Lesson 14: How to Raise Capital

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Good morning. Beautiful day out here. Got a nice sunrise.

Heading up on the east coast of the United States. Got my coffee. Go ahead and grab some coffee for yourself.

Sit down. We're in a chat today about how to raise capital. So let's get into it.

Okay, capital is a big one. A lot of companies need it. And there's only really a couple ways to raise capital.

So let's break these down. There's three major segments of the market. The first one is a startup, high growth startup.

Don't have revenue, just building a product, just building a team, just getting started. Second one is private equity. First one, venture capital.

Second one, private equity. That's mid-market customers. You've got millions, hundreds of millions of revenue.

You got some profits through the lens of EBITDA. And then the third one is public companies. And these would be larger public companies.

These could be your Fortune 1000, Fortune 500. These are tens, hundreds of billions of dollars in revenue a year, large market caps, publicly traded on stock exchanges. So how you raise capital for each one is a little bit different.

But let's talk about the fundamental ways. There's really three sources of capital that you can get. The first one, ding, ding, this is going to be on the test, by the way, is, and this is the best, this is the one we like the best, is customers.

You build a product that your customers need and want, that they're willing to pay for, and they buy it from you more than once, over and over again. That is the best way. Why? Because you don't have to pay interest on it.

You don't have to give up equity on it. So then that gets us into the second two. So that's hard when you're first getting started, because you need a product or service in order to generate revenue, such that you can pay a team, pay suppliers, spend the time, actually build the thing, pay the bills, living expenses.

So that getting started piece is really hard, which is why the venture capital industry started. The second method is through debt. So this could be credit cards, that's debt.

Could be a loan from friends or family, that's debt. Could be a loan from investors, that's like venture debt. Loans from a bank, pay an interest rate, heck, even student loans are a source of capital.

But I hope you spend that on education, and maybe there's a little extra in there where you can start to work on things that you're being educated on at the same time. And then the third one, so that's your selling, essentially debt. The third one is selling equity or raising equity.

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This is the most popular one in the venture world, in the private equity world, in the public markets. And this is where you're selling equity ownership and likely voting rights in a company to the outside market. So in order for you to raise a couple million bucks in outside capital just getting started, you might have to give up 20% of your company.

So it's the first thing that Jeff Bezos did to start Amazon, same thing with Apple, Meta, Facebook, Nvidia, they all raised capital. So they got on this capital raising train and they've never gotten off. They were never taken private.

The founders do not own the money. And even when there's an exit, a lot of times founders may only own 2, 5, 10% of the company at exit. And it's really the outside investors who's put capital in, who really own the company.

So you got to get really clear on which method you're going to use, because that then determines your trajectory over time. It determines who your quote unquote customer is, determines what attention you focus on. We love customers because no matter what, you're just kicking the can down the road with debt or selling equity.

Eventually, at some point, you have to sell something to someone to earn revenue, to earn positive cash flow, to pay back debt, to pay your expenses, and ideally, make a profit. That's the whole point of this thing. And then you can use that profit to reinvest in the business and then continue to grow, make better products or services, and then go to the market.

So let's talk about each one in turn. How do you raise capital for an early stage startup? How do you raise capital for a mid market private equity backed company, or maybe just a mid market company that's founder owned or led? And then third, how do you raise capital for public companies? And we'll use a couple case studies on each one. So let's start at the beginning.

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Brand new company, because of tech crunch, and VCs, and the media, sort of these darling stories that have scaled from nothing and made a bunch of people rich, to like global conglomerates, especially in the tech industry. The first thing you see from a lot of folks, founders with ideas, is they say, we're just going to go raise capital. Now, that is a difficult task to do.

It's easy to say and it's survivorship bias in media and publications, because they're only reporting on the ones that do. They don't report on the thousands, tens of thousands, or millions of companies that have tried and failed. So what does it take to actually raise early stage capital? Well, a couple things.

One, you have a certain pedigree or you're a cornered resource. So for example, you worked at big tech, less important these days, or you worked at one of those really amazing brand new AI companies that took the world by storm, and you know how to build these LLM thingy bum bobs. So in that case, you could leave that company, and then you could hang out in Silicon Valley, and they can give you lots of money to go do the same thing, but under your own, your own banner, your own brand, your own company.

So that's one way that's difficult. The other way is you're wealthy already. Your family's wealthy, you have friends who are wealthy, you're really invested in your success.

That one also is difficult. You can't plan on that one. The third one is you're already growing a lot of revenue.

