The Equation You Need To Evaluate Your Fundraising Options: a VC turned Founder's Guide
I have recently gone on the weird and wonderful journey of equity-free grant application with my start-up (more to come soon!) and it has certainly been interesting to compare it to the world of Venture Capital (VC).
Why did I go for equity-free grants over VC funding?
After spending some time in the “game”, I have hopefully come to the healthy conclusion that VC funding is a fantastic source of capital only for the very few.
Namely, those who want to exit their company at a multi-billion dollar valuation. I won’t go into the long-winded rationale behind this statement, but in short, it is because the Venture Capital industry is based on balancing risk with extreme outliers.
Very few companies ever reach these heady valuations, yet this has generated a warped view of what it means to be a “successful company”.
Personally, I have no interest in being a unicorn founder. I have seen many founders grind away with the ambition to reach this goal while selling off vast amounts of their company to fund their heady expenditures, and it does not appeal to me. But don’t get me wrong—I have the utmost respect for those who do.
A path rarely discussed within the VC realm is the “bootstrapping” strategy, i.e. to surround yourself with a small but brilliant team that can build a product that can sustain itself (i.e. reach profitability) sooner rather than later. However, this approach still comes with significant risk; namely financial risk, as until revenue comes in, you can burn through your savings in no time. In many ways, raising a significant chunk of VC capital significantly reduces the risk of going bankrupt before your company reaches product/market fit but of course, at the cost of VCs expecting significant returns in the future.
Although as with any country (!) Germany has its flaws (!), but what I have discovered in the last few months (as a Brit living in Germany) is that there are many brilliant programs in place to help people start a company, not only with capital but with a myriad of other perks such as office space, visa sponsorship and access to industry experts. Regardless of whether you want to raise Venture Capital funding or not, I would encourage those founding a company in Germany to explore equity-free funding as well, these programmes can easily keep you (personally) financially afloat as long as you don’t have significant outgoings. If you are fortunate enough to live in a country that has set up policies and budgets to support SMEs, I urge you to explore this route – after all, what is better than getting an equity-free grant to pursue your dream business?
I have given a lot of thought to how best to raise funds for my company and I devised a comparison of VC fundraising versus equity-free fundraising. So without further ado in addition to the obvious fact that VC requires equity and the other does not, here are the nuances I have deciphered regarding these two options:
The Similarities
The basic premise of pitching to both types of funding is very similar. Namely, both want to understand why you, your product, your financial projections, your assumptions, the size of your market, how you differ from competitors, etc. It's all pretty similar stuff.
Both require the ability to research “who you are pitching to” well so that you can custom your pitch according to what you think will be their preference (e.g. an impact VC will want to see impact metrics) and you must be able to present your vision brilliantly. A top tip that applies to both is to try to build relationships with the decision-makers or champions (often juniors who really like your idea) of these respective institutions. Often it is much easier to get a grasp of what style or emphasis you should put on your presentation or submission if you have spoken to someone in person. Sometimes you get absolute nuggets of information from a single conversation that has not been explicitly outlined e.g. a grant has an ‘unspoken’ quota to invest in female founders or this VC partner has a strong preference for products that have a bottom-up GTM approach. At the end of the day, as is the case with almost everything (see previous blog), it always comes down to convincing others of your vision.
Top tip - speak to people who have received funding from the grant or VC, who have been through the process and succeeded. They will certainly be able to provide you with some top tips, plus they might even put in a good word for you if you are lucky.
Thankfully for me (!), most pitches are encouraged to take place in English to demonstrate an ability to internationalise and see your markets overseas.
Both types of funding require that you report your progress to someone. The cadence of this reporting very much depends on the grant and the VC, but if you are someone who likes to be completely free to do as they choose, be sure to ask what the expectations are of the organisation that is giving you funds.
The Differences
And now for the differences:
Difference 1: The Way in Which you Apply
Equity Free Funding - Tick the Boxes in the Application
The German Government allocates a pot of capital for either state, trade departments, or third parties to deploy as grant funding, in fact, this number is in the billions and segregated into thousands of different pots.
