VC industry changing due to new platform – death or life?
Recently, I have read a very interesting article that continuous my argument that aside from many sectors the financial sector is also changing rapidly due to digitalization. The author states that:
“In my life, I have been very fortunate to chronicle the emergence of the commercial internet (as we know it) from its early days. Over next decade or so, I came to realize the amazing deflationary powers of the internet. It was — and still is — a great deflator, squeezing out middle men, friction and of course, profits.”
The author argues that the next wave of change will affect the way businesses raise venture capital. Intransparencies will be broken open by Angel List and other fundraising platforms that force a secretive VC industry to differentiate their offerings beyond the initial cash injection. While I agree with the broad thesis of the argument I would highlight two aspects that seem to be overlooked frequently.
As previously reported the VC industry as a whole does not generate positive returns. It is an assets class where only very few firms make money. These firms generally are not “smarter” than others but have a strong PR function and therefore get more deal flow than the other industry participants. If platforms now “socialize” deal flow and every investment is instantly shown to the entire industry then the professional selection becomes even less important. An automated investment distribution among Angel List offerings based on a set of pre-determined criteria would probably beat the returns of most VC firms and would require minimal direct investment attention. This would not alter the VC industry but give it the last punch in its current death struggle.
Secondly, the start-up market is now becoming an asset class that is open to the broad public. Crowd funding platforms and projects like kickstarter are already expanding the available investor base. In my opinion, this is not a positive development. Start-Ups as an asset class are much to volatile and hard to read – if professional VCs cannot create a substantial return – how can private investors do so? These platforms are setting 99% of private investors up to lose all their money invested in this asset class.
In addition, there are just a lot of businesses out there that do not deserve funding. The current funding market is a Darwin based system that kills of a lot of bad companies prior to raising capital. If the investor and funding base is now drastically increased we will see more and more zombie start-ups that live much longer than they should based on a “stupid-money” infusion through crowd funding platforms. If you look at the quality of start-ups coming out of places that received a large cash infusion (e.g. Berlin in Europe) you see so, so many ideas that should never have been funded but are now raising funds because way too much money chases too few good ideas.
Crowd funding and platforms like Angel List will significantly disrupt the VC industry but it remains to be seen if this is positive or negative for start-ups and investors alike.
VCs vs. Angel
Recently, there have been two interesting blog posts that once again highlight the ambivalence between choosing either a VC or private/business angel investor. One very entertaining rant(!) from Paul Jozefak (Liquid Labs) that focuses on the “more than money” promise each VC makes. He has a very clear opinion what VCs really provide and how their “advertising talk” should be evaluated by future entrepreneurs. (LINK) “Enough with the Kool-Aid though….without your money most entrepreneurs wouldn’t really care much about you. It’s OK, you still have your triathlon, cycling or foodie friends.”!
Protonet on the other hand has chosen to ignore higher valuations and instead go with angel investors. More about their rational here: (LINK). Interestingly enough they left money on the table in order to go with business angels among other reasons due to the easier negotiations and less tight up management time. This is often an overlooked point – VCs are experts when it comes to negotiating deals (given that aside from trying to get a proprietary deal flow that is their only other expertise ;)). If you negotiate with experts you have to take into account that these negotiations will be very drawn out. Your starting point will most likely be documents drafted by a VC who has written many, many preferable treatment clauses in the documents before negotiations have even started. So time and complexity of negotiations is an important consideration beside the price tag.
Does that mean you should leave VC cash on the table and always go with angels? Probably not … this approach will only work for smaller financing rounds – angels will bottom out if you are looking for 1m+ x – or you have to take so many angels on board that it becomes annoying to keep all of them in the loop. They will also have a very limited ability to go for another round or to provide additional capital on short notice.
So chose carefully when you are planning to raise additional funds. Make sure you understand the major pros and cons between investors and try to determine what your long-term strategy looks like. Are you going to raise more funds down the road? Do you need certain individuals in order to grow your business? Will VC connections support your business right now? … … lots of thinks to ask yourself and unfortunately this is highly subjective and there is no clear right or wrong here.
Healthcare and digital innovation?
