Understanding and navigating burn rate: a startup primer – 9: the cash-flow implications of having outside investors – 1
This is my ninth installment in what is perhaps the most important operational set of issues that a startup is certain to be faced with – understanding and managing monetizable resources available, and cash flow that would be drawn from them (see Startups and Early Stage Businesses, postings 67-74.) And I start this series installment from a foundation I set with two earlier postings: Part 8 of this series, on stakeholder buy-in and Startups and a Word that Divides Them – Investment.
In a fundamental sense, this posting is in fact a direct continuation of my earlier posting as noted above on investments in a startup. And for the purpose of this posting, I will at least initially broaden the span covered by the term “outside investor” to include anyone not a founder/owner of the business per se. That earlier posting looked at the issues to be covered here largely from the perspective of those stakeholders. This posting is oriented more from the perspective of the business and its founders and owners.
As I have already noted, other stakeholders make investments, and of both negotiable, monetary form and as sweat equity and as other non-monetizable contributions. And each of these stakeholder classes: employees and outside consultants if any, and angel or venture capital investors have expectations as to the value of their contributions to the business and in what they will receive in return and when. I start out looking at outside investors in the widest sense so that when I focus in on angel and venture capital investors – the stakeholders that people more usually think of as “outside investors”, I can do so noting both how they differ from other stakeholders and how they in fact look for and expect many of the same things as other stakeholders and investors.
• All stakeholders make investments in the startup or early stage business they are engaged in.
• They all do so with an expectation of receiving a return on their investments, even if there can be and usually are systematic differences as to amounts and time frames involved for different stakeholder types.
• All stakeholders who chose to buy in on a new venture, should be participating in it as as investors from a solid understanding that they are taking a risk that their initial investment might be lost and without them being compensated as expected – and that this diminution of investments made may be partial or it may mean a total loss, which they might or might not be able to take as a tax write-off.
• In this, angels and venture capital investors are simply following a more general pattern, with their own particular implementations of that. And from the founder and in-house owner perspective it is important to remember that, and that making a decision to bring in these types of stakeholders needs to be determined with other stakeholder obligations and the entire business picture in mind.
• Do not simply approach the decision as to whether or not angel or venture capital investment is a good idea as if in a vacuum. In this, my recommendation is that you view potential angel or venture capital involvement the same way they would view you and your venture – looking at the complete picture and how the pieces fit together in it.
• And consider any potential stakeholder for both short term and long term benefits and costs, and for positive and negative due diligence possibilities.
With that, I turn to “outside investor” in the narrow sense and focus on angel investors and venture capital as potential sources of significant cash infusion and startup and early stage liquidity. And that is a perspective that most every startup founder takes when considering these potential investors. And unfortunately, that is as far as many if not most of these founders go in thinking through what is involved and what commitments they have to make in order to secure this type of support.
I am going to continue this discussion with a part 10 installment in which I will explicitly outline some of the core considerations that angel and venture capital investors make, and simply assume as givens – but that startup and early stage founders and owners need to understand even if they are not always explicitly stated to them. I will also outline some of the core and fundamental due diligence considerations that founders need to take into account as they make their strategic decisions as to whether to pursue angel and/or venture capital investments. There are benefits to be gained in sudden and even very significant increases in working capital but there are costs too, and some of them may not always be apparent up-front for their long term significance.
You can find this and related postings at Startups and Early Stage Businesses.