With a sound concept and a quality product in place, it’s time for your emerging brand to start thinking about the next steps, but raising funds is often a critical hurdle to overcome. In this four-part series, Marc Levit, Founder of ML Advisory and ForecastEasy, breaks down the process of securing capital. From identifying sources of capital to setting valuations, Levit lends his expertise and perspective every step of the way.
In the first video of the series, Levit assists in identifying potential sources of capital at the startup level. Levit uses the example of Ava, a fictional RTD entrepreneur, to explain why one’s immediate support network should be the best resource during the initial rounds of fundraising.
In the second edition of Raising Funds 101, Levit explains the steps to projecting your brand’s costs and revenue streams when determining cash needs. He also discusses the advantages of breaking your financial forecast down into digestible bites so prospective investors can see what’s driving your brand’s growth.
In his third lesson, Levit takes a look at some of the financial instruments that startups have at their disposal to raise capital. He breaks down deal structures like convertible debt, SAFE, and priced round agreements so that founders have an idea of the available methods for securing funding.
In the final installment of Raising Funds 101, Marc Levit helps brand owners set a strong valuation for early early-stage grants. From keeping a keen eye on comparable valuations of similar startups to identifying peripheral metrics that indicate your brand’s potential, Levit offers a path to accurately calculating your brand’s value.
Raising Funds 101: Startup Capital Sources
Marc Levit 0:09
Hello everyone, my name is Marc Levit, and I’m the founder of ML Advisory and Forecast Easy. My background is in beverage alcohol M&A, where I’ve sold over a billion dollars worth of transaction value from independent businesses to strategic acquirers. Today, I’m here to help share best practices related to beverage alcohol brands raising their first rounds of capital. Most beverage entrepreneurs start with a burning idea of a product that they have to bring to market. They may know a ton about the production process, consumers, or gatekeepers, but they are often not experts in capital raise strategy. Today, I’ll help navigate you through this process.
Marc Levit 1:08
In part one of our journey, I want to introduce you to our heroine entrepreneur, Ava, who just launched a Paloma RTD product that tastes better than existing products on the market and speaks directly to a unique consumer. Ava has her product in market, she’s running tests, and everything she is doing seems to be working. People love her product, and she’s selling way more than she could ever produce. All the money she receives from selling her product goes into funding more inventory build. Ava thinks she may need to raise capital to help further expand her business, but she really doesn’t know where to start. Where can she look for funding?
Marc Levit 1:58
Many entrepreneurs dream of raising capital from strategics and their venture groups—the Pernods, the Beams, the Constellations of the world. However, a business at this point in time is probably premature to prove product-market fit and the appropriate financial metrics to be interesting to strategics. Other entrepreneurs hear about private equity and venture capital and how there’s cash available for new, exciting brands. While this may be true, the VC and PE community is focused on measuring how a business is performing in small areas and how that can be replicated in other geographies.
Marc Levit 2:55
Typically, it takes about $2 million in revenue to give private equity and venture capital firms enough data to feel comfortable with their investments. Sometimes you hear of these firms going as low as about half a million dollars in revenue, but that’s still way more than what Ava is currently doing. So where can Ava look? What would be an appropriate area to seek funding at this stage?
Marc Levit 3:23
Likely, she self-funded to start, putting in her own savings and capital to get this off the ground and see if there are legs to her idea. The next stage is getting additional funds from outside investors: friends, family, and angels. The reason these people are appropriate right now is because at this stage in the business’s life, they are likely to invest because they think Ava’s product is great, and more importantly, they believe in Ava and think she has what it takes to succeed as a businesswoman.
Marc Levit 4:06
We’ll play forward that Ava will look to seek funds from her friends, family, and angels to carry her to the next level. In the next section, we’ll talk about how much money Ava needs to raise from these friends, family, and angels, and what form of capital raise she should use.
Raising Funds 101: Determining Cash Needs
Marc Levit 0:09
Hi there, this is Marc Levit again with ML Advisory. Today we’re looking at Ava, the entrepreneur who has just launched an RTD Paloma brand, and she’s decided that she’s going to raise money from her friends and family. In this section, we’ll discuss how Ava can calculate the amount of money that she needs to raise from these friends and family. First, what Ava needs to do is to create a three-to-five-year forecast of what her business may look like if everything goes according to plan. It’s an absolute certainty that Ava will either be over plan or under plan for just about everything, but the process of identifying what reasonable income streams and reasonable expense streams look like is essential for the planning process.
Marc Levit 1:07
So how does Ava do this? On a quarterly or monthly basis, Ava should outline all of her expected costs—most notably salaries, rent, utilities, and marketing—everything she can think about that she’ll have to spend to bring this company to fruition. Then, she needs to concentrate on how much revenue her business can bring in each quarter or month. Finally, but perhaps most importantly, Ava should begin to think about how much her inventory will cost and when she needs to buy it, as it will potentially be well in advance of when she is actually able to sell it.
Marc Levit 2:01
In most scenarios, Ava is going to plot these revenues less expenses less big cash outlays, and she’s going to have negative cash flow for at least the first couple of years. So when determining how much money she’s looking to raise from friends and family, the best practice is to look out 12 to 24 months, understand what this cash burn looks like, and then try to raise about that amount of money.
Marc Levit 2:39
When we think about getting more detailed and granular on how to think of Ava’s revenue build, we want to break it down into as much detail as reasonable. If Ava simply says she is going from a small amount of revenue to a large amount of revenue, it’s very tough for her to plan how and where that’s coming from. It’s even harder for her to tell the story to investors about why her business is exciting and why they should come on board.
