Capital strategy for startups and scaleups

Starting and scaling a business is an exciting but challenging journey. One of the most critical factors for success is the ability to manage capital effectively, i.e. having a capital strategy to execute on. In this article, we will explore what a capital strategy is, what you should consider when creating one for your business and some tips along the way.

What do we mean by a capital strategy?

Insufficient capital is the biggest challenge for most startups and scaleups.  

Therefore, it is important to have a good capital strategy that states how much capital you need, where it will come from, what the capital will be used for, do you need replenishment several times, how much ownership you are willing to give up each time, etc.

Some companies choose to bootstrap, i.e. build themselves up using revenue rather than raising capital from external sources. This is the best option, provided that the company is not in a critical race against competitors. Other companies choose to raise venture capital from investors and others. This article is intended more for companies that want to raise investor capital, but many of the aspects it covers are relevant to everyone.

There are several factors to consider when creating a capital strategy, including the stage the company is in, the importance of different milestones, whether to share ownership with employees and how capital requirements develop over time. We will take a closer look at this.

There are some pitfalls that all startups should try to avoid. You should avoid diluting your ownership stake too much in the beginning, and avoid having many passive owners. This can lead to what some investors call a "broken cap table", i.e. an unfavorable ownership structure that is not investable. The reason is that institutional investors require entrepreneurs to own enough to be incentivized after they have been diluted for several rounds in the future. It is a rule of thumb in the international investor context that the team should own more than about 50% after a Series A round. This is often difficult to achieve in a market with little capital and low pricing of companies. Read more about this below.  

A milestone-based capital strategy

If the intention is to develop the company with venture capital and raise money in several phases, it is normal for the company to fall into a venture pattern. This involves a rough categorical phasing of companies based on different milestones achieved and maturity. See example in the illustration below.

In recent times, the sources of capital have grown and what we call pre-seed has been introduced, which comes in before the seed round. The rounds have also gradually become larger, although a certain correction has been seen in the last couple of years. The illustration is nevertheless representative of how the venture model is divided into different phases and what is expected of different companies at different times.  

Source: Stanford University in San Francisco, California, US

The X-axis illustrates the different phases a company goes through as time passes. The green Y-axis represents the valuation and shows that it increases as the company matures. Similarly, you can see that the risk decreases as the company matures, represented by the red line.

There is a statement in venture that says "money buys down risk". This sets the tone for how some investors think and how valuation is a function of risk, or "perceived risk". This is important to bear in mind when creating a capital strategy.

How risk is assessed in different companies and industries varies. In the beginning, it's mostly about selling the vision, getting a team in place, the MVP (Minimum Viable Product) and the first customers. As the company evolves, the importance shifts from a hairy vision to the importance of validation via data. Already in Series A, unit economics start to become important to show that the company can create future margins in a larger context. Then it is important to start measuring key performance indicators (KPIs) and work purposefully to improve those that are decisive. Expectations for KPIs in different phases vary from industry to industry and market outlook. It's too big a topic to cover in this blog post, but there's a lot you can search for on the internet.

When calculating how much capital you need, it is a good idea to think of the company phase in stages and set some milestones accordingly. You should set milestones that either reduce the risk in the company or increase the value of the company. They often coincide. You should then think about how long it will take and how much money you need to reach those milestones. You should then take into account that it can take up to six months to raise new investor capital before you run out of money. It is not uncommon to raise money for 12-18 months. If economic times are bad, it's good if you can make the capital last longer.

Example: If it takes 12 months to reach an important milestone, you should secure enough money for 18 months. This gives your company a buffer in case you need more time, while leaving you time to work on securing new capital for the next phase.

It can be an art to balance how much money to raise. But basically, you want to have the least possible dilution of ownership, which is equivalent to raising the least possible capital. At the same time, you want to raise enough capital to reach the milestone that increases the value of the company before you have to raise new capital. In this way, you can raise capital in several rounds and gradually achieve less and less dilution in each round.

How much capital is normal to raise in different phases, at what company valuation and how much dilution must be accepted? It varies, and there are no rules here. However, it's important to bear in mind. In the beginning, you often get higher dilution than you get in later rounds. There can be a range from 15-25% in each round up to Series A. From Series B, 10-15% dilution is more common in a normalized capital market.  

What are the different types of capital sources?

There are several different sources of capital. The best capital is that which comes from customers, i.e. sales. This is both validating and has no dilutive effect on ownership.

In Norway, we are fortunate to have a good support system. In the beginning, it's a good idea to match this with some investor capital. This can be used to kick-start the first phase of the company. Once you have tested the idea, preferably assembled a team and gained your first customers/market validation, and reached certain critical milestones, you are better equipped to take things further, including capitalization. Innovation Norway offers various start-up grants and can offer several grants in different phases. The Research Council of Norway also has the Skattefunn scheme, which can reimburse 19% of eligible development costs. The Research Council also has other schemes. There are also other municipal and regional schemes that vary from district to district. Siva has a national business park program with various partners offering support in rural Norway, which can be a good place to start for many. There are also good European schemes under the auspices of the EU, but many of them are aimed at later phases.

It should also be mentioned that there are various national and international startup initiatives, so-called incubators and accelerators, which offer various schemes to startups, including knowledge programs, advice, discount schemes, financial awards and some offer investments.

Then there are different types of crowdfunding, both product, loan and equity-based. If you have a consumer product, you might consider using it to secure your first sales. Companies that are more advanced can consider equity-based crowdfunding. Different types of companies have different levels of success with this and you should be aware of what it entails. You suddenly get a lot of owners, a reasonably public profile and it requires more administration.  

