The Financing Process in Innovative Startup Firms

THE FINANCING PROCESS IN INNOVATIVE STARTUP FIRMS
TALES FROM THE ENTREPRENEUR PERSPECTIVE EIGHT SWEDISH CASES
PhD Anna Sderblom, PhD Mikael Samuelsson & PhD Pr Mrtensson

Stockholm School of Economics
November 2013. Version 3.0
The study outlined in this report constitutes one part of a larger research project set up by the Stockholm School of Economics, Center for
Entrepreneurship and Business Creation. The aim of the larger project is to increase our understanding about companies choices of early
financing as well as about possible connections between funding sources and future firm performance. The project is managed by PhD Anna
Sderblom and PhD Mikael Samuelsson. The project started in July 2012 and will run to December 2015. The project is funded by the
Handelsbankens foundations and VINNOVA.
1.
INTRODUCTION
Young innovative firms as engines for economic growth have garnered substantial attention during the
last couple of decades. Much of this focus stems from the wide-spread view that such businesses account
for a significant share of job creation, innovation, and economic growth (e.g., Storey, 1994; Birch et al.,
1995; Henrekson and Johanson, 2010). Hence, the possibility for innovative startup firms to develop
and prosper has become a major objective for most economies, whereby policy makers put lots of energy
into finding direct or indirect methods to stimulate this type of efforts.
In this context, the lack of funding facing young and innovative ventures is an ever-occurring
theme (e.g., Berger and Udell, 1998; Cassar, 2004; Vanacker and Manigart, 2010). That is, given their
liability of newness due to an absence of track record and a high default risk (Stinchcombe, 1965;
Hannan and Freeman, 1977; Baum, 1996), potential financiers are skeptical to provide funding. Hence,
innovative startup firms are considered more financially constrained than other companies, which in
turn restrain their development and growth paths.
As a consequence the area of finance for startups has enjoyed an increasing interest from
scholars, resulting in a substantial body of research over the years. A vast majority of these studies
concerns startup funding from the supply side, first and foremost focusing on venture capitalists
(Tyebjee and Bruno, 1984; Fried and Hisrich, 1989; Wright and Robbie, 1998), and to some extent
business angels (Amatucci and Sohl, 2004; Paul et al., 2007). Meanwhile, our understanding of the
entrepreneurial view on financing issues is still limited (Cressy and Olofsson, 1997; Paul et al., 2007;
Sorheim and Rasmussen, 2010).
This study aims at contributing to the small stream of research investigating startup financing
from the perspective of demand, where we particularly explore entrepreneurs opinions on, and
approaches to, financing. More specifically, we study the four stages in the financing process, i.e.,
planning, search, evaluation/negotiation and post-investment activities, from the entrepreneurs
viewpoint. The aim is to widen our understanding of similarities and differences among entrepreneurs
of innovative startups regarding their approaches to funding. Moreover, the paper examines the
relevance and applicability of well-established theoretical explanations in the field.
Due to this scarcity of research, an explorative inductive research design in the form of case
studies was called for. Therefore, we have conducted in-depth interviews with eight entrepreneurs were
we were able to get a deeper understanding of the entrepreneurial perspective on financing processes.
Our results show that more experienced entrepreneurs in general have a more strategic
approach to funding based on predefined funding plans, while less experienced entrepreneurs manage
funding on a more ad hoc basis. Furthermore, we found that entrepreneurs exercise high levels of control
in their relations with equity investors both ex ante and ex post the investment. We also found a path
dependency pattern in the choice of funding, where the firms tend to use the same types of funding over
and over again. One significant finding regarding funding sources is that capital arriving from family
and friends is absent in our study and that formal VC investments are highly limited.
S de rb lo m , S amu e ls so n & M r te ns so n
2.
THEORETICAL FRAMEWORK
The lion part of studies about investment processes in startup firms occur in the venture capital (VC)
and business angels streams of research. Typically, investor processes are split into three phases
(Tyebjee and Bruno, 1984; Fried and Hisrich, 1994; Wright and Robbie, 1998; Paul et al., 2007). First
the pre-investment stage, which involves investor activities related to the search, initial screening and
thereafter more thorough due diligence activities. Second, the investment stage, which concerns the
negotiation of contractual terms and conditions as well as of firm valuation. Third, the post investment
stage concerning the activities taken place after an agreement has been settled, including control and
coaching of investee firms, management of future rounds of financing, and exiting. In one of few studies
that shift perspective, Amatucci and Sohl (2004) explored the investment decision process involving
women entrepreneurs and business angels from the perspective of demand. They split the process into
three stages, search, contract/negotiation, and post investment. In this report, we structure the
discussions around Amatucci and Sohls (ibid.) proposed process stages, but also add a fourth
component, planning. This stage concerns activities and decisions made before the entrepreneurs start
to search for external financiers, i.e., their approaches to, and preferences for, various funding sources.
Figure 1 below illustrates the four stages.
Planning
Search
Evaluation &
Negotiation
Postinvestment
Figure 1. The financing process from the perspective of entrepreneurs
2.1.
PLANNING
One of the more influential ideas in the finance literature used for explaining firms capital structures is
the pecking order theory (POT) a theory about hierarchical financing order stemming from a presence
of information asymmetries between companies and their potential financiers (Myers and Majluf, 1984).
According to this theory external finance is costly, and therefore managers prefer to finance new
investments with internal funding as far as possible. Only when internal funds are insufficient to meet a
firms financing needs, managers will turn to the more expensive outside funds. Of the external sources,
the theory stipulates that debt financing is preferred to equity since the former will suffer less from
information asymmetries and, hence, is subject to lower premiums (Myers, 1984; Myers and Majluf,
1984). This hierarchy is referred to as a financial pecking order. While the pecking order theory was
originally developed to explain financial strategies of large and mature companies, several scholars
acknowledge that the traditional pecking order hierarchy applies also to startup firms (Berger and Udell,
1998; Huyghebaert and Van de Gucht, 2007; Robb and Robinson, 2010; Vanacker and Manigart, 2010;
Minola and Giorgino, 2011). Just as larger companies, small and emerging firms prefer to finance new
projects with internal means, and thereafter, if necessary, seek external debt capital and only lastly look
for expensive external equity given the high costs associated with giving up ownership stakes. Hence,
using external equity funding would be a signal of low quality since this is the last resort for firms. Other
scholars, however, maintain that the traditional pecking order is reversed for startup firms due to two
reasons. First, the rank order is likely to be distorted if the investors have superior knowledge about the
commercialization of an entrepreneurs innovation. Second, external equity may also be ranked higher
in case the investors are able to add value to their investment projects (Garmaise, 2001; Carpenter and
Petersen, 2002).
Another theoretical model used for investigating determinants of financing sources for firms
is based on the company life cycle paradigm, with the proposition that different capital structures are
optimal at different points in a firms lifetime (Berger and Udell, 1998). The basic idea is that financial
needs and options are likely to change as the venture grows, gains more experience and becomes less
opaque. According to Berger and Udell (ibid.), smaller and younger firm have to rely more on insider
finance, trade credits and angel funding. As they grow, equity finance will also be available from venture
capitalists, as well as debt capital from banks and other financial institutions. Eventually, if the firm
continues to grow, it may gain access to public equity through an IPO. Figure 2 presents Berger and
Udells (ibid.) illustration of the financial growth cycle for small businesses (somewhat simplified).
Firm size
Firm age
Very small
firms, possibly
with no
collateral and
no track
record.
Small firms,
possible with
high growth
potential but
limited track
record.
Medium-sized
firms. Small
track record.
Collateral
available, if
necessary.
Large firms of
known risk and
track record.
Owner
Angels
VC
Public equity
Trade credit
Bank loan
Figure 2. The financial growth cycle of firms according to Berger and Udell (1998, p. 623),
somewhat simplified
In addition to explanations based on the POT theory and the lifecycle perspective, a growing stream of
literature has identified other factors that affect startup firms funding structures related to the