That's the best one. We figured out a way to make a thing, we bootstrapped it, we put it in the market, or we've got a sign up list, and people are going bonkers for it. Like they can't get enough of it.

It's growing like a weed. I can't fund it. I need help.

I need more people. I need more compute. I need more suppliers.

I need more raw good inventory. I need to take this thing to market even broader and take the market like Uber. And so you will have people lining up to give you capital.

Why? Because the risk profile is much less on that. I already know that I'm not just going to give you money, and it's just going to get burned immediately on salaries, or wasted advertising spend, or bad marketing, or building product that never hits with the market. So it's been de-risked.

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And then there's sort of a... Let's move on. We'll save that one for later. That's the big one.

All right, we'll talk about it. So the final one is it's a game that you have to play. This game is played in certain hubs that you can probably figure out.

And the game is, I will call it, lemming behavior, which is I'm a new hot thing in town. And I, for some reason, have gotten like a lead and some other people interested in it. And this is back to like human behavior and aping is, oh, because they're interested, I'm interested.

And oh, they're interested. Oh, I got to get in this. And oh, this is the new hot trend.

I need to get in on this. So I'm perceived as like being on the frontier, getting in these deals so I can raise a new round for my fund because I'm in the best deals, right? I do deal sourcing. I have the great selection capability.

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So that's the last one, which is like human behavior hacking, which is also hard. You've got to be there in the middle of it, and you've got to have something novel or unique, and you've got to generate a buzz, and it has to be on trend. So those four areas, out of all four of those, the one that you can control is creating something people want, putting it into the market, and they go crazy for it and talk about it through word of mouth.

To figure that out, you've got to watch all the rest of our videos. That's where the work comes in. That's why you don't see hundreds of thousands of zero to a billion a year.

That's why it's hard. People don't want to do hard work. So do the hard work.

All right, that's venture. Let's put that aside. So then once you get past venture, now all of a sudden you've got revenue, you've got profits, then enter private equity land.

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More sophisticated investors, not betting on a team or a vision or early stage product or maybe a market that's growing, they're betting on what's actually showing up on your financial statements. How much revenue do you have? What defensibility is in your product or service? And where's your profit? And are you growing your rule of 40, your recurring revenue growth plus your EBITDA? So you don't get into this game until you're at like 10 million in revenue and at least like a million in EBITDA, which is earnings before interest, taxes, depreciation, amortization. Essentially like take the costs of paying people, your suppliers, like your marketing and advertising expense, your hosting costs, subtract all that out before taxes and yada yada.

And that's your EBITDA profit. So at a minimum, you've got to have like five to seven million in revenue and like either break even or like a million in EBITDA. Before that, you're still in venture.

So a lot of these investment firms, they'll actually have like your venture arm and your growth arm. So growth equity is more in this private equity space. So how do you raise capital from private equity? Well, we see a lot of them, especially in enterprise SaaS, like a lot, a lot of them.

We've seen a lot of companies. And I will tell you that you've got to be somewhere in the upper quartile of rule of 40 performance. That's just to get in the ballgame and get a bidding war going.

And you'll hire investment bankers from one of the big investment banks. We've worked with them as well. And so your rule of 40, you've got to have like ARR, recurring revenue growth, north of 15, 20% per year for the last three, four years.

You've got to have EBITDA margin, similar 25% margins. Basically, those two things need to add up to like rule of 60 to rule of 90. Then you're like, okay, these things, this is pretty cool.

Then we get into a conversation about defensibility, AI displacement risk, AI disruption risk, AI strategy, investment grade roadmaps. What are you doing each quarter? What are you working on? What are you building? What is the revenue or EBITDA impact directly from that investment that I'm putting in? And then we got to make sure that you can scale with the existing team, the tech can scale without additional investment. And it's like, hey, it's like buying a house.

I don't want to buy a house to flip it and then have to turn around and sink a million bucks into the house when it's worth $500,000. That's crazy. I'm not going to do that.

Plus I got debt service because I took out a loan to buy this thing. So I need some cash flow to pay the debt off. And then if we're growing and things look good, then at the end of a five year hold period, I'm going to exit that to another private equity firm, maybe a secondary sale where I'm selling a piece of it or just, you know, we take it public, which is sort of less common.

Or there's a strategic acquirer, which is like a Fortune 1000 company. So the public companies in the Fortune 1000 companies will acquire private equity backed companies as part of their growth strategy, rapid growth to capture a market, a roadmap, a technology, a customer base, etc. Private equity will acquire an AI startup to accelerate their go to market their AI story.