Marc Levit 3:17
What we typically do is break down revenue by channel and by SKU. By channel, we mean where Ava is selling her products—is it in liquor stores, supermarkets, on-premise, club, or airlines? She should think about two to five different channels so she can measure them independently from the rest of the business.
Marc Levit 3:49
At the same time, Ava will want to think about her product mix. Is the Paloma going to be the only SKU she sells for the next 12 to 24 months, or will she introduce a different RTD drink or another flavor? Explaining how the product mix will get her to her forecasted revenues is really going to help Ava strategically plan as well as tell this story to her investors. In the next section of Ava’s journey, we’ll break down the different typical structures for raising capital that she may look to use when raising money from friends and family.
Raising Funds 101: Financial Instruments for Startups
Marc Levit 0:09
Hi there, this is Marc Levit again with ML Advisory. Today we’re looking at Ava, the entrepreneur who has launched an RTD brand. In this section, we’ll discuss some of the different ways that Ava can raise capital. At this stage in her business, we see three instruments that are typically used: convertible debt, SAFEs, and priced rounds.
Marc Levit 0:28
Convertible debt is an IOU-type debt instrument that allows holders, at their election, to convert their debt into ownership shares of the company. This provides significant upside similar to the founders themselves. This debt is often accompanied by an interest rate, a maturity date, and is sometimes secured by company assets. A SAFE, or Simple Agreement for Future Equity, is borrowed from the tech community and is becoming increasingly popular across consumer brands. It is very similar to convertible debt as an IOU instrument that converts into equity, but it is much simpler and typically lacks an interest rate, maturity date, or asset security.
Marc Levit 1:27
An alternative to convertible debt and SAFEs is a priced round, where founders sell equity directly in their companies at an agreed-upon valuation and terms. To dig deeper on whether you should raise capital through convertible debt, a SAFE, or a priced round, definitely consult your advisory team. However, to give a high-level overview, convertible debt and SAFEs are relatively inexpensive to paper, quick to execute, and facilitate rolling closings so you can collect money immediately as interest comes in.
Marc Levit 2:28
A key feature of convertible debt and SAFEs is that the company’s valuation is not set upon initial investment; rather, it is punted into the future when all parties have a better understanding of what the business is worth. However, holders of these instruments typically include two key protections to reward their early belief in the company: a valuation cap (which sets the maximum valuation at which the debt or SAFE converts into equity to limit investor dilution) and a discount (which grants early investors a discount on conversion compared to a later financing round).
Marc Levit 3:25
When we look at priced rounds, what’s great about them is that they spell out more terms, conditions, and operational governance in detail, offering greater transparency for how the business will run. However, because they are negotiated in significantly more detail and are more complex, they take longer to complete and are significantly more expensive to execute. Priced rounds often cover terms such as corporate governance, information rights, and budget sign-offs.
Marc Levit 3:56
The reason some brands start with priced rounds even at an early stage is that eventually most companies do raise capital through a priced round, so some founders prefer setting that structure up straight from the beginning. Now that you’ve learned a little about the different ways to raise money, in the next section, we’ll talk about setting a valuation for your company and how it leads to future rounds of raising capital.
Raising Funds 101: Setting a Strong Valuation
Marc Levit 0:09
Hi there, this is Marc Levit again with ML Advisor. Today, we’re continuing to look at the journey of Ava, the entrepreneur who has launched an RTD brand. We’ve decided that she’s going to raise money from friends and family, we’ve determined the amount of her raise, and we’ve discussed the different instruments she may use in her raise. In this section, we’ll discuss how to think about valuation and eventually next steps for her brand.
Marc Levit 0:38
So how do you set valuations for early-stage brands? At this point in time, setting valuation is a lot more art than it is science. The first way is simply looking at what valuations other beverage alcohol startup brands with under $300,000 in revenue are raising capital at—comparable capital raises. The sweet spot here would probably be pre-money valuations between $2 million and $7 million.
Marc Levit 1:16
The second method, a scorecard or Berkus method, is a way to quantify what are typically unquantifiable metrics—such as the experience of the founding team, successful launch of a product into the market, and maybe the overall market being large and growing. Each one of those gets a checkmark and an associated value assigned with it, and you add them all up to determine the valuation.
Marc Levit 1:40
Typically at this stage, I tend to see old-school handshake deals within the framework of those comparable capital raises. It’s all about finding a fair number between the investors and the founders. An investor isn’t going to want a 1% share of the company for $500,000, and a founder doesn’t want to sell 80% of their company today at any price. There are silent iterations to get to the middle, where a deal appears that is interesting to both parties, typically giving away around 15% to 35% equity.
Marc Levit 2:35
A lot of founders ask if they should be raising capital at the highest valuation possible. The answer is yes, but it depends. Raising at a higher valuation means giving away less of your company today, but alongside that lofty valuation comes pressing demand for fast and aggressive growth, high multiples on future capital raises, higher shareholder activism, and a narrower range of acceptable exit outcomes. Most founders try to find a middle ground that is attractive to investors while allowing the company to grow at a natural rate.
Marc Levit 3:44
Toward the end, let’s play Ava’s scenario forward in more detail. She’s secured funding from friends and family using a SAFE, putting her brand on a $2 million annual sales runway. She sees a $10 million revenue opportunity in the near future and wants to raise capital to approach this. At this revenue and traction level, avenues for private equity, venture capital, and strategics are wide open, and she may be able to receive a value-add investment or acquisition from these groups. Thank you very much for following along!