in Investment Know How

Setting the tone…

Financing is a fundamental decision for each entrepreneur. Unfortunately, there is no perfect financing partner and each financing process should be highly tailored towards an entrepreneur’s individual needs.

I often compare financing to marriage – as crazy as it might sound a financing process has many comparable steps. From the initial flirtatious phase where a person goes out and looks for a date to eventually marry–an entrepreneur’s initial hunt for an investor to the final signing of documents in front of a notary has a lot of similarities. Whether you see your perfect partner on a dance floor or see a famous venture capitalist walking around at a networking event – I promise your heart will start to beat faster. Once a relationship becomes serious and an engagement looms on the horizon an entrepreneur will face a lot of due diligence questions – similar to going for your first trip with the future in-laws. Marriage is just the same – some will be great, long-lasting and highly profitable for both sides, while others will end in a quick and maybe even messy divorce where both sides wish they would have paid more attention to the wedding contract. Most importantly there are a couple of comparable lessons entrepreneurs should take from marriage:

  1. Choose your partner wisely – you might be together for a long time
  2. Make sure you can live with each other BEFORE you get married – after you signed the contract it is much harder to get out
  3. Make sure you have a complementary skillset – as with most marriages your partner will help to mitigate your weaknesses with his strengths and vice versa
  4. A good relationship requires hard work, dedication and trust – both sides need to work on keeping the relationship happy

Before going into the more technical aspects I hope that I set the tone for financing and the importance it will have for your venture – it can be a game-changing experience and that is how seriously you should take your financing partner selection process.

This post will now highlight different funding options for entrepreneurs and their new ventures. Aside from all the operational issues the question of a) how much money do I need and b) who should I get it from – are often the most difficult choices an entrepreneur has to face.

In order to define some variables for the case studies below I will show my view of financing stages – there is a lot of debate and options on what stage is what so here are the definitions I found easiest to work with:

Pre-seed:        €0 – €50.000

Seed:               €50.000 – €250.000

First round:    €250.001+

Pre-seed should always be used to get a small test case going that outlines the feasibility of the project and in my opinion this should be 100% financed by the entrepreneur and her team. If an entrepreneur is not able to either raise that amount of capital from FFF (friends, family and fools) she should reconsider if starting a venture is the right thing to do.

eCFO Tips: Especially online focused ventures can easily create a fully functional click dummy, wireframes and a strong web presence to convince investors with more than just nice looking slides. This will help you to move your valuation discussion to a whole new level.

It becomes trickier in the seed financing round. Here the amounts of money needed are more substantial and can often not be contributed by only the entrepreneur or FFF. I would advice to look for a partner in this stage who can contribute more than just capital. This is probably one of the most overused and equally misunderstood statements ever used. 

eCFO side note: my personal favorite and number one overused phrase is: teams – people are everything and I only invest in A team – especially if it comes from a VC or incubator team that replaces its entrepreneurs after every little bump in the road and does not care at all about the entrepreneur who put his blood, sweat and fortune into building a high risk venture. Make sure you check on an investor’s reputation and how past teams of entrepreneurs have been treated.

more than capital 

More than capital for me means either excellent investor contacts that lead to initial sales, technology knowledge or direct hires. It is often difficult to fully understand how good these contacts are prior to actually using them. Here I would advise the entrepreneur to call at least three different references who can talk about their relationship and experience with the investor. Often entrepreneurs think that ONLY the investor can undertake an in-depth due diligence – this is not true. The entrepreneur should also fully understand whom she is taking on board as an investor and should make sure that her due diligence is thorough.

…sources of capital…

In terms of capital sources I would like to provide three sources of capital that are build on my prior experience and the experience of many other entrepreneurs I have talked to over the years.

Venture Capital

Pros: Venture capital from a professional VC firm or investor is a highly potent source of financing. A VC will, in most cases, have an excellent network and a strong understanding of financing processes. He (and most often it will be a he) is also a specialist in legal and financing documentation. The can provide strategic advice and will have strong market knowledge. In addition, most VCs will have access to either additional capital from their fund or alternatively have a network of financing or exit partners that ensure future capital when an entrepreneur needs to raise more capital.

Cons: For an entrepreneur there is a dark side to all of the previously mentioned positives. VCs will have an excellent network but make sure that the network is right for you – just knowing a lot of other VCs and entrepreneurs might not be what you need. Strong contacts to marketing partners or future clients might be much more important. The strong experience in financing processes and legal documentation is the most frequently used weapon against an entrepreneur. Always remember it is a VC’s JOB DESCRIPTION to write financing documentation that will give him every possible advantage. There is no easier way to completely lose control of your venture than to sign a document drafted by a VC.  A VC will always be better in contracts than an entrepreneur is – remember an entrepreneur is generally operationally focused. A network for follow-up financing and exit partners is exactly that – a quick way to EXIT the investment and get a return. A VC will always want to exit your business in order to get returns. Remember by entering into this financing relationship you are also defining a sale of our business.

eCFO Tips: ALWAYS make sure you understand what drives a financing partner. The average VC will have a three year fund raising cycle that means they have to go out and raise / pitch for new capital one year after closing their current fund. The VC world has become a significantly tougher place – many VCs failed to raise capital during the financial crisis. If an action that puts your venture in jeopardy but will help their fund raising comes up it will be clear what they will do. Be prepared.

They will also have huge return expectations from their capital providers and can only use very limited leverage– so an exit is the ONLY way for them to be successful. Keep that in mind if they ever tell you that they will not push you towards an exit.

