As the founder and CEO of CircleUp.com, an equity-based crowdfunding portal for consumer products companies, one of the questions I am asked most often by consumer packaged goods (CPG) companies is "when should I start raising money?" Every day, entrepreneurs hear tales from Silicon Valley of the latest consumer Internet startup raising $10 or $100 million at a gaudy valuation even though the company may be years away from generating dollar one of revenue.
The playbook for raising outside capital (which includes money from friends, family, angels, private investors and venture capitalists) is much different for natural products companies, however, due to their different scalability trajectory versus tech companies. While the beta for tech company success is greater, when these companies do succeed, they scale incredibly fast due to their de minimis customer acquisition cost.
However, natural products companies generally need to scale retailer by retailer, buying inventory and dealing with suppliers and customers along the way. Thus it takes more than a great idea to raise money: it takes some proof of concept (sales).
While there are no hard and fast rules for when to raise outside money, below are three crucial items a natural business must check off before embarking on a successful capital raise:
1. You need retail sales.
Natural companies need retail success cases to attract outside capital. By retail success cases I don't mean you need to have national distribution at Walmart, but some sales success in a Whole Foods Market region or even a 10-store supermarket chain is very helpful.
This can often present a chicken and the egg problem—many retailers charge upfront slotting costs and working capital is needed to fill a retailer's order. That's why retailers like Whole Foods, Costco and local supermarkets are great targets because they don't charge the expensive slotting that Kroger or Safeway do.
As for the working capital to fill the first retail orders, this is where you need to take a leap of faith on your business and use savings, credit card debt or friends and family money to sustain the business.
2. Understand your gross margin situation.
There is a big difference between understanding your gross margin situation and having strong gross margins (relative to your category). It's okay to have 10% gross margins as an ice cream company even though category average is in the 30's. The important thing is to be able to show investors the path to get to 30's.
Maybe the path is a new co-packer, shipping full truck loads or using a different ingredient supplier but an outside investor needs to see the ability to earn strong gross margins because gross profit is what you have left over to invest in sales and marketing—the most important drivers of CPG success.
Oh, and a path is not just saying that higher gross margins will come with operating leverage. Be able to explain exactly how the margin will change and what the key drivers will be throughout the process.
3. You've nailed the product.
Ultimately, a natural brand will live or die based on how good the product is that you are putting in people's mouths/on their skin/in their pet's mouths, etc. When you are at the point of seeking outside capital, you need to have the product nailed. That doesn't mean the packaging needs to be the best in the industry, but investors don't want to risk capital on a prototype that's never been tested with consumers.
I've talked with companies that were trying to raise money while experimenting with their first flavors, or changing packaging or even developing the brand name. Smart investors will want to invest behind something they know is working—even if it is just beginning to work. Until you can point to a product that is receiving real customer interest, the inherent risk is just too great.
Once you've checked off the three items above, the question about when to raise money becomes one of knowing how much money you'll need to execute your business plan. For that advice, click here.