Backsolving your growth trajectory based on investor expectations

A short story from a discussion with a founder that I had who wanted to raise money for an ICO.

For first time entrepreneurs it is typical quite hard to come up with a financial plan for their business. This is mostly due to the fact that it is hard to estimate the growth trajectory of the cost base. Assuming reasonably how you want to ship product and get first revenues in, it is a bit harder to get what needs to be done and understand the cash burn you will experience.

So here is a very high level educational walkthrough on how a serial might look at the economics of a business idea very quickly and dirtyly.

The case here is that of a company that wants to do an ICO. Unlike modern ICOs, we assume the founders are conservative and look at the ICO somewhat as a fund. they will incubate a Blockchain operations company that will do the ICO which here is targeted to be raised by Year 4. The amount raised is used for operating the chain, building partnerships with mining partners (no BaaS here, and no Capex for building own infrastructure assumed) which is a global relationship business that takes some Sales and Marketing along the line. This is just a reminder to understand that this company isn’t pulling any revenues untill after ICO (which it gets mostly from net income generated from the ICO vehicle flowing to the start-up).

So this is an extreme example in terms of traction/valuations and the degression of founder ownership might not be for you and also considered too agressive.

The founder ownership degradation:

So the idea is simple, you backsolve your valuations to reach a 1 billion valuation in Year 10. The graph shows a progression till year 4. How does that work? Well, you want to end up with the final valuation of a unicorn at 1bn. Good. You should know in your business plan and pitch deck what this means. If you want a 1bn valuation, you should have the right YoY growth of revenues, model must have proven scalable with interesting gross margins, your valuation should reflect common multiples (e.g. with a 10x Revenue Multiple you should gross 100 Million in revenues, with a a 20x EBIT multiple you should have 50 Million EBIT. etc. etc.). That said, what is your TAM, SAM, etc. ? Does it make sense?

With all this mechanics checked and positive outcome of the analysis, you research the typical round sizes of comparable companies on their way to IPO. Also makes sense. Make sure you also get the current count valuation-to-cash-raised multiple in line with market standard. Make sure your YoY Valuation to Cash raised multiple makes sense. And make sure your last valuation vs total cash raised multiple makes sense. Why?

Well, in Year 8 you raise 140 million at a 600 Million valuation. You need the valuation to have the trajectory towards the IPO of 1bn. Your investors will only pay a reasonable amount for a particular share in your company. So it boils down to your cash demand. Remember the Cash demand.

The funds raised YoY or Period-by-period also is important to understand that your post money expectation matches your cash demand, which would be a measure for the effectivity of your milestones achievements and cost base expansion, or putting it different: you put money to good use.

Most importantly is the total cash raised to current valuation. Because this defines your CoC / Cash on Cash multiple for the investors. Whoever invested in some period with whatever liquidation preference, your nice ownership of founders in the company only works if everyone converts to common and doesn’t take away common equity value which is typically the case if the Valuation/sales value of the company is well above the typicaly 1.5 treshhold.

But the important thing here is the cash demand. 😉

Understanding cash raised and effective use of it

In this case we started with 75k equity from founders which will burn rather quickly and should warrant an Angel round of €150k within 5–9 months. In that time, you will hardly pay any management salary and pay most money for base infrastructure of operations, some freelancers and employees and eventually rent for your company registered address and laptops and communication. Once you have the 150k, you also don’t do much with it. That’s enough to pay 2–3 employees for a year and travel for business relationships. You will run another 6–7 months. Time for your 500k Seed round. This still isn’t much. You can pay yourself a low income salary, hire three to six more key employees and travel more. You will burn again within less than 12 months and hopefully you have something like a prototype and some first potential clients discovered. With that in your pocket, you are quite aggressive and self-confident to raise a 2 million Series A, which finally allows you to eventually hire a secretary, get a coffee machine, do a marketing and branding campaign, travel even more and get a first test customer into your proof of concept. In our case, you don’t have any revenue because your ICO hasn’t happened yet, but you might get some extra cash from future partners that participate in the ICO to make sure you prioritize their needs in the product development.

