One of the most important (yet overlooked) areas of a startup or early stage scaleup strategy is its financial strategy. Lots of focus goes into sales, marketing and product, but the financial strategy is often the most poorly defined or even understood area. The reason for this is because a large percentage of founders may not have any financial grounding nor have easy access to a suitable finance expert to support them.
The lack of a suitable financial strategy is one of the main reasons early funding rounds stall, stutter, and fail. Because, without a financial strategy that informs the type and level of funding needed, founders often find themselves chasing the wrong kind, with the wrong investor materials, from the wrong type of investors, for the wrong amount, and at the wrong valuation. This is a costly mistake to make, that can waste six to 12 months on a failed fundraise.
Therefore, getting a clear understanding of your financial strategy will help you find the right funding options. This will immediately flip your odds of success and make the process dramatically more focused.
Let’s jump into the four key areas you need to understand before creating your financial strategy:
1. Why you need a financial strategy
i. No two businesses are the same: Each business is unique, shaped by its industry, market, growth trajectory, size, the founder’s vision, and crucially theirs and their team’s ability to execute. It’s this individuality that underscores the importance of crafting a bespoke financial strategy that’s completely suited to your venture.
ii. What is your end goal: Some people want to create a lifestyle business that gives them a good living. Others want to grow a huge business and create a unicorn. And some are somewhere in between the two. The decision is solely down to yourself, however, the investors you approach have their own investment criteria for deploying their capital. You therefore need to have a clear view on your end goal to make sure your financial and funding strategy aligns with their investment thesis.
iii. Your Funding Needs Over Time: The goal is to anticipate your funding requirements over a period of time such as three to five years – not as a one off exercise. If you aspire to really scale up then you cannot afford to slow down by stopping to find more funding midway through. You must therefore create a financial model to provide you with this visibility over your journey.
2. What are you raising funding for?
Funding requirements can be split into three types:
i. Capital expenditure: CapEx is the term for capital expenditure where you are buying assets for the business, such as buying plant and machinery or investing in a software platform build. This is a long-term investment that will be used to generate ongoing revenue for your business and isn’t lost once the money is spent.
ii. Operating expenditure: Known as OpEx, this is for things such as salary costs, marketing expenses or any other operating cost to run the business. Investing in OpEx may be seen as a riskier activity given there is no asset remaining after the costs have been incurred.
iii. Working capital: The easiest way to understand working capital is to think of the cash requirement of a business to fund the purchase stock in advance of selling and receiving the cash from customers. This activity can tie up a considerable amount of cash as stock may be ordered and paid for months in advance of when the customer finally pays for the goods. If you grow quickly and need more cash to be tied up in stock, then your working capital needs will also grow significantly.
These three different needs of funding can be funded in very different ways and all depending on the stage and risk profile of your business. Some of these methods will require you to sell parts of your company to raise equity, whilst others may be in the form of debt, which will require repayments, incur interest and may need a form of guarantee.
3. Different types of growth strategies
Diverse Paths, Different Strategies: For many startups there is an instant draw towards raising substantial capital from day one to get moving quickly, but this isn’t the only way to grow! There are multiple routes that cater to varying risk profiles, and it’s essential to debunk the misconception that the ‘done way’ is to seek venture capital immediately. In reality, in the land of venture capital only about one in 100 applicants succeed in securing funding this way, simply because most aren’t even suitable. You may have an idea about your end goal, but the path and pace you chose can vary.
Consider these three straightforward financial growth strategies:
i. Bootstrap: This self-funded approach allows for organic growth and retains control by not selling any equity. It’s the safest growth path while you are figuring things out, and ideal for those averse to external influence by bringing onboard shareholders or other funding stakeholders. Investment may still be an option down the road, just not at the start.
ii. Fundraise and build: Relying on fundraising as the primary source of initial capital, this strategy involves investing the initial funds to reach a pivotal milestone, such as entering the market, or achieving a significant proof point, then assessing needs thereafter. Grants, debt, or angel funding may be more suited to a first investment round while you are laying the foundations, prior to approaching a venture capitalist.
iii. High-growth cash burn: This path prioritises rapid scaling and value creation, often at the expense of short-term and mid-term profit. It’s particularly attractive to venture capitalists seeking rapid growth and substantial returns.
4. The vital factors that inform your financial strategy
Now you understand the importance for a financial strategy, what you are raising funding for and three simple types of financial growth strategy. Before you finally decide on your growth path, you should contemplate a final few key factors:
i. Risk tolerance: Your comfort level with risk and uncertainty. Raising money from external sources comes with risk and stress. So ensure you are fully accepting the risk you are creating by onboarding third-party funding, and the immense pressures that can create if things don’t work out.
ii . External influence: External funding brings with it a level of external influence, or restrictions, which you need to be willing to accept. This may be providing a board seat to an investor who can heavily influence key decisions, or creating conditions in your business to ensure you meet covenant requirements with banks.
iii. Active or passive funding: Your plans for shareholders to play an active role and the relationships you aim to establish are a strategic value opportunity. The ability to obtain shareholders that add active involvement and bring real value can be a huge catalyst. Whereas too much involvement can sometimes stifle and cause conflict and you may much prefer a totally passive funding partner with no involvement.
Your answers to all of the above will guide you in determining the funding types and levels that align with your distinct business vision. If your decision to start and grow a business revolves around an exit, then the choice between retaining a larger equity share of a smaller exit or a smaller equity share of a more substantial exit hinges on your personal aspirations and the funding you’ll need to help get you there, all determined by your financial strategy.
A financial strategy is a critical part of a startup or scaleups wider business strategy. The right level and type of funding, injected into the business at the right time, is fundamental to it achieving its goals. Without this, sluggish growth, or even total failure are the harsh realities.
There are four key learning areas around the importance of a financial strategy:
Firstly it’s the knowledge underpinning why you need one, such that no two businesses are the same. Your funding needs will change over time, but can be planned ahead and you need to align your financial strategy to your end goals as one informs the other.
Secondly, it’s understanding what you are raising funding for, and identifying whether you need investment for capital, operational and working capital purposes. They can be sourced differently from different providers, and the cost of each type of capital and how you obtain it is very different.
Thirdly, having a basic awareness of the different types of growth strategies is important, because the path and pace you choose can vary significantly.
Finally, consider some of the vital factors that inform your financial strategy such as your own risk appetite, the level of external influence you want, and if the funding should be providing active involvement and bringing value, or merely playing a totally passive role of simply supplying cash.
Your chosen path, the funding you seek, and the strategy you employ should align seamlessly with your business’s uniqueness and your future ambitions. The key is to develop a financial strategy that not only keeps you financially stable but also propels your business toward your envisioned success.
A venture capitalist won’t necessarily expect you to have this all figured out but they will expect to see a level of financial maturity that shows a sound end game, with a good financial strategy to achieve it, that can evolve and be built upon.
Jim Shirley, a CFO who is now the founder of FundingHero.co.uk and author of The Startup Fundraising MBA available from Amazon, which is based on the 6 Pillars of Fundraising, a guided process to raising funds.
He runs a West Midlands-based high-growth fundraising accelerator for founders looking to raise pre-seed or seed funding from £250k to £2m+. As a CFO he has raised millions in equity and debt in growth funding for high-growth businesses, taking two scaleups all the way to exit, and helping to sell both to billion dollar overseas organisations.