There are often very strict criteria put in place as to who can apply for specific grants. For example, only founders based in a certain area of Germany, and/or have not founded a company before, and/or are building something in a certain sector. Be sure to read the fine print as if you do not fit the criteria, you may have wasted a lot of time.
Applying for Grants requires a MOUNTAIN of paperwork to complete in order for the Government to ensure that funding is being placed into the right hands. This paperwork can be very laborious (particularly as a non-German speaker) and to then get rejected seems like a lot of work going to waste. There is often a requirement of reams of words for the sake of it, and a lot of contextual explaining. This is understandable, as often assessors of grants do not come from an investment background or have industry knowledge.
The good news is that once you have done one grant application, the rest are not drastically different and therefore some recycling is doable, but it still requires you to fill in PAPER-BASED forms all over again.
What is most important is that you tick all the right boxes in the paperwork. Top tip - most grant applicants provide a ‘cheat sheet’ for grant applications. An analogy that I deem fitting, is that it feels very much exam-based with assessors looking for ‘keywords’ rather than actually spending time understanding the problem.
Often the final round involves you pitching to a number of panellists, from my experience, they expect that you can communicate your idea well but not have all the answers.
VC Funding - Don’t Apply Directly Via Their Website
One of the biggest differentiators between grant and VC funding is how you first interact with the respective institution. Many VCs only take founder calls via warm introductions or via a LinkedIn message. If you apply via an application form on their website, you are most likely at the bottom of a review pile, and ironically, the harder you are to get hold of, the better.
Additionally, although as a pre-seed/seed stage start up there is often some wriggle room to not give the slickest pitch in the world (at Series A it is not the case), you really do have to be a very strong presenter and give off a level of confidence that you are unflappable and have understood every single aspect of your business.
From a paperwork perspective, there is also an expectation that you have to create a deck and eventually, a dataroom so that VCs can flock to you to view it, so little extra effort is needed once you have completed it (saying that some VCs will request extra documentation in order for them to better understand aspects of your business).
Top tip - Often with more technical products, the less you put in your presentation the better, remember VCs like feeling smart - design everything in order to make them feel just that.
Difference 2: Perceptions of Realism
Equity-free Funding: Talk about weaknesses and impact
One thing I like about grant funding is that, in a way, it is more realistic than VC. Germany is one of the very few countries (and probably the richest) that has the majority of their GDP generated by SMEs. In essence, the country’s success is off the back of companies that make 10s of millions in Euros annually. Therefore, it comes as no surprise that Germany is keen to foster more of these types of business and that would be deemed as a success to them.
Subsequently, applications encourage you to state clearly your weaknesses and where you need support so be realistic with your business model. Additionally, there is in general a big emphasis on what kind of ESG-related impact you are going to make. These are important metrics for the German Government and they are very focused on aspects like how many people you are planning on hiring and how you are going to contribute positively to the German economy in the future. Although this is just a ‘guestimate’, I imagine the principle is giving a slice of taxpayers' money to start-ups will equate to these companies growing and the Government being able to tax both the business and employees in the future whilst promoting innovation = a win-win.
VC Funding: Talk about strengths and a massive market opportunity
Although VCs like to ask the question “what areas do you need support in”, in most cases they want to see a completely polished and unflappable founder who has an unnerving drive to succeed and succeed fast. They would like to see seven zeros plus in your Serviceable Addressable Market or they are not interested! There are of course some funds that care about impact, but Venture Capitalism (as the name suggests) will always and forever come down to returns for investors and that means the objective is to grow as quickly as possible regardless of the toll this might take on the bottom line and/or employee welfare.