During my work with eTribes we have completed several projects for merchants, producers and publishing houses. All these industries have already been heavily impacted by digital innovation and new, web based technologies. Many of the established players in these industries have not quickly enough “braced for impact” and will eventually disappear since their business models have become obsolet in the digitalized economy.
Recently, the healthcare sector has picked up on the ever fastening process of digitalization. Funding is moving to all time highs and even crowd funding is picking up on the trend. Rock Health recently published an interesting analysis of where funding is allocated in the United States.
“With half of 2013 behind us, we’re able to uncover some interesting insights and trends in funding in digital health. We saw continued growth with $849M invested in 90 different companies. This is 12% more money and 25% more deal volume than this time last year.”
So there is money, other industries as examples and a definite need in the healthcare industry to innovate. Therefore, we have now combined the traditional “start-up weekend” methodology with the healthcare industry and created the “Healthcare Innovation Weekend 2013” in Hamburg. We hope to encourage budding entrepreneurs in the healthcare sector to innovate and to build new businesses in this favorable environment. Come join us for an interesting and fun weekend in September!
What to do with all this liquidity…?
Encouraged by Alexander Graf and his critical analysis of the current digital environment I asked myself why so many irrational business seem to get an almost unlimited amount of funding. In Germany there is always Zalando as a great example of this trend. The business is so far not profitable and investments that by now are topping over a billion Euros will never be recovered but international money is being thrown at Rocket Internet with an ever increasing speed. Its business model is not closely examined and investors push new capital into the firm without even asking some of the most basic due diligence questions. Is it really a plan to buy up the fashion market and pray that your proprietary brands and size will eventually lead you to break even? How are logistics organized behind the shiny technology and TV commercials? Why is there such an irrational rush to throw more money at these kind of businesses? Since we are now starting to talk about investments going into the billions I am going to take a macro economic perspective to create a possible explanation.
Due to the current monetary crisis money has been pumped into our economic environment – if printing presses would still be responsible for monetary supply we would be running out of ink.
As you can see from the graph above monetary supply has increased substantially. In Europe it is a fairly even growth story but it becomes even more drastic if you look at monetary supply expansion in the United States.
What are investor to do with all this capital that has been pumped into our economy? There is no substantial growth in the “real” economic output within the developed word – in fact there is a decline based on the recession the European Economic Area and the United States are currently going through. In addition there is only so much capital that can be invested in “traditional” economies in rapidly growing markets e.g. BRICS countries. On top of these factors investors are also scarred – the ongoing EURO crisis, horribel US economic data, emerging conflicts in the Middle East and Asia … all this has impacted the ability to invest large amounts of capital. Investors now have less opportunities and more importantly have come to terms with lower return expectations, while taking higher risks.
What does this mean for digital investments?
Based on the above described trends we will continue to see irrational capital allocation in digital growth projects such as Zalando. Investors will increasingly accept long-term returns that are barely above inflation just for a chance to allocate some of their access capital. It does not mean that it will become any easier to raise growth capital below EUR50 million but it is becoming easier to collect amounts above EUR250 millions for growth projects.
Entrepreneurs THINK BIG!
So in conclusion tech-savvy entrepreneurs: stop thinking about running a business on EUR10 million start to think how you could allocate EUR500 million!
Conclusion: Venture Capital – does it still work?
…finishing of my post series in regards to VC industry changes …
Will prices for start-ups significantly change?
In my opinion most start-ups will continue to raise the necessary funds in Germany. Firstly, venture capital never played a significant role here and secondly a large range of new capital sources have been developed over the last years. Corporate investors have become much more active and crowd funding offers a new way to raise initial proof of concept financing. Universities and government agencies have also been offering additional financing sources. So I believe that in terms of start-up financing there will not be a significant impact from the declining venture capital funding. Internationally, this will probably be a different story.
But what does it mean for valuations? Again I believe that most German start-ups would not have been sold/continued financing rounds to/with VC funds in any case. Trade exits are the normal route to go for start-ups here and most corporates are not only willing to invest in start-ups but have been allocating significant amounts of capital. In terms of pricing I also believe that Germany is looking at incredibly low valuations anyhow and that equity markets are not an exit route for start-ups due to depressed listing outlooks. Hopefully corporate capital availability will actually help to increase pricing levels here.
