“The VC method is not a smooth, seamless step-by-step production line for funding new ventures successfully. It is messy, complicated, legalistic, dynamic, and often acrimonious. It is a hard-nosed bargain in which investors and entrepreneurs carve out enough to satisfy their incompatible hopes along the journey. If you can develop an appreciation for the stepping-stone approach, valuing startups based on future multiples, venture capitalist psychology, and the nuances of term sheets, you should acquit yourself well in the cut and thrust of the great financing game.”
The key takeaways are:
Build strong stepping stones to your business plan
There are two possible great end goals for every venture capital deal – the initial public offering (IPO), or a successful trade sale of the company. To reach these goals, there is a five-to-seven-year map that charts the course of a company’s journey. For early-stage ventures, it is best if the plan is broken down into three to four major stepping stones. These typically are the financing blueprints for the business.
The author explains that this concept of building a valuable business through multiple staging posts, each of which is financed separately, is the core tenet underpinning entrepreneurial finance.
The stepping stones typically relate to product development, acquisition of customers, recruitment of management teams, and others. Each of these provides an integrated perspective on the progress of the company. Generally, these can point to the evidence that can demonstrate the business’ momentum in progress.
Match financial strategy to the stepping stones
If you have been able to build workable stepping stones and if you can execute the plans well, then it helps in raising the next rounds of funding – typically Series A, B, C, and D. Thus, it’s important for the stepping stones to match the financial strategy of the business.
So, a Series A round should help you get to the first stepping stone 1 or even to the next. It is important to note that the more funding you raise, the more you’re diluting the ownership percentages in your company.
As Dermot puts it, “This is the essence of the early-stage venture game—raising just enough to get to the next stage of development of the company (with a reasonable margin of error) in the hope and expectation of raising more capital on much more attractive terms later.”
What you need to convince the investor is – the ultimate amount is worth it, there are logical and achievable steps in raising that amount, and finally, the first stepping stone is in itself worthy of investment.
Draw a map of possibilities
Most business plans are written to reach goals linearly. And while the concept of stepping stones may seem to further emphasise this, entrepreneurs need to keep in mind that businesses are non-linear. Each stepping stone is a destination in itself, and there can be many turns along the way.
Taking the example of the fictitious company Creditica, Dermont says, “The prize being sought by Creditica in Q2 2008 might not end up being the prize attained in 2012 and beyond. There can be a series of existential crises (like the one now), making executing strategies more difficult. So the plan also needs to focus on – what are the possible big things that can go wrong, and how will the business handle them?”
The entrepreneur will also need to define what are the big options that may open up further down the road, and how can one take advantage of those. Thus, always keep a plan B, and be open to big options that may open up later. These options may not necessarily be open today, but you may find them at a later stage.
Create a map of alternative sequences
While it is practically impossible to articulate the twists and turns that may occur in the future, one can create a high-level map of major alternative sequences. This will also help the team to think laterally and show alternate ways of developing the business.
Figure out the resources needed
At a broad level, try to map out the resources you would need to jump from one stepping stone to the next, to finally reaching the end goal. The idea is to create an in-depth view of the resources you would need. Based on this, you can find the investor you need to finance that first push.
Work on a win-win deal with the investor
Once you find an investor suited to help you reach your first stepping stone, you need to hone your negotiation skills and convince them that the value of your startup will increase by at least two to four times. This gives the investor a share of the final price, and the entrepreneur gets leverage to pursue his goal.
“Don’t forget that all the investors who will finance the jumps to future stepping stones will need to be allocated a piece of the prize as well,” Dermont says.