characteristics and desires of the entrepreneurs, including their backgrounds, growth ambitions and
reluctance to lose control (Howorth, 2001; Sapienza et al., 2003; Eckhardt et al., 2006), their knowledge
about finance alternatives (Seghers et al., 2012), and their established networks and existing
relationships (Atherton, 2009).
Taken together, the literature has identified a large variety of factors that will impact startup
firms funding portfolios.
2.2.
SEARCH
The next step in the financial process concerns how entrepreneurs identify and approach various funding
providers, including subsidy providers, governmental debt providers, banks and other financial
institutions, business angels or other private investors, and venture capitalists.
While there is limited research on startup firms financial search process in general, some
studies about business angels exist. Sohl (1999) identifies five touch points for business angels and
entrepreneurs: (i) venture capital clubs, (ii) angel alliances, (iii) physical matching networks, (iv)
internet matching networks, and (v) loosely organized referrals from for example other entrepreneurs,
lawyers and service providers. Paul et al. (2007) recognize three major sources of business angels
investment opportunities: business associates, business angel networks and investment syndicates.
How entrepreneurs search processes for other types of funding, e.g., subsidies, governmental
debt, private debt, funding from corporations, are structured is still largely unknown.
2.3.
EVALUATION & NEGOTIATION
When the entrepreneur has identified an investor who potentially is interested to invest in the firm, an
evaluation and negotiation phase takes place. In the venture capital and business angel literature, agency
theory has been the dominant theoretical perspective used to explain the process (Sahlman, 1990;
Sapienza and Gupta, 1994; Van Osnabrugge, 2000). Agency theory puts forward that the entrepreneur
(the agent) has more and better information compared with the investor (the principal). Hence, the
principal seeks ways to mitigate any risks involved (Jensen and Meckling, 1976). Van Osnabrugge
(2000) argues the business angels and venture capitalists differ in their approaches to mitigate risks. He
suggests that venture capitalists seek to decrease asymmetries of information primarily through
extensive investment screening and due diligence of the potential investee firm followed by
constructions of optimal contracts, i.e., they base their control through an ex ante approach. Business
angels, on the other hand, mitigate uncertainties primarily through ex post control, referred to as an
incomplete contract approach. Supporting this view, Wong et al. (2009) find empirically support for
that venture capitalists and business angels differ in their ways of overlooking investee firms. While
venture capitalists primarily use terms in the shareholders agreements, such as board rights, staging of
investment and contractual provisions, to control their investee firms, business angels exercise control
by post investment activities and assistance.
Besides terms and conditions in the shareholders agreement, the valuation of the firm is
usually a central part of the negotiation between investors and entrepreneurs. Entrepreneurs are
considered to strive to obtain as high valuation as possible, i.e., minimizing giving away equity, while
the investors seek a lower valuation, enabling them to obtain more equity for their money.
Finding a reliable valuation of a startup firm can be challenging. Four major corporate finance
valuation methods are: transactional comparisons, discounted cash flow (DCF) method, price earnings
multiple and the net asset method. However, these methods to a high extent depend on strict theoretical
assumptions and require information that young ventures cannot easily provide. Hence, arguments for
that their applicability is limited in valuating early-stage ventures have been put forward (Miloud et al.,
2012). There are even claims that startup valuation to some extent remains a guess. Particularly for
business angels, where the angel and the entrepreneur try to feel their way to an agreement (Paul et
al., 2007). That is, some angels tend to approach the issue of firm valuation intuitively, unable to provide
rationales for final valuation decisions.
2.4.
POST INVESTMENT
The post investment phase concerns the interactions between investors and the investee firm after an
investment has taken place. Also here the venture capital and business angel literature dominates, while
the post-investment relations between other types of financiers and entrepreneurs remain relatively
unclear.
It is argued that the ex-post involvement differs between venture capitalists and business
angels. Venture capitalists are considered to take on formal roles such as strategic sounding boards and
financial advisors (Manigart and Sapienza, 2000). In contrast, business angels typically expect not only
to contribute strategically, but also to interact with the entrepreneurs on a more operational, day to day,
basis (Madill et al., 2005; Paul et al., 2007).
3.
METHOD
The aim of this study is to describe and explain the financing process in innovative startup firms from
the entrepreneurs perspective. Due to a scarcity of research, an inductive explorative research design
in the form of a multiple-case study was called for. The case-study approach is considered appropriate
when addressing the whys and hows (Yin, 2003) and facilitates analyzing when patterns are sought
for (Patton, 2002). Accordingly, in-depth interviews with eight founders of innovative Swedish firms
were carried out with the purpose to reveal the subtleties of the financing process.
The eight cases were identified from applications to the VINN NU program at VINNOVA (the
Swedish Governmental Agency for Innovation Systems). VINNOVA aims at promoting sustainable
growth by improving the conditions for innovations and by funding need-driven research. Every year
VINNOVA invests about 2 billion SEK through various programs. The competition program VINN
NU, targeting young innovative firms, is one of them started in 2002. The purpose of the program is to
support new innovative firms to prepare and clarify commercially-interesting development projects in
an early phase in order to promote further development, including attracting additional funding and, in
the long term, become viable and successful companies. Given the exploratory nature of this study, the
cases included in the study were selected with broad variation, enabling analysis of different ends of the
spectrum, as well as identification of important themes (Eisenhardt, 1989; Yin, 2003).
The interview process can be described as qualitative interviewing (Rubin and Rubin, 1995)
or active interviewing (Holstein and Gubrium, 1995), where the interviewing is built on three types of
questions: (i) main questions to begin and guide the interview, (ii) probes to complete and clarify an
answer or ask for further examples, and (iii) follow-up questions to pursue implications of answers to
main questions. In six cases the interviews were carried out by two researchers, and in two cases they
were conducted by one researcher. All interviews were held in May and June 2013 at the premises of
the respective firm, with one or two of the founders. The lengths of the interviews ranged from 45
minutes to two hours. During the interviews we tried to create an open atmosphere in order to make the
communication as open as possible (ibid.). With the permission of the entrepreneurs, the interviews
were recorded and assurances given that the identity of the individuals and the firms would not be
disclosed.
The empirical material was collected through the interview process described above, which
was based on an interview guide (see Appendix 1). Given our primary unit of analysis, being the
financing process in innovative startup firms, the interview guide focused on aspects of this process.
Examples of the main questions included (i) How did you identify possible sources for funding?, (ii)
Who were involved in the discussions and decisions about funding?, and (iii) How was the valuation of
the company done?
The information collected from the interviews was first summarized case by case. The
summaries of the eight cases were displayed in multiple tables with the purpose to give an overview and
facilitate the comparison between the different cases. Each researcher read summaries and looked for
patterns (Patton, 2002). In workshops with the three researchers, cross-case analyses were carried out.
We were searching for commonalities as well as inconsistencies within the context of the research
question. In this analysis we identified patterns, which will be discussed later.
4.
CASES
In this section, empirical findings are presented. Each presentation follows the same basic structure: (i)
a background presentation of the company and founders, (ii) presentation of their planning phase,
emphasizing the founders attitudes towards various funding sources, (iii) empirical findings with
regards to the search phase, (iv) empirical findings with regards to the evaluation and negotiation phase,
(v) empirical findings with regards to the post investment phase, and (vi) initial interpretations from the
case. In order not to reveal identities of the respondents, names in the case descriptions have been
replaced with pseudonyms. Table 1 presents an overview of the eight cases included in the study.
Table 1. Overview of the eight cases included in the study