In my experience …
Overall, I believe that corporates will play a significantly larger role in the German start-up scene than VCs ever had, have and will. The OTTO Group alone has an early phase incubator (Liquid Labs http://www.liquidlabs.de/), later stage incubator (Project A http://www.project-a.com/) and a later stage VC funding partner (eVentures http://www.eventures.vc/). Most other large German corporates are following this trend and are establishing their own teams.
In addition, I am pretty sure that we will start to see an increasing number of more specialized incubators that offer additional guidance and support as well as follow-up funding through corporate buyers. Here an interesting trend from the US are specialized healthcare incubators like Rockhealth or Medstartr.
“Rockhealth is one of the growing incubators in the healthcare industry. They help teams with venture capital, advice and their network to find proper healthcare business models & help to scale them. The startup industry is just starting to innovate around healthcare and those incubators are likely to be in the centrum of this development.” http://rockhealth.com/
These significantly more specialized funds will take over start-up financing and provide industry trade buyers for growing start-ups. Entrepreneurs who are looking to grow their business should therefore forget about impressing VCs and start building their corporate contact network.
eTribes Business: StartUp-Roundtable am 19. März 2013 – come see Alex in action!
Liebe Mitglieder und Freunde von Hamburg@work,
Woche für Woche sprießen neue StartUps wie Pilze aus dem Boden. Es lockt der Traum der Selbstständigkeit mit der zündenden Idee. Doch nicht jedes StartUp kann zum Knaller werden.
“Rising Star oder Flop! Ist Erfolg eines StartUps planbar?” heißt das Thema unseres nächsten StartUp-Roundtables am 19. März 2013:
- Wie bewerte ich, ob mein Geschäftsmodell erfolgreich sein kann?
- Der ‘Proof of Concept’ ist erbracht; aber wie bringe ich meine Idee
zum wahren Erfolg? - Auf welche Faktoren kommt es dabei wirklich an?
Auf diese und viele weitere Fragen zur erfolgreichen Umsetzung einer Geschäftsidee, werden Ihnen unsere 4 erfahrenen Podiumsteilnehmer in der moderierten Diskussion Antworten geben.
Freuen Sie sich mit uns auf:
- Jörg Binnenbrücker; Geschäftsführer von DuMont Venture, Beteiligungs-Unternehmen für digitale Medien & IT sowie Capnamic Ventures, dem neusten Multi-Corporate Fonds.
- Alexander Graf; Gründer und Geschäftsführer der eTribes Framework GmbH sowie Herausgeber von kassenzone.de.
- Katharina Wolff; Bürgerschaftsabgeordnete der CDU und erfolgreiche Gründerin der Personalberatung “Premium-Consultants“.
- Christian Richter; bekannt als Serial Entrepreneur, gehörte z.B. zu den Initiatoren von radio.de; heute Geschäftsführer der internationalen Digitalagentur Spoiled Milk.
Weitere Informationen zu den Podiumsteilnehmern finden Sie hier.
Ablauf:
Einlass: 18:00 Uhr
Beginn: 18:30 Uhr
Networking: ca. 20.30 Uhr
Im Anschluss an die Podiumsdiskussion laden wir Sie sehr herzlich ein, sich bei Drinks und einem kleinen Buffet auszutauschen.
Anmeldung:
Bitte melden Sie sich bis Mittwoch, den 13. März 2013 zu der Veranstaltung HIER an.
Wir freuen uns auf Ihr Kommen – ob junger Gründer, erfahrenes StartUp oder innovativer Unternehmer – und danken Ernst & Young ganz herzlich für die Unterstützung!
Herzliche Grüße,
Ihr
Hamburg@work Team
What are the implications for start-ups?
cont’d from last post VC funding…
Does it matter whether venture capital is a failed asset class or not? Yes, some capital restrictions will apply but I would argue that there are sufficient alternative sources of capital to not significantly restrict new venture creation. Smart entrepreneurs can bootstrap, rely on angle networks or newly emerging crowd funding platforms in order to bring a venture through the proof of concept phase.
