Financing a start-up is more complicated than you might imagine

Entrepreneurship is a subject on which Vlerick Business School has no shortage of expertise: MastersExecutive Education and customised programmes all promote entrepreneurship and contribute to knowledge development and innovation. And now there is also a handbook: Entrepreneurial Finance, The Art and Science of Growing Ventures. Co-authors Professor Sophie Manigart and Professor Miguel Meuleman explain why this is required reading for anyone who wants to know or learn more about the financing of start-ups in Europe.

Europe is not America

Entrepreneurial Finance, The Art and Science of Growing VenturesIn recent years, a great deal has changed in the field of entrepreneurial finance. With the rise of crowdfunding, ICOs and accelerators, amongst others, the landscape has become more diverse, and existing handbooks offer insufficient coverage of these new areas. But equally important is that this handbook places entrepreneurial finance in a European context and uses European examples. “There is nothing wrong with showing students how things are done in Silicon Valley,” believes Sophie, “but if they want to launch a start-up here, they are confronted with the European situation and that is fundamentally different. With the financing of American start-ups, the amounts involved are larger and their valuation is generally higher, but American investors are also likely to pull the plug on initiatives more quickly. If you exclusively use American handbooks, then you are saddling students with a distorted picture of start-up financing.”

For both students and entrepreneurs

The book is not only aimed at students, but is also useful for start-up entrepreneurs. In five sections, the authors – academics and experts in the field – take a detailed look at all the peculiarities of entrepreneurial finance. What sources of financing are there? What is involved in the financing process? How do you grow a start-up? And how do you approach a possible sale? But also: how can you be entrepreneurial without going down the start-up route? Academically-underpinned principles are applied and illustrated based on numerous practical examples, case studies and newspaper articles. Each chapter concludes with key lessons learnt, questions and exercises, as well as a handy reading list. The result is a practical guide for considering the entire path from launch to exit.

Financing is a strategic choice

Whole libraries of books have been written about corporate finance, the financing of established companies, but the financing of start-ups and small growth companies is a very different story. Start-ups and their financiers operate in a context of uncertainty and that has its consequences. “Entrepreneurial finance is about more that just the financing of a start-up; it’s about their strategy”, Sophie explains. “As an entrepreneur, you have to know what your ambitions are. And then you also have to ask yourself whether you really want external financing. If you do, how much, when and from whom? These choices partly influence how quickly you can grow. For an established company, which bank they get a loan from is also less significant as the differences are minimal, but for a start-up, crowdfunding has completely different consequences to teaming up with a business angel or a VC.” 

“The identity of the first investor can have a big impact on your chances of success, as well as on the follow-on financing”, Miguel confirms. “What’s more, the founders of start-ups have to take dilution into account. Investors want to be compensated for the risk that they are taking. It is therefore vital to find the right balance between growth and control. This is barely an issue for large, listed companies with a widely-spread share ownership. The specific formulation of contracts between start-ups and financiers also reflects this context of uncertainty – the latter want to safeguard themselves as far as possible.” Sophie nods: “And we know from experience that students and entrepreneurs do not always understand the full scope of these clauses. This book ensures that they are fully prepared for negotiations with investors.”

A financial plan is more than just arithmetic

How much financing do you need? Sophie and Miguel help answer this question in the chapter that they co-authored: Preparing the Financial Plan – Forecasting. “We have tried to go further than simply adding and subtracting income and expenditure”, Sophie explains. “The interpretation of a financial plan is more important. We introduce concepts that financiers like to juggle with, such as cash burn rate and runway – how much cash you use per month and how long it will take for you to have no money left. And we look in greater depth at how you can assess whether your plan is robust, and whether your assumptions are realistic.”

Miguel adds: “Your financial plan stands or falls by your assumptions. Where will your income come from? What is the value of each contract? How productive is your sales team? What is your gross margin? For the margin you can still base your calculations on sector information, but as a start-up you do not know how productive your sales team is going to be. What approach do you need to take to ensure that you produce a meaningful financial plan? Because putting together this kind of plan is an essential exercise to determine whether your start-up will ever be profitable. You may discover that you have to change your business model.”

The examples in this chapter were also chosen to allow readers to think about strategic choices – what products and services do you want to offer? For instance, the example of the now-listed Biocartis illustrates that a recurrent income stream, such as that provided by the disposable cartridges for its diagnostic platform, can offer the necessary financial stability. The case study of QualiPro, a spin-off of Ghent University, illustrates how a financial plan evolves and how even more realistic estimates can still prove over-optimistic.

Sophie and Miguel emphasise that creating a financial plan involves a great deal more than simply filling in a template. Even if you find sector-specific examples here and there, you will still need to radically adjust them. “The book does not give you any ready-made recipes, but it does teach you to cook” is how Sophie describes it.

If the classic ratios fall short

As a start-up you want to know at all times whether you are on the right path, and whether everything is going according to plan. Financial parameters and ratios based on classic reporting – balance, profit and loss account, cash flow table – that monitor the performance of established businesses not only lag behind events, but sadly are also unsuitable for start-ups. If your balance sheet primarily shows losses and debts, profitability ratios are of little use and you need different parameters. Miguel collaborated on the chapter Monitoring Tactics and Key Metrics. “This links into what we say about financial planning. Customer acquisition cost, for example, is a parameter that you would be well advised to keep an eye on as soon as possible. You may be generating turnover, but if your sales and marketing to attract customers is costing too much, then that is putting your future profitability under pressure. This parameter cannot be inferred in the blink of an eye from your profit and loss account. The e-commerce conversion rate is another good example: if you have a webshop, you want to quantify how many visitors actually purchase something. These kinds of parameters give an indication of the long-term viability of your company. It is important to set up a dashboard with indicators that help to steer your operational decisions, which means that they ultimately also favourably influence your profit and loss account.”  

Feel free to think a little bigger

Together with Hans Vanoorbeek, Professor of Entrepreneurship at Vlerick, Co-founder of the Platform for Entrepreneurial Buyouts and Founder and Partner of the investment fund BV Capital Partners, Miguel also wrote a third chapter: Entrepreneurship through Aquisition: MBOs and MBIs. “This is often a somewhat neglected area, but entrepreneurship is not just about start-ups. You can also be entrepreneurial by buying an existing business. And then the question is how best to set up and structure the deal. How can you still take part in big deals with limited means and get as large a slice of the cake as possible?”

“Those looking to invest their savings are too quick to assume that they can only buy a company that is worth a maximum of the value of their total savings. But by combining your savings intelligently with other sources of finance you can access bigger deals. That leverage effect is something that too few people fully understand”, Sophie believes.

Further reading?
Entrepreneurial Finance, The Art and Science of Growing Ventures (editors: Luisa Alemany and Job Andreoli) is published by Cambridge University Press. You can also order the book from Amazon.  

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