Difference 3: The Size of the Cheque
Grant Funding: Gives you time to prepare
Particularly at the beginning, these grant funding programmes do not offer a lot of money, but it can be an ideal place to start building up your company whilst keeping the wolf from the door and not digging too much into your savings. Many founders are new to the start-up world, and so being part of grant programs where in addition to covering your living expenses, the programme can also provide you with guidance on how to prepare to start pitching to VCs and of course community. Founding a company can be a lonely journey and so doing it with others can also help build a support system around you, often a critical requirement to maintain your mental health.
Venture Capital: Gives you the firepower to hire fast
Venture Capital can often be seen as the perfect way to start a business, having to potential to have an injection of millions of euros can help hire exceptional talent, spend more money on marketing costs and boost your reputation in the market. You also have investors who can support you and be part of a community of the fund’s other portfolio companies. All this for a percentage of a business ‘on paper’ seems like an excellent ROI.
Friends and Family and Angels: The middle ground
An option that I won’t dive into too deeply into this topic but a happy medium between the above is raising from angels. These are individual investors who are willing to put their own dime into your business. This can be a great option as their return expectations of a private individual are typically much lower than that of a VC and they would tend to be on the more patient side (i.e. they would not want you to exit so quickly), plus they often own a much smaller stake in your business so have less influence over the decisions of running your company. However, finding and building relationships with angels is not easy - it is often down to pre-existing relationships that have been built over time through the circles you were born into or worked your way into - in short if you have any wealthy friends/family/colleagues - be nice to them ;).
Closing Remarks
At the end of the day, decisions over what type of funding to take could be broken down into an equation: Time to Value
Or more specifically (final equation is at the bottom of page):
(Time x Likelihood of getting $) / Amount of $
I think it is important to consider having a blend of different types of funding but also the order of how you go about doing it. Why not have up to a two-year runway of equity-free funding, to then have enough of a product to pitch to VCs once you have managed to raise private capital, you can also raise additional grants that match private funding and then move into debt. This pathway really helps keep your dilution low, and if this is a priority for you and your exit strategy then well worth the effort of pitching to different types of institutions.
Big thanks to the brilliant Malte Berresheim founder of Heuris for these wise words:
‘You can always raise VC capital later on if you want to accelerate growth, you can never go back to bootstrapping.’
The way to calculate this ratio can be determined by asking yourself the following questions:
Do you want to create a billion-dollar company?
Yes - VC funding or Combo
No - Just Grant funding
Do you have enough savings to give you a year’s runway and either the skillset alone or those who will join on this journey in the same financial situation?
Yes - Start with grant funding and see how you get on
No - VC funding
What kind of business are you building?
Rapidly scalable but busy market so needs financing for rapid growth - VC funding
Rapidly scalable and has the potential to become profitable within a year - Grant funding
Not rapidly scalable but has the potential to become profitable within a year? - Grant funding and then debt
Not rapidly scalable and does not have the potential to become profitable within a year? - Grant funding first then VC funding
Do you think it is VC backable/are Governments looking for solutions like yours?
One last thing to consider
Something I have touched on lightly in this post is that it is worth weighing up not just the impact of giving your equity away on the end outcome i.e. exit, but also how it plays into the journey.
It is important to think about what you want the end outcome of your business to be.
If you own 50% of your company and you sell it for $100 million, or if you own 5% of your company and you sell it for $1 billion, the monetary outcome is the same; however, the journey you will have to get there will be very different.
Giving equity away is a double-edged sword: it can help keep you on track to hitting your milestones and be supported by investors who can open new doors of capital for you plus help guide you into unicorn status, but it also limits you in regards to decision-making, paying out dividends, early exits, etc.
In short, I urge you to truly think about what does success look like for you with your business and work backwards from there.
So as such, my final equation would look like this:
(Time x Likelihood of getting $) - (Amount of expected dilution + Governance levels) + Level of value-add / Amount of $
The higher the value the better and, depending on how much you weigh each variable, you can tailor this equation to your preferences.
I hope this helps and please feel free to ping me if you think I have missed any key considerations. Stay tuned for part two where I share some key rockstar contacts/grant allocators that have helped me navigate my fundraising path to date.
Ciao for now.