Additional follow-up capital rounds can then be financed through trade investors who are currently committing significant amounts of capital. There is a significant interest from trade, publishing and pharma companies to invest in digital start-ups. These companies have hundredth of millions available for new venture creation or “corporate innovation” outsourcing. Almost daily new funds, initiatives or deals are announced by corporates who are looking to mitigate the impact of digitalization on their core investment business. These sources of funds should be able to replace venture funding (at least in Europe). In addition, German/European entrepreneurs are also cashing out and are ready to invest in new ventures. In Hamburg there is a wide range of angle / VC money available from successful industries partners e.g. HackFwd – Lars Hinrichs.
Therefore, I would argue that especially in Europe the decline of the venture capital industry does not create significant problems and is compensated through alternative sources of capital.
What consequences does this bring for VC funds, which have fully invested their current capital?
As discussed in the previous post – times are tough for VC funds – but what implications does that bring? Funds need to start lasting value creation to attract new capital! As a first step I think that VCs need to reevaluate how they select investments. So far the industry has a way too high failure quote – I even think that VCs with their general herd behavior often miss interesting opportunities. Secondly, they need to increase their target range. There are lots of successful start-ups outside of the Silicon Valley and SV like hubs that would present interesting funding targets. Thirdly, they really need to develop beyond pure capital providers. Almost all of them will tell you that they are really value add above and beyond capital – that is generally just a statement but far from reality. Increasing number of start-up accelerator programs indicates that pure venture capital financing is not successful. More skills, support and knowledge are necessary. Investing in a VC environment is incredibly hard and finding the right investment criteria and sticking with them is quite a challenge. This is nicely described in Paul Graham’s “Black Swan Farming” article. Source: http://paulgraham.com/swan.html
Small is beautiful
VC firms should also stop raising larger and larger funds. Even if they successfully invested their smaller funds it does not meet that they should now double or triple their fund size. In several articles and also in the conclusion of the Kauffman Foundation report the authors argue that only smaller VC funds are able to provide decent returns. In addition, they focus a lot on the compensation structure and clearly show that having a significant amount of “skin in the game” is necessary to get solid returns from a VC management team.
„The incentive for small funds is aligned with investors and more achievable. A $100 million fund could buy 20% of 25 startups and handily outperform the public markets by building four to five companies into $400 million exit values, or a broader set of successes across the most typical venture exit values of $50 million – $500 million. Annual fees keep the lights on in the meantime, while the potential profit share from generating 300400% gains provides the prime incentive.“
Source: http://venturebeat.com/2012/08/18/lean-vc-why-small-is-beautiful-in-venture-capital/
Compensation for the industry should also be changed. Funds will have to proof that their management team is not only investment savvy but also resourceful and has significant skin in the game.
While we agree on Kauffman’s recommendation on looking beyond large funds, a deeper analysis suggests the need to look at the risks and returns in the fund structure — the profit share of each partner, the spread of capital committed per partner, and so on — and remove the reliance on a heroic grand slam as the only, yet unlikely, path to outsized results. Other qualitative factors include structurally leveraging all partners’ expertise across the portfolio, and garnering meaningful returns from more than just a few deals. These are among the many critical and structural advantages of the smaller venture fund.
Source: http://venturebeat.com/2012/08/18/lean-vc-why-small-is-beautiful-in-venture-capital/
If these challenges are met successfully VCs will continue to play a significant role for start-ups – if not it looks like the industry’s funding sources will dry up and soon start-ups will have to look for funding elsewhere.
Venture Capital – does it still work?
Previously, venture capital as an asset class has been critically discussed by Jochen and Alex in their respective blogs excitingcommerce.de and kassenzone.de.
