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Michael MassadVice President

Three Financing Tips for Startup Founders from Growth Investors

The world of startup financing has drastically changed in the past few decades. Tech startups used to have just a few options: Raise a round of venture capital, maybe take on debt, then file for an IPO or try to sell. Today, the range of options feels endless: There are different types of venture firms, various debt options, non-financing options, and exits ranging from financial sponsor acquisitions to partial liquidity to SPACs to IPOs.

With the industry’s continued evolution, it’s no surprise that financing is one of the most confusing parts of building a business for entrepreneurs.

At Elsewhere Partners, we believe founders should have the resources they need to make the best decisions possible for their startup—especially when it comes to money. That’s why we’ve broken down term sheet lingo, answered founders’ top financing questions, and questioned the “billion or bust” mentality. Recently, our founder Chris Pacitti joined a webinar with other growth investors to share his knowledge on navigating growth capital for B2B SaaS startups.

Hosted by S3 Ventures, the panel was packed with a variety of other perspectives:

  • Vik Thapar, Partner at Cypress Growth Capital, offers royalty-based funding—an alternative to equity or debt financing, where investors provide growth funding in exchange for a fixed percentage of your company’s future monthly revenues.
  • Charlie Plauche, Partner at S3, makes initial investments in Seed, Series A, and Series B rounds ranging from $250K to $10M.
  • Robert Sureck, senior marketing manager at Silicon Valley Bank, is an expert on venture debt financing—a non-dilutive capital source that can complement an equity round.

Combined with Chris’ expertise as a software investor primarily focused on pragmatic growth for early-stage SaaS startups, the panelists shared a variety of tips and insights into the world of startup financing—from how founders should pick their funding partners to why you should exit when you’re ready. Here are three main takeaways from the conversation.

1. “Do as much diligence on investors [as we do on you].”

Whenever you bring on a new capital source, you’re also adding a new stakeholder. They’ll have different requirements about the return they need to see from their investment in your company, which in turn dictates your exit path and timeline.You want to ensure that you’re aligned with your investors (who often double as board members). Alignment between yourself and your investors also sets you up for “syndicate” success, meaning your investors are aligned with each other as well.

As Chris shared, “We obviously do reference checks on people we back, and we recommend startups do the same on us. It’s easy for a VC to highlight all the companies that worked out, but you should talk to some of the founders that weren’t performing as well to see how those situations are handled. That’s how you’ll know if we're the right partner.”

Charlie echoed this sentiment. Whenever his team is about to give a term sheet to a founder, he shares a long list of every CEO in S3’s portfolio with their contact info, a short blurb about them, and notes on what to ask them. “I would encourage all founders out there to do just as much diligence on the investors [as we do on you],” he said.

Vik mentioned that the pandemic was a particularly revealing time for investors’ true colors: “There's no better time to see how your investors have really stepped up to help you in a situation. You know, everybody's happy when things are going great. It's when things are not going so great that your investors really, really need to step up and offer a helping hand.”

2. “In the early stages, debt should be complementary.”

Venture debt is a relatively new funding option that follows equity. You’re contractually obligated to pay back debt, unlike equity, but you also don’t lose any ownership of your business in exchange for the funding.

“When a company is reaching $12 million or $15 million in revenue and growing at a reasonable rate, you can use debt to further accelerate growth,” said Chris. In addition to preventing dilution of your equity, debt can also help with alignment since you’re not bringing on additional investors.

There are several different types of debt entrepreneurs can get from providers like Silicon Valley Bank. These include a line of credit that can be tapped at the founder’s discretion, a term loan that’s repaid over a particular time period, or a bridge loan which fills the gap between fundraising rounds or other milestones to help a startup extend its runway.

“In the early stages, debt should be complementary [to equity],” explained Robert. You don’t want to rely too heavily on debt or take it on too early, but a balanced amount of debt and equity can help your startup achieve its growth and profitability goals. Silicon Valley Bank traditionally aims to provide one third to one-half of debt relative to the equity in a venture round–in a $30 million equity round, this would be $10 million to $15 million in debt.

3. “There can be partial liquidity at major growth milestones.”

If you raise multiple rounds of funding, your cap table will likely start to look crowded.

Elsewhere or other private equity partners can buy out investors during big turning points in a company’s trajectory. Referred to as “partial liquidity events,” this strategy invites early investors—such as family and friends investors—to cash out on some or all of their equity. Partial liquidity can help clear a cap table, benefiting early investors who may not want to be as involved in the ongoing functions of a business while improving overall alignment for existing investors.

“There can be partial liquidity at major growth milestones, such as when a company’s going from $3M or $6M to $20M,” said Chris. “We've seen partial liquidity help folks become more patient about getting to a more meaningful exit.”

The panelists also highlighted that raising multiple rounds of capital to achieve an elusive billion-dollar exit isn’t the only potential end game for a startup. There are many viable options, such as acquisition by a PE firm or strategic partner, or even transitioning the company to a new CEO and pursuing a new idea. It’s important to have a sense of your ideal exit when you take on capital or pursue a liquidity event, as each firm will have different requirements and are beholden to generating a good return for their limited partners (LPs).

Once that alignment is in place and you are on your way, it’s important to remain transparent and honest about when you are at that juncture. You’ll know as a founder when you’re ready to exit.

Have more questions about the financing process and what kind of growth capital is right for you? We’ll soon be launching a new series that honestly and transparently addresses founders’ capital raising questions. Keep an eye out on the blog or sign up for our newsletter.

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About the Author

Michael Massad

Michael is a software investor at Elsewhere Partners where he co-leads all sourcing and diligence efforts in the IT infrastructure and cybersecurity sectors. Michael strives to connect capital and operational expertise with growing software companies across industries that are located outside of traditional VC hubs.