We have spoken about principled negotiations between start-up entrepreneurs and potential funders of the new venture in an earlier article. Even though those negotiation principles are universal, the main drawback remains, which is that as technology entrepreneur you are a visionary, whilst the potential funder will look at the lay of the land, being the current financial statements. This drawback can only be overcome if you can interpret the income statement, balance sheet and cash flow in such manner that you can convince the funder that conventional metrics are not necessarily applicable – in other words, finding sustainable common grounds. This is easier said than done when you do not have a trading history, like most start-ups.
Seeing the Financials Through the Lens of the Funder
Yes, you need to have a strong working knowledge of WACC, EBITDA and IRR because these metrics are mostly used by experienced VCs. Funders will also carefully scrutinise your burn rate. Here a dead give-away would be is salaries for the entrepreneurial team are market related – no sweat equity means no commitment and you can prepare yourself for a tough round of negotiations. Another give away is the extensive use of third parties to do product development – the immediate red flag is that you are not in control of the IP that you are creating and relying on to raise funding.
Seeing the Financials Through the Lens of the Entrepreneur
Yes, you need enough resources to fund a minimum viable product (MVP), or to generate your first sales. This is a cost approach, which is only a fraction of what the funder is looking at. Yes, you would have prepared a discounted cash flow (DCF) model, which is indeed a relevant metric. However, your lens would be blurred since the funder will argue that “Excel sheets are patient”, even more so if the proverbial hockey stick sales graph is presented as part of your DFC model. Yes, you need to have a deep insight into the market and base your sales projections on realistic market penetration. However, if the percentage is not supported by a due diligence on the innovation adoption lifecycle of the underlying technology, your forecasts will be frowned upon by the funder. More specifically, you need to have a deep understanding of Rodger’s theory and how it was disrupted by Downes and Nunes.
The Sustainability Lens
With our IP valuation strategy, we suggest that you prepare for negotiations on the financials from a sustainability perspective. To do so we propose a simplified approach towards return on investment (ROI).
Each of the three metrics are nuanced. Revenue can be seen as gross sales, royalties, ex works, and so the list carries on. Cost can be inclusive or exclusive of tax, interest, depreciation. Investment can be tricky too. Depending on the sector, the investor will focus on how hard the assets are sweating – an aircraft must be in the air to sweat – meaning that the investment will require working capital to unlock the investment in the underlying assets. But these are financial metrics. ROI should rather be approached with a lateral thinking mindset.
Have you ever considered ROI in the manner proposed below:
This insight brings governance to the fore and is a good argument towards sustainability. This is said because the investor will, like all good VCs do, pay a premium on a strong team with proper governance being in place.
Another lateral view on ROI is as follows:
What we observe with this perspective is a symbiotic relationship between key stakeholders without which no innovation will ever reach the marketplace.
In all three instances the message is the same: To achieve the required ROI, sales must go up, cost must be contained, and the assets must sweat. Bringing this home to principled negotiations, it can be concluded that during the preparation phase of the negotiations the entrepreneur should put herself in all nine permutations of the ROI formula to appreciate that there must be a natural tension between the three metrics – without well-managed tension sustainability will not be achieved.
