A well chosen board: collective wisdom that will will take you places.
Do You Really Need a Board?
Legally, every company is required to have a board of directors. It could be just one person (i.e. you), but building a well-functioning board is an opportunity to increase your startup’s chances for success. The board is responsible for authorizing major decisions like senior executive hiring and compensation, issuing debt and equity (including stock, options) and approving budgets/strategic plans, major expenditures and significant transactions.
Many founders I’ve met are focused on their percentage ownership in the company as the primary measure of control, with 51% often the magic number. But the reality is that very few decisions require a shareholder vote – generally, raising money or selling the company. As noted above, far more decisions (including those that require a shareholder vote) require board approval, making your board at least as, if not more, important to controlling the fate of the company.
A good board helps you refine your strategy, improves your decision-making and adds stability to your company. It should also help you recruit senior managers, secure customers and partners and raise capital. Board members can and should make introductions to relevant parties and sometimes help you close the deal. Having the right people on your board also increases your credibility with these parties, allowing you to punch above your weight. You can use positions to attract highly-experienced talent that would otherwise not be interested, available or affordable.
How Do You Build the Board?
The ideal size and composition of your board can and will change over time depending on the stage of the company. As a general rule of thumb, smaller is better and an odd number is often preferable so there is no potential for a tie vote that is the same as a “no” vote (in practice, this is quite rare, however). Given the importance, be very thoughtful about who you add to your board. Each board member should add some unique value or perspective and be able to work effectively with the other board members and the senior management team.
Initially, just you and/or your co-founder is probably sufficient to make sure you can move quickly and get your company set up the way you want. The CEO should definitely be on the board and lead the meetings. If the founder is not the CEO, it may be appropriate for him or her to have a seat as well, but beyond that I don’t recommend having anyone else from the management team on the board. They will pretty much always vote with the CEO and don’t bring much fresh perspective. The remainder will be made up of investors and independent “outside” directors.
Often, your board will expand or change each time you raise a round of financing. Investors should hold seats that are roughly proportional with their ownership of the company. For example, if an investor (or group/series of investors) owns 20% of your company, then one seat on a five-person board is appropriate. In order to maintain this relationship, early investors may need to give up their seats to later investors. Smart investors bring a lot of value to your board given that they have broad experience with similar companies and business models as well as relationships with industry players and potential follow-on investors. That said, the marginal value of adding additional investors to your board goes down quickly and investor-dominated boards are not ideal.
Your outside directors are a tremendous opportunity to add talent and guidance to the company. Given the math below, it makes sense for the early outsiders to be people you know and trust so that you can rely on them to not only help guide the company but to be aligned with your vision should there be critical early decisions to be made. That said, resist the urge to appoint them based solely on the reliability of their vote and instead pick people who bring real industry knowledge and contacts to the table. As the company grows, you will likely add outsiders who lack a personal connection, but if you choose individuals with wisdom and integrity, you can be assured they will act in the best interests of the company and its shareholders (including you). This may not always be in your best interests as a manager, but this needs to be OK as your goal should be to maximize the value of your equity not to protect your compensation or perks.
See below for the ideal board based on each stage:
Resist the urge to expand your board beyond seven people until you are much larger or publicly-traded as it makes scheduling and decision-making more difficult. One way to accomplish this goal is by appointing “Board Observers” who have the right to attend meetings and receive information but don’t have a formal board seat/vote and/or by allowing people (e.g. the larger management team) to attend meetings by invitation.
How Do You Compensate BoD Members?
In an early-stage company, it is generally not necessary to compensate management, founder or investor board members. Each of these individuals typically already earn cash compensation based on their management roles and own a meaningful equity stake in the company. Some companies provide a small stipend to their outside directors (often paid on a per-meeting basis) but the primary compensation is usually via participation in the management equity plan. For an early-stage company, each independent director might receive 0.5-2.0% of the company, which gets diluted over time. The company should reimburse the directors for their out-of-pocket expenses incurred while attending meetings or otherwise discharging their responsibilities.
