Chapter 40
FINANCIAL MANAGEMENT : Setting up a company or financing start-ups

The start-up phase is the most risky phase in the economic life of a company, with financial aspects that are strongly influenced by the particularities of this phase: extreme volatility of capital employed as most often the economic model still has to be built, which results in a highly speculative and unstable value; need for external financing because cash flow is rarely positive before several years; crucial role of the founder, who is a virtual demigod, and whose behaviour is the antithesis of that put forward by the CAPM; investors who are more closely involved than they are in an investment in a listed company in order to be able to help the investor by giving advice and connecting him with their networks.

Faced with the very high risk of starting up a company, the virtually exclusive means of financing must be equity capital, because this is the only type of financing that will give the entrepreneur the time needed to validate his concept and find his economic model, which rarely happens on the first try. Most frequently, financing using equity capital is provided in several rounds of financing, on condition that the company passes a new stage of development. This allows the entrepreneur and the investors from the first rounds of financing to hope for dilution with the best price conditions. If goodwill is paid at the start by investors, the founders will be less diluted but they will be taking a major risk of deadlock if the business plan is not met, which is the rule rather than the exception when it comes to start-ups, or if a ratchet clause is triggered, with potentially devastating effects.

Depending on the stage of development reached by the young company, its investors will be, other than the founders, their family members, business angels, venture capitalists or industrial players, and in the event of success, the stock exchange. Unless the company uses assets which have a value that is independent from its operating, debt has no place in the financing of start-ups.

Shareholders' agreements of the young company mainly include clauses relating to the founders, to the consequence of any goodwill paid at the start, to the liquidity of the investment and to access to information.

In terms of financial management, the emphasis is placed on the amount of cash on the balance sheet, in order to be able to measure the number of months before a next round of financing, the timing of which is crucial – neither too soon nor too late.

Finally, in terms of valuation, because it is practically impossible to come up with reliable forecasts, the usual valuation methods are not used and a hybrid method made up of the multiples and the discounted cash flows method has been developed for valuing start-ups.