Source: http://www.excitingcommerce.de/2012/09/vcs-und-die-hohe-wahrscheinlichkeit-des-unwahrscheinlichen.html and http://www.kassenzone.de/2012/09/12/venture-capital-funktioniert-nicht/
In his last blog Alex already hinted that I am working on a more detailed analysis of the subject. Why do I find this interesting? Well, after having worked in the PE and VC industry I always wondered how it would feel to change sides – become an entrepreneur and learn the nuts and bolts of daily operational challenges. It has been very interesting and I am tempted to claim that “professional” VCs who have been in banking or consulting all their lives and therefore represent the favorite MBA trained elite that joins VC/PE firms on a junior level – know next to nothing except how to draw pretty slides, talk in “investor” slang at fancy conferences and run after hypes like a crazy bunch of headless chickens. This is clearly an exaggerated view but overall the question remains if venture capital is an asset class with a future. The question is, if the more experienced senior staff has the ability to find deals and make investments that are profitable. In addition, I am wondering if only a select few sometime “get lucky” or if this is a sustainable industry with a risk/reward ration that should be attractive to investors.
In addition, Germany has seen a significant increase in venture capital through the Berlin “hype”. Now, with the entire industry under fire it becomes extremely interesting to see how the industry is going to develop. Even more importantly I am certain that these new analysis will have an impact on the rapidly developing European start-up environment.
Based on a range of studies it has become clear that the venture capital industry in general simply sucks at being investors and even more importantly sucks as an investment vehicle for their Limited Partners (“LPs”). Returns of venture capital as an asset class are simply not sufficient to continuously attract new capital.
How bad are returns?
The Kauffman Foundation, a highly reputable Limited Partner in many venture capital firms, has published the following facts based on their significant, long-standing venture capital investment history.
“Only twenty of 100 venture funds generated returns that beat a public-market equivalent by more than 3 percent annually, and half of those began investing prior to 1995.
The majority of funds—sixty-two out of 100—failed to exceed returns available from the public markets, after fees and carry were paid.
There is not consistent evidence of a J-curve in venture investing since 1997; the typical Kauffman Foundation venture fund reported peak internal rates of return (IRRs) and investment multiples early in a fund’s life (while still in the typical sixty-month investment period), followed by serial fundraising in month twenty-seven.
Only four of thirty venture capital funds with committed capital of more than $400 million delivered returns better than those available from a publicly traded small cap common stock index.
Of eighty-eight venture funds in our sample, sixty-six failed to deliver expected venture rates of return in the first twenty-seven months (prior to serial fundraises). The cumulative effect of fees, carry, and the uneven nature of venture investing ultimately left us with sixty-nine funds (78 percent) that did not achieve returns sufficient to reward us for patient, expensive, long- term investing.”
Source: http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf
There are also other articles and reports that are based on the Kauffmann analysis and the inability of venture firms to raise new funds. Limited Partners have finally woken up to the reality that blindly investing in larger and larger venture capital funds no longer makes sense. Why is that? As Fred Wilson states in a recent MIT technology review interview:
“Because the returns haven’t been very good in the venture capital industry for a long time. I think if you talk to the investors in venture capital partnerships, they’ll tell you that they’re very much on the fence on venture capital, and if venture capital continues to put up mediocre returns, they’re not going to stick with it forever.”
Source: http://www.technologyreview.com/qa/428869/fred-wilson-on-why-the-collapse-of-venture/
At the moment Berlin delivers a wonderful live case study to prove my point. The current hype, number of horrible investments and general herd behavior of investors in Europe’s new venture capital “capital”. Where are the actuals businesses that are supposed to generate lasting returns in the current “hype-cycle”? Where are the returns, exists or just simply lasting value creation? A small elite group of investors such as the Samwer Brothers are highly successful but from my impression the overall industry does not generate lasting value.
The Kauffmann report goes on to argue that actually LPs should re-evaluate their investment behavior and focus on other key value drivers within the VC industry.
- “Invest in VC funds of less than $400 million with a history of consistently high public market equivalent (PME) performance, and in which GPs commit at least 5 percent of capital;
- Invest directly in a small portfolio of new companies, without being saddled by high fees and carry;
- Co-invest in later-round deals side-by-side with seasoned investors;
- Move a portion of capital invested in VC into the public markets. There are not enough strong VC investors with above-market returns to absorb even our limited investment capital.”