The bottom line is that a good board makes you more effective and increases your company’s probability of success. A bad board not only does the opposite but can make your life miserable. Be thoughtful about how you assemble your board and seek the advice of experienced mentors and advisors to ensure you do it right.
Now that you’ve built your ideal board, stay tuned for next month’s article on how to manage it…
Photo courtesy of Christopher Michel.
A trove of profitable information may be hiding under your horizon.
Photo courtesy of Christopher Michel.
Are you overlooking a revenue opportunity?
In the past you could identify a location, sink a well and black gold would flow from the ground. Today, all you need to access these riches is to identify data sources that already exist in your business and drill down into it, or information you could have access to, but have yet to collect. With a bit of analysis and help, you can create new revenue streams by monetizing your un-tapped data, by thinking of it as “liquid gold,” while creating rules of engagement with your customers so that all this is transparent and safe for everybody.
A lesson from Facebook
Facebook founder Mark Zuckerberg, who hopefully just learned the hard way that data presents huge opportunities provided you use it responsibly, recently described his business before Congress as a “community” (with 2.2 billion members), a vehicle to connect people all over the world. In reality, Facebook is a data / advertising company whose currency is your information. It collects hundreds and sometimes thousands of data points from its users, aggregating and monetizing them by offering targeted advertising to various companies while maintaining control over them and making a fortune! Mark’s net worth is currently $66 billion – all built with my information and yours.
You too may be sitting on a wealth of untapped data or the opportunity to collect it. Most of us don’t like to stray from our core businesses; however, in today’s environment it’s imperative to grow and diversify. Plus, having this additional revenue stream may allow you to give your customers lower prices, just as Facebook can afford to be free as long as it can monetize information collected from their customers. Mining existing data (customer lists, buying patterns, preferences, etc.) or creating simple mechanisms to capture it (apps, websites, discount and loyalty programs, collection of email addresses that access Wi-Fi at retail locations, etc.), enables you to collect, aggregate and monetize it.
Lose your fear of data
Many companies are reluctant to monetize the information they control for fear of breaching customer confidentiality. However, if the problems Facebook is facing can teach us a lesson, data collection and data use can be part of a ‘covenant’ with our customers where they get some benefit in exchange for the rights to use their information to generate revenue via ads. This, when done properly, allows a company to maintain control over the data without losing customer trust.
One way to monetize your data is by focusing in your core industry and utilizing it to enhance your sales or offerings to assist industry partners in enhancing their sales, at a price. Another is to think out-of-the-box and look at other verticals that may be interested in reaching the companies or consumers in your data base. The one thing to remember is that the goal is to facilitate the marketing effort while maintaining control over your data so that your customers’ trust is not weakened by having third parties misuse their information – which has contributed to Facebook’s current trust problems. Ensuring this takes considerable planning and dedicated resources but enables you to continuously monetize data with confidence. By following simple rules of engagement on third-party use of your information, each time a vendor needs to initiate a new marketing campaign, you create a new revenue opportunity without compromising it. This is the Facebook model: each bite of the apple generates additional revenue for your company and enables you to offer your customers lower prices or even a free service!
Your CFO can help
Like oil, data can be a blessing or a curse, depending on how careful you are when monetizing it. One of the ways a strategic CFO can help you is by applying some out-of-the-box thinking so that you can identify and collect it in a way that maintains your customers’ trust and monetize it with confidence.
Proper financial modeling is critical, but not for the faint of heart.
Work with enough early stage companies, and you’ll inevitably hear reference to a financial model. Depending on the company in question, the model will be either a mysterious topic discussed only in hushed tones, or something casually mentioned on a Friday afternoon as a box to check in the start-up’s sure-to-be rapid ascent to riches. Neither is correct; in my experience, entrepreneurs at early-stage companies almost always approach financial modeling from the wrong angle (if at all), resulting in incorrect expectations and potentially costly decisions down the road.
Here’s a quick list of the five most common misconceptions and mistakes that early-stage management teams make when it comes to modeling.
