team around it. Today, however, the venture must come to investors as a proper operational company, where the function of each entrepreneur is clear, and where feasibility tests have been carried out on the proposed product or service.

Aspiring entrepreneurs may mourn the passing of the age of easy money, but wiser entrepreneurs know that the real cost is the non-monetary resources (time, energy, mental resources etc.) invested in the venture. So if it is possible to prevent the establishment of ventures that are doomed to fail in the end, this is good for all parties concerned. The reason is that entrepreneurship is a way of life; successful entrepreneurs are usually serial entrepreneurs, therefore it’s better for them to focus their resources on ventures that have a good chance of success. It’s true that today it’s harder to raise funds from angels, venture capital funds and investment companies, but on the other hand, a venture that does receive such investment is at a much less dangerous stage than similar ventures a decade ago, and therefore its chances of success are far greater.

The key to successful capital raising for startups and high tech ventures

So, what should entrepreneurs do to raise capital? They must reach the stage of "Investment Readiness". This term has become the daily bread of investors in recent years, and it refers first of all to the readiness of the entrepreneurial team, their experience in team work, and the maturity of their business model, with genuine proof of feasibility (users in the case of an internet site, revenue in the case of a physical product, paying customers in the case of a service).

In other words, companies seeking to raise capital must do it at a later stage, and must therefore find alternative solutions until they can obtain investment from a professional external source. These solutions usually take the form of loans from the founders, working on other projects while developing the venture, even taking part time paid jobs, while working on the venture at night, on weekends and during holidays. This initial effort will certainly help the company to reach investment readiness, and thus enable it to raise capital from professionals who bring the added value of many years of experience of supporting startups, contacts with other professional investors, and potential strategic partnerships.

How has the Wall Street crisis of September 2008 affected entrepreneurship?

The first stage, “the panic stage”, saw a halt to all investment and capital raising, as well as credit facilities from banks. In the second stage, “the recovery stage”, there is selected investment in ventures already operating on the ground and able to show products and customers. Only the third stage, “the normalization stage”, will see things return to normal, but will limitations due to the relatively small amounts available for investment.

When will we get to the third stage? In my assessment, we are already there. Nevertheless, both angels and venture funds are being very cautious when it comes to investing in startups at the seed capital stage, and they will continue to be so.