Fogarty Workshop Tackles Fundraising in Difficult Environment

by | Apr 5, 2024 | Education, Fogarty Innovation

Navigating today’s constrained fundraising environment, understanding your capital requirements, and the mindset that company leaders need to succeed were the headline themes in our recent half-day workshop on funding. The event, which drew a full house of attendees, was moderated by Fogarty CEO Andrew Cleeland and featured panelists Gayle Kuokka, Fogarty Chief Financial Officer; Mike Carusi, General Partner at Lightstone Ventures; and Marc Galletti, Managing Director at Longitude Capital. 

Cleeland led off by calling out the elephant in the room, characterizing the current fundraising environment as the worst in his career. “It’s the first time I’ve actually seen venture capitalists scared,” he said. 

 “The whole venture-backed ecosystem is struggling,” said Carusi, explaining that, at the end of the day, it comes down to exits. “When there is M&A and IPO activity, public market investors get cash back and then reinvest it, often in private companies,” he said. But high interest rates and the lingering effects of supply chain disruptions shut down the IPO market in 2022 and it hasn’t recovered. This stopped the flow of capital and is significantly affecting investments in early-stage companies. 

The same circumstances have forced venture firms to pull back from new investments and instead concentrate on protecting existing investments. “Funds aren’t as liquid as people think,” said Carusi. “Each fund is fully allocated to a portfolio of companies with reserves for future rounds, and there are limits to how much the firm can invest in each company. Additionally, capital has to come out of the fund that is invested in that company; with few exceptions, funds don’t ‘cross over.’”

The longer these conditions persist, the more fundraising cycles occur, opening the door for new investors to come in and dictate terms, regardless of company accomplishments. As a result, until a material shift increases liquidity and investor confidence, many companies today will likely need to accept lower valuations (or down rounds) in order to secure new equity investments. 

“Don’t take down rounds personally,” advised Cleeland. “Your job as a company leader is to find a way or make one so that you can live to fight another day.”

Understanding valuation

Key to any fundraising conversation is valuation – can you raise money and if so, at what price?  “Valuation isn’t intuitive,” said Kuokka. Rather than trying to determine the value of a company based on its potential to save lives and the work it will take to bring a solution to market, she suggested a more straightforward analogy – building a house. 

“Fundraising is basically selling equity in the future house in order to build it,” she said.  The percentage of equity you sell is determined by the amount of money you need to build it (capital required), the expected sale price (exit value) and the return the investor requires,” she said. While all three drivers are important, exit value is especially crucial. So to illustrate, if you need to raise $1 million, you believe the house can sell for $10 million, and the investor requires a 2x return, the investor needs to own 20%. If the house can only sell for $5 million, that same investor will need a 40% equity stake. 

Multiple factors can affect valuation. Some are external, like interest rates; others can be influenced by company leaders. “One way to boost valuation is to correctly estimate the amount of money you need to raise,” said Kuokka. “Then try really hard to control your time and costs so that the raise is sufficient to get you to your next milestone.” If you end up needing to raise more and the end value of your project hasn’t changed, you will see dilution. If you spend more money building the house that sells for the same end price, a founder will see a lower return.

Another way to influence valuation is to explore different business models that might increase your company’s exit value. These include increasing market size, increasing penetration, increasing recurring revenue, accelerating sales, and so on. Notably, higher value projects have other benefits as well, including more flexibility, upside, and a better ability to absorb delays and other unexpected events. “Keep in mind that small projects don’t necessarily have small problems,” added Carusi.

Credible optimism

To understand how much you need to raise, it helps to go through a budget process. “This is more than a financial plan, it’s really understanding what your strategy is, translating it into milestones, identifying your core assumptions, and showing all your essential dependencies,” said Kuokka. “It’s an iterative process.”

To help, she shared a valuation model that allows startup entrepreneurs to plug in variables, see what the multiples are by round, and model the impacts of less obvious influences, like taking less money at first and needing to raise more later, doing a down round, a flat round, raising an extra $20 million, and so on.

Despite the most careful modeling, however, Cleeland warned that “when you’re in the beginning stages of a company, the odds of your schedule and your forecasts being right are pretty much zero.” Accordingly, he recommends going in with a plan that is credibly optimistic and a strong management team that investors know will solve problems and navigate their way through challenges.

The fundraising journey

One of the most important considerations is thinking about the big picture and how much money you’re going to need for the long haul.  “While your window might be only $5 million today, if you are successful, you will need a lot more money to get and keep your product on the market,” said Cleeland. “The biggest chunk of that is likely to come from venture capital, so you must be prepared to deal with the VC community.”

