Reverse Fundraising is a new methodology that involves reducing the risks posed by start-up companies to investors, and streamlining the fundraising process for start-ups.

 

 

THE LEAN STARTUP NEXT STEP

 

The Reverse Fundraising method is the natural progression of the start-up targeted-oriented methods such as The Lean Startup. It helps start-up companies advance from the ‘Proof of Concept’ phase to the critical fundraising phase by increasing their traction and demonstrating the ‘Proof of Success’ required for securing funding. The Reverse Fundraising method focuses on fundraising and is intended to increase a start-up’s chances of raising initial capital or capital for their future operations.

 

Although nowadays many startups try to figure out their customers’ needs and preferences as early as possible, it doesn’t guarantee that they can actually succeed in raising capital and pave the way towards a positive cash flow. In fact 98% of all start-ups worldwide fail to raise capital, and more than 90% of startups that manage to raise capital, have trouble or fail to raise additional funds later on.

 

According to the theory underlying Reverse Fundraising, the main cause inhibiting start-ups from raising capital is the difficulty to gain the investors’ trust, in terms of creating a positive cash flow. Like Catch 22, this difficulty creates wishful thinking that obstructs the effort to raise capital in the first place: A lack of faith in the chances of attracting customers and reaching profitability hinders the start-up’s ability to raise funds to begin with, preventing it from getting the resources needed to attract customers and achieve its market objectives.

 

 

 

A NEW WAY TO RAISE FUNDS

 

The “Reverse Fundraising” method solves this paradox by reversing the process: First of all, the start-up will secure in advance the significant capital required for breaking into the market and attracting customers in the future, and only then raise the initial capital required for product development. This reverse action will help the start-up company guarantee in advance the resources it will need in the future for reaching its clientele. Thus, it increases its potential to create a positive cash flow - which should directly help enhance the start-up and make it attractive for investors who look for signs of future success already in the initial fundraising stage.

 

The main insight underlying the method is as follows: Since investments in start-up are sometimes made before anyone knows if the venture will succeed, such decisions are taken at high risk. Investors use various instruments to reduce the risks involved in investing in a start-up, like examining start-ups proposed by accelerators. Thus they aim to find the one with the best chances of success compared to the other start-ups examined at the same time. For example, a start-up led by a team of partners who complement each other will be preferred over one led by a single entrepreneur. This stems from the prejudgments of investors that aren’t necessarily based on research, but rather a general belief. Similarly, a startup guided by a well-known mentor will be preferred over one guided by a less known mentor or one without any mentor at all. The investors will examine other aspects of the start-up company based on their preferences: Did they get any prior investment or is this the first investment? Does the start-up have any registered customers on the waiting list or has if not yet launched? And so on. We can therefore conclude that success in fundraising reflects the degree of trust in the start-up, and the stronger the faith, the bigger the chances are to raise capital successfully.

 

So if a young start-up wants to gain the trust of potential investors, the Reverse Fundraising method offers process composed of two models: PENDING FUNDING  | PROOF OF SUCCESS

 

 

PENDING FUNDING

 

Under the Pending Funding model, the start-up raises capital for the next round, contingent on passing the ‘Proof Of Success’ test. This kind of guarantee for future financing can help the start-up gain the investors’ trust early on and complete the current financing round.

This model proposes that established corporations with leveraging capability provide start-ups with a letter of intent (LOI), committing themselves to investing the funds required for breaking into the market and attracting customers (the investment can also be in the form of marketing resources equal to the funds needed for leveraging and getting exposure to the target audience, not necessarily liquid cash). This letter of intent stipulates that any future investment is contingent on the start-up company meeting the ‘Proof Of Success’ criteria set by the corporations in advance. The indicators can be the number of app downloads over a certain period, click-through rate (CTR), conversion rate improvement, increased sales, amount of users, or any other gauge the corporations think measures success.

 

Besides future guarantees, corporations should provide their marketing resources to help start-up companies get exposure to their target audience. This will allow them to conduct a few limited pilot projects where they can demonstrate their performance.