The Kauffmann report also has an interesting title:
“MET THE ENEMY… AND HE IS US” – Lessons from Twenty Years of the Kauffman Foundation’s Investments in Venture Capital Funds and The Triumph of Hope over Experience“.
They consider the problem the be the LPs – they need to change their asset allocation in order to substantially alter industry behavior and subsequently the return rate for the industry as a whole.
The previously listed investment recommendations are only one side of the equation. I think that there is a general consensus that due to the lack of returns and the issues outlined by the Kauffmann Foundation the VC industry will change.
Therefore, there are a lot of questions that remain:
What are the implications for start-ups? What consequences does this bring for VC funds, which have fully invested their current capital? Will prices for start-ups significantly change?
Web Future Awards in Hamburg!
Web Future Award is now open for applications. Any new start-up in Hamburg should not miss this great PR opportunity BUT be warned… though judges, including our own TAREK MÜLLER, will evaluate your ideas: http://www.hamburg-media.net/awards-webfuture-jury/
Applications: http://www.hamburg-media.net/awards-webfuture-bewerbung/
Strategy – why do we even bother with all of this? (b)
Balance sheet
Your balance sheet – yes, you have seen it when the yearly accounts were prepared but it really did not matter to your start-up. For you the one and only key was liquidity in the beginning, followed by profitability \but what now? Yes, those accounts become important eventually. What do I mean by that – well, once you have established your strategic goals you will need to optimize your balance sheet accordingly. If you are preparing for a sale, potential investors (and their highly-skilled forensic accountants) will look at your accounts. Are you planning to change your debt to equity ratio and work with more capital? Will a bank lend you money? Are you going to build / buy your next office or remain a humble tenant?
There are a lot more questions to ask and you are now playing with the big boys. A Fortune 500 CFO will be very concerned with her balance sheet and watch movements in these accounts closely. As an eCFO of a start-up this is a new area for you and you should slowly get into it as your business develops.
In summary a balance sheet can also teach you lots of interesting things about your business and serve as an important stepping stone to your business’s next growth / development stage.
eCFO Tips: Do not be afraid to think about new things. If you are working in an innovative start-up there might be lots of balance sheet optimization questions that nobody has really thought about. Are facebook fans in generic groups that are rented out for advertising assets? Should the initial investment into these groups be on your balance sheet and depreciated over time? How do you value your investments in other start-ups? What happens with your old, cancelled projects? Make sure you have good advisors and get lots of support when tackling these questions.
Strategy can mean a lot of different things depending on your situation but as a general rule of thumb I would suggest that you consider anything that is not based around daily operational tasks as “strategic”. Given your unique position in the business and access to information, you have the opportunity to support the other management team members in occasionally taking a look around and consider the bigger picture, away from the grind of daily demands. This is were you can add a lot of value and a sound strategy will help the business to develop faster and to reach goals that you did not think possible only a short while ago.
Strategy – why do we even bother with all of this? (a)
So, why do we even bother with all of this? Initially, you need to make sure that your business performs well, does not run out of money and that financials analysis and data points support operational decisions. All of that you can do but if you are a serious eCFO this is probably not the stuff that makes you get out of bed every morning.
What really should get you excited is building a healthy, growing and extremely successful venture. Your operational measures will support that but more importantly you should be influencing the strategic development of your company – if you are not doing that you chances are you will never be more than a glorified accountant.
Strategic decisions
In order to make a strategic decision you will need a strategy. This may sound a little too simple, but ask some start-ups about their strategy and often you will find that they either do not have one or are unclear in what it is they are trying to achieve. How much time do you think an operationally involved management team has for strategic discussion, decisions and evaluations? From my personal experience: very, very little. Daily business and the demands of a growing venture will eat up all available time.
This in turn means that your role becomes more important. As an eCFO you can provide plenty of data and input for creating a strategy. Often you will also be more shielded from client demands and product needs than the other members of the management team. Make sure you that you add a discussion about strategy every now and then to the weekly/monthly meeting agenda.