He continued, “As a result, you have to keep in mind that the terms and conditions and partners you accept today, whether they are angels or other nontraditional Series A investors, are going to impact your ability to raise your B, C, and D rounds from VCs going forward. So balance short term execution with long-term vision.” 

How venture capitalists think

Because VCs will inevitably be part of a startup’s fundraising mix, it is essential that management teams understand the venture mindset. Similarly, VCs must think about their own Limited Partners, investors who entrust the firm with their money. These investors range from large pension funds to high-net-worth individuals. Carusi explained that Lightstone’s Limited Partners are investing in an asset class – healthcare venture capital. “They have other choices, and if our returns are below the other sectors, they’ll start to allocate to different places,” he explained. Second, they expect a discount because venture funds aren’t liquid relative to some of the other sectors. And third, this portion of their portfolio is typically considered higher risk/higher reward. “So when you peel all of that back, investors are looking for an IRR on the order of 25%, as compared to 8 – 10% for public markets,” he said. “The shorthand model is for a 10-year fund to achieve a 25% IRR, you need an average 3x multiple across their entire portfolio.”

The other data point is that only about 40% of companies actually return capital of 1x or greater, which means that the winners have to reach bigger multiples for the fund to meet its target. 

Getting through the VC screen

Carusi estimated that Lightstone Ventures sees 1000 investment opportunities each year, invites 300 in-person pitches, and funds four companies. Two key slides in the pitch deck help him quickly dismiss half of the 700 pitches the firm won’t take.  “The first slide I typically go to is the five-year Gantt chart that shows progress, timeline, and capital needs,” he said. The chart clarifies how much the company intends to raise round by round, which translates to value inflection points – how much it will cost to get to each de-risking milestone. “I can probably dismiss 25 percent based on that chart alone because the story doesn’t hold together,” Carusi said. “Unlike in some other asset classes, in medtech, investors are expected to be involved in those next rounds, so we need to be thinking about the journey and our ability to play along the way.”  

The next slide he looks at is the team, seeking experience and expertise, a track record of success, and a strong leader with a clear vision for the company’s future. “By the time I layer the team onto the chart, I can dismiss half of those 700 deals in 30 seconds,” he said. 

Fundraising tips and tricks

The last hour of the event concentrated on delivering helpful advice for would-be fundraisers. Pearls of wisdom shared included the following:

  • Understand the VC investment thesis

Understanding and aligning with a venture capital firm’s investment thesis is crucial for securing funding and building a successful partnership. This requires analyzing the firm’s previous investments, portfolio companies, and investment strategy to understand their goals and determine whether your company fits into their strategy.

For example, Galletti noted that while his firm is passionate about early stage medtech development, he is most able to fund later-stage companies because of exit timing. “We live in a world where pension funds and endowments and other people give us three to four years to deploy capital, and then 10 years to return that capital,” he said. “At that point we get a lot of pressure to liquidate assets in those funds. If a portfolio company hasn’t finished maturing, we’re probably going to sell that holding at a discount. So that time pressure doesn’t always align with the timelines of early-stage innovation.”

  • Build relationships

This starts with warm introductions and goes on from there. “You, as the CEO, have to own this process and build the relationship with the investor and go through the hoops that we put you through on diligence and so forth,” said Carusi. “We’re really trying to get to know you, because if we go forward, this will be a five-to-seven-year relationship.” 

  • Be organized

“Fundraising is a process, so get your ducks in a row,” said Carusi. “Have your data room ready so that if you get that hook set, you can build momentum and keep going. You don’t want to tell an interested investor that you need three weeks to get the data room ready. It just looks like amateur hour.” 

  • Think through the pitch

“Take a step back from your project, use a third party or other colleague you trust, and really think through the elevator pitch of what you’re trying to sell,” said Galletti. “What is the need that you’re trying to address? How is your technology uniquely positioned to address it? Why does that need matter for people, global health, hospitals, physicians and patients?  And then how are you going to execute on the delivery of that solution?” 

He noted that, too often in medtech, he sees CEOs come in with a product and believe it is sufficient to explain what it does. “My response is, well, why do I care? And how do I know that it’s going to work better than everything else?”  Galletti continued, “It’s your job to provide landscape for why I should get excited that we might invest in this company. It sounds kind of obvious, but you’d be surprised how often people are not prepared for that conversation.”

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