Proper financial modeling is not for the faint of heart, and it’s one of the areas in which Burkland’s on-demand CFOs excel. It requires an interesting mix of accounting knowledge and good, old-fashioned operating experience to do well, which means modeling is often the very last thing an entrepreneur wants to tackle. But it’s critical to not only understanding and managing the inner workings of your company at a granular level, but also to raising outside capital, and most importantly, to understand all the moving parts that affect your own business. Take the time to do the modeling right; your company, your investors and you will be thankful you did.
Photo courtesy of Christopher Michel.
Don’t let bad practices turn into stormy nightmares.
Photo courtesy of Christopher Michel.
Running a successful startup is a feat of enduring determination. What begins as an awesome idea for a couple entrepreneurs, becomes a growing Company that demands more attention to how you administer the business than those things which captured your excitement to begin with (i.e., product design, marketing plan, technology roadmap). Careful early attention to Finance and Administration (i.e., process, procedure, and people stuff) can avoid trouble later in what I term “nightmare growth.” This is when you are growing but your time, attention, and pleasant dreams are sacrificed to frustrations even as you sleep!
Here are four examples how a lack of discipline and culture can turn the small cracks in a wall appearing with growth over time, into a watershed dam rupture that ultimately derails a business. Avoid pending nightmares as you grow by paying attention early on to how you administer your Company.
Top management sets the tone. How they conduct business, treat people, deal with big and small Company issues, and portray the Company to the world establishes the values and social mores to be emulated internally. I’ve seen leaders in good times become driven by ego and limelight and in bad times experience significant stress – but in both cases – I’ve witnessed leaders who stray and become unpredictable or undisciplined in their behavior, causing volatility in the foundation of their culture. Guard yourself to maintain culture in good times and bad, or you’ll have employees adopt your poor behaviors or just leave.
A talented Strategic CFO can help you guard culture and even repair it in times of decay. Leaders need to regularly engage in conversations about culture, defining the values intrinsic to culture, and take the pulse of the organization through surveys or other formats to make sure they stay on course.
We’ve all heard stories of crazy dynamics inside startups that often make venture investors impose “adult supervision,” many times in the form of a new CEO. I wonder if Facebook would be Facebook if a seasoned CEO had replaced Mark Zuckerberg early on. The truth is that many times the vision and drive that a founder has is key to driving the business forward. Often, the problems begin when startups ignore cultural fit as they hire people to fill key positions, focusing more on specific skills a potential candidate brings to the job. This approach to hiring for growth can lead to “people problems” later.
I’ve found that hiring people who share the same passion that drives the founders and the CEO is more important than hiring people who seem to have the perfect skills. Spending time understanding where a candidate comes from, what inspires them, and how the work habits they bring fits with your culture will pay off in good times and in bad!
Humans are wired for fairness, so when your team perceives things as unfair, you will lose their energy and passion as they emotionally check out. In my personal experience, I witnessed a young and thriving small Company with highly paid key executives and a weak Board (i.e., proxied votes) drift into a downward spiral as employee effort dwindled and ‘pseudo sabotage’ set in as employees demonstrated who is really key to success. Compensation was not the Company’s only problem as culture was also weak, but it proved that comp structure is a cultural glue, for you nonbelievers try not paying people adequately and you’ll find out.
The Company would have been better off designing a formal comp plan that rewards a larger set of employees for rowing in the same boat in the early stages, striking a balance between base pay, incentives and upside in an exit. Prioritize creating a compensation plan early, one which you can flex up with incentives to balance growth objectives across your most critical employee base.
Cash flow always seems to be in short supply. It is a slippery slope where you lose footing fast if you start funding expenses through payables to buy time for cash to come in. This works (but still with risk) for Companies that have reliable recurring revenues, stable liquidity sources, and market power with vendors. They make tradeoffs with short term liquidity in mind as they take creative measures to pay bills.
