Thoughts Prior to a Funding Round

Translated by Núria Adell.

As my partner Toni mentioned when he talked about updates in Nelio, in June we moved to our new office in the Parc Tecnològic of Barcelona. Before that, we were in the incubator of Barcelona Activa for three years. Being part of an ecosystem of startups has allowed us to participate in workshops, courses, and events for startups for free; have mentors who have helped us (and continue to help us); be up to date on any news related to startups; and know what other companies are doing.

During our first year there, one of the issues that overwhelmed us was that of requesting external funding. Most of the startups installed there were either financed with a bank loan, or an ENISA loan (from the Spain Startup Co-Investment Fund), or had gotten one (or two) funding rounds. We didn’t have any of this ?. Well I guess it’s normal, since we simply hadn’t taken any steps to seek funding.

What is an Injection of Capital?

There are numerous reasons to seriously consider seeking capital. As Andy Freire says in his book Pasión por emprender (Passion to Undertake), in general gathering third-party capital allows you to:

• Start a business. It’s clear that all those businesses that don’t depend exclusively on human capital and capacity may need an initial investment.
• Grow faster, open new markets, etc.
• Reduce risks. Having a capital mattress can be very useful in lean times.
• Get a salary. Regardless of whether you’re a founder, it allows you to secure a fixed salary for the tasks as an employee.
• Have internal order and discipline. Being obliged to give periodic information to investors encourages more discipline in the company.
• Make strategic decisions. Many investors not only contribute in terms of capital, but they also bring value and knowledge to your startup.

According to our mentors, we had to focus on getting capital to be much more aggressive in our marketing strategy and grow faster, because our metrics showed that we had a product that seemed to work in the market. In fact, one of the mentors we had, an expert consultant in startups financing processes, would have been delighted to lend us a hand…

Considering the advantages of financing and the suggestions we received, we decided to study the subject in detail. We attended many events organized by networks of business angels of the best business schools in Barcelona (ESADE and IESE) and sponsored by companies or local entities with the aim of learning what one should know about getting investments.

In the end, we realized that taking this step is much more complicated than it seems. And, not surprisingly, we eventually decided not to look for external capital. Let me share with you some of the issues you should consider before jumping into the pool.

How do I Establish my Startup’s Value?

Here’s the first question, not trivial, that you should ask yourself when thinking about getting financing. The best talk that I attended on this topic was by Luisa Alemany from ESADE, who explained the technique of equity dilution to value a company (take a look at the venture capital method for more details). The basic idea is that it’s not possible to evaluate an informal structure at its initial phase, with barely any metrics, a multitude of challenges, everything half-done, and a lot of expectations to fulfill. Therefore, they suggest you value the project backwards. That is, the question shouldn’t be how much my startup is worth, but how much money do I need to take my project to the next significant phase of development:

[The next phase] depends on each project. It may be going from having no income to finding some initial business model that produces the first recurring customers, it may be giving the next push to the prototype to be able to launch a decent beta model… But (…) it is not enough for us to move forward a little bit, there has to be a strong development in the following 6 months that creates value and that allows us to justify a new valuation to get enough money to reach the next milestone without an excessive dilution of the founders. It is a jump that should be repeated in every round until the final exit, and that should be managed carefully from the start.

Unfortunately, many founders do not think about these things and are overly diluted in the initial stages. Or, on the other hand, they make a round of a valuation so high that it is impossible for them to raise the value sufficiently in the next round.

Miguel Arias (source: Cuánto vale mi startup en fase seed)

In fact, if you think about it, it makes a lot of the sense. If you’re looking for financing it’s because you have a project in mind for whose development you need capital that you don’t have. If you’re able to define this well, you’ll be able to establish the subsequent steps.

However, although this valuation system is supposed to be easier than others, it’s still not free of difficulties. Could you really define and evaluate the cost of the project that will make you grow significantly? To us this seemed quite complicated… and if you want to follow a Lean Startup methodology (as we did), it almost seems incoherent to plan projects that need a lot of funding.

