Navigating Venture Finance: CFO Insights on Founder's Financial Readiness

Welcome to Propeller Perspectives, a monthly newsletter focused on sharing expert industry knowledge from the top strategic finance and accounting partner for venture-stage companies. In this month's newsletter, Propeller CFO David Davick delves into the financing challenges faced by founders, particularly the heightened scrutiny in the current venture financing landscape. As an experienced CFO, he emphasizes the importance of financial readiness to guide founders through successful fundraising.

January 2024 Newsletter with David Davick - Propeller CFO

When you first sit down with a founder, do you have a series of items you dive into first?? ?

DD: One of my favorite things to do is to speak to founders for the first time. That discovery meeting is where I really get to know both them and the company, which is one of the most fun parts about being at Propeller. I typically will start by asking them: “Catch me up on what you've done thus far with the business. How have you financed the business and ultimately, where do you want to take it?” Usually, that'll lead to a bit more of their story as to what they're trying to build, where they've hit some challenges, and hopefully where we can be a resource for them.

What are the main unexpected challenges that founders face in various industries, from your perspective as a fractional CFO??

DD: There are certainly some industry-specific challenges, but almost always the biggest challenge, regardless of which industry, is financing the business. In the early days most of these companies are burning cash, and having enough financing to do what you want to do and get to that next catalyst for the next fundraise is often the biggest challenge. Typically, that's where we start, which is finding out how you have financed the business to date and what we can do to help you either make the cash you have last longer or position the company better for that next fundraise.??

By industry, there have been some differences in venture funding, willingness to invest, and risk profile. The CPG businesses have been a bit more out of favor of late, so the bar has been raised for what you need to demonstrate in order to get financing. Many investors have become more risk-averse and less willing to take a risk in those early days. Often the feedback we're getting from investors when they're looking at companies or when we're showing them a prospective deal or investment is, “Hey, it's too early. I want to see a bit more traction.” So, a lot of the conversations we're having with our companies are centered around how you can make the cash you have last longer and what you need to demonstrate to attract that priced round or institutional raise for the next level of the business.

How do you lead founders through a conversation about how much to raise and what criteria are you taking into account??

DD: One of the big questions that founders often will come to us with is ‘How much money do I need to raise to get to that next stage of the business? How much should I be targeting?’ Ideally, if we've been working with them and they're already a client, we have some sense, based on the financial modeling that we put together, of how much cash they have, how long that's going to last them, and which catalysts they need to demonstrate to get that next level of financing.?

If it’s a new conversation, it typically will start with a more detailed financial model of that catalyst. Where are they against that and how much of a cash buffer do we need to make sure we have in reserve just in case, inevitably, most of these companies hit a bump in the road? Things take longer and cost more, so you want to plan that in. This full three-statement financial model goes out into the future so that we can match catalysts and key performance indicators against the types of things that investors are going to want to see in order to invest in that business.

If you think of some of the successful equity investments you've led founders through, what's changed today versus months ago??

DD: A lot has changed in the investor, and particularly the venture financing, landscape just in the last 6-12 months. The bar is much higher for what companies need to demonstrate in order to get institutional financing. It was certainly easier a year or two ago. Companies today are still getting financed— great companies are getting financed, but again, the bar is much higher, so a lot of venture firms have gotten more risk-averse. They want to see more traction, and that might come in the form of higher revenue if it's a CPG business i.e. that might mean they want you to be nationwide in Whole Foods or another retailer. They want to have some sense of how well you're doing or how well you will do at scale, whereas it used to be that investors were more willing to take a risk and there was a much more competitive atmosphere where they were investing earlier in that stage. Today, I think that's certainly shifted to where investors want to see more traction and demonstrated success before they're willing to put money in.??

The other dynamic that we've seen is investors increasing their check size. Lots of investors that used to participate in seed or earlier stage rounds— as that fund has gotten either more concentrated or more successful, have moved up in terms of their check size. They want to make a handful of more concentrated investments, so it's worth their while only if you're above a certain scale. So, it's harder to find those smaller checks, earlier-stage, higher risk-tolerant investors these days. A lot of times for those first seed, early-stage financings, you're looking for friends and family and that money needs to carry you a bit farther along the path than maybe it used to just 6-12 months ago.

If we look at the Transaction Advisory teams track record of success and we think about the equity investments you've been a part of, what are the biggest challenges that those companies face that the TA team had to help guide them through?? ?

DD: When companies come to us for help fundraising or with a transaction, we often see two types of engagements. One where a founder has done it before and realizes just how much time and focus it takes to get a successful financing round done. What they're really looking for are people who have done it many times and can help take some of that work off their plate. Or we see companies that are looking for help, they've never done it before or they've only dabbled a little bit and they want people like us, who have relationships with lots of venture funds. And if you think about it, Propeller has 300+ active clients and over 1,000 companies that we've worked with over our 16-year history, and almost all of those are venture-backed. So, we know a lot of investors that are likely to invest in your company. The transactions that are successful start with one of those two paths, where we're bringing to bear the relationships that we have.?