 

As stated, a letter of intent guaranteeing the start-up company a budget for getting exposure to its customer base may help the start-up attract investors early on.

 

The Pending Funding model is also meant to reduce the risks corporations currently face, since investing in start-ups is contingent on them fulfilling the indicators of success set by the corporations themselves. This model may also give corporations the opportunity to connect with young start-ups at a very early stage, and thus help them avoid future price wars when they want to make a purchase offer. Moreover, this early acquaintance will allow the corporation to rejuvenate, pursue new opportunities, and avoid future threats from the start-ups or one of the competitors.

 

In addition, this model helps the start-up company focus its activities on demonstrating ‘Proof of Success’, based on the benchmarks set in the letter of intent. Such focus will ensure the investors' money is used effectively in the early stage, and prevent the scattering of resources on secondary objectives.

 

Even more mature start-ups that already have a product or service ready for the market and passed the initial fundraising round can use the model and get investments from corporations, provided that they meet the ‘Proof of Success’ criteria.

 

The Pending Funding model might also work effectively with alternatives to corporate investment, such as leveraging the power of celebrities, opinion leaders, or through venture capital funds.

 

 

Double Pending Funding 

Start-up companies can make use of the Pending Funding model through a dual process as well. Thus, the investors will condition their initial   investment on the issuing of a letter of intent by a corporation. Thus, the start-up won’t have to wait until getting the letter before appealing to investors, but rather proceed on both avenues simultaneously.

 

 

 

PROOF OF SUCCESS

 

The second model examines a start-up’s success based on real test results. Thus, potential investors give up the private selection process for the chance to examine the start-up, its idea, and execution through the eyes of the market. This resembles the existing model in the television industry, in which a television series gets a chance to make a number of pilot episodes to determine whether it will succeed or fail based on ratings, not on chance and guesswork.

 

Most bodies in the industry, including venture capital funds, incubators, accelerators, investors and corporations tend to sort and choose the start-ups the ones that they think have the best chances of success. However, most companies fail during the gap between the initial funding round and the next round, even after getting support from accelerators and incubators. Instead of the private selection, the Proof of Success model proposes a public alternative, giving start-up companies equal opportunity. The goal of this model is to create a real test for predicting the success of a start-up through its target audience, using the corporate marketing resources as an experimental environment where the start-up tries to meet the performance criteria specified in the letter of intent. This process will help determine whether to give up on start-ups that perform poorly and save the successful ones, which could be ignored by investors under other models.

 

 

 

CONCLUSION

 

The Reverse Fundraising method can be explained through a scenario in which several start-ups turn to a corporation owned by a leading news site, all making the same claim: We have an algorithm that will generate a greater return on investment for advertising on the site. Under this method, the corporation does not rule out any of the start-ups off hand, even though they can’t tell which one of them will succeed and which will fail. Instead, the corporation grants each of the start-ups a letter of intent, guaranteeing to allocate limited exposure. The cost of such exposure for the corporation is minor, but it’s sufficient for each start-up to try and prove its performance and gain the lead over the other competitors. The letter will define not only the measures of success, but also the guarantee investment in the most successful start-ups, according to a predefined value. Through this process, the corporation will ensure its partnership with the successful start-ups. The investors will have a safety net at an early stage by securing the next round of exposure to the market and the start-up will get an equal opportunity to prove itself.

 

 

THE METHOD'S EFFECT ON OTHER PROCESSES

 

Reducing dilution for investors

Since the model is built as a reverse process, the two funding rounds, (The Seed round followed by the Series A round) are carried out simultaneously. This reduces the dilution of the holding later on for the early investors, thus increasing the return on investment.

 

Optimizing the support programs

Mentors, accelerators, and incubators that regularly guide start-ups can focus and optimize their time by helping the start-ups meet the conditions specified in the letter of intent, since the future of the start-up may be determined by these results, and such success may increase the start-up’s chances of survival in the portfolio of the mentoring figure.

 

 

ReversExit.com

The Reverse Fundraising method is applied by ReversExit.com, a fundraising platform that automatically analyzes all start-ups and matches and connects between start-ups and organizations that can leverage them into the market through the Pending Funding model.