The journey of a start-up can be difficult, made more complicated by the different rounds of external funding needed for growth. Startups seek this funding from external investors to fund their growth journey and it is usually raised through a series of investment rounds from friends, family and early business angels, and capital- venture (VC) and private equity (PE) ventures at later stages. These financing rounds become more expensive for the start-up as the capital invested increases.
Generally, the venture capital funding stage is considered crucial, as it is often the first major professional funding round, and indicates that a start-up is showing true potential. Attracting VC interest and ultimately closing a funding round is cause for celebration, however, this success also signifies the start of a new chapter in the startup’s growth journey. This chapter brings a whole host of opportunities, but also higher expectations and the need for a step change in financial reporting and KPIs. It is therefore imperative that the company’s finance department is effectively set up and prepared for scaling.
This blog will discuss the expectations of start-ups before and after funding and the vital role finance leadership plays in effectively achieving those goals and overall business growth.
Pre-financing: the expectations of a start-up before a funding round
For a VC to decide whether or not to invest in a startup, they need a wealth of information, including but not limited to:
- Financial reports, analyzes and timelines
- Due Diligence in Support of Commercial/Financial
- Forecasts and future plans
- Model projections
- Capitalization tables
- Terminology records
It is clear that it takes a lot of time and effort to produce these reports and documents, which often require several iterations. Most of the heavy lifting is done by the finance department, a function that is usually already understaffed and overused. The finance department must therefore ensure that it is prepared for these increases in demand by having (surge) capacity, skills and tools in place.
Post-financing: the permanent expectations of a start-up after a funding round
A common and often underestimated consequence of securing a large investment is that the business must now operate to higher standards, across a variety of dimensions, for example after completing a round of equity funding- risk, start-ups are often subject to a strictly enforced shareholder agreement. . The shareholder agreement for professional investors is much more complex and difficult to navigate than a simple funding agreement typically used for friends, family and angel investors. The professional/institutional investor’s Shareholder Agreement contractually guarantees the investor certain rights such as the provision of financial information, consultation rights, rights of first refusal and observer rights. As part of the Shareholder Agreement, the start-up can be expected to provide the following financial information:
- Historical annual, quarterly and monthly balance sheet, income and cash flow statements
- Audited financial statements with year-over-year analysis
- Capital structure schedule
- Projections, annual capital budgets and strategic plans
- Complete tax schedules
- Schedules of assets, liabilities, expenses and equity
While a startup may not need a large finance department and a dedicated CFO during the pre-funding stages, the need for a connected, scaled finance team can quickly materialize afterwards. funding and once revenues have increased.
An underdeveloped and understaffed financial department could prevent a start-up from meeting the aforementioned requirements, which could hamper its future growth.
Challenges and possible solutions VCs see in scaling start-up financial services
Through discussions with technology-focused venture capitalists, we discovered that an often underdeveloped area of a startup is its finance function. Lack of capacity within the finance department is usually revealed during the pre-funding due diligence phase, which tends to lead to delays in producing accurate financial data, financial statements and schedules – both prospective and historical. This can significantly delay the investment process and in some cases cause it to stop.
The financial management of a start-up must therefore be prepared for growth. However, there are some challenges in addressing and expanding this critical function; these challenges relate to leadership, people and technology. Finding a strong leadership personality (CFO or CFO) with relevant experience is tedious. Additionally, hiring and retaining finance experts is difficult due to a limited pool of qualified talent and competitive offerings from major brands. Finally, start-ups often struggle to implement an effective IT architecture that enables automation and can scale with the business due to time and budget constraints.
In summary
In conclusion, the above challenges can often be overcome by ensuring that an investment in the finance function (particularly in leadership, people and technology) is made early enough in the business journey. This investment should result in the recruitment of the right profiles and the establishment of adequate and scalable systems, processes and controls. Relying on a managed service provider to achieve these goals can also allow a business to set itself up for success and prepare for challenges before and after funding, with a relatively limited budget. Meeting these challenges will prepare the function for future success and save considerable costs and time in the long run.
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