Conclusion: VCs have a lot of money available and are highly professional, agile and focused. They will be exit-driven and push you forward as long as you generate returns. They are only in it for the money – never forget that and use it to your advantage.

Joint Venture / Strategic Partner

Pros: A joint venture with a strategic partner can be a great thing. A strategic partner will have deep operational experience and in most cases significant non-financial assets. Aside from capital this partner will often offer access to clients, knowledge and team members that a budding entrepreneur could never source independently. In addition, it will be a strong financing partner who is not discouraged by small bumps in the road and is in it for the long-term.  An entrepreneur can also be sure that the right exit partner has already been found. Most strategic investors will add a call-option to the financing document that allows 100% purchase of the business in the future.

eCFO Tips: Call-options are funny things – you are giving away your company at some point in the future without having any indication, beyond wild hopes and dreams , of its value at the time of exit. Remember that in general there are some things are just as true for a strategic partner in the future as in the present– they will still have more lawyers than you do, they will hopefully still have a substantial strategic interest in your company and they will have cash.

So try to lock in a valuation method now that rewards you for parameters you know your business can potentially reach. As an example: don’t put an EBIT based valuation into the contracts if you know that you won’t reach break even for a while or agree too easily to a “at fair market” valuation. Especially with fair market value valuations it will be hard to argue for a correct market value if this asset makes only strategic sense to your individual investor and when you have no realistic way of shopping / showing your company around to other investors when you are trying to exit. Even if you put in the popular phrase that allows for an evaluation of an independent auditor remember that this auditor will most likely be working for your strategic investor and that they will always be a more interested to work for the strategic in the future than you – magically that can influence valuations!

Cons: Again, what is true for VCs is true here as well. Most of the pros of a strategic investor can be turned around into negatives. Most of all, be prepared to be in it for the long-term – that is true for EVERY SINGLE ASPECT of this relationship. In the beginning be aware that most strategic partners will have decision making processes that make a snail seem to move at rocket speed. From the first pitch to actual investment it can easily take 9-12 months.

In general, strategic partners will also be huge organizations – getting to the right people at the right point of time and piercing through inter-corporate politics can keep you quite busy. In a start-up there is no time for politics and things that move you ahead in large corporations. Things like number of employees (overblown teams), budget (spending & wasting) ability and political connections (sucking up) will actually be disadvantageous for any start-up.

You will also not be able to move in any direction you want. Certain clients, business methods and entrepreneurial shortcuts will be off the table. The strategic partner will also be sure to keep the upper hand in any contract and it will sometimes be hard to show that this is a joint venture between equals.

Conclusion: A strategic partner can unlock assets that you couldn’t buy with money – contacts and operation experience can be right at your fingertips. It will be generally a lot nicer relationship than with your average, cut-throat financial investor but you will have to deal with a lot more politics, size and slow- moving operational structures.


Pros: For me this remains the true key entrepreneurial discipline. There is no better feeling than growing a company based on the strength of your team and your personal efforts. Almost nothing feels better than looking at your financials and generating substantial returns and knowing that all it took was your hard work and not somebody’s capital. You did not buy your success – you truly built it.

Aside from this motivational aspect it also means that when it comes to making decisions you do not have to ask anyone else. Your team and you have full freedom to run the business. It also means that you can grow a business and maintain ownership of the business as long as you want. This is also true for all returns that your business generates.

As an entrepreneur this also prepares you for making hard and fast decisions. You do not have time for waste of capital, bad employees or unprofitable clients. You have to act quickly and decisively to stay alive since there will be no capital buffer to keep you going if you run out of cash.

Cons: Bootstrapping is hard, often prevents you from making necessary investments and always distracts from the operation side of your business. It is also only good for highly cash-generative business models such as services provider and agencies. The constant liquidity pressure will also shape you as an entrepreneur and make you hesitant to go on sometimes necessary spending sprees and/or investments.

It will put your team into a hard place that often requires to opt for short-term cash generative measures instead of focusing on long-term value creation.

Conclusion: Bootstrapping stands for freedom from external investors but puts severe operational restrictions on your business. It can only work for some business models and will make it almost impossible to quickly expand your business or to rapidly capture markets. For me this remains a key test of your entrepreneurial skills but most people will not be able to build a significant business without any external capital.

…and finally

In our business we have successfully raised capital and grown businesses using all three of the above mentioned financing methods.  That taught us that there is no perfect financing partner but depending on which venture you are trying to get funded one or the other will be a significantly better choice. Just make sure that from the get-go you understand your motivation and what motivates your financing partner. Any relationship then needs hard work, dedication and trust. Make sure that all three of these aspects are maintained throughout your financing partnership … come to that and going full circle from the beginning it might even help in private partnerships as well 🙂

Quick Disclaimer: I have only focused on equity capital. There is a lot to be said for alternative financing or debt financing. Stay tuned for a discussion of these topics at a later stage in this blog.

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  • Francois

    Great stuff, liked it very much.

    My comments:

    – Series A starting at €250k is a bit confusing… I would move it to €750k ($1m)

    – What about Angel investments?

    o Angel network are ubiquitous when approaching any first fundraisings

    o I personally think that it represents a great way to get the company started (they usually bring a wealth of experience and open the firsts doors)

    o Worth also mentioning the current “super Angel” trend with private investors investing up to €2m in a single ticket

    – Regarding JV/Strategic Partners:

    o Don’t see them as such an obvious investor

    o They however can be strong partners (to channel sales or R&D)

    – I liked the way your provide insights (eCFO tips):

    o What really drives the VCs

    o Long process cycle for strategic…

    o It wouldn’t be harmful to expand these points