The problem occurs with smaller and less stable Companies that begin financing growth initiatives through vendor payables. If you don’t have adequate capital to fund a growth initiative, the temptation to fund growth by slow paying vendors and growing payables is hard to avoid. After all, you have employees inside who are critical to the initiative at hand, and vendors outside who are less so. Having adequate capital to support investment decisions is an issue management needs to solve at the time the decision is made, not doing so turns growth decisions into bad decisions that create bigger problems. There is always embedded risk in any strategic decision you make (e.g., one that requires incremental short or long-term resource investment), understanding that risk and how/when it trades into cash is key to understanding how you should fund the initiative at conception.
Increase your odds of winning by setting smart goals for the new year.
KPIs, MBOs, OKRs. You’ve probably heard of these and several more ways to set your company’s objectives. With so many options to get to the same goal, it is no wonder why by the middle of the year, objectives, as originally set, often go the same way as New Year’s resolutions. The problem often lies on the goal development: sometimes goals are crafted at the leadership level and not effectively shared and refined with the rest of the organization. Also, there’s a tendency to focus on numbers without regards to the operational goals that drive these numbers, for example, growing revenue by x% (a key business goal) may require sales restructuring (an operational goal).
OKR: a framework that may work for you
Although there is no magic formula for setting goals and sticking to them, I’ve found that the framework provided by OKRs (Objectives and Key Results) can set teams on the right track when it comes to goal setting. Before going into details, diving into the Wikipedia definition of OKR can be useful:
“[OKR’s] main goal is to define company and team “objectives” along with the measurable “key results” that define achievement of each objective. One OKR book defines OKR as “a critical thinking framework and ongoing discipline that seeks to ensure employees work together, focusing their efforts to make measurable contributions.”
The key term to focus on is “to ensure employees work together.” The OKR framework is good at steering top management to align their goals with those actually in charge of driving the business towards them throughout the year. This means that as you think of OKRs, you need to make sure you’re delivering on the key initiatives the company needs to get done to get to where it needs to be. I find it useful to think of a “value chain” that will support the OKRs with specific initiatives from your team.
Some guidelines about setting objectives and key results
Setting goals and key results together – which is basically what OKRs are all about – can help you create the discipline to have the right internal conversations initially and throughout the year to ensure the team stays focused.
Here are three easy ways to get you going:
The benefits of using a framework like OKRs go beyond just ensuring you develop objectives and meet them. Crafting objectives and key results together disciplines thinking at all levels, communicates the company’s vision accurately, establishes a measurement culture, focuses the effort of your team and enables employee engagement.
Are you ready for OKRs?
Goal setting using OKRs is valuable regardless of your size. As stated before, creating a culture around setting measurable objectives is always a good thing. Think in terms of developing OKRs around functional or product teams in addition to the executive team.
No matter your size, aligning goals with the specific results needed to get there will only result in an organization where everyone – from the CEO to the most recent hire – point their efforts in the same direction.
To play the marketing game prepare a solid marketing budget with which you can win.
Photo courtesy of Christopher Michel.
Crafting a marketing budget can feel like a guessing game. The options to invest your marketing dollars could seem endless, and you could spend weeks debating what will move he needle for your startup. In this article, Steve Lim, Vice President and Head of Marketing at Vantage Data Centers, and I have put together a quick guide that our CEOs and their marketing teams have found useful for budgeting marketing spend. We divide this brief guide in two parts: the three guiding principles for guiding your plan and the process for defining your marketing scope
Guiding Principles: The 3 Cs of your Marketing Budget
We’ve found three simple guiding principles we call the “3 Cs” that can help you navigate your marketing budgeting options.
Your budget must include spend for the key areas:
1) brand awareness
2) content and tool creation
3) demand generation
Specifically, to drive awareness for the brand, you need to budget for public relations, social media, websites and digital presence as well as other brand related programs that reach customers but do not drive direct lead creation or engagement. Then, to develop content and tools, you need to budget for thought leadership content and sales tools. The important thing to keep in mind is that you need an ongoing strategy to tell your story in a compelling way and to portray your company & products in a positive light. Finally, to deliver contacts and leads to sales, you need to budget for things such as digital programs, digital media, trade shows & events, and partner marketing – all of these create a blended program that directly engage customers and drive lead or contact creation for sales teams.