Alpha
Beta
Gamma
Delta
Epsilon
Zeta
Kappa
Omega
Product
SW for internet
services
SW B:B
Consultancy &
SW
Internet service
Internet service
Manufacturing
Manufacturing
Manufacturing
Firm founded
2011
2010
2004
2010
2003
2002
2004
2009
Founders education
Mix of masters
in techn. &
business adm.
Masters of
techn. entrepr.
school
Mix of masters
in techn. &
business adm.
Masters in
business adm.
Mix of masters
in techn. &
business adm.
Entrepreneurship
school
Masters of
technology
PhD in Medicine
Startup experience
Some extent
No
High extent
Some extent
No
No
No
No
Cooperation within
the founder team
High level
Low level
High level
High level
High level
High level
High level
Single
entrepreneur
Business and/or
financial plan
High extent
Limited extent
No
No
No
Some extent
High extent
No
Number of external
owners
~8
180
40
30
Responsible for dev.

of shareholders
agreem.
Founders
(initiated by
investor)
Has no
agreement
Founder
Has no
agreement
Founder
Founder
Founder
Founder
Customer/financing
orientation
Financing 30%,
Customers 70%
Financing 80%
Customers 20%
Financing 15%
Customers 85%
Primarily
customers
Primarily
customers
Primarily
customers today
(before
financing)
Financing 70%
Customers 30%
Financing 15%
Customers 85%
View on financial
portfolio
Relatively broad
portfolio
Business angels
major route
Customer
financing, debt &
factoring
Customers and
subsidies
Public funding,
business angel
Mainly governmental subsidies
Subsidies
Subsidies, public
loans
THE FINANCING PROCESS IN INNOVATIVE ST ARTUP FIRMS
4.1.
ALPHA
Background
Alpha develops software targeting internet businesses. The firm was founded in 2011 by a group of
friends, whereof two founders joined the team after the firm had been set up. As a group, the team
possesses solid financial and engineering expertise.
Planning
The founders were all well aware of the need for external funding, i.e., that the firm could not survive
on customer revenues in the early phase. Already at the start, venture capital was the preferred choice.
Two of the founders had financial backgrounds and their knowledge of, and contacts within, the VC
industry was relatively good. But also business angel investments were discussed.
Before the CFO entered the firm, some discussions were ongoing with potential business angel
investors. However, the CFO was concerned of diluting the existing owners in case the company was
forced to fund the company on a low valuation. Hence, he also advocated capitalization from other
sources such as governmental subsidies and various types of debt. Which was a strategy that was
approved by the other founders.
Search
As a result of the decision to fund the firm with a relatively broad spectrum of funding sources, the CFO
took the lead to investigate the funding market. In a nascent stage, the firm got a seat in an incubator,
was awarded a few subsidies and also received an innovation loan from ALMI.
In parallel, the Alpha founders explored the VC market. Since one of the founders made a
study of the VC market before starting Alpha, he had developed a few contacts in the Swedish as well
as in the UK VC markets. The CFO complemented the list with information from the trade associations
SVCA and EVCA. Taken together, they worked with a list of about 30 potential VC investors. In the
beginning of 2012, the founder team started to approach VC firms. The response was rather poor.
Although the VCs showed interest in the proposed business idea, the general feedback was that the firm
was too young with an unproven business idea. Therefore, the VC track was closed after a few months.
Instead, various debt providers, subsidy providers and small investment companies were approached.
Alpha managed to get funding from a few of these sources.
After one year in business, the founders re-started the process to look for external equity. This
time not only venture capitalists but also business angels were approached. Identifying business angels
was significantly more difficult than finding VCs. Through personal connections and by utilizing the
incubators network, the founders managed to identify a few business angels who were approached.
Finally eight investors showed an interest to invest in Alpha, whereof six business angels and two
smaller investment companies.
Evaluation and negotiation
When negotiating with the investors, one issue concerned how to arrive at a reasonable firm valuation.
One of the founders proposed the usage of traditional valuation techniques such as DCF or multiple
approaches. Something that the others thought was more or less impossible given the early phase and
hence difficulties to make reliable financial forecasts We thought it was high chaparral to make a
DCF. Instead, two factors were included in the equation when calculating a valuation capital needed
and the entrepreneurs dilution willingness: We needed 10 mSEK and were willing to give away 10
percent. This led to a rather high valuation. However, after receiving negative responses from the
investors, the founder re-thought the setup, We realized that we could take half [of the capital] from
ALMI, halving the valuation and still give away only 10 percent.
Still, the valuation level was met with hesitation from the business angels. Therefore, the
entrepreneurs tried to get the investors to state their expected valuation level instead. This turned out to
be a bit confusing and in hindsight lengthened the process. Finally, one person in the loosely connected
consortium of eight business angels and smaller private investors, took lead in the negotiations with
Alpha. A valuation of 25 mSEK was finally set, giving the external investors 20 percent of the company.
For the development of a shareholders agreement, the entrepreneurs were referred to one of
the largest Swedish law firms by the lead investor. The firm became the legal advisor for the
entrepreneurs and drafted the contract, originating from a standard agreement. While the contract was
far from as strict as a traditional VC-contract, according to the respondents, a few terms were of
particular importance to the investors: (i) the entrepreneurs salary levels, (ii) veto right with respect to
stock option programs above a level of 10 percent, and (iii) terms concerning potential future financing
rounds. But the investors did not get any preference shares, other veto rights were not stipulated, and
the total amount of investment was made at the same time, i.e., not due to fulfilling any particular
milestones or similar. That is, it seems like the entrepreneurs had a large portion of control of the terms
stated in the agreement, It was our contract since we had drafted it. We started on our half of the battle
field.
After all parties had accepted the valuation, a due diligence was taken place. According to the
entrepreneurs, this was to a high extent a tick in the box-exercise. The founders consider the due
diligence to be rather detailed given that it was a business angel investment, not a venture capital ditto.
Post investment
After the investment had been carried out, the board was complemented by members from the investor
group. Thereby a formal board work started, which up to then had been considerably more informal. In
addition, each month investor reports including financial prognoses are sent to the investors. The
entrepreneurs consider that this is of great value to the firm, since it forces the entrepreneurs to keep
good control of their financial situation. Or as one of the founder says, One cannot underestimate how
important it is to be whipped.
Interpretation
Alpha offers standardized software to a limited number of business customers. The founders have kept
to their original business idea, and have not developed alternative revenue streams such as providing
software consultancy services. Hence, the company has clearly been in need for external funding.
The founders have good financial skills although limited startup experience. While equity
capital is the preferred financial strategy, the founders have strived to keep dilution levels down by
10
minimizing costs as well as capitalize their venture also by subsidies and debt. This has led to a rather
broad portfolio of financial sources already from start, as depicted in Figure 4a, We have not followed
the school book step by step, starting with family and friends. [] Because of the free premises at the
[incubator], the VINN NU-subsidy, the ALMI innovation debt, and the currently low office rent, we have
managed to develop the company to an attractive position without becoming too diluted. Alpha was
able to attract capital from rather professional business angels, who have contributed to the development
of the company. The financing activities have taken lots of time and effort, which seem to under a period
of time have had a somewhat negative impact on the founders focus on core activities such as sales and
market development.
Alpha. Year 0 - 2.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4a. External funding sources Alpha (SQR of investment)
4.2.
BETA
Background
Beta was founded in august 2003 by Peter Landstrm. The company develops and sells software that
hinders illegal activities on the Internet. Peter invited three former colleagues as co-founders and
management team, while taking on the role as the CEO himself. From the interview it is clear that he
takes the vast majority of decisions in the company concerning the overall strategic direction including
financial related matters. Peter has a masters degree in entrepreneurship as well as an engineering
education in software development. Peter states that the three major takeaways from the
entrepreneurship education were: (i) the skill how to write an attractive business plan, (ii) how to find
soft money, and (iii) getting the legitimacy associated with graduating from the school. Beta had a seat
in an incubator.
In an early phase, Peter was in contact with the World Childhood Foundation and received
high interest. Not only did the foundation donate some money, but also provided legitimacy to the idea
and contributed with important connections. Furthermore, dialogues were initiated with the Swedish
police authority and with Interpol early on.
11
Planning
Peter did not have any financial plan for the company, i.e., a written strategy for how to fund the
business. Neither did he have a clear view on how much money that was needed to develop the firm,
but rather a pragmatic we just raised as much money as possible.
However, one key learning that Peter brought from his education was to apply for as much
soft money as possible. Hence, Beta applied for various public subsidies, and was successful. In those
applications the entrepreneur learnt how to adjust the idea to fit the requirements from various sources.
In a similar vein, public loans were considered useful leading to an approval of an ALMI loan.
But the major financing source was from business angels, or private persons. The issue to be
diluted has not bothered the entrepreneur more than that dilution is ok as long as not too much. To
date, seven financing rounds from up to 180 private investors have taken place, typically with rather
small amounts per investor.
Revenues from customers have been scarce until recently, with only a few exceptions. Paying
customers have to high extent been identified through the network, not least through the contacts with
the World Childhood Foundation. The good cause characteristic of the product was the factor that
convinced the CEO of Telia, as well as a few others corporations, to enter into an agreement with Beta.
The software has not been used though to any high extent in these organizations.
Over time, Peters interest to raise venture capital has increased. Besides the infusion of
money, the competence and network associated with venture capitalists are sought for. However, two
factors have hindered the firm to attract venture capital according to Peter: (i) the high valuation (see
below), and (ii) the large number of owners.
The possibility to get industrial corporations as investors has been considered as well.
However, the interest from large organizations such as Microsoft and MacAffee to invest has turned out
to be limited.
Commercial loans have not been an alternative since such institutions, according to Peter,
demand personal securities that he is not willing to provide. Hence, the company has no commercial
debt, not even a trade credit.
Search
Instrumental in the search for business angels and private persons willing to invest was the chairman of
the board, Kerstin Larsson. With a financial background, Kerstin had a broad network of potential
investors that she invited to invest in Beta. In preparation for each round of investment, Peter put
together a prospect. In each round, the existing investors helped in the process by identifying additional
investors.
Over time Peter wanted to complement the investor base with venture capitalists. Peter went
to the US where he managed to meet a few well-known venture capitalists. Existing investors helped in
the process to open doors to these firms. Also in Sweden, Peter identified a few venture capitalists.
When approaching the Swedish VCs, Peter engaged a small corporate finance advisor. Currently, Peter
is negotiating with a Swedish VC, which was identified though through recommendations.
12