In terms of what makes for successful financing—there are a few different ways to get a successful deal done. One of the most important aspects is running a process. Sometimes we'll have founders that come to us and say, “Hey, I've got relationships with these five funds,” and you might get a deal done if you're an especially great company or have an especially close relationship. But most of the companies that come to us benefit from running a process. Going out, you want to have multiple parties invested in your round to keep things moving. Often some of the biggest challenges to a deal is time, time kills deals. The longer it takes, the more things that can go sideways. If you've got a process that you're running, it keeps the pace going. You're trying to minimize the distraction for you as an entrepreneur running the business so you can run a successful business, and that's where we can help by taking some of that work off your plate.

What does financing readiness mean to you?? ?

DD: How do you know if you're ready to run a process and get institutional financing? That's where we can help quite a bit because again, we're seeing companies all the time. You want to be buttoned up before you go out in front of institutional investors. That might mean getting your financial model into shape. Often companies come to us with a year or two of a PnL, or an income statement model. One of the things you're going to want to have to get an institutional round done, however, is a full three-statement model: your income statement, your balance sheet, and ultimately a cash flow. We often will help companies put together enough time in their model to demonstrate to an investor what this business looks like once it reaches scale or gets into the future far enough so that your gross margins or your profitability start to normalize. So, what is the potential of this business? You’ll want to paint a picture for investors. They're often going to run their own models, but you want to start the conversation with your version of what you expect the business to do. So, one aspect is to get your financial model buttoned up and in shape to share with investors.?

There are also items that when you get into that second or third conversation with an investor, they'll want to start digging into the data room and some of the other diligence items. So, for example, your CAP table, how have you financed the business to date? Who else has invested in the business? You'll want to make sure that's ready to share with the prospective investors so that you avoid surprises or anything that can derail the process. So financial statements, CAP table, and your pitch deck—how do you tell your story? We do this all the time, and we can be a good first resource for entrepreneurs and companies as you practice telling that story. We will give you some feedback as to what sort of questions or feedback you can anticipate from institutional investors and what roadblocks or landmines to avoid because we've seen this come up and derail a process. As an example: if you had a customer churn issue in the past that you've since addressed, let's proactively make that part of the conversation to avoid any surprises when you get into diligence.

How do you guide founders and CEOs around their sales and marketing expenses?? ?

DD: For CPG businesses, one of the dynamics that's really changed over the last 6-12 months is sales and marketing, your marketing return, and how to think about that balance between revenue growth and profitability. The pendulum has swung dramatically towards profitability, or at least having a path to profitability. So, it's still important in the early days to get enough scale that you'll get attention. That attention might come in the form of distribution points. Are you getting distribution points in bigger businesses like Whole Foods? Then, once you get that distribution point, are you staying there? Your velocities within stores - that's changed. It used to be much more of a geographic land grab, where you wanted to get into as many doors as possible as quickly as possible. I think that's shifted now to where companies are taking a much more concentrated, regional approach. So, rather than trying to go nationwide, they'll stay in a tighter region and make sure that they're putting their sales and marketing spend against that tighter regional footprint to make sure that they get velocities and demonstrate that within the regions where they play, they're doing quite well. That gives them permission, if you will, to expand beyond that region. A lot of retailers want to see that. We've certainly seen this with some of the beverage brands that we work with so that they can make their dollars go a little farther. That's been a much more successful strategy, particularly in the last 6-12 months, where getting a nice return on the investments you're making is especially important, and trying to preserve cash rather than taking unnecessary risks.

Are there balance sheet or cash flows challenges for a SaaS company that are unique to that industry?? ?

DD: By industry, we definitely have seen some different dynamics. For example, in the SaaS businesses that we work with, a lot of the focus, as you would expect, is around customers— both what it takes to acquire customers as well as churn or lack thereof. So, if you've got an efficient business that doesn't have much customer acquisition costs and you're keeping those customers, even if you're growing more slowly, that has a ton of potential versus others where if your churn creeps up, or if you've had some issues with churn, that can often derail your financing. We've seen this more than once with either a SaaS business or a direct-to-consumer business that has a lot of customer churn— that becomes an issue right out of the gate.??

Before you go out to fundraise, you want to make sure you've got a tight story around your customer acquisition costs, your opportunities to bring on new customers, and your customer retention. That might mean, for example, if you're a direct-to-consumer business, getting some help running analysis on your cohorts. How are your customers performing over time? Are there patterns? Is there feedback to the extent you had some churn in the past? Have you addressed it? Or is it a more fundamental issue? You better know the answers to those before you go out to the market because it's going to come up in your diligence, and a lot of the more sophisticated investors are going to run their own analysis and dive very deeply into the customer performance and make sure that they have a great handle on the health of your business and whether or not your customers are happy and stay with you.

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