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So you see how these things kind of compound. And that's a growth strategy across a whole network and lifecycle of the business. All right, let's pause there before we go into Fortune 1000 public company capital raises.

Enjoy the weather. Yeah. Okay.

All right, let's crank it back up. Who's ready? We got our coffee flowing. All right.

Public company, public company, they have shares on the open market, they're listed on the NASDAQ, the New York Stock Exchange. Maybe if you're overseas, the FTSE, you know, 250 Hong Kong, so different exchanges, the Japan exchange, it just depends on where you are in the world. The American exchanges, the Dow, or the NASDAQ, the New York Stock Exchange, those are sort of like, where you play a lot of ball.

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With that comes a lot of public disclosure requirements and compliance requirements. You got to file a definitive 14a proxy every year, get proxy vote, shareholder votes, describe exec comp, you've got a 10k with a management discussion and analysis, outside auditor to review your financials. You've got a board who has a fiduciary and legal responsibility and liability for the operations of that firm.

So they could go to jail, they have real risk if people are cooking the books or doing something legal. So the first rule of thumb is don't break the law. Do whatever you want, just don't break the law.

And then do it in a positive way such that you can continue to grow profits. So the public company investor, arguably is a value investor, but still seeks growth. They're looking at discounted cash flow models, they're looking at perpetuity of returns, they're looking at new product development of the news, they're looking at outside forces, macroeconomic forces that could impact the customer base, large populations of consumers, COVID issues, major disruption events.

And the other way you raise capital is like once you get big enough and sophisticated enough, you go in these indexes like the S&P 500, then you have access to a lot of let's say brokers, mom and pops, funds, calipers, pension funds that have a mandate to invest in certain asset classes. And so you will just get growth and investment that automatically comes through 401ks, for example. So it's a different way to raise capital.

You just have to run a good operating business, have a solid growth strategy, and then because you're public, you're actually putting your strategy out there in a document as part of the investor relations website and forms. And so competition becomes harder because everyone can kind of see what everyone else is doing for the most part. And you have global visibility.

And so brand becomes very, very important. And the stickiness of that brand. So famously, Warren Buffett didn't invest in tech.

And then one day he finally discovered Apple and the iPhone and how sticky that product was, and how people carry it with them everywhere in the shower and bed. It's an intimate device. And he invested in it.

And then they hit a growth trajectory. The other way to do this, which is more novel, is a company like Strategy. Strategy is a Bitcoin company.

They productized Bitcoin, a commodity. And they developed different types of financial investment products on the back of Bitcoin with different return and risk profiles along a graph and a continuum. One of them is STRC, which is now paying you 11% per year guaranteed just for giving them some money and holding your money with them.

So it's almost like a long duration bond or a U.S. Treasury bill backed by Bitcoin, backed by Strategy. So they have a huge Bitcoin balance. They're starting to have a huge cash balance on USD to reduce risk profile even further.

They've got 77 years right now of duration to pay their dividends on these investments that people have made. So that's another way to do it, is you have something truly novel, a novel financial product, and they've raised tens of billions of dollars in a few years, which is wild. So that is kind of all three venture, private equity, public.

And and the key on this whole thing is you whether you're growing revenue, profit or cash flow, you need to maintain that pace and you need to surprise on growth. It's not just that you're growing 5% per year. You need to then grow the growth.

So you need to go from 5% growth to 10% growth to 20% growth to 50 to 100% growth, which then gets harder and harder the bigger you get, because then the denominator is bigger. So at first, 10% growth is like a million bucks. Then you've got to grow by like five million bucks to get the same percent growth rate.

So then you need to like get an engine really going. So, yeah, it's the question in the game you want to play is, are you hacking consumer behavior? Are you raising short term debt, paying higher interest rates? Can you service that debt with the cash flow from somewhere, from products that you're selling? Is it a recurring revenue base? Is it a leaky funnel? Do you have to keep going back out and finding new customers every month, quarter, year? Do customers continue to pay you? And the best that we've seen now actually have four different types of business models. So they have a usage based, they've got advertising revenue, they've got subscription based, and they've got one time based.

And all four of those are compounding and combining to get that growth engine going. So, yeah, that's it. That's it.

And how do you get that growth engine going? Well, go back through our videos from the beginning. And you got to do all of those things. And then good things will happen.

And it will attract capital because you have a solid, real business with real revenue, real profits, real product, real customers who have high NPS and CSAT scores. And they tell other people about it. And then your marketing costs are decreased.

That's it. Reach out if you need help. My name is Sean Everett, Evergence.team. And we're here for a long time and a good time.

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So let's go. All right, y'all. Have a great one.