There have been seven rounds of equity financing from an increasing group of business angels and
private investors. In the first round, six external business angels, or rather private persons, decided to
invest. Peter proposed a valuation of 32 mSEK, a valuation level that was not based on any particular
calculation: Why 32 mSEK? I dont know. When the potential investors argued that the level was too
high, Peter responded What about 16 mSEK?. And thereby the valuation was set. The investors were
interested to invest for two reasons: to make a good investment with potentially good returns, but also
because they liked the good cause angle.
Also in the next round the same valuation level was kept. Thereafter the valuation has
increased in each round. Not because the company has developed according to plan, rather the opposite
since the product has been constantly delayed and the list of customers has been unsatisfactory low.
Instead, the valuation has been based on the valuation set in the previous round with an abundant
increase each time. That is, existing investors have been keen to keep a high valuation with the
expectation that it must be a higher valuation given the time factor. When the investors started to buy
and sell shares amongst each other, the expectations on valuation raised even further. In the end, the
valuation reached remarkably high levels around 250-280 mSEK. Despite the fact that about 40 mSEK
has been invested in the company from business angels and private investors, the founder team still
owns 50 percent of the company.
In the last round of funding, i.e., at the exceptional high valuation, also more professional
investors in the form of investment companies and venture capitalists were invited to participate. For
the first time, the proposal and financial forecasts were scrutinized in more details. These more
professional investors did not accept the high valuation and proposed a significantly lower level.
Furthermore, an existing base of 180 investors was considered a major issue. Hence, none of the venture
capitalists were interested to invest. Finally, the company managed to get funding from the existing
investors on a valuation between 250 and 280 mSEK.
Up to now, all negotiations had been managed and to a high extent controlled by Peter, i.e., he
has been the one to suggest the valuation levels and the level of funding needed to his large base of
private investors. There has never existed any shareholders agreement among the shareholders.
However, the set valuation has become a major obstacle for the firm since new investors do
not accept such a high level, while existing investors have a hard time to accept that their shares have
lost in value. In the current negotiations with a new VC, the VC has reduced the valuation significantly
in comparison with the previous round. This requires a lot of negotiations with current owners, and is
still not settled. Peter is willing to proceed though, despite a heavy dilution in ownership, since other
alternatives are limited. Furthermore, he look forward to bring in more professional and active investors.
In this negotiation, it is the venture capitalists that have the negotiation power and the numbers are
more scrutinized. Still, a valuation based on traditional valuations techniques is difficult, according to
Peter: They have to base their calculation on my numbers and these are not real, we know that for
sure. If the deal that is currently negotiated will be carried out, the founders will have about 30 percent
of the shares after this round.
Peter believes that they made a big mistake by not rising more funds when the valuation was
on a very high level: We should have realized that we had an exceptional high valuation. People
13
accepted it. It was not linked to our performance. [...] We should have taken the opportunity to raise
considerable more money.
Post investment
The company had since its foundation an external board of directors. While Peter represents the
founders, the chairman of the board Kerstin used to represent the external investor group. The latter are
passive owners, where the only contact is through a newsletter sent occasionally.
Interpretation
Beta is to a high extent a one man show, where the CEO has the control of all major decisions in the
firm. The early decision to capitalize the firm by business angel/private money has clearly had the effect
that other funding sources hardly exist in the firm (see Figure 4b for an illustration). Moreover, the
financing process has taken lots of energy and time from the CEO, where he has spent much time on
searching for funding rather than on other core activities such as sales. An overall feeling is that product
development has constantly been delayed paved with some quality issues, while investor expectations
have remained high.
Beta.Year 0 - 10.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4b. External funding sources Beta (SQR of investment)
4.3.
GAMMA
Background
Jacob Ullstrm, Peter Rundberg and Rasmus Larsson had been working for a number of years in a
startup firm, founded by a well-known Swedish entrepreneur, when they in 2004 decided to start their
own venture, Gamma. Initially the idea was to develop software but when Jacob decided to leave, the
strategy shifted into offering IT consultancy services. Today Gamma is once again more of a software
company, with a portfolio consisting of mobile applications, e-commerce platforms and other softwarebased solutions. Peter is an engineer and Rasmus has a university degree in business administration.
Peter took on the role as the CEO of Gamma, while Rasmus is the chairman of the board. The founders
work close and share decision making in, and control of, the company. Or, as Rasmus puts it, my wife
refer to Peter as my second wife.
14
During a period of time, Gamma was partly owned by a Finnish corporation. After a few years,
however, the entrepreneurs bought back the company. Today, Peter owns 78% of the firm, Rasmus 21%
and the remaining 1% of the company belongs to the employees in Gamma.
Planning
It was to a large extent their experiences from the dot com boom and bust that led to Peter and Rasmus
strong views on how to finance their venture: (i) customer funding should always be a vital part in
development projects, (ii) as far as possible, money should be earned before spending, and (iii) the
ultimate control of the business should be kept in the hands of the founders. Or, as Rasmus puts it: We
learned the hard way that if you spend [other people's] money without making yourself worthy of them,
you will live on others' merits and that is never sustainable.
Keeping solid financial control of cash-flows, liquidity status, etc. and continuously evaluating
various funding alternatives have always been important. Initially the founders financed Gamma to some
extent by governmental subsidies. The entrepreneurs view on subsidies is however rather negative, and
today considered a waste of time. Rasmus says: When applying for subsidies you write the application
to get funding. However the money needs to be assigned to certain pre-specified projects, which turns
out to be problematic for a startup that constantly needs to adjust the business to meet market needs.
Taking on external investors such as business angels or venture capitalists have not been an
alternative due to the founders unwillingness to lose control and ownership, If you take on a venture
capitalist or a business angel [...] you know that they have a different agenda: they make money by
lending money. And it is not certain that it matches your needs at any given time - it's more likely that it
does not.
Instead, the major funding sources in Gamma are early customer payments, factoring and lines
of credit.
Search
Rasmus continuously evaluate banks and other credit providers to find the best deals. The company has
changed bank a number of times, where the terms are the only thing that matters when choosing
providers of commercial loans, lines of credit or factoring services.
The founders are willing to sell Gamma in case the price is attractive enough, but have never
been actively seeking a buyer. In 2007, a Finnish corporation approached them and presented a bid to
acquire the company.
When it comes to negotiations with banks and factoring companies, Rasmus spends significant efforts
to get the best deals.
The negotiations with the Finnish corporation started in 2007. Since the acquiring company
had limited experience from acquisitions, the entrepreneurs managed to take control of the process,
including the responsibility to draft the contract with some help from a lawyer. Rasmus was surprised,
or as he puts is They did, in my eyes, a blunder when they asked us to draft the purchase agreement.
According to Rasmus, the founders of Gamma suggested a rather high valuation, close to 40 mSEK.