We recommend that rather than using rules of thumb, you calculate estimated marketing spend based on lead conversion or customer acquisition costs (CAC) payback period. To do this you need to incorporate specific building blocks, including:
For each category of marketing spend, there is a minimum threshold. Either you commit to spending a certain amount or, in the category, forego spending anything. Do not try to find cost savings in specific line items. The worst possible scenario is to try and execute a plan after your board agrees on that plan but asks for simple percentage cuts across the board. You have to look at each area of marketing spend and determine what the minimum threshold for spending should be, and either decide to proceed or cut entirely. This is especially true for demand generation programs that drive direct contact acquisition and lead creation. For example, activities like media spend (digital ads, SEM, etc.) require a certain level of investment with some consistency over time to tune, adjust and manage before you see real results. If you cannot commit to spending consistently for a minimum of 6-12 months, you are best to forego this activity completely.
Some areas are more flexible in how you can tune spending up or down, but you need to ensure that you know the thresholds for each as well as the overall mix of spending required across the key areas of marketing. Properly planned and executed marketing is a well thought out mix of spending across the key areas with deliberate thought to how each investment influences the activities overall – essentially the sum is greater than that parts.
Process: Size and Shape of your Marketing Budget
You need to spend time to determine the right size and shape for marketing spend based on your unique circumstances and your market.
The size of your marketing budget should be based on an overall estimate of spend. To determine the range for marketing spend, we recommend using the average cost for an inquiry and lead conversion analysis to estimate the spend per closed/won opportunity (Marketing program portion of CAC). With a range of estimates for leaders and laggards, you can then determine the overall Marketing spend level with confidence. It’s important to note in the process, however, that there are both minimum thresholds that you need to be conscious of and ceilings that are capped based on total addressable markets. Simply put, you have to spend at certain levels across marketing to achieve any results at all – if an average cost per lead is $100, you can decide to invest $100 and get one lead. On the other end, you should not assume you can put an unlimited budget into marketing and generate infinite leads. You’ll be limited by the total addressable market and by some basic assumptions about what a reasonable penetration percentage is for your target market.
To size the marketing budget determining the average costs per inquiry, answer the following key questions:
The shape of your marketing budget is determined based on the relative importance and spend between brand awareness, content & tool creation, and demand generation. For an early stage company to build infrastructure and capabilities, there is a minimum amount of spend needed in all areas. In later stages, companies can shift emphasis and spend depending on whether they need to build awareness, capabilities or sales leads. The shape is also determined based on the approach to planning and executing your marketing programs. This approach can be either agency or internal-resources led with the appropriate management resource for each approach and is a basic build vs. buy decision. To achieve high levels of quality, many startups should use an agency-model until they can hire enough people to assume relevant functions – after all, the trend in marketing – and in finance also BTW – is rent versus own.
Co-author Steve Lim is Head of Marketing at Vantage Data Centers. He has deep experience in marketing strategy, field marketing, sales enablement, program development & delivery, content marketing, and operations.
Make sure you fill those crucial initial spots with a great team that will take you places.
Congratulations to the Houston Astros, 2017 World Series Champions, and to the city of Houston who can use the win after a rough summer of devastating storms. How did the worst team in baseball in 2013 with only 51 wins turn it around so quickly and reach the pinnacle of their sport? They committed themselves to building the best possible team using all means available. The Astros beat the Los Angeles Dodgers, another great team that also had a great season. Both teams won over 100 games and survived a tough run through the playoffs. Also, both teams made major in-season moves that just may have been crucial to getting them to the World Series.