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Loan Application

Let’s assume you have a clear idea of the project you’ll develop to quickly grow your business and have identified how much money you need; a good financing option is applying for a loan. Among the different loan options available, in Spain we have the ENISA participation loans in which the partners are exempt from any guarantee and whose payment of interest is subject to the evolution of the company. The terms of these loans are very good for startups. But note that they have small print: you must also have contributed a % of capital to the company.

So, for example, when Tomi Santoro created SumaCRM, a Spanish startup, and got €60,000 from an ENISA loan, he commented:

The truth is ENISA is very helpful: you have up to 2 years to start paying it back, month by month, with a very low interest rate (3% in our case). In addition, they give you many months to return it, for us it was 48 months. Thus, it is very comfortable, and if you do well you almost forget about it, since you pay about €1,000 each month if you have been given €60,000.

The great advantage of a loan is that you don’t lose share by requesting it. But the big disadvantage is that, of course, even if the loan conditions are very good, it must be returned. And that means that if you’re lucky and get your project started (which apparently is not what happens to the majority), it’ll be time for payback. Soon, you’ll realize the first two years flied by and now you have to add the return of the loan to the expenses of your startup. And that’s when you get into a vicious cycle: just when you started to create some income, the expenses increase and, again, you need more capital to continue with the project… ?

Getting Funds

If you want money without having that monthly debt, the other alternative is to get third-party capital. You may know the story of Otogami, the startup David Bonilla founded in 2012 with his wife Candela Milán and his friend Jerónimo López. A story that David published (in Spanish) in his own blog. In the article “the story behind 330,000 euros“, David summarized how they had gotten their first round of investment and some of the difficulties it involved:

• Raising funds is slow. As David says, on January 23 he started considering applying for capital, on April 29 he had the first meeting with the Vitamin K fund, and the whole process was completed early in November. Quite a bit more than half a year!
• Getting capital requires multiple investors. The cases of startups that get capital from a single investor are exceptional. The process is slow precisely because you have to gradually gather the amount of money from various fronts.

The trickiest part is, as you can imagine, the negotiation process. Investors will probably have already participated in multiple investments and will therefore have had multiple negotiations. In your case, it’s probably your first time… and that leaves you at a distinct disadvantage. So don’t even think about getting yourself into this jam without a lawyer to advise you. David didn’t have any problems in this aspect, but you’ll find some horror stories as the news of sexual harassment of the investor Justin Calbeck from Binary Capital to CEO women looking for capital). Anyway, I don’t want to be dramatic: there are many examples of projects that have had the potential to become the incredible companies they are today thanks to great investors behind them (Specialisterne, La Fageda…)

Finally, keep in mind that fundraising is only the first part. You can imagine that achieving this is not easy: you have to know how to seduce the investor and show him a high growth trajectory. But then comes the reality, when you actually have to fulfill the promise:

Do you really want this fast growth or would you prefer something more controlled and organic? Are you aware of the great effort involved in ensuring the way to obtain the great return you wanted? Think about it, maybe you’re betting rather than undertaking…

Conclusion

Be aware that getting an injection of external capital into your startup doesn’t come without difficulties and it implies a great cost in many ways. Investment doesn’t mean success. Having capital so that your startup can invest in improving its position and structure can be vital to the development of the goals set, but it doesn’t provide explicit success. And if you want to know a little more about what success is, don’t forget to read the pillars of a startup’s success.

So, if you’re overwhelmed, as we were at the beginning, about the great success of some startups with rounds of investment, remember that a round is, in most cases, the reflection of the inability of that company to auto-finance its own projects. Don’t let the figures blind you!

In our case, we’re still very excited with Nelio, having a great time and striving day by day to make our company more profitable, better managed, and with a long-term vision, which is no small thing ?. So, for now, we’ll follow the advice of Luis Martin Cabiedes (a partner from a well-known Spanish venture capital firm):

https://twitter.com/luismcabiedes/status/815601534402760704?ref_src=twsrc%5Etfw&ref_url=http%3A%2F%2Fdelvy.es%2Ftruco-trato-rondas-inversion%2F

Purpose of the year for entrepreneurs: get rid of rounds and VCs. ?

Featured Image by NeONBRAND.