15
The valuation was not due to any particular valuation method, but rather: We wanted 20 million SEK,
and ended up at 19.7 million after the negotiations. Moreover, the terms were favorable for the
founders. Payments for the first 51% was delivered immediately, while the remaining part should be
paid after three years. However, if the Finnish company decided not to carry out the second part of the
deal, the entrepreneurs would be offered to buy back their shares on favorable terms. In the final
negotiations, the Finnish corporation had only a few objections to the terms in the proposed contract.
For example, the entrepreneurs needed to accept a lock-in period of three years, which they willingly
accepted as a way to keep control of Gamma throughout this period. The acquirers then accepted the
purchase agreement, which gave the Finnish company 51% of the shares immediately with an option to
buy the remaining 49% within two years. The shareholders agreement was clearly to the founders
favor, since it gave them control of the company even though they were minority shareholders.
Post investment
Gamma continued to operate as a separate entity, a subsidiary of the Finnish company, also after the
acquisition. There were no plans to integrate it with the acquiring corporation. In the deal, the Finnish
company had the right to staff two board seats, which they did with own personnel. The entrepreneurs
consider these three board members ability to contribute to the development of the company as nonexistent. After a few years, the Finnish corporation filed for bankruptcy and Peter bought back the
company. Rasmus had during this time left the company, but soon after joined Gamma again.
The entrepreneurs have throughout the companys history been keen to develop a board with
external high-professional, independent board directors. The board meetings, about 10 per year, are
relatively formal and structured and are kept primarily on a strategic level.
Interpretation
The founders of Gamma had experience from startup firms previously and had a very clear strategy
about how to finance their venture, i.e., primarily based on customer revenues. Their guiding star has
been not to lose control, and therefore they have preferred to modify the business idea in order to develop
alternative revenue routes rather than capitalize the company from external equity sources. Hence,
Gammas funding is based on customer payments, factoring and commercial debt as illustrated in
Figure 4c.
16
Gamma. Year 0 - 9.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4c. External funding sources Gamma (SQR of investment)
4.4.
DELTA
Background
Early spring 2010, three of the founders of Delta is preparing a presentation for the Swedish Dragons
Den in the cellar of the incubator they currently have a seat in. The CEO of the incubator is invited to
listen and comment on the pitch. The idea is innovative and highly scalable for a global market. The
pitch is pretty awful at this time. However, after a full day of preparations they present to the Dragons,
and manage to convince one of them to invest in Delta. The investor is experienced, with a long and
proven track record both as an entrepreneur and investor. From now on, its full throttle. The team goes
into sales mode. Among their first customers is a large international company and the deal is closed over
the phone. Delta is also quick to double the Dragon funding with soft money, loans, price money from
competitions, and also later on by more formal capital. Delta thereafter enters an international market
and is in 2013 a market leader within its niche.
Planning
The four founders have, despite their young age, experience from various startups and from
capitalization of young firms. Before founding Delta, they knew that they needed some kind of
muscles, based on earlier experiences from being underfinanced. The plan was simple: go out and get
money. Venture capital, loans, soft money, and price money from competitions anything goes. By
coincidence, they got an invitation to participate in the Swedish version of Dragons Den, We were six
months down the road and needed to get some kind of funding. We thought that venture capital could
be an alternative. The team hesitated because we got all to lose and nothing to win. However, they
decided to go ahead, which resulted in that one of the business angels actually closed the deal on prime
TV. An early valuation was also made during the TV show. The team had a plan, but it was more of an
ad hoc plan.
Delta focused from the beginning on sales and customer funding. The company got a large
international customer on board early on, where the deal was closed over the phone. This provided Delta
with a proof of concept.
17
Search
The Delta team searched through all types of soft-money schemes and developed almost a profession in
getting soft-money, We went on all sources and especially soft money and competitions. But also
other sources of funding were sought for, We doubled with ALMI. Then we looked at business angels,
and some kind of partners. Delta also thought of capitalizing the firm from providers of larger
investments, but hesitated, We always thought that a big investment would be great. However, the
business model is constantly changing so it was difficult to go for the big money.
All founders were initially involved in the funding process together with the board of directors.
Later it was two of the founders, the CFO and the CEO, who did most of the work. During the first
years, the company used four major funding sources, i.e., various types of business angel investments,
public grants, price money from competitions, and governmental loans. No money did arrive from
friends and families, neither from formal VC firms in the early startup phase. The team met with a
number of VC firms but did not really have a solid case for spending the amount of money that such
investors would commit.
Delta got a valuation at the Dragons Den show, which was both god and bad. The problem was that it
was a fast, paper-based valuation, rather than based on more thorough analyses. The first agreement was
also made during the show, which obviously is different compared to most investment deals. The
valuation level set on Dragons Den was subsequently used during discussions with governmental
funding organizations as well as in discussions with VC firms and business angels.
The relation with investors is rather informal, We never have had any contract. It is a
handshake and then back to work.
Delta considers it difficult to negotiation with governmental authorities regarding funding, and
hence the founders have been forced to make a few modifications of their business idea in order to fulfill
criteria stipulated for some of the governmental subsidy programs.
Delta is today a more mature company and have come to a position where the management
team can present a case based on a stable business model and a plan to use a larger investment, Now
we can sit down and make a budget for a valuation of 20 mSEK. We have a proof of concept, some key
metrics, a large database of users, and therefore a real value. Negotiations with private investors are
based on informal information and trust rather than on any type of formal due diligence. They used the
Dragon as a sign of legitimacy.
Post investment
Delta is still young and is learning from their own processes. The Dragon has been, and still is, an
important sounding board to the entrepreneurs. A new business angel has made an investment and also
taken a seat in the company board. Today Delta has a more stable organization and a strong professional
board of directors.
18
Interpretation
Getting a deal in the Dragons Den was important for the founders since it provided them with money
to kick-start the venture, legitimacy through the Dragon, and an active business angel. It is also typical
for the case. The plan and search is ad hoc rather than planned, where also funding decisions are made
based on urgent needs rather than on formal plans and prognoses. This has resulted in a range of small
and large subsidies, loans and also business angel investments (see Figure 4d). It has been a time
consuming process, which has forced the team to tweak the business model and from time to another
lose focus on other core activities.
Today, the founders are confident with their situation, Now we know what we are doing, and
it is possible to approach an international VC with a solid plan. Over time, Delta has developed a
better governance structure. There are no written shareholder agreements and no formal post investment
control though. Clearly it is a learning process where the founders continuously develop their business,
gain more confidence and also knowledge. In the beginning everything was trial and error.
