If you plan to launch a startup, at some point you’re going to face a dilemma. You might have the most innovative, disruptive idea in the world. But without investors, it’s worth practically nothing.
Funding is one of the key ingredients that can mean the difference between success and failure for a young company. And budding entrepreneurs that know how to secure capital are in the best possible starting position.
That’s why we invited Pau Fernandez to talk to EU students about how entrepreneurs can finance their business ideas. Pau is the CFO (Chief Financial Officer) at Factorial, a startup that builds innovative human resources software and has over sixty-thousand corporate clients.
He has spent most of his career working in senior financial roles, with a brief stint running his own company. Although his startup – a “football wiki” – wasn’t successful, he learned many valuable lessons from the experience.
In this post, we’re going to look at the main insights from his discussion. If you find the idea of running your own startup appealing, you’ll learn exactly how to finance it successfully.
1. Understand Your Idea Is Worth Nothing by Itself
Entrepreneurs should understand from the outset that an idea by itself doesn’t have any intrinsic value. You could be primed to build the next Microsoft or Apple. But without implementation, nothing will happen.
Pau said that entrepreneurs need to seriously think about the practical dimension of bringing an idea to market. This involves validating your idea and finding a strong product-market fit. He recommended Steve Blank’s customer discovery framework, which consists of four consecutive stages: create the hypothesis, test the problem, test the solution and (if necessary) pivot.
In essence, you’re asking, “Is somebody willing to pay for my product or service?” To convert your idea into a business, you need to be able to change prospects into customers.
You’ll likely find that your friends and family say they love your idea. But when you ask for their credit card details, the excuses start to roll. So you need to talk to a broad cross-section of people to see if they’re willing to pay for it.
Pau also recommended that entrepreneurs should think about working for a startup to learn practical skills like the ones described above, rather than jumping in at the deep end straight away.
2. Build Initial Revenue
In order to test, prototype and pitch your idea to investors, you need a preliminary war-chest. Pau recommends the “Three Fs” as an initial source of investment: friends, family and fools.
In the early stages, it’s essential to demonstrate that you have traction to investors. You don’t need thousands of customers. But you do need to show that there’s definite interest in, and support, for your idea. Some businesses can produce revenues from day one. Most can’t, however, especially if they’re online. So you will likely need to account for this.
When you start to talk to bigger investors, you’ll need to prove three things. First, that people are willing to pay for your product or service. Second, that you can generate margins and in particular contribution margins, which refer to the amounts left over after you’ve deducted the cost of raw materials and the customer acquisition cost. And finally, that you have a short-term “survival plan” that will cover you until you start generating sufficient revenue. Keep in mind that most startups don’t make money for the first few years.
3. Look for Early-Stage Investment
Once you’ve validated your idea and generated some initial revenue, you can begin to look for other sources of money.
Pau said that government-backed soft loans are good for the early stages of most startups, assuming they’re available. He also suggested that angel investors should be considered seriously, but only as a last resource when other sources of capital have dried up.
A “business angel” is looking for a return-on-investment by risking money during the early stages of a startup’s life. This approach is becoming more and more popular as people look for alternative places to keep their money due to high levels of risk in the stock market, real estate, government bonds and so on. When looking for investors, make sure you do background checks and ensure that your values align. Don’t sacrifice too many shares in your business.
Remember that you need to prove that your company can scale. And you don’t need an elaborate business plan to do this. You just need to communicate your idea and broader strategy in an effective way. Pau suggested using a brief pitch deck to demonstrate proficiencies and opportunities without boring potential investors.
Finally, Pau emphasized that it’s essential to consult with a lawyer and create a robust shareholders agreement. Many entrepreneurs overlook this point only to regret it further down the line.
4. Hire the Right People
When it came to the topic of hiring, Pau reiterated the well-worn sentiment that “a company is only as good as the people it employs.” Entrepreneurs need to recruit talented people if they’re going to scale a company that can compete with existing players in the market.
But that poses a problem. Startups can’t offer talented individuals the same package of benefits as big corporates. So how can you, as a founder, find people that are both highly skilled and committed?
First, leverage personal connections as much as possible. Second, if somebody is essential to your company, give them an equity stake. This is one way of ensuring that you keep top-tier talent when you can’t pay them a salary available in a large company. You should also offer team members more freedom and flexibility than they might find elsewhere.
Technical skills are also essential. Businesses nowadays have to leverage new technologies to gain a competitive edge. So when you find good technical people, do everything you can to hold onto them.
Also, remember that superheroes don’t exist. You can ask a lot from your team. But maintaining standards that are too high is one of the surest ways to ruin team morale and send your employees looking for another job.
Investors will often look for a high-quality team, so you should emphasize the experience and skills that you bring to the table.
Pau also said that it’s better to have no more than three co-founders with a controlling stake. Otherwise, the decision-making process becomes far too arduous.
5. Look for Venture Capital
While it is possible to bootstrap a business, eventually you will have to look for venture capital. And most startups undertake multiple “rounds” of funding.
Pau pointed out that it’s important to remember that you may lose significant amounts of control the further you go down this route. So it’s crucial only to give away shares when absolutely necessary.
Be prepared to talk to hundreds of venture capitalists across the world. What’s more, you should start looking for money when you don’t need it, giving yourself a grace period of at least six months. If not, investors will take advantage of you. They can smell a founder that’s desperate for money before they enter the room!
When the time is right, you should also consider an initial public offering (IPO), which will provide you with extra liquidity.
6. Consider an incubator
As a final point, Pau suggested that if you’re early in the process of developing an idea or company, you should consider working in an incubator.
An incubator is a tailored environment where you can develop your business. Usually, you’ll have to give up a share of your company (up to ten percent). While this might seem like a lot, Pau said that one of his big mistakes when launching his own startup was locking himself in his room and not seeing the bigger picture.
Incubators offer free office space, mentorship and a general creative space. Accelerators offer similar services but are focused on helping companies scale.
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