Cool, right? Maybe you now can even afford a Christmas dinner as your first employee retention campaign and maybe someone sponsored a TV and playstation.

Within less than a year growing your engineering, product and eventually sales/Bizdev team and switching freelancers with hires, low-value interns with top interns, you are out of cash again within less than a year, headhunter and legal advisory around structuring your ICO plans. You raise your 8 million Series B round. You massively increasing travelling, start building proper operations to support the non-disruptive servicing of customers and build a customer success and support team, you start testing larger-scale on the Blockchain infrastructure and you acquire more and more potential users of the your coin (e.g. some target market B2B partners), you have your infrastructure partnership mostly in play and negotiate final terms and start marketing your ICO. Time to finalize the legal structuring of your ICO vehicle and getting in touch with supporters from teh finance world, trying to get that market making and balance sheet risk of a currency of your back, with doors closed because they all fear regulatory pressure.

You quickly burned through the 8 millions after successfull HR ramp-up, office expansion, satellite company and office set-up and getting your partners onboarded into your product-development and onboarding processes. The ICO stands near.

Your ICO vehicle raises its 500 million around 5–15 full timers are just busy with maintaining FX rates, keeping partners happy, smoothing out bugs in the transaciton system and so forth.

The first thing you notice when you start modelling cost base expansions following such a high level fund raising plan is that you are running out of cash fairly quickly, that you think the time you have is too short given the headcount you have. And the total items you should do. Coordintation effort continuously rises, politics enters your tiny system because you had to hire quickly to make the run rate and you don’t appear to have time for replacements. You raised your series B2 and got another 4 million of cash to finally do see the marketing success you didn’t see before the ICO and now run out of cash again.

But lucky you, your ICO didn’t break your operations company, the system runs, partners are busy onboarding customers on using the coin, the transaction numbers increase and investors stay interested and liquidity on major FX channels is strong enoug hto transition from your market-making protected partial-float to an actual free-float regime. Regulators were slow and your market timing was great, so no big hazzle and some big ones see a shot of you taking the winning spot in this 20 billion annual transaction volume market and shoot 45 million into your company. This is the time when a normal founder starts losing it and runs out of the “entrepreneurial control” over his company. Because now scaling to spending the cash you raised becomes a non-trivial task. HR must work, role based and hierarchical systems must be put into place, KPI-based performance management starts and no single individual can do all the stakeholder relations anymore. You need to have the people you trust, that know their role and keep everything running as a single entity with one mission and goal.

Assuming you managed this — eventually by bringing a seasoned CEO on board with his network — you are now entering the 120 million fund raise only 1–2 years later. Everyone is exhausted, everything is chaos, but you somehow muddled through. You sitll have to scale, but you also have to clean up the mess you created. The founder-CEO now starts to become blind to his company. He has to focus on the most value-adding activities which at maximum contribute to 5% of the success of the company. There is a substantial legal department, a lobbying unit, a product and partner focused area, an area focusing on optimizing end user success on the plattform of partners. Revenues don’t seem to grow the way they should so new ways of monetizing the system must be found. But the original business plan didn’t cover this. Competitors come and want to take over having early successes. We are looking at a war room from the management board down to the mid-level management.

Once the 140 million round 2 years later is coming, it’s time to focus on bringing the behemoth on track for IPO. Re-evaluating global satellite office architecture, changing the entire organizational structure and lots of replacements might become valid. The aggressive gold-digging employees must be replaced by administrators that would die to keep errors and process problems low. And finally you IPO.

So, you probably can’t forecast your Year 8 development when you found your business. But you should be able to look ahead at least 2–3 years and understand the demands your growth expectations put on the cash demand implied by the tickets you raise and how to put that money into optimal use.

Hope this was interesting and helpful. Comments appreciated.


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