Delta. Year 0 - 3.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4d. External funding sources Delta (SQR of investment)
4.5.
EPSILON
Background
Epsilon started out with three founders from two leading universities in Stockholm. Together they could
be considered a dream team: One tech person, one sales person and one person that could structure the
business. The team was young but highly motivated with a clear sales focus. They did not have a product
but they sold their vision to large Swedish companies on a dummy product. The strategy was to develop
the technology as fast as possible, which turned out to be more complicated than the founders
anticipated.
We meet the companys representative in the new offices downtown Stockholm, The business
model is changing and I am leaving the company says the representative. We are moving closer
towards coupons and a more promotion based business model compared to our initial plan. It is early
in the life of the business and the team is young. Change is part of the game for Epsilon.
19
Planning
Epsilon is a sales focused company, where the team was able to sell a dummy version of their product
to a number of large corporations. The team members divided the work between themselves early on
and also recruited external board members. The planning process was rather ad hoc, We just went along.
We had a plan about what we wanted to do and we started to sell it. We got positive feedback and just
kept going. The first employees were paid with a promise of future salaries and ownership. Few papers
were signed.
Neither was the process of securing funding planned and far from straight forward, or as one
of the founders puts it: We started without thinking of the future and had to solve each obstacle when
is arose. Epsilon managed to get a micro loan, a subsidy from the VINN NU program and also a
somewhat larger loan from ALMI.
Search
The search process was also ad hoc. The CEO basically went out to meet with all kinds of investors,
including providers of public subsidies, ALMI, venture capitalists, business angels, etc. A price in the
venture cup competition helped them with some money and more importantly connections, i.e., as price
winners they had no problems to set up meetings with potential investors. Furthermore, Epsilon had
customers from day one even though the company did not have a product to deliver. The development
process took much longer time than they expected.
The management at this point met with a few VC firms, but we know we were not ready.
Instead business angels were approached. A lot of referrals were used and networking was important in
the search process. The founders got an early investment proposal from a business angel that they turned
down. Currently, the team once again seeks formal venture capital.
The team had an early shareholder agreement that was developed by one of the founders with input from
a lawyer. The founders set firm targets for themselves in the contract with a vesting scheme, but
otherwise the funding was not dependent on fulfilling particular milestones or similar. The contract was
accepted by the investors and the board of directors. There was really no negotiation of the terms and
conditions, The investors bought the big picture. Epsilon needed a sum of money, rather small at this
point in time, and that was it. Epsilon used the investment as co-funding required for getting
governmental loans. Since then, this agreement has been used over and over again.
Given their limited experience from valuation, the founders of Epsilon got outside help in their
first negotiation with investors. Thereafter the board of directors have been helpful in the valuation
process.
Post investment
The Epsilon team is still young without a stable business model. A professional board of directors were
recruited early on to balance the founders limited experience. Epsilon has formal board meetings and
the board invested an initial small stake in the company. The board also guaranteed the larger equity
investment.
20
Interpretation
Epsilon did not plan their funding process. It was an ad hoc exercise, where demand drove the funding
activities. Figure 4e shows the funding portfolio for Epsilon during their first two years. Early public
funding in terms of subsidies and loans was later balanced with business angel investments.
Getting the VINN NU-subsidy was a breaking point for Epsilon. It gave them legitimacy,
acknowledged their innovative skills, and also had a positive impact on their possibility to attract other
types of funding.
The team regret saying no to a business angel in an early phase, If you can get funding take
it! During the early days we thought it would go better than it did. Its hard to be under-capitalized as
a startup in Sweden.
Epsilon. Year 0 - 2.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4e. External funding sources Epsilon (SQR of investment)
4.6.
ZETA
Background
Zeta was founded in 2003 by a researcher at Chalmers University of Technology, where after he invited
a student mate as cofounder. The company produces unique innovative products. The two co-founders
have alternated on the CEO position over time. The major owners in Zeta is today the co-founder and a
few larger business angels, while a small share of ownership is spread among approximately 40 smaller
investors. In 2008, the company expanded and was established in several European countries as well as
in the US.
Planning
There was no plan in the beginning other than applying for as much soft money as possible in order to
get a proof of concept and then go for larger investments. The CEO shows a binder with all their funding
sources, amounts and dates. It is a long list, We went for all kinds of subsidies and grants in the
beginning and we financed ourselves with student loans. The VINN NU-program and Venture Cup
was also appreciated funding sources used for developing the business.
21
Search
The Zeta team lacked experience from raising funds, although they received support from a somewhat
more experienced member of the board of directors. The company used all kinds of financing sources.
Everything was used to try to proof the business and the technology. At first they went for subsidies and
soft money but also business angels and more formal investors were approached. Finding investors was
a rather informal process.
The first equity investment was made through an emission with new shares that paid for an
existing company with an IP right. This deal brought approximately 40 private investors from the other
company into Zeta. Zeta made seven to eight new rounds of equity investments. Then sales kicked in.
2010 was the best year and Zeta generated a solid profit.
In the first equity-based financing round, Zeta was funded by a ratio of 1 to 3 mSEK on a pre-money
valuation around 3 mSEK. The founders developed all paper work and all contracts using templates
found on the Internet. They also developed a stock option program. Also here the founders designed the
legal documentation. Over time, new stock option programs have been reviewed by the companys
auditor, although the existing agreement has been used as the template.
Post investment
Zeta has a relatively large number of owners due to the early investment round. That has imprinted the
post investment process. It is almost as a public company with a lot of information gathering,
information diffusion, and formal board meetings. They have had a strong board of directors
continuously and the board has been instrumental in negotiations with other investors. Later the bank
has played an important role, both as a provider of capital but also helped with contacts and networks.
Interpretation
The CEO believes that the process would have been different if carried out today. In retrospect, the deal
should have been embedded in a larger environment and with the aim to close a larger first investment.
The founder thinks that they should have been more confident in their negotiations, We thought a
million SEK was a lot of money. The founders of Zeta also had a different starting point since they were
not majority owners. They developed the business from scratch and had only a small share of the
company. In the beginning this was never an issue but has become so over time, We were a bit nave.
The two founders could have negotiated a larger equity stake earlier. Now they introduced stock option
programs later in the process instead.
Zeta has used over 20 sources of capital (see Figure 4f). The early stages were dominated by
public funding, where all sorts of governmental subsidies were used to get the first proof of concept.
Thereafter, Zeta has been able to fund their expansion mostly through equity investments. Later in the
process, they also used commercial bank loans for investments in machinery.
22
Zeta. Year 0 - 10.

Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4f. External funding sources Zeta (SQR of investment)
4.7.
KAPPA
Background
Steven Sandstrm was working as an engineer at a Swedish company where they introduced Japanese
quality work principles. He thought this was interesting and started to read about these principles and
soon found out that he did not think that the Swedish company really had understood what this kind of
quality work was all about. Steven decided to start studying Japanese at a Swedish university, I planned
to move to Japan, start working for Toyota, and then come back home again and tell them what this
really is about!
He left his work and started to study Japanese and at the same time he also studied more at the
engineering school. During his studies he spent one year in Japan to learn the language. When Steven
did his final project at the engineering school, he got in touch with a company producing compact discs
(CDs). He then started to work for this company, both in Sweden and later in the US. When the CD
market declined, he thought of other ways of using his expertise in this production technology. Together
with three friends, Steven decided to start working on an idea for alternative usage of the production
technology for CDs, but now in the energy sector.
Planning
Steven and his colleagues started to look for various way of funding their new idea and someone gave
us the idea that we could apply for EU funding. But the procedure to apply for this grant was quite
complicated, there was a lot of documentation to read. We spent 2-3 months reading about how to
apply and writing our application, which became a 50-100 pages long detailed plan. The founders
hesitated, since the call included a demand for a consortium of two to three different organizations from
various countries. But they found a way to organize this and to attract international partners, We would
have preferred to do it all by ourselves, but we needed to have international partners for the
application. The application for the EU grant forced the founders to formulate a detailed three-yearplan from day one. This meant that they had a clear structure laid out for their business activities from
the very beginning.
Kappa was successful in the EU application and got a positive reply in the beginning of 2005.
The EU grant not only meant financial support, but also gave them legitimacy. However, the EU grant
23
was conditioned and hence, the founders needed to find other financial sources to combine with the
grant. Another aspect of the EU grant was that it also meant a lot of bureaucracy for the company.
Search
At an early stage Steven and his co-founders were considering bank loans, but this route turned out to
be difficult, There was no way for us to get loans from banks. After the positive response from EU,
however, the Swedish Energy Agency provided some funding to Kappa.
When Steven was searching for additional financial sources, he realized that a startup course
the founders had attended earlier became useful. The main usefulness was that they now could pitch
their business idea in a professional way. Through this course, they also got in touch with investors
willing to invest in Kappa.
During the search process, one of the founders was responsible for constantly look for public
subsidies. Given that they had received the EU funding, they found it easier to receive other grants, The
EU grant gave some kind of quality assurance.
When Kappa had received the first funding, and became operational, things changed. Suddenly
people called and wanted to invest in the company. The Swedish Energy Agency also provided loans
and grants to the company.
They also received material support from a Japanese customer, who provided an expensive
production machine.
In their first round of financing, ten investors were willing to invest in Kappa. The question was how to
value the company. First no one wanted to suggest a valuation level. Then Steven and his colleagues
suggested 30 mSEK. It was a level that they just came up with without any particular analysis. In the
negotiations, the investors then offered 6 mSEK. The four founders replied that they wanted 7 mSEK,
which the investors accepted. That was the negotiation.
In 2007, the company needed more capital, and the founders engaged a consultant to calculate
a valuation of their company. He first came up with 500 mSEK, which later was adjusted to 150 mSEK
and they raised 18 mSEK from private investors (one investing 15 mSEK and the other 3 mSEK). By
now the founders of the company owned 65% of the shares.
Steven and his colleagues continued to successfully search for different grants. Most of the
grants were conditioned so they also needed other funding. Next funding round took place in 2008-2009
when they raised 20 mSEK, based on a valuation of the company of 280 mSEK. The founders now
owned 55%. This turned out to be a fairly high value of the company and partly as a compensation for
this, they put a very low valuation of the company in their next round of financing, amounting to 10
mSEK, which took place in 2012. The valuation of Kappa was now set to 30 mSEK and the founders
owned 40% of the company.
Throughout the different rounds there were no real negotiations about the different valuation
levels of the company. The founders suggested something that was accepted by the investors.
24
Post investment
The work in the board of directors has been a smooth process. The board meetings are mainly used for
informing the board about the current situation. In practice the four founders are running the company
more or less without involving the board, and they make all major decisions. When there are, for
example, strategy meetings, these are only held with the four founders. The legal competence in the
board is perceived as an important contribution, but besides that the four founders do not perceive (or
feel that they need) much support from the board of directors.
When managing their company they focus mainly on one thing: We only look at the cash
flow we have kept track on that since day one.
The capital that the founders have managed to attract has not only contributed financially and
with legitimacy, but also been important in building Kappas brand.
During the process of developing the company, the employees of the company were given 3%
of the shares as a bonus. In retrospect the founders thought this was a mistake. They did not value the
shares. Instead it became a discussion about who received what. In the end it became the opposite of a
motivator to give them these shares.
Interpretation
Although the founders of Kappa have applied for many grants over time they do not claim that they
have changed their business activities to adapt to the applications, perhaps just tweaked it a bit
sometimes. The four founders have throughout the financing process managed to find quite complex
financial solutions, where they have combined different forms of financial support to the company. They
have been successful in finding and receiving grants. Even if there is no emergent need for more funding
at the moment, they still continuously look for new opportunities to search for grants. They have
developed a competence in applying for grants and creating innovative solutions to combine various
forms of funding. The funding of Kappa started with a grant and then the founders continued on that
path and they have had a strong focus on finding, applying and receiving grants. This process also forced
them to produce a detailed plan for their business activities at a very early stage, which helped forming
a structure for the company from the beginning. See Figure 4g for an illustration of funding sources used
in Kappa.
25
Kappa. Year 0 - 9.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4g. External funding sources Kappa (SQR of investment)
4.8.
OMEGA
Background
When Alison Andersson was about to conclude her doctoral program in medicine, she took a course in
entrepreneurship. She thought that this knowledge might be helpful when she was about to start applying
for a job. During one lecture there was a slide showing ten characteristics of an entrepreneur. Alison
remembers this slide it was a very weird aha-moment I had all ten of them!.
This course or lecture, or perhaps even slide became the starting-point for Alison to become
an entrepreneur. She talked to the only entrepreneur she knew her grandfather. She had two more years
to complete her dissertation and she decided to test her idea during these years, without starting anything
before she had completed her doctoral work.
After having defended her thesis she was offered a post-doc at a top-university in the US. But
she felt that it is now or never and decided to decline the offer and instead start her own business. Her
thought was: If I do not do this now, someone else will do it.
Planning
Her business idea was in the healthy food sector. She knew a lot about her idea and what she wanted to
do. But she did not know much about other aspects of starting a company. So when Alison started her
business the first thing she did was to read a book about fundamentals in business administration. She
did not have any financial resources when she began, so she started to engage students who were about
to do projects during their education, as she had previous experience from working with students. She
says: I had zero in budget.
Meanwhile Alison attended various courses and searched for input from mentors. Her private
economy became very strained and when she felt that she really suffered from her choice to start her
own business, one mantra kept her focused on her goal: I will be financially independent!.
Search
From her time as a researcher, she had experience from applying for grants. She therefore started to
apply for grants and when she had received her first 250 tSEK, she formed a company and hired the first
26
employee on a part-time basis. They had apparently met at a course about how to write CVs a couple of
years earlier.
Alison also received a grant to conduct a first customer survey to learn more about the market
situation. She attended different types of competitions where she was competing with her business idea
and gradually did better and better in these competitions. She continued to search for different grants
and was successful. Beside these grants, she also managed to get some loans from an organization
supporting new businesses.
She decided to move from the south of Sweden to Stockholm. Her idea was to join a business
incubator but she found it very difficult to get an opening. After a while she found an office space and
continued to develop her idea. Finally she was offered a seat in a business incubator. She also won a
few awards that gave her and her business some PR. At the same time she did not want to attract too
much attention, as she did not want to reveal details about her business idea.
In the process of developing her business, Alison has found one issue far more difficult than
anything else to find funding. She says: Money is the key. [] it has taken SO much time.
The first round of capitalization took much longer than expected. The goal was to bring in 3
mSEK, but Alison managed in the end only to get 1 mSEK. Alison dealt with this round on her own
without help. The business incubator did to not support her in this process. After being turned down by
a number of parties, she succeeded to attract capital from six external investors where she had a personal
relation with only one. During this period, Alison had limited time to spend on developing the business.
Alison made the valuation of the company herself. She simply calculated the value based on the
restriction that she wanted to own 51% of the stocks after the third round. There was no negotiation
about the valuation and after the first round Alison still owned 90% of the company. She says: I was
surprised that no one of them wanted to discuss the valuation of the company.
When contracts were to be set up, Alison got hold of two different templates of typical
contracts for these purposes. Based on these templates, she put together a contract herself. She now had
great use of one of the courses in entrepreneurship that she had attended earlier. No negotiation took
place about the contract either. She says: No one asked about the contract.
Post investment
The next phase for Alison is to start building the brand. Even after the capital infusion the financial
situation is challenging. The dips are significant from time to time. There is some support from the board
of directors, although the board is playing a rather passive role. The six investors contribute mainly with
capital, not with non-monetary support.
The loans that she has received have been under the condition to increase the turnover in the
company with a certain pace. Now Alison is struggling to meet these demands. Too much time has been
spent on raising money from investors and searching for grants. There has not been enough time to
approach new customers. Alison is upset with the conditions they have put on the loans: I am so
frustrated so I do not know what to do, [] there is a Catch-22-situation.
27
When the focus is shifting more towards marketing and sales, there is also a need to improve
organizational structure, to work with CRM-systems, and particularly to increase sales and the number
of customers.
Alison is now facing the challenge to strike the balance between focusing on the second round
of funding and developing the company. The company's financial situation is severely strained, and so
also Alisons private finances. At the same time, a partly new business idea has turned up that potentially
could change the direction of the company. The pressure on Alison is obviously tough from several
perspectives and time is a scarce resource I work 60 hours a week, [] I usually work until 10 pm on
Friday nights.
Interpretation
Alison is an example of an academic who has learnt from courses and books how to start a company.
There has been a very strong wish for her to keep the majority of the company and not to give up too
much of the shares. The price she has paid for this in terms of stress and financial challenges seems
high. Throughout the process, the issue of funding has taken much of her effort and time. Which in turn
has meant that the time to focus on building the company and approaching customers has been more
limited than she would have wished. She has been rather alone in the funding process.
Figure 4h illustrates the external funding sources used in Omega during its first four years of
existence.
Omega. Year 0 - 4.
Founders
Venture capital
Biz angels/private
Commercial loans
Friends and family
Subsidies
Public loans
Figure 4h. External funding sources Omega (SQR of investment)
5.
RESULTS AND DISCUSSION
All case companies in this study can be classified as innovative firms with growth ambitions, situated
in either Stockholm or Gothenburg, and managed by entrepreneurs with higher educations. Concerning
these entrepreneurs approaches to financing, this study reveals both commonalities as well as
differences. Table 2 presents a list of some of those, which will be discussed further below.
28
Table 2. Commonalities and differences among the eight cases

