There is a set of venture finance issues that I’ve heard now for the past 30 years. These issues come up for most, if not all, entrepreneurs in early- and growth-stage companies. These are the 8 principles around which I’ve designed my New Venture Finance course at UC Berkeley and which I’ve derived from nearly 30 years in the Silicon Valley.
The New Venture Finance Cycle
The cycle is similar for both for-profit companies, like the ones I’ve worked with in the Silicon Valley, as well as non-profit companies, like the ones that I am now working more and more with today.
Here’s a bit on each of the steps in the cycle. The cycle matches up to the company’s growth cycle, but it actually keeps repeating. A good entrepreneur is constantly implementing a funding and a finance strategy…it is a never ending cycle.
Exit Strategy: Why not start with the end-game? A lot of entrepreneurs work from a passion, jump on a new opportunity with zest, build a team, and launch their company. But somewhere down the line, they are faced with issues of whether to grow the company, sell the company or take it public (which is like graduating into “graduate” school, according to my friend Scott Dettmer fr
om Gunderson Dettmer law firm). And they haven’t considered what type of an exit they’ve been building for. Jon Fisher, in his book Strategic Entrepreneurism provides some compelling reasons for coming up with you exit strategy when you first start your company…and then executing on that vision for an outcome. Jon’s book is about how to start a company that describes “how to design a company that a great company would want to acquire.” Although many would argue that you build the company first for long-term value, there is sometihng to be said about understanding your options early, designing to maximize the market swings and sentiments – and be the guy/gal who is in the “right place at the right time”.
Vision & Strategy: There are too many books on management and strategy and too few on aligning this strategy with one’s financing or fund-raising approach. This alignment is critical however. If a company has a strategy that is poorly/thinly funded, or that isn’t supported by a workable business model, odds are it will fail – unless it’s one of those fast-ride dot-com consumer deals that someone scoops up for “eyeballs”. Most real companies need to have an alignment between all the parts of their internal financing strategy (revenues, costs, cash management, balance sheet) and their approach to fund-raising (which investors to bring in, how much money to raise, timing of raises).
The Business Model: most entrepreneurs I talk with confuse business model with revenue model — they think that the business model of the company is how it charges for its product/service. But a true business model is really the entire story behind how a company makes, distributes and sells its products and then services its customers. All the pieces have to hold together: pricing model, value proposition, channels, customer focus, customer relationship, core competencies, key costs, key partnerships. A great way to test out your business model is to see how well you can articulate it. A friend, Alex Osterwalder, has created a worthwhile book, Business Model Generation with a straightforward method for describing and innovating business models.
Financials: Most companies think they need a CFO on the team to create great financials. They really don’t …they just need someone who is really good at taking input from the company leaders and market knowledgables, and organizing it in a way that it yields some good answers about how the company will be run and make profit. The Financials must accurately reflect the business model – they go hand in hand. A good set of financial plans also allows management to easily create “what-if” scenarios around the most important variables to the business. This sensitivity analysis helps create a range of answers in Capital Budgeting.
Capital Budgeting: In what I refer to as the capital budgeting model, a company takes its best set of financial projections, sets target “milestones” (goals) and then determines the range of money that might be needed to fund the attainment of the milestones. By this I mean “how much money do we need to do X?”. Not surprisingly, many entrepreneurs are not good at this process, which means when they go to ask for money it is unclear to the investors what they are funding exactly, how far the company will get with their cash. Not knowing these things makes your company look risky. Putting a good projection out that is good at predicting the amount of money it will take to get to your next big milestone is important. If you get the job done with the amount of money requested, you are typically rewarded with an up-round. If you don’t get the job anticipated done with what you have raised, you may face a down-round…or worse, you may run out of money and be forced to short-sell the company or go out of business.
Identifying Sources of Capital: the choices for raising capital – for both for-profit and not-for-profit companies — have grown dramatically in the past few years. In the 1930-90s the choices were simply: Friends/Family , Angels, Venture Capital. Today the list includes: angel groups, camps, online angel networks, customers, venture lenders, incubators, accelerators, online marketplaces, seed-stage venture funds, early-stage venture funds, late/mezzanine stage venture firms, private equity investors and strategic investors. It’s a pretty dizzying range of options. I often see companies that are raising money from many different sources – all at the same time. They are gender-confused. The pitch for an angel investor will not always work well for a VC, or a strategic investor – they all have different financial goals and needs and knowing how to cater to these needs is a useful thing. The best thing to do is know your venture players (or hire someone who does to work with you), and match up your capital budgeting needs to the correct players.
Securing Capital:
Cash Management: once money is in the bank from financing the fun begins.
And the Cycle Continues…
The cycle for new venture finance is never ending. The best CEOs – whether for-profit or non-profit are in a perpetual fund-raising mode. They are out connecting with future potential investors, talking with bankers, learning about their market from research houses, meeting with competitors who could be future suiters. The New Venture Cycle is one that is more detailed and delicate than first meets the eyes.