How to raise capital in a recession, according to a founder who’s bagged $74.9 million so far

Pieter Danhieux Secure Code Warrior founder

Pieter Danhieux, co-founder and chief of Secure Code Warrior. Source: supplied.

The world is gearing up for a global recession, and as a result, capital raising is likely to prove more challenging, though not impossible.

Investors — whether angel investors, angel groups or venture capital firms — will have a mix of personal and business reasons to factor in when making investment decisions.

If ‘the great recession’ that ended in 2009 is anything to go by, investors are likely to become very risk-averse and reduce the number of investments they make, or they may prefer to turn inward and invest in their existing portfolio instead to ensure they are able to weather the storm.

In short, it means that many investors will be off the market for any new investments.

Furthermore, in March 2020, due to COVID-19, the Morrison government added more red tape around foreign investment whereby all proposed foreign investments into the country will require approval from FIRB. This is regardless of the value of the investment, as long as the foreign person or company is acquiring at least 20% or more of the Australian company. This additional layer of government regulation means the process of raising capital will take even longer, which will have a knock-on effect on companies’ growth plans or even survival.

However, it is not all doom and gloom for startups, entrepreneurs and founders who start planning now and prepare their scale-up strategies to attract interest from potential investors during the next market downturn.

We have been fortunate to successfully raise capital from foreign investors, attracting the largest US investment in Series B funding for an Australian cyber security company in December 2019. These were obviously more bullish times, but there are learnings and best practices that the Australian startup community can benefit from and use to start getting some visibility from the right investors.

With a global recession looming, here’s how Australian startups can set themselves, their next funding round, and their company, up for success.

Play the Aussie card

The increasing number of successful entrepreneurial stories coming out of Australia in recent years has changed the perspective foreign investors once had on the local startup ecosystem and its true potential. 

Over the past couple of months alone, many Australian startups have been making headlines for successful funding rounds during a pandemic.

Australian software developer Canva recently announced its $8.7 billion valuation after successfully raising $87 million from venture capital investors, Preezie secured just over half a million in seed funding for its e-commerce technology and Melbourne-based buy-now-pay-later Openpay recently raised an extra $33 million.

This is a clear indication that early-stage startup funding is still up for grabs and the thriving Australian startup landscape is still attracting investors.

Our economic climate is also playing in our favour, especially compared to other countries across America, Asia and Europe that have taken a bigger hit from COVID-19. As such, investors are more likely to turn to countries or startups that have the highest chance of scaling-up and generating profit as soon as possible.

A recession is always followed by a recovery that includes a strong rebound in the stock market and Australia is well-positioned for a rapid and robust rebound.

Leverage the startup community

According to Crossroads Report 2020, Australia has a rapidly growing number of $100 million-plus companies within its startup ecosystem. This represents a huge opportunity for founders to build connections and grow their network. It is vital for those seeking angel investment to have a plan to get in front of potential investors, build relationships with the right people before they even get to pitching.

Networking events, introductory coffee catch-ups and overseas travel are not viable options nowadays for founders to build connections. 

One way to circumvent this is to tap into the local entrepreneurial community, social media platforms such as LinkedIn and virtual events.

Also, don’t be shy in asking for introductions from other Australian entrepreneurs who have successfully raised in the past or seek advice about how best to approach investors. In tough times, our sense of community is always stronger, and I would be surprised if a fellow Aussie wasn’t willing to help. 

Austrade (the Australian Trade and Commission and Investment Commission) is also a great resource as its mission is to help local businesses expand overseas. It runs a number of (virtual) events which are the perfect opportunities for entrepreneurs to grow their network and get recommendations from people who are in-the-know.

Focus on profitability and your cash position

In a down economy, when growth and profitability are rare, having a business in the black can be your golden ticket to be part of a very small, elite set of entrepreneurs, making your business very appealing to investors.

To be successful at raising capital during a recession, it is vital for entrepreneurs to prepare beforehand by establishing a clear defensive moat around their business strategy and growth metrics with a strong focus on profitability.

Investors will respond positively to this in down periods, especially if many of their other portfolio companies are facing significant threats. 

Startups or companies with a weak cash position during a downturn are not going to attract investors’ interest, no matter how great their idea, products or services are. Now is a good time for entrepreneurs to take all necessary measures to ensure they have a strong cash position with a clear runway to ride out the storm.

To make their business more attractive to investors, startups need to be relentless in their focus on cutting costs and streamlining operations. It may mean eliminating side projects, new ventures, or other under-performing business units or even a restructure of personnel.

Adopt a targeted approach 

Don’t take a blind shot when trying to raise funds with the hope that one or two investors will bite. That’s a rookie mistake.

Instead, do your homework. Venture capital funds often focus on specific industries, so make sure you target the ones who are likely to be interested in the nature of your business and offering.

In a recession, focusing on values-aligned investors who get your space and business model, will make it easier for you to raise. 

As you do your research, look for investors that are near you geographically, have a history of investing within your industry, and typically invest at the same stage of evolution that your business is currently in.

The location of your targeted investors has to be aligned with your commercial priorities and scale-up plans.

Don’t seek funds from US-based investors if your next stage of growth is in APAC. Most investors, especially in the US, expect your business to have a foothold (office or customers) in their country or region already. 

Be flexible and adjust your expectations

Round sizes and valuations play by different rules during a recession. Where entrepreneurs would normally have the upper hand on valuations and negotiations on equity in a strong economy, it works the other way around in a down economy. Investors have more bargaining power as there’s less capital available in the market and, therefore, will try to minimise the valuation in order to maximise their percentage ownership. 

It is important to go through the process knowing what to expect. Work through scenarios that will still get your company where you need it to go even if you raise less than you would have hoped. Watch the local, regional, and global trends in round sizes and valuations to ensure you’re comfortable with the new expectations or have a backup plan that will allow you to wait for a longer raise.

If raising capital right at that particular time, during a recession, is essential to the survival of your business, be prepared to take a lower valuation with more dilution than anticipated. 

While the rules of capital raising during a recession are a little different and more challenging, there is hope for Australian startups. 

Do your research, leverage your network and the community to seek some introductions with relevant or targeted investors, start the conversation well before you pitch, and keep your eyes on the prize. Adopting a targeted approach will help you maintain a laser-like focus to have successful funding rounds for your business.

NOW READ: Interview with an angel: Why early-stage startup funding is still up for grabs, and how to get your hands on it

NOW READ: COVID-19 sees more dollars invested into bigger deals, while early-stage startups get left behind

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