Perhaps the best-known form of capital is securing funding from various investors. There are different types of investors for different phases. The first are often referred to as FFF (Friends, Fools and Family). These are those who are willing to help and invest in someone at an early stage. Then there are various angel investors, who have extra money to invest a little and who are also happy to contribute knowledge and networks. Wealthy families who invest actively are often called Family Offices. Then there are various types of Venture Capital (VC) funds, which are financial risk funds. Some larger companies have what is called Corporate Venture Capital (CVC), which is strategically oriented. For very mature companies, there are Private Equity Funds, which are late stage capital and work with larger projects and financial engineering.  

We'll cover more about investors in a separate blog post, specifically about Venture Capital. If you want to raise capital from this type of investor, you should understand the dynamics, what they are looking for and what is required. They invest in cases that can become big and operate according to the Power Law principle and take some "bold bets". They know that several investments can fail, but they are happy to take the risk given that the company has enough potential to pay back those that don't succeed. In all cases when looking for an investor, you should try to understand the investor and that you are a good match. It's perfectly normal to get some "no's" when seeking investor capital. It's part of the game. Not one size fits all, but keep looking until you find the investor that suits you and your business.

Companies that are further along the path and have income can consider loans in various forms. Innovation Norway currently offers some favorable loans, some can get bank loans, and some offer risk loans. You should be cautious about borrowing capital before you have good financial control. Defaulting on debts can lead to bankruptcy and compulsory liquidation of the company.

Use of different types of financial instruments in different phases  

This is an important part of having a well thought-out capital strategy. By various financial instruments, we mean share incentive schemes and investor agreements. This is often interrelated and is unfortunately an area where many companies make some unfortunate choices, especially first-time entrepreneurs who may not have experienced the consequences of these choices over time.  

There are various forms of capital injection by investors. An ordinary capital increase (share issue) means that the General Meeting resolves to increase the share capital of the company by printing new shares and selling these to shareholders so that the company receives working capital. This means that a value is placed on the shares and thus the company as a whole.

Capital can also be injected immediately via convertible loans or convertible notes. For the latter, Norway has established a standard called SLIP (Startup Lead Investment Paper), which is often the first investor instrument a company uses. The SLIP structure is based on the Silicon Valley model SAFE (Simple Agreement for Future Equity), which is the most commonly used structure in that environment for the initial capital in the company. See separate blog post about SLIP here. These are instruments that can/should be converted to shares at some point in the future

There are some clear advantages with SLIP. You can implement it quickly, get money the same day and avoid having to align all investors in the same time-consuming funding process, you can wait with the administration and registration of the capital injection, you can record it as equity and you postpone the valuation of the company.  

If you postpone the valuation of the company, you also have a completely different range of options when it comes to incentivizing key employees, any advisers and board members. You can make use of so-called "sweat equity" schemes, where you can make a form of remuneration with shares instead of capital when the company has a shortage of liquid assets. In such cases, restricted stock arrangements, often referred to as Restricted Stock Awards, are often used.  

But you have to use all these structures with care and be aware of the pitfalls. If you don't have a good capital strategy or fail to deliver on milestones, it can be difficult to convert loans or SLIPs into shares if you have raised a lot of capital and failed to build value in the company. If you give shares to contributors, these should also include restrictions and repurchase options. This is to prevent a so-called "broken cap table", with many passive owners and a small ownership share for active owners. This can make it difficult to raise more capital later on.

However, if you have raised capital at a high valuation of the company, you can no longer give away shares without this having tax consequences for both the recipient and the company. You can resort to other share incentive schemes. There are many choices here, but for the first phase, it is common to try to use the option scheme for startups. This provides tax benefits for both the recipient and the company compared to the ordinary option scheme. Here you must be aware that there are many requirements for both the company, the recipient, the option and reporting to qualify.  

How is the market for capital now?

The answer to this question is still a work in progress. We mention it anyway to give some tips for you founders. Chances are that if you are reading this, you are in an early stage. Investors will argue that the capital market is demanding and pricing must therefore be adjusted downwards. Buyers will always argue for this.  

The fact is that in an international context, data and statistics show that the pricing of early-stage companies is not much lower than it was at the peak. However, if you go to the later phase, type series B and beyond, pricing has fallen somewhat. But this is also on the way up again.

The reason is that there is a kind of floor. If you raise a lot of capital at low pricing, you ruin the cap table from the start, making the rest of the journey difficult. This serves no one well. Smart investors who know the market and its dynamics understand this.  

That said, it's important to remember that it's the market that decides. There is less early-stage capital in circulation today than there was a short time ago, although this seems to be improving. However, it should be noted that there is much more capital available today than a few years ago. Statistics also show that fewer companies are actively raising capital. So this is a little pep talk for you entrepreneurs who are going out to raise capital. Point to international benchmarks and use the argumentation to ensure a sustainable valuation of your company when raising capital.


In other words, there are several things to consider when creating a capital strategy.  

Think of this as a milestone-based journey and divide it into phases based on milestones that mitigate risk and add value to your business. Be smart and use different instruments at different times to achieve what suits your business. Make sure to ensure minimal dilution and balance this with the necessary capital.  

Create good agreements that ensure maximum ownership among active owners over time.  

When introducing share incentives, you should try to optimize this based on the desired effect, cost to the recipient, tax and risk.  

Unlisted can assist both with capital strategy, and the introduction of share and option schemes that are optimized for a venture run. Unlisted also offers a free digital shareholder book and a solution for managing various ash incentive schemes and various financial instruments. You are welcome to contact us for a non-binding conversation about this.  

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