Formulating a strategy will require a highly customized approach as your business will have individual needs, goals and problems. Nevertheless, I can assure you that if you have implemented the measures discussed on this blog, than you have all the necessary tools, processes and data to support and drive a successful strategy formulation and implementation process. This in turn will help the entire management team to make better business decisions. I have chosen a couple of strategic measures that can be undertaken to provide examples of what I consider to be strategic decision for an eCFO. As I said these are just examples and you should think long and hard about strategic elements for your specific business situation.
Profit distribution
So let’s assume that business is going well and money is flowing in. Operationally, you have fixed most major issues and business is good. With the money comes a totally new perspective for a start-up. You have to decide what to do with a refilling pool of cash – should you distribute to hardworking employees, enrich your shareholders, reduce prices for your valuable clients or invest like crazy? Again there is no perfect answer to this but a sound financial analysis will help you to make a better decision. You should start to think about concept such as ROI calculations to evaluate which return perspective each of your investment/payment decisions has. Furthermore, you need to open a dialogue with all of potential stakeholders to find out what exactly there demand and needs are. Often you will be surprised by stakeholder expectations. Note: it might be dangerous to communicate too much to each stakeholder on, as this may raise unrealistic expectations which then lead to disappointment.
eCFO Tips: Communication, communication, communication… when it comes to strategic decisions never assume that you know what each stakeholder wants. You will most likely approach a decision from a financial analysis perspective – most other (normal) people will not think that way – so make sure you talk to everyone and do not assume anything. Often you will be surprised – sometimes pleasantly and sometimes not so J.
Interesting article “Managing the legal process in an early stage startup” …
Here an interesting article from London based Seedcamp partner Carlos – great read!
FolienKnecht – a case study (b)
Business model testing (Is it profitable? Is it scalable?)
Regular checks are important for a start-up. Have your previously set goals been reached and if so, can the business be scaled further? We usually measure the scalability by starting with relatively small trial cases that cover a broad range of marketing measures. Can we generate sales through Google Adwords, mailings, e-mail marketing, tele-marketing, direct marketing events or any other method? If there are a couple of measures that allow us to generate sales with a positive return e.g. if we spend 50 cents we can generate 51 cents in revenue we know that this potentially could allow the business to scale. Once we have found a method that seems to work, we scale the test case – if we can generate EUR10,000 in revenue by spending EUR500 through adwords, could we also generate revenue of EUR100,000? As an eCFO you need to push this test case as quickly as possible to make sure that the business model actually is sustainable and has significant revenue potential. If not – kill it quickly.
eCFO Tips: Make sure that management teams can differentiate between expenses and investments. In our company everybody gets a VOIP phone installed on their computer and uses a headset for calls. We do not have actual phones anymore. Nevertheless, the FolienKnecht team requested to spend EUR40 for an actual phone – it took a long discussion for them to convince me that this was a necessary expense and approval took a while. At the same time I suggested that they should get together with the city of Hamburg and sponsor a networking event. Sponsoring fees here were a small 4 digit amount and they asked why I did not have a problem with such a comparatively large amount, versus all the hassle for the EUR40 phone. The answer is easy – for a start-up it is essential to spend money on the RIGHT things not on those that are nice to have. As an eCFO it is your responsibility to ensure that this principal is actually enforced and that every expenditure is measured.
Investments and financing
I admit – this is a special case since FolienKnecht is a services business, a powerpoint designer, which can grow through its own cash flow generation ability. Therefore, I just needed to make sure that I fully understood the cost structure and what was needed to bring the business to break even cash flow generation without raising significant capital. As with most agencies it is possible to grow with this easy formula: “one employee needs to generate enough cash to pay the salary of two, two for four, four for eight and soon growth is possible”. In addition, your cost structure will mostly consist of salaries and some marketing investment but both cost items should quickly generate revenue. What is more important is that you create structures that are highly efficient and streamlined for cash generation.
For any other type of venture that require significant start-up capital I would suggest that you calculate your financial needs, then add 30% of that total to your numbers and you are good to go. Once you have determined your financial needs, raise a little bit of capital yourself and build a prototype. Investors are much more likely to give you money (even for a higher valuation) if you can show them a working prototype vs. a slide presentation with nice ideas on it.
Overall, I hope that these posts provided some operational examples of how to implement the measures I described in previous posts. As always I am looking forward to receive your feedback and comments!