Assembling the best team
Like every other major sport, it’s now conventional wisdom that to win a championship, you do everything you can to put the best team on the field. The Astros traded for Justin Verlander, who went a combined 9-1 in the remainder of the regular season and playoffs and was key to all three of their playoff series wins. The Dodgers picked up Yu Darvish who helped solidify their rotation and get them to the World Series. Last year, it was Aroldis Chapman joining the Cubs and Andrew Miller joining the Indians. In 2015, it was Johnny Cueto and Ben Zobrist for the Royals and Yoenis Cespedes for the Mets.
This lesson applies just as well to startups and to companies as a whole. The best team wins, and the question to ask is: are you doing everything you can to put the best possible team on the field?
I spent 13 years as a venture capitalist and during that time we had a saying. If the three most important factors in real estate investing are “location, location, location”, we often said the three most important factors in VC investing are “management, management, management.” We would take an “A” management team with a “B” idea over the reverse every time. Why? Because we had confidence the “A” team would be able to handle all the twists and turns required to successfully navigate the startup minefield and eventually find the “A” idea. While the “B” team might just get stuck and fail to execute.
As a founder and entrepreneur, I had the same experience regarding the importance of having the right team. No matter how novel the idea, there were always multiple other companies chasing the same goal. With the proliferation of startups, accelerators, incubators, seed funds, crowdfunding, etc, this is likely more true today than ever. There is no doubt that timing matters. Market size matters. Business model matters. But all else being equal, the better team has a much greater chance at winning. I’ve seen it personally from both sides. Bet the jockey, not the horse.
The relentless pursue of opportunity
Of course, as a startup you don’t have unlimited funds to pay seasoned leaders to join your team. So, you need to be creative and grab talent whenever and however you can. Probably the best definition of entrepreneurship I ever heard was from legendary Harvard Business School Professor Howard Stevenson, who defined it as “the relentless pursuit of opportunity beyond resources controlled.”
I joined Burkland Associates about a year ago and one thing that has surprised me so far is how many founders I’ve met who spend their time building Excel models, creating pitch decks and even doing journal entries and reviewing expense reports instead of leading their companies. At a stage where assembling a great team is crucial, a great founder focuses on setting the vision, charting the course, motivating the team and assembling the resources to be successful. Recruit a team of experts – full time or part time, employees or consultants – to help you execute.
Justin Verlander and Yu Darvish may only take the ball every fifth day. They may not even be around 2-3 years from now, but this year, they made all the difference. The lesson to learn from this is: who can you add to your team to give you the cover you need to put you over the top?
Think about it.
There will be storms ahead. Make sure you learn resiliency from the ones that came beforehand.
Photo courtesy of Christopher Michel.
For millions of people in the U.S. and the Caribbean, the summer of 2017 is synonymous with tremendous suffering and loss, as one of the most active hurricane seasons in history hit their communities. As tactical response to the storms scales down and recovery begins, strategic focus will shift to making critical systems more resilient – such things as the water levies in Houston, and the power grid in Puerto Rico.
Although there is a world of difference between how governments and organizations respond to the challenges of large-scale disasters like storms and how a management team runs a business, I think there are some valuable resiliency lessons that can be drawn for startups.
When I’m not working as a consultant, I serve as a Civil Air Patrol liaison officer to FEMA’s Region II. In this capacity, I’ve worked six major hurricanes in the past several years, including Sandy in 2012 and this year’s Irma & Maria. Aside from master-of-the-obvious missives like “failure to plan is planning to fail,” here’s my top five list of lessons from disaster response every CEO can incorporate into their business strategy.
In many cases, your CFO can help you not only properly define your company’s strategic goals, but also help you execute the day-to-day demands in order to reach them in a focused and efficient manner. Like with disaster response, there is no one thing that makes all the difference, but rather countless small elements that make up the overall effort. To sum up, remember another old saying: Manage the little things right, and the bigger things will take care of themselves.
If you’re in for a long race, venture debt financing could give you the air you need to get to the next peak in better shape. Photo courtesy of Christopher Michel.
