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Financing a startup involves synchronizing potential fundraising rounds with the key technical and business development stages. This exercise is challenging due to the lack of a track record and the focus on a promising yet risky future. Startups must juggle various resources, such as capital, repayable advances, and grants to support rapid growth characterized by often negative operating results. As the startup progresses, its financing evolves, with more sophisticated mechanisms and various exit options that strengthen the parallel between startup financing and structured financing.
E. Krieger
Financing a startup involves aligning potential fundraising rounds with the key technical and business development stages. This financial exercise is all the more challenging as the startup lacks a track record and only has a presumably promising future.
While the launch of a startup differs from large industrial and infrastructure projects, the complexity of its financing plan brings us closer to the category of so-called structured financing, designed to structure cash flows and shape the liquidity structure of balance sheets using various financial engineering tools. These solutions help address financing challenges not covered by self-financing and traditional loans.
Financial Challenges in Line with Growth Rate
The very nature of startups involves rapid growth, which creates increased pressure on investments (Capex), often negative operating results for several years, and working capital requirements.
During the creation of these startups, few assets can be provided in exchange for potential bank financing, which means that entrepreneurs will have to juggle with other resources to launch and grow.
In addition to the margins generated by initial sales, startups must mobilize a mix of new capital, repayable advances, grants, and/or other public assistance, such as the research tax credits.
Risk Sharing and Future Profit Sharing
Potential private investors (business angels, seed funds, venture capital funds and growth funds) take the risk of non-technical or commercial execution of an innovation program in exchange for a significant stake in the newly created company, provided that the prospect of substantial profits allows them to accept an even higher probability of losing everything.
For impact investors, this essentially financial logic is accompanied by a requirement to create social and/or environmental value.
The State (i.e., the public authority) is often associated with balancing these inherently risky financing plans through various subsidy schemes, repayable advances, tax credits, and contributions to seed funds and/or technological venture capital funds.
Some entrepreneurs manage to involve strategic partners in balancing their financing plans, for example, through pre-financing from future customers or key suppliers in exchange for time and space-limited exclusivity.
An Increasing Array of Financing Mechanisms
While financing the early stages of a startup development may not initially have the same complexity as the array of structured financing mechanisms inherent in large industrial and infrastructure projects, you will still need to develop a genuine financial expertise to model your financing needs and find suitable resources.
This search for financing is not limited to optimizing your weighted average cost of capital (WACC), which can be the subject of endless debates when it comes to discounting future operational cash flows. At the start of the business, the main challenge is to mobilize high-level skills to successfully execute accelerated strategies for technical and commercial derisking, which are the hallmark of startups. The confidence of fund providers will primarily depend on the quality of the team mobilized by the startup.
The ability to achieve technical and commercial objectives without significant cost and time overruns will enhance your credibility and your ability to secure new financing.
Once a startup has passed the seed stage, technological risk gives way to commercial and execution risk. The company’s development then involves more professional management, often less intuitive than at the start. This development, which generally comes with greater financial visibility, opens up new, more sophisticated financing mechanisms than before.
Exits via LBO: Another Form of Structured Financing
While most startup financial exits occur through the sale of these companies to major industrial players, some companies provide liquidity to their equity investors through Leveraged Buy-Out (LBO) mechanisms, which brings us back to a particular mode of structured financing extensively used by one of the most dynamic segments of private equity.
However, these interventions are reserved for a minority of companies that have managed to develop and are now generating significant cash flows capable of allowing a holding company to repay the acquisition debt and thereby realize a comfortable profit for new investors who have replaced the previous ones. Future cash flows of the acquired company are then used to secure multiple-ranking debt: senior, mezzanine, and junior debt.
The financing of startups at different stages of their existence resembles artistry, beyond the technological and commercial achievements required for the creation and development of these companies. This imposes on the concerned companies the need to develop genuine financial expertise within their team and/or with the assistance of their advisors.
