Raising growth capital from venture capital investors or angels is exciting and fun, but it will only work if you can convince the investors that your plans will lead to phenomenal growth. And it comes with a hefty price tag, because the cost of the shares you spend in an investment round can easily reach 100% or more per year.
For many startups, it is better to raise money through bank financing, revenue-based financing and smaller equity rounds.
In this blog post, I will give you five essential points of attention that you as a wise entrepreneur should think about before you start fundraising. At the end, a suggestion on how to raise smart growth capital.
The first milestone for the entrepreneur
You have translated an idea into a product. You have a team together, worked really hard and now there are customers! That nice feeling of attention, recognition and appreciation for your startup is your first milestone. You can celebrate that because not all ideas of entrepreneurs lead to turnover. A large part of the startups remain in the pre-revenue phase and are closed down or go bankrupt. You already belong to the minority …
But it is only the first step and you are probably already starting to notice that your ambitions are being hampered by a greatly reduced bank account.
Now is the time to take the five lessons and start making a financing plan for your growth strategy.
Lesson 1: ensure proper administration and a solid financial plan
Excel is your friend and your enemy. Certainly for startups without a team member with a financial background, it often proves difficult to maintain good and consistent insight into the figures.
A customer administration in Excel, a budget and monthly reports can be easily maintained in Excel and give you enough insight to create a nice pitch deck before you start the fundraising. But a mistake is easily made and what happens much more often: the administration is compiled by the accountant afterwards and is not linked to the spreadsheets.
This means that once you have progressed a few months, there appear to be differences between what you have included in your budget as “actuals month x” and what appears from the financial administration. And usually the deviations are not favorable. Debtors pay a little later, the sales tax is not yet refunded because questions have been asked, etc.
Unrest and panic. Especially if you are already sitting around the table with banks and investors in this phase, it is extremely annoying to have to correct the figures during the process. Every bank and every investor keeps everything and checks newer versions of pitch decks and budgets for consistency.
The advantage of a small business is that the administration is not complicated. So attention is everything. Be aware of the fact that you keep an eye on the connection between the financial administration and your Excel plans on a weekly or monthly basis.
The biggest advantage is that you also more easily develop a feeling for not only the costs and revenues, but also the balance sheet and the cash flow. And that is another good basis for thinking about the costs of your capital structure.
Lesson 2: Consider whether profitable growth is possible before raising growth capital
In recent years, loss-making startups that continue to make losses well into their development phase have become the rule rather than the exception. That is a big difference from twenty years ago and the question is a) whether this will remain the case and b) whether this is desirable for your company.
Anyone who wants to execute a market dominance strategy and opt for growth over profit, has to rely on venture capital. This type of capital is ideally suited to provide startups with growth capital to grow exponentially and become the new Facebook, Spotify or Adyen. It may be that your company qualifies for this.
However, there is also a good chance that your company will ultimately not be the one who wins the main prize. After all, whatever idea you have, assume that at least twenty startups worldwide are doing exactly the same thing.
Venture capital can only be used if the company has a chance to increase in value enormously. The venture capital investor takes this into account. It invests in twenty companies, one of which ultimately has to make an extraordinarily high return.
But is this the best strategy for your company? Or is it better to grow a little less fast and go faster to break-even and profitable growth?
I am convinced that for the vast majority of startups the answer to this is yes. Rather a new sales executive every quarter than 6 at a time.
Does that make you less interesting for an investor? Yes, for high profile venture capital. But there are alternatives and more tastes for investors.
The costs of other forms of growth capital are also substantially lower than those of venture capital. The venture capital investor wants to earn back 10 times his money (with shares that are still yours – :).
Structuring a round and negotiations can easily cost € 20,000 or more. Those are serious numbers. Raising less capital and financing, faster to profit: it used to be the norm and seems to me a somewhat undervalued choice at the moment.
Lesson 3: study the term sheet phenomenon
The first term sheet on your desk with a high rating will of course flatter your vanity. Suddenly you are a millionaire. On paper then …. But don’t let a high rated term sheet blind you. A high valuation also means an obligation to deliver solid performance in the future. And nothing is more annoying than having issued shares at a too high valuation: the relationship with your investors does not improve and if you have to issue shares at a lower valuation in the next round (a down round), you will often be extra. punished by a disproportionately low valuation.
If you raise capital at a low valuation in a first round, you can run into problems later because you as founders are too diluted. Not desirable either.
And that is only the appreciation. Liquidation preference, reserved matters: the term sheet often contains many provisions that are not only there for decoration. It doesn’t have to be bad, but you do have to think about it. Fortunately, there are excellent books explaining venture capital and the term sheet.
If you have thought carefully about the term sheet, you will also better understand that there are also disadvantages to venture capital rounds. And you also have to take those advantages and disadvantages into account when weighing the costs of the growth capital against the risks and the opportunities.
Lesson 4: the “golden rule of 40”
For internet and Saas companies that have progressed a little further in their growth strategy, it is important to have the right balance between growth and profitability. The 20/20 rule stipulates that the sum of growth percentage and profitability must be able to lead to a 20% growth year on year with a 20% profitability. Faster growth means lower profit or loss and vice versa.
If you compare that 20% with the hockey sticks that are often presented in the first pitch decks, you will realize that in the end everyone is very happy with a company that makes € 5,000,000 in turnover with a profitability of € 1,000,000 a year!
If, as founders, you still have 70% of the shares, then you really have a considerably larger share of the pie than if you were diluted to 25% shares through expensive investment rounds. It is therefore important to make a fair cost comparison before you start investing rounds.
Lesson 5 Profitable growth is efficient
If your products are well priced and contribute positively to the cash flow fairly quickly, then it is much easier to manage the costs of acquisition and organizational development, as well as the working capital. All this requires is that you have the confidence that you have marketed a good product, that it is worth something and that you don’t have to let yourself be fooled.
A one-time bank balance of millions just after an investment round also gives a calming feeling, but often this is short-lived.
have started their fundraising, they are generally not ready for that yet. But if several investors have already expressed doubts about the valuation, there is more support for changing the perspective.
As far as we are concerned, this is not only thinking about the valuation, but also thinking about the amount and costs of the growth capital that you collect. The earlier the better.