Many startups fail on the bumpy road to becoming a successful company, we want to help you to become one of the ones that makes it. This article is the first of a series of articles that will come out every six weeks. The purpose of these articles is to explain to you how we see the life of a startup and how we think you can be more successful.
This first article will talk about our view on the startup lifecycle and introduce the topics we will cover in the next articles in more detail.
Most startups find their inception in a bar late at night. If, after brushing off the hangover, the idea still sounds like it will change the world for the better, you might decide to defy logic and become an entrepreneur. Your first step is making a first product or prototype and validate the product (can we make it, does it do what we want it to do, etc.). Maybe your rich uncle finally starts believing in your idea and is willing to put up some money.
Now the real fun can start: finding and optimizing your product-market fit. This is one of the most critical stages in your lifecycle where based on what your customers want, how you are able to add value for your customers and how to win in selected markets, you will optimize your product. You will think you finally got it many times, only to realize you were wrong. That's part of the fun in the end, but buckle up, this part is definitely bumpy!
Once you have found your product market-fit and gained rapid traction in your target market, it is time to start flying (or just scaling-up). To do that you probably need money from a venture capital fund… Since you have started growing quite rapidly in your target market, you might already be on their radar. But how do you make sure you get from that radar to a signed term sheet?
We believe the answer is preparation (my mom was right after all). Before you walk into the VCs office you need to know: where do I want to be in 1 year? 2 years? 3 years? How are we going to get there? Do we have the capacities to get there? What capabilities do we need to bridge and how? Who do we need to hire? Etc. We call this building the foundation for scaling-up.
So here is our vision: raising money is not the goal. It is a consequence of a well thought out process. First we need to know where we are today (what's our revenue, # of clients, etc.) and where we want to be in a 1, 2, 3 years. To road to get there starts with your strategy which is translated in an operational model, which is the detailed roadmap to reach your goals. With the operational model we can make a financial model that tells us how much money we need, what our valuation ranges are, etc. Based on the operational roadmap, the funding needs, and the markets we want to play in etc. we will decide on the funding strategy and lead you through the process of getting funded.
Below an overview of what this could look like. Each topic is briefly described below and will be explained in more detail in the next articles.
(Long term) strategy development
- What is your winning aspiration? In other words, what does winning look like for you? For example, do you want to be the market leader in terms of volume, profitability or do you want to be the cost leader?
- The next thing we work on with our clients is answering the question: where do you want to win? What geography and what market do you want to win in?
- Once we know what winning looks like and where we want to win, we need to understand how we are going to win in these markets. This is your product/market fit. Only a thorough understanding of the industry and more important: what your customers want, can tell you how you will be able to add value for your customers and win in your selected markets.
- What capabilities do we need to win? This will tell us what capabilities we already have and what gaps there are in our capabilities that we need to bridge to win.
Build operational model
The operational model translates your strategy into a detailed plan. It tells you how to implement the strategy and reach your goals (milestones). When composing the operational model we try to understand the capability gaps which have surfaced from the strategy development and look how these gaps can be bridged. For example the strategy sets the sales target and in the operational model we look at how many sales employees are required to achieve these targets. We also examine the production capacity of the factory and how this aligns with the targeted revenue. Furthermore in building the operational model we also take the conversion rate of advertising into account and calculate what marketing budget is required to reach the objectives (milestones).
Build financial model
Once the team is aligned, the goals are clear and the KPI's have been set the financial model will indicate how much financing is necessary to reach your next goal (milestone) and how this required financing changes if the growth trajectory changes. It's very important that the financial model is flexible in nature as the projected revenue will most likely be off target. Contrary to the projected revenue the projected cost should be 100% on point. This allows you to use the financial model as both a budget forecasting tool and a cash flow balance.
The financial model also helps in determining the valuation of your startups which most likely has, contrary to an established company, very volatile flows of revenue if it makes any at all. Valuation is both an art and a science. In our experience with traditional methods of valuation (Discounted Cash flow method) the principles of forecasting cash flows require a different approach as startups have little or no historical revenues. A more appropriate alternative which seems to work more effectively is the bottom-up approach. Here the value of a company is estimated by looking at the value drivers and estimating how much these will change if the underlying parameters reach a new milestone. This will be covered extensively in the third sequel of these papers.
Create funding strategy
Once the financial needs of the startup are estimated the question arises how and where to (go) attract financing. This is a cumbersome process because it can take anywhere between 3 months and a year before funds are collected. Therefore an early start is important in order to prevent a dry run.
When composing the funding strategy, the financial model, strategy and operational model are equally important. The financial model serves as a guideline for the required amount (how much?) but also the type of funding round (angel, seed or series A) and the preferred source of financing (notes, equity etc.). Furthermore the strategy and operational model provide insights on what type of investor is preferred as these can also bring experience and connections to the table.
In conclusion, if a British fintech startup aims to raise EUR 2m for its US expansion it is important not to target an angel investor as these often provide smaller amounts of financing (Sidenote: 20 smaller angel investments of EUR 100k amount to EUR 2m but the chances of that happening are rather slim but more importantly would you want 20 angels looking over your shoulders?). Furthermore as a startup you would want to have a partner on board with knowledge of the US market and experience with fintech.
The funding process is about discussing the terms which include economic terms (Price, Employee Stock options etc.), Control terms (Board of directors and protections) and other terms (Dividends and right of refusal).
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