FolienKnecht – a case study (a)
Enough of all the theoretical posts! Here is a more interesting, operationally focused case study. I think that my previous posts have theoretically highlighted various aspects of being an eCFO but what does it mean for operational reality? In order to further highlight this I was able to get permission from one of our venture teams to write about them in this post.
Here a quick description of the business model:
FolienKnecht (German for “PowerPoint slide servant”) is focused on providing high quality outsourcing services. Its first line of business is creating, designing, and improving PowerPoint presentations. (www.folienknecht.de; Spanish: www.ppt-express.com)
Its second business line has recently gone online with a video creation/design offering (www.videoknecht.com) and it also provides a range of other outsourcing services through www.165euro.de. The business was initially tested through an intern and eventually bringing it into fully operational mode through incubating it within our company (www.etribes.de).
Timeline of development
FolienKnecht was incubated in the beginning of January 2012. We found a very capable management team consisting of two guys. One is the intern who developed the project and the other is an experienced entrepreneur. Both were willing to take this project forward with the eventual goal of founding a company and creating a business outsourcing company with multiple revenue lines from various business services.
Operationally, they received support from our incubation structure but this case study will focus specifically on the financial aspects. If you are interested to read a case study from another perspective you can find additional insights (sorry, in German only) here: http://www.kassenzone.de/2012/05/30/powerpoint-malerei-outsourcen/
eCFO tasks for a new venture
As the eCFO in our holding company it was my responsibility to take care of the financial aspects. In this role I helped the management team to develop a strong financial understanding to ensure that the company eventually developed into a financially strong independent entity.
Team
Within the team responsibility was shared between the two founders. In start-ups everybody does a little bit of everything to make sure that things get done quickly. This is necessary and a good starting point but fairly quickly set roles should be developed. I asked the founding team to provide only one contact point for all financial questions, analysis, and data points.
Basics
Our incubation services take care of all central basic services. This ranges from office space, to laptops, water/lots and lots of coffee and other basic things you need to run a business. In addition, we take care of central services such as accounting, HR, recruitment, and legal consultation. These services are initially provided free of charge to speed up the incubation process. However, it is important to make sure that the entrepreneurs are aware of the actual (expensive) services the venture incurs. The company therefore needs to track these expenses and needs to start to implement liquidity controls, budgets and financial planning. This is best done through an Excel spreadsheet that mirrors an actual P&L statement.
Controls
Initially, we determined the basic costs incurred by running FolienKnecht and set clearly defined goals we needed to reach in order to move all activities from our incubator into the new entity. Spreadsheets and preparation of financials are also important controlling functions. Here it was important that once a clear goal had been defined, the necessary measures were put into place to ensure that it could be tested on a monthly basis whether or not the venture was successful. We came up with a simple P&L statement that showed expenses, income, and sales funnel in an excel spreadsheet. This is a quick, slightly dirty, way of preparing the necessary financial information. In addition, we provided access to our billing software so that every bill can be generated by the management team but, more importantly, so that they can understand payment cycles and all connected liquidity concerns. If you are incubating a business within an already existing structure, you need to make sure that from the get-go the management team feels the same constrictions and problems it would feel as an independent business.
eCFO Tips: Especially in a start-up environment do not get bogged down in the details. If you are looking to establish financial goals do not say EUR9,287 because your business plan spits out that number – instead just define easy to remember goals e.g. we need EUR10,000 revenue per month with at least 30% EBIT. Do that for 3 months in a row and this business starts to be viable. This is an easy rule for not only you to remember, but it also sets a financial target the management team can work towards.
To be continued in the next post …
Here you can find an example of their work:
FolienKnechte
German tax privileges for entrepreneurs under fire…
Very interesting article for German entrepreneurs on Gründerszene.de. Watch out what the tax treatment for your equity shares will change in the coming month!
http://www.gruenderszene.de/recht/gesetzesaenderung-exit-holdings
Ernst & Young Article
For those of you fluent in German here an interesting article from Ernst and Young in regards to financing phases. http://bit.ly/JOprgC
eCFO news for start-ups! 
