When you are an inexperienced entrepreneur, managing your funds is a tedious process. Nevertheless, entrepreneurial finance is the backbone of any successful start-up.
Our EWOR Academy students had the opportunity to hear from Dr. Veronika von Heise-Rotenburg, a specialist in start-up financing. She’s the EU Finance Director of Cazoo and has managed finance and legal departments at various companies.
In this article, Veronika will teach you how to approach entrepreneurial finance and avoid common pitfalls.
The Beginning of Your Entrepreneurial Finance Journey
Unless you have a finance background, it’s hard to figure out the first steps of funds management in your start-up.
You don’t have to do complex balance sheet accounting to be successful. In fact, you don’t even have to make a profit in the early days of your start-up.
Keep track of your liquidity, especially in the pre-seed phase. Is your money going to last long enough for what you want to do? At this point, all you need is a simple Excel sheet and a clear understanding of your spendings.
Don’t invest in an accounting team when you don’t need one yet. Know your liquidity basics and be detail-oriented in your tracking to create a clear overview of your finances. Ideally, you’ll have someone on your team who has a finance background or is a fast learner.
Tips for Financing Metrics
Finding the right financing metrics is important for any start-up. The perfect metrics vary from founder to founder based on your business model.
As a general rule, don’t discuss overhead costs during the first few years. Even though rent, utilities, insurance, and marketing are important, don’t dwell on them during the launch phase.
Instead, focus on analysing your operating profit and define the income drivers. Invest your time and resources into optimising these key drivers to keep your company running.
The Best Market Sizing Approach
Before they invest in your start-up, venture capitalists (VCs) and other investors want to know your market size. Do you know you’re targeting the right market and that you’ll be able to capture it?
Generally, a big market is always better than a small market. VCs tend to prefer the biggest possible markets to make the most profit. The bigger the market and the higher your market share, the more financial success for all parties involved.
However, there is value in becoming a champion in a small market. If you can gain a large market share in a small market, it translates into more success than a marginal market share in a large market. For example, 40% market share in a niche market is better than 0.1% market share in a highly competitive and large market.
In short, don’t be deterred by a small market, if you believe you can claim it with your start-up.
When Is It Time to Look for a CFO?
Let’s say you’ve gained some traction with your start-up over a few years. When is it time to look for a CFO?
After the pre-seed stage, it’s important to hire a good accountant who’s able to keep your books tidy and neat. This basic accounting helps you pass audits and handle invoices.
The faster you grow, the sooner you’ll need someone who can do basic bookkeeping and has a strategic mindset.
A good CFO knows that entrepreneurial finance can be a value driver to help scale your business. Maybe someone on your founding team has been in charge of finances or even has a finance background.
Applied to a start-up’s timeline, finding a good CFO is typically critical after series A funding rounds. If you’re struggling with fundraising terms, check out this article.
Unfair Vesting Practices
Some investors take aggressive vesting approaches that can hurt your financial stability. It can be an unfair power dynamic, especially if you’re in dire financial need.
It’s common practice to do prolonged vesting and share negotiations that leave you tied to the company under unfair conditions. Be smart about term sheets and binding agreements, and don’t let investors take advantage of you.
“Would I personally still do it if there was no other way to get the money?” Veronika mused about this type of investor dilemma. “Probably yes.”
In reality, you typically won’t have the chance to hire lawyers during series A and series B funding. After that stage, however, invest in lawyers that work in your best interest, not your company’s.
How to Avoid Common Legal Pitfalls
Veronika shared her advice on avoiding common mistakes and good finance practices:
If something seems unfair or suspicious during negotiations, ask about it. Play dumb and make your partners explain themselves again.
If a clause sounds off to you, it probably is.
Get a Lawyer
As a founder, you’ll do anything to grow your business and lose sight of your own needs. A good lawyer will help you meet a healthy balance between what’s best for the company and yourself.
Invest in a great lawyer.
Make sure you read all clauses and agreements, even if you have already agreed on their details. Some investors hire great lawyers to twist term sheet clauses into something harmful in your binding agreement.
Read all contracts with great care.
Separate Business and Personal Expenses
When investors have a motive to get rid of you, the founder, they tend to use unfair claims.
Be careful about expenses and loans and separate personal and business spendings. Pay yourself a decent salary and use that money for personal expenses to avoid it being used against you.
Be mindful of legal loopholes and prevent making yourself vulnerable.
Give yourself the same contract as your non-founding co-workers to increase founder protection. There are better legal protection clauses in place for employees than for founders.
Protect yourself through equal contracts.
Start-up financing is not rocket science, but it demands attention to detail and a good management plan.
Make sure to find the right metrics for your start-up, monitor your liquidity, and avoid common legal pitfalls. With those business practices in mind, you will nail your entrepreneurial finance.