Raising capital is a huge challenge for any startup. It’s not just the who, what and where – it’s the how.
There are generally two types of capital available for a startup or scale-up: debt and equity. Debt capital is the kind of capital you’re used to: you borrow money from a lender and pay it back with interest. Equity, on the other hand, means you are selling company stock in exchange for financing.
For high-growth startups, venture capital (VC) is the most common form of equity. VC can be delivered as technical or business expertise, as well as monetary form, depending on how involved a VC firm intends to be.
“Startups are interesting because they require some of the most advanced products very early on, but also have limited capital,” said Timothy Hui, Senior Manager for Startups and VC-in-Residence at the global accounting firm. BDO Australia said at the recent Startup Daily From Idea to Unicorn event series.
“So it’s a good balance that we play between just-in-time delivery, but also making sure we set you up so that we don’t have to reverse engineer or come back to anything in the future.”
Understand your numbers
When it comes to raising venture capital, Hui cannot emphasize enough the importance of knowing and understanding your numbers. Investors are looking for a scalable business opportunity with practical unit economics and you need the numbers to prove your track record.
“We made the investment early to ensure we have a robust management layout for your income statement,” Hui noted. “Which can also be used for your board reporting, which can also be used for your general stakeholder or potential investor list. So understanding your numbers is critical.”
Hui said the best way to value your startup is to be reasonable with your numbers. A little optimism is fine, but aim for the highest rating appropriate for the stage you are in.
For seed-stage startups, with little or no operating income (or even a salable product) and high expenses, valuation can be especially tricky. This is where techniques such as market multiple analysis (where you value your company against what comparable companies in the market have been acquired) can give a reasonable indication.
Hui also pointed out that in today’s market, you need to be prepared for 10 or even 20 percent dilution. So a financing partner will look for buckets of monthly incineration that are acceptable for each stage of your startup’s lifecycle. Based on that burn, they calculate your rough rating.
Have a solid business plan
The majority of venture capital investors will be looking for a solid business plan that demonstrates well-managed, scalable projected growth.
“When it comes to the numbers, it’s about the vision,” Hui advised. “For VCs and for angels and early stage investors, it’s about finding the opportunity.
“The last part of your business is money. It’s basically building income and how that works as you go through the growth phases. Inevitably, you’ll have all these KPIs and milestones that will give you indications of growth, but behind the scenes it’s all about how you actually got that trade.
Your business goals and strategy will support every aspect of VC negotiations. Where your startup is going and how you plan to get there is key to demonstrating your company’s potential.
Make teams strong
One aspect of your business plan that is critical to your success is how you build your team and company culture. To ensure the success of both, Hui is going all-in by adopting an ESOP (employee share option plan).
“If you don’t have an ESOP, I really encourage you to enter it and you don’t necessarily have to plan an ESOP,” Hui advised. “If you want, you may have a back-of-a-napkin from day one [ESOP] until you do your first raise, and then we cement it all in place.”
Hui thinks an ESOP is the best way to get buy-in from everyone on your team. “When Eventbrite IPOed, Eventbrite had this pure philosophy where every person had an element of ESOP right down to the kitchen,” he said. “And so, when they got to the show, everyone in every single office worldwide could hold a glass of champagne and say, ‘We were part of that journey, and we benefited from it.
“And to this day I tell that story and just imagine the shivers down my spine as to why we do ESOPs.”
Timothy Hui of BDO talks about venture capital financing at the recent Startup Daily From Idea to Unicorn event series. LR: Martin Karafilis, Tiliter; Timothy Hui, BDO; Tom Humphrey, Merel Ventures; Simon Thomsen, Startup Daily. Image: Pinstripe Media
Consider the lifecycle of your business
It is especially important to have a strong team and a solid business plan when you are in the start-up or early stage (series A and B) financing round. Keep in mind that early stage financing is significantly riskier for the venture capital investor than later stage financing. So if you want to fund your first raise, your forecasts have to be very tight.
“Think about your next raise more than your first raise or the raise you’re doing now,” Hui advised. “So, when you go through your first raise or your second raise, or even in the later stages, when you go into private equity, think about that next raise…”
Another important consideration here is scaling only when your channels reach saturation point. If you try to grow earlier, you could be swept away by bigger competitors that you can’t handle. So focus on proving concepts, growing your customer base and developing your IP, team, channels and overall company culture before you start pitching for VCs to grow your business.
Perceived loss of control
“There are two things I like [people] really get stuck negotiating deals,” said Hui. “One is appreciation and the second is a sense of loss of control. So that’s the balance sheet that you create on an economic and financial level.”
We’ve all heard the story of the founder being relegated to employee status after investors made all the big decisions. The fact remains that unless you can get a huge loan, at some point you will have to give up your equity in order to scale up.
One of the most underrated negotiating tools a startup has is what Hui talked about above: starting with an honest valuation in the first place. That way, whatever stage you’re at, your investors stand a chance of making great returns.
“What you as a founder should do is review your numbers,” Hui emphasized. “So you should be constantly reviewing your financial model so you can determine what you’re up to or what you’re up against?”
Remember that your venture capital partner has the same goals as you: keep your startup viable and scale it as high as possible.
Build lasting relationships
To do that, a good VC firm offers more than just money.
“It is truly [about] finding that team that understands your business and can add value to it,” said Hui. “We’re talking internally around BDO about the focus on not only having the compliance work, but being the trusted advisor… for us it’s critical to be there on a daily basis as an available advisor.”
Ironically, the more involved your VC is in your day-to-day business dealings, the more likely they are to leave you to you. Transparency in your business operations allows your VC partner to see what your long-term goals are and whether you are on track to achieve them.
“Look, inevitably founders always break their financial model,” Hui said. “So whether it’s in three months, eight months, or when you make your next raise. The model is really about the logic, not really that number that we’re going to benchmark you exactly to…”
It’s insights like this that point to another great advantage of your VC partner’s expertise: While everything is new to you, your VC company has been here many times and they have the opportunity to benchmark your startup against that from others in the market.
In fact, if they are a global company, they can make it much less complicated to go global. “We pick up the phone with the team in America and we go, startups are coming your way,” Hui said. “They’re landing on this date, watch out for them.”
Know more about BDO’s services for startups and scaleups here†
This article is brought to you by Startup Daily in association with BDO.
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