Should you take the smart money?

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Earlier this fall I had the pleasure to spend some time with Finance Master´s students at my alma mater, VU University. One of the topics we touched upon is: How can venture capital help you create more shareholder value, without diluting financially?

It’s the topic of a conversation I am often having with founders and board members; to fund or not to fund? I generally show them two hypothetical cases: first, a growth case for a software company without external capital, and secondly a growth case for a software company with external capital.

Bootstrapped growth

Say, you are a founder of a software company and decide to accelerate growth for 5 years until your exit:

  • Reinvesting all your cash flow back into the business. No more and no less;
  • Growing fully self-funded;
  • Putting most of the growth investments into the hiring of sales & marketing staff, developers, customer success, people development and systems.

For this example, I am assuming pre-requisites such as a healthy, large enough market, a scalable business model, sales efficiency, scaling, hiring- and business-building knowledge are all met. Moreover, founders are prepared to step back if that’s better for the plan.

Bootstrap Assumptions

In this scenario you could reach the EUR 80m revenue mark in 5 years:

  • The 40% rule applies, so 20% growth means 20% free cash flow (“FCF”) margin. 40% growth means 0% FCF etc.;
  • The enterprise value-to-revenue multiple offered by investors is 5x (the public SaaS median is about 8x, currently);
  • We consider the 2023 FCF as net cash. That would imply a EUR 393m payoff to the founder, management team and any other owners of the common shares.


Not bad! But certainly, not easy. This is a spreadsheet of a success scenario! The real hard work is making it happen. In the operation, kickstarting that growth engine and aligning the roadmap with customer needs and wants. This could take years and the payoff may never come at all.

What about raising capital to accelerate?

Once you’ve decided that you would like to bring on experienced capital you want to move fast. Increase the chance that the accelerated growth scenario will work out. You start to forward invest as the market opportunity may not always be there.

Capital Scenario Assumptions

The starting point is the same, but this time a total of EUR 56m is raised to accelerate growth:

  • Again, I applied the standard 40% rule, 20% growth means 20% FCF margin. 80% growth means a negative -40% FCF;
  • Growth investors provide 8% preferred stock with a participation feature (a participation in the equity value created at exit);
  • Due to the capital and experience, the company succeeds in taking market share, rapidly attaining a EUR 160m in revenue.

Wow, times two!

If we use the same principles (5x revenue exit multiple; exit year FCF is net cash) we achieve a total equity value of EUR 805m. That’s the bootstrapped equity value times two!

However, don’t get too excited yet. First, the providers of growth capital want to be paid. And your shares have been diluted. So, what’s left for you? EUR 618m. Or 1,6x the EUR 389m you would have realized by yourself.

Not so fast!

So, don’t sign up for growth capital too fast. There’s a lot to consider before you do.

This is the upside scenario, but is it realistic?

It can be. But only, if you’re one of the happy few.

I wrote a previous article on Elastic’s incredible growth trajectory; from EUR 0 to EUR 160m 6 years. The company went public against a USD 2,5bn valuation (15x trailing revenue), but the market gave it a 30x (!) trailing revenue valuation on that same day. This makes our 5x revenue assumption look pale.

However, these kinds of trajectories and valuations are the exception to the rule. Keep in mind that over the years, only 0,5% of start-ups make it to scale-ups, and the absolute amount of Dutch start-ups that make it to scale-up in the Netherlands was stagnant in 2017.

As mentioned, the current public SaaS median valuation is tending around 8x trailing revenue. Not 30x!

Also, consider this:

  • Is your market large enough to justify the revenue growth that is envisaged?
  • Is the company ready for scaling?
  • Can the company efficiently absorb the growth investments?
  • Can you get decent terms on the capital?
  • Do you mind, losing (some) control over the company?
  • Do you know how to restructure and scale-up a company yourself?

So, rethink before you say no to investor interest, or start raising capital and get help to understand what you should ask AND offer in return. That is certainly worth it!

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