The type of funding you should pursue depends on your business’s value in addition to also scalability.
7 min read
Opinions expressed by Entrepreneur contributors are their own.
When we launched Cielo MedSolutions, a SaaS provider of population management healthcare apps, in 2006, my co-founder in addition to also I assumed we’d be able to raise venture capital. After all, we both had track records of having built in addition to also run software businesses in addition to also creating money for investors. However, we failed to raise VC funds, in addition to also had to settle for a far more modest amount of capital via a combination of angels, economic development agencies, non-profits in addition to also federal grants. Partly as a consequence, we grew considerably more slowly than we had hoped. We ended up that has a nice exit — sold to The Advisory Board Co. (ABCO) a little over four years later — so nobody’s feeling sorry for us. yet, the item wasn’t the big splash we set out to create.
Why? Even I, as a student of the game, have had trouble gauging startup investor interest.
This specific experience — combined with observing hundreds of different startups — motivated me to look more closely at these tough questions: As you’re thinking of launching a business, or looking to take your existing business to the next level, should you aspire to raise outside financing? in addition to also if so, what types of funding sources might consider your business to be an attractive investment? VCs? Angels? Friends in addition to also family? None of the above?
The Startup Fundability Matrix
In my recent book, The Launch Lens: 20 Questions Every Entrepreneur Should Ask, I introduced the Startup Fundability Matrix (see below), a conceptual framework in which can provide you with preliminary answers to these questions.
A quick, nerdy explanation
The x, or horizontal, axis of the Startup Fundability Matrix indicates capital efficiency (ranging via low to high). All different things being equal, outside investors prefer to put their money behind a business in which’s capital efficient, meaning in which for every dollar invested, the item’s not bad at producing strong returns on a dollar-for-dollar basis. On This specific scale, the more “investable” businesses tend to be those in which (a) require only a modest amount of capital to launch, in addition to also/or (b) can be scaled dramatically in addition to also efficiently by injecting just a modest amount of additional capital.
The y, or vertical, axis denotes valuation multiples (again, ranging via low to high). Valuation will be the value of the company, or its overall financial worth to investors. Since early stage companies are privately held, in addition to also therefore don’t have a stock cost you can look up on a public exchange, investors often use patterns via comparable companies to estimate the valuation of a startup. The most commonly used metric will be the valuation multiple — in which will be, how much certain types of companies are typically worth, measured as a multiple of the last 12 months’ earnings (profit) or revenue (total sales). In general, businesses in which achieve high valuation multiples are those in which show three characteristics: high growth potential, sustainably high profitability in addition to also strong differentiation versus competitors.
So, today we’re ready to look at where various businesses fall inside the Startup Fundability Matrix. Here are the four quadrants:
Quadrant 1 (upper right): Venture Capital — Businesses have a combination of high valuation multiples in addition to also high capital efficiency — inexpensive to launch in addition to also/or inexpensive to scale; these startups are the most attractive to VCs, corporate strategic investors in addition to also organized angel groups (which often behave like VCs).
Quadrant # (upper left): Patient Capital — These companies share the high valuation multiples with Quadrant 1 firms, yet are less capital efficient, often because they lend themselves to less rapid scaling due to addressing a more modest market. These businesses tend to be better suited to investors who are more patient in addition to also perhaps less oriented toward pure financial returns — such as friends in addition to also family, specific angels that has a special affinity for your particular sector, federal government grants, or state in addition to also local little-business loan programs.
Quadrant #3 (lower right): Bootstrap — These businesses rank relatively poorly on the scale of valuation multiples; on the different hand, they tend to be capital efficient (inexpensive to launch in addition to also scale). Think of Quadrant 3 firms as cash-flow or lifestyle businesses. the item’s often possible to get such a business up in addition to also running that has a modest investment out of savings or a bit of credit card debt.
Quadrant 4 (lower left): Dead Zone — Businesses here are extraordinarily hard for entrepreneurs to finance, in addition to also for not bad reason — they require a lot of capital to launch, in addition to also once up-in addition to also-running, are simply not in which valuable. As a consequence, outside investors tend to run away via such startup ideas.
How I could have used This specific tool
Circling back to Cielo MedSolutions, we launched the company assuming we were in Quadrant 1, an “investible deal” for VCs. We were wrong, because most healthcare the item-oriented VCs, while feeling comfortable with the high valuation multiples in our sector, suspected in which we were too niche-y — addressing too modest a market — to be dramatically scalable post-launch. Although we didn’t develop the benefit of the Startup Fundability Matrix at the time — in addition to also hindsight will be 20:20 — what the VCs were effectively signaling to us will be in which we belonged in Quadrant 2.
We raised a couple of million dollars via a blend of “patient capital” investors. Had we known our “quadrant” up front, we could have saved a lot of time pitching VCs, in addition to also redirected our efforts toward selling to customers, building industry alliances in addition to also the like. Alternatively, This specific clarity of thought might have motivated us to explore broadening our product offering.
How you can use This specific tool
Applying the Startup Fundability Matrix to your startup can help you be clear-eyed about whether you should aspire to raise outside capital, in addition to also if so via what types of investors.
If you think you’re high on the y-axis (i.e., high valuation multiples), then the primary determinant of whether you’re in Quadrant 2 (Patient Capital) or 1 (VC) will be market size. Narrow or niche product businesses push a company to the left (Quadrant 2), while very large addressable markets in addition to also broader product platforms tend to push a company to the right (Quadrant 1).
On the different hand, if your business ranks low on the y-axis (low multiples), the principle factor pushing you left or right on the x-axis will be launch cost. Companies in which can be launched that has a modest amount of capital fall into Quadrant 3 (Bootstrap), while those in which require large amounts of capital to build (e.g., to fund construction of a factory or a large store, in addition to also to purchase large amounts of inventory) fall into Quadrant 4 (Dead Zone).
At the earliest stages of company development, the Startup Fundability Matrix can even help you think through the pros in addition to also cons of different business products.
If, for instance, you’re an entrepreneur that has a passion for buying in addition to also selling used musical instruments, a Quadrant 3 approach might be to open a brick-in addition to also-mortar store, with all its associated overhead in addition to also geographic constraints. Tough to get financed, so you’ll probably need to bootstrap the item.
Alternatively, you could pursue a Quadrant 2 (or even possibly 1) business design in addition to also create a re-commerce marketplace where your website enables sellers/consigners of instruments to find interested buyers. By creating in which business design shift, you’re tying up less capital in a physical store in addition to also inventory, while broadening your geographic reach, profitability in addition to also scalability.
In This specific example, the latter business design may not only be more fundable, yet stands a much better chance of being sustainably profitable, in addition to also eventually earning money for you while you sleep.