Fundraising is always front of mind for every startup, early-stage, or growth stage company. Although each stage has different funding requirements, financing throughout a company’s existence will always be a critical factor in determining if a venture meets its full potential. You can bootstrap in the beginning and get away from funding for a while but eventually your venture is going to need some real gas in the tank. The more you understand how these financings work and how to prepare for them, the better positioned the company will be for success.
The Early Stage
The financing options in the early days of a company’s existence are typically limited. The reality is that in the beginning, you are selling the dream. It takes time to produce the revenues or assets needed to open additional financing options like credit or debt so you’ll need to sell the future and potential and that typically means selling equity. But, selling equity in your company does not have to be a terrible outcome. If you align yourself with quality investors that are aligned with the vision, you will not only fund operations, you will also expand your team with partners that have a shared goal for the success of your venture. Good financial partners with some skin in the game and a vested interest in your company can and should provide new resources that you can leverage to help drive growth.
Once a company is funded and operational, then it’s all about hitting milestones and advancing the initiatives laid out during the funding process. If you are achieving the clear goals you have laid out with your investors, the more likely you are that these investors will continue to fund the company or that you will be able to bring in new equity investors. One of my company’s largest investors has a motto that we adopted into our way of thinking in the early days; “Eat what you kill”. If you are killing it, you can eat or in this case, you get funding, so have your goals clearly laid out with your early investors and make sure you execute so you can go back for more money when you need it (and you will need it).
Entering into the Growth Stage
The early days are often duck and cover for companies. Long days, stressful development cycles, crucial commercial deals; these are consistent with all start-ups. If it was easy, everyone would be doing it, and it is not easy. Far from easy. But, if these companies stay focused, are persistent, and continue to hit milestones, eventually they are going to look up and realize that their little company has grown beyond the start-up or early-stage and is now in the growth stage, preparing to scale from a proven market fit. This new growth phase is exciting because it is proof that you have been successful building a great product and in growing your venture but growth needs capital and typically this stage means much more capital. The days of bootstrapping are well behind you. Welcome to the world of “Series B+ financing”!
The challenge of funding a rapidly growing company is not just the money, it is also the type of money you secure. Growth will require significant resources and often this means funding levels well beyond what you needed in the early stages. Typical “B” rounds are in the 8+ figures and that brings a whole new set of requirements and hurdles but, depending on what value the company has created by the time it needs to raise series B-type funds, there may also be new options for funding.
Options beyond Equity Funding
The evolution of venture debt has become a new potential source of capital for growing companies. Debt is often considered a dirty four-letter word in the venture world, but the reality is debt can also be a terrific way of funding your company without giving up much or any equity. Not every company can qualify for debt financing but if you have built certain key assets when you need this growth capital, debt could be possible.
Typically, there are two qualifiers that need to be present for venture debt; revenue and/or intellectual property (IP). You don’t need both although it helps to have a growing revenue stream backed by solid IP. Revenue does not need to be current, you can have purchase orders or contracts in hand, but without a solid revenue stream or guaranteed path (contracts/PO’s) to significant revenue, there is nothing to protect a debt funder against default. However, not having a significant revenue stream in place does not prevent a company from qualifying for venture debt.
Some tech companies have built impressive technology platforms on the way to creating their “killer app”. These companies, backed by strong patents, can qualify for venture debt. Patents will need to go through an extensive valuation process to determine if there is enough value to use as collateral against a loan. The assessed value of these patents usually needs to be four to five times the value of the loan but, for some companies that have created significant protected IP, this asset can be used if their revenues are not yet to the level needed to qualify for a credit-based financing. The key will be to have created something with real value that these venture debt firms can use as collateral to protect their loan.
The IP valuation process, however, is no joke. There is a tremendous amount of due diligence done by the lenders to put a credible valuation on your IP and often this due diligence will require significant input from the team that created that IP. If you go into this IP valuation process with open eyes, understanding it is a grind and can often require many, many hours with the company’s team that developed the IP, you won’t be caught off guard. But, even with realistic expectations of the IP diligence process, it is still going to be longer and more involved than you expect. Get through it and you have proven the value of your IP and from that assessed value you now have an additional asset you can use to secure that loan.
Once the company has produced either the revenue opportunities or IP valuation needed to qualify for venture debt, the next critical step is finding the right venture lender. There are many horror stories of venture debt “vultures” loaning money with difficult terms and then working to seize control of these companies if any of the loan conditions are not met. Typically, these terms or “covenants” are based on minimum revenues or minimum cash reserves but there can be other covenants depending on the loan. The risk is that thorny covenants from a lender that is not aligned with the best interests of the company will, at best, lead to friction throughout the loan or, at worst, you will lose your company.
Reducing Debt Risk
The remedy for reducing this risk is to really to do your due diligence on your potential lender. Venture lenders will be interviewing you as a potential client, you should be just as thorough interviewing them. The wrong lender could be catastrophic but, like equity investors, the right lender will provide funding and a partner to help you move your company forward. During this due diligence process, the questions you should be asking are:
- Does the lender have a history of working with portfolio companies when they fall into default on their loan covenants?
- Have they foreclosed on any loans in the past and if so, why?
- What are these lenders like to work with? Past or present clients should give you some insight into the working style of the lender and whether these lenders are friends or could be potential foes.
The track record of these lenders will give you a good insight into how they behave in difficult times and there will almost always be difficult times. When, not if, the lender’s clients have missed their covenant conditions, how did the lender work with the companies to resolve the issue? These are all data points you can and should gather before formalizing any kind of loan with a venture lender to know whether that lender could be a fit for you and your company.
Financing is always a hard road, but the good news is that today, there may be more options than there were just ten years ago. Venture debt can provide an additional option for companies that need to scale and grow but may not have the right profile for typical venture capital or would prefer to avoid dilution through debt vs. equity. Every company is different but for those that qualify for venture debt, it is an option you should explore. The right venture lender will provide funding and can help you avoid significant dilution as you prepare the company for growth. Debt, in the end, may be the right path to getting your company to the critical next stage so before you dismiss the option as too complicated or somehow a nefarious move that will cost you your company, think again. Sometimes, when you find the right partner, debt can be the best option for your company’s growth and in the long run it may be the best choice for preserving equity while still moving that ball ahead.
Ned Hill, CEO Position Imaging
Ned Hill is the founder and CEO of Position Imaging (PI), a pioneer in the field of advanced tracking technologies. Ned has raised close to $50 million in equity financing and $30 million in venture debt led by GT Investment Partners. Ned is the inventor or co-inventor of over 50 patents/patent applications, has been an invited speaker at industry conferences including CES, Live Free and Start, and at MIT, and leads Position Imaging’s technology, product, and partner roadmap.