Raising venture debt is always an interesting subject for startups. For some CEOs it is completely off their radar, and for others it is a taboo subject. In between these extremes, there’s a growing number of startups using venture debt effectively to buy time for a higher valuation, making it a cheap form (in terms of amount of stock it costs) of financing while the value of your company rises.
I thought we could shed some light into whether venture debt is a good thing for your company by creating a simple model you can use to project its long-term effects on your valuation and on your stock and explore if it makes sense for you. For a sense of the value of this exercise, under a relatively conservative growth scenario, Venture Debt could save the company from having to give away 3% of equity. Before getting into detail about how this model works, it’s worthwhile to spend some time reflecting on a couple of issues you will need to think through before raising money this way: covenants and purpose.
Covenants and Purpose
Many think that some banks and venture debt providers require excessive terms and may tie up the company with covenants that hurt you in the long-run. Our experience with this is that most of the terms and covenants can be negotiated, with the exception of the investor support covenant, which requires the venture investors of your company to agree they will continue to support the company or the covenant is triggered. Even the MAC (Material Adverse Change) covenant, which seems to be the most draconian of all because it gives the venture debt provider the option of not following up on their promise if there is a significant change in the company (based on their definition), can often be negotiated. What you need here is a supportive board that has a venture investor with venture debt experience, working closely with you and your CFO to ensure you get the best deal for the company.
Putting in place venture debt is best done right after a VC raise. You can usually structure it to pull the funds much later – and face only a small portion of the costs before pulling the funds. The goal is to have it available in the future in order to buy time for growth so that the next round comes a bit later, giving you more time to increase the value of your company. This means that growth should be the purpose for making your case to raise venture debt with your board. Emergency money or, worse, an excuse just to spend more, is what this kind of financing can unfortunately be wrongly associated with. Although if it comes down to using it in the event of an emergency, that can also be a valuable use, but in that case, it’s usually just to give another shot at pivoting and potentially save the company rather than juice value. In any event, raising venture debt with growth in mind, before you need it, will help you get better terms with debt providers and negotiate favorable covenants.
The basic assumption behind our model is that you’re raising venture debt for the purposes of growing. As such, the spreadsheet helps you look at two scenarios of growing: with and without venture debt. The results, once you input your numbers, are quite simple:
If there is a positive number answering these questions, then you should take a closer look at venture debt. We plugged in numbers to show you how it works, feel free to substitute these with yours (red fields are input fields and the two key outcomes are highlighted in yellow).
Click here to access the spreadsheet.
The model begins by assuming a venture raise just happened (Cash at the End of Period 0, $10 million in the example). In the example, you raise $5 million in venture debt, giving away 0.2% of equity (0.1% when you put the facility in place and the other 0.1% when you draw the money), and paying a setup fee of $30,000. Cash burn is the same in both cases ($3 million), except for the venture debt payments. The example assumes a valuation growth of 25% every period (in this case, every 6 months). Note that you pay the bank the initial fee ($30,000 in the example) even though you don’t draw the venture debt of $5 million until you need it in the third semester.
This model is built to show the debt enabling a six-month funding delay in your next round ($20 million in the example) and assumes the same valuation for both scenarios, as it is just comparing financing structures in isolation. The result in the example: you raised money at a valuation of $97.6 million in the last semester rather than raising it at a valuation of $78.1 million six months before. The net value saved was $3 million, leaving you with 3.07% in equity you can keep. Not too bad!
Does venture debt work for you?
If you plug your numbers into our model through this link (red marks indicate input fields), you will see the impact of using debt in addition to equity for some of your financing. The model buys you time, but you need to keep in mind that growth needs to happen.
Venture debt works when it buys you time for a better valuation because things are going well. You pay for this time with debt and not with equity, saving you equity in two ways: initially by raising debt, and then afterwards by using that debt to get to a better valuation. If your growth scenarios come to fruition, venture debt enables you to raise money a bit later than you would, when the value of your company is higher. That is a great deal if you’re good at forecasting. You can also explore the impact of the debt using different growth scenarios, thus further exploring the potential value or the downside. Have fun 😉