COMMONALITIES
DIFFERENCES
The financing process is central and takes lots of time

and efforts
The entrepreneurs differ in having either an ad hoc or

a strategic approach to funding
The use of financial sources follows to a high extent

the life cycle model, while a clear support for the
POT-theory cannot be found
Differences between the cases in terms of opinions of

the importance of ownership dilution and losing
control
All make use of governmental debt and public

subsidies
The importance of customer funding and focus differs
Financing from family and friends is non-existing
The financing portfolios differ dependent on earlier

experience and the entrepreneurs preferences
Formal venture capital is almost non-existing
Funding arrives from on average more than 8 sources

in the first 3 years
There is some type of path dependence, meaning

that founders continue to use the same type of
funding throughout the early years of existence
The founders have large power in negotiations with

investors/buyers
No traditional techniques are used when setting a

value on the ventures
5.1.
PLANNING
For all firms included in this study, funding is a question of vital importance, and a process that the
entrepreneurs put considerable efforts and time on. This tends to have negative effects on attention given
to other core activities such as sales and product development.
To what extent funding is an ad hoc, often short-term, activity or rather a strategic, more longterm, concern differs. The entrepreneurs in our study who could be classified as ad hoc entrepreneurs,
do not have a clear plan for their funding but rather arrange funding along the way. To a high extent
they have a strong ability and drive to convince financiers to invest in the company, even before a viable
product/service has been developed. Often these entrepreneurs also have support from an institution
such as an incubator or school. The other entrepreneurs in the study may be classified as strategic
entrepreneurs. This group typically have more startup experience, have a funding plan and a clear view
of the types of funding that is preferred, what amounts that are needed and how the relationship with
investors should be set up. Of the companies included in the study, Beta, Zeta, Delta, Epsilon, Omega
and Kappa have more of an ad hoc and short-term approach to external funding, while Alpha and
Gamma have more of a strategic, long-term attitude.
When it comes to what type of funding that is used, the companies share a similar funding
pattern, which to a large extent is in line with the life cycle model outlined by Berger and Udell (1998).
A clear support for the POT, or the reversed POT, theory could not be found though (Myers, 1984;
Myers and Majluf, 1984). That is, Gamma seemed to support the POT-theory and Alpha the reversed
POT theory, while the others did not have any clear strategy for their funding in the early phase.
29
Figure 4 below depicts the financial sources used at different periods in the firms life-time.
First the founders invested a small sum to establish the company. Then they typically used a broad range
of capital arriving from public sources, ranging from subsidies, price money from competitions, public
loans, and line of credits, to private investors, business angels and finally loans from commercial banks.
Capital from private sources almost always came after the public money. Commercial bank funding, in
the form of line of credits are used early in the process for cash and rescue purposes, and more traditional
bank loans late in the process for larger investments and/or cash management. One source frequently
mentioned in the literature is friends and family. This category is absent in our study, which is rather
interesting. The same pattern is evident for formal venture capital, which is almost non-existent as a
funding source for these ventures. This is also somewhat surprising, since our study include innovative
high potential ventures spanning over 12 years of operation. Furthermore business angels, or smaller
private investors, invest somewhat earlier than stipulated in the life cycle model (Berger and Udell,
1998).
Governmental funding, in the form of subsidies and grants, is perceived as rather inflexible,
but still a highly interesting source of low cost money a source of funding that is not discussed in
Berger and Udells (1998) life cycle model to any large extent. Private capital is difficult to get early in
life cycle. Instead, public money is used to create legitimacy, get a proof of concept and, thereby, reduce
risks. Getting funding from governmental sources provides a positive signaling effect to private
investors, and thus increases the likelihood to get funded from private sources.
Besides the life cycle model, entrepreneurs background and preferences seem to have a clear
impact on the choices of funding alternatives. We also see a path dependency pattern in the funding
portfolios, where the firms tend to use the same types of funding over and over again. This is in some
cases due to own choices, but for others due to that other options are not easily available given an earlier
choice of one particular financing type. For example Beta had problems to attract venture capital because
of their high number of investors and their high valuation.
For the eight cases in this study, the average funding per deal is approximately 635 tSEK,
while the companies average annual burn rate is approximately 1.7 mSEK. This small amounts of
money to a high extent forces the entrepreneurs to start looking for new financing within a period of
three to six months after funding has been obtained. The firms use a large number of funding sources,
on average 8.3, during the initial three years of operation. This could be a sign of an intentionally aim
to build funding portfolios. However, it seems rather to be an unintentional result of the small amounts
provided in each funding round and thereby a necessity to look for more funding.
5.2.
SEARCH
Whether the firm has an ad hoc or a strategic approach to funding, also affects the search process. The
ad hoc entrepreneurs spend more time, have a broader search area, and are constantly searching for more
financing. They are in addition more prone to change/adapt to funding schemes.
The strategic group balances their funding sources with personal preferences and what
they consider to be most efficient strategy for their firm. They may also allow alternative development
strategies for their ventures just to avoid a certain type of funding.
30
Common for both groups is that they approach most available funding sources at some
point in time, especially in the early phases. The search process is institutionalized if the startup is
located in an incubator or belongs to another formal organization. Furthermore, the funding sources and
search processes follow the same patterns for startups from the same type of environment.
The early search process is broad and open. All sources are approached simultaneously.
Entrepreneurs typically use web search, networks, board members, and other connections. Then
meetings are booked and feedback is generated. If one source looks more promising than another, search
is intensified for this source. It appears that governmental funding is the most promising area in the early
stages. Positive feedback will reinforce the search strategy to one funding area.
5.3.
EVALUATION AND NEGOTIATION
Negotiation is an important part of the funding process.

The companies in this study seem less likely to negotiate with public financiers, i.e., providers
of subsidies. There are, however, various opinions among the entrepreneurs concerning whether to
adjust to a particular public call or not.
Negotiations instead appear for external funding other than subsidies. Not least in discussions
with providers of governmental debt, where both amortization plans and interest rates are negotiated to
a much higher extent than we expected.
Otherwise, the majority of funding negotiations take place between the entrepreneurs and
equity investors, here dominated by business angels, or acquiring corporations. A rather surprising
finding from this study is that these negotiations to a high extent are championed and managed by the
entrepreneurs. Typically, it is either the CEO or the CFO who takes lead in the process, providing the
potential investor/acquirer with a rather standardized business plan. Thereafter, in all our cases, the
investor agreement is developed by the entrepreneur.
Valuation is one important part of the negotiation process but, in these case companies, is not
really negotiated. The common valuation method is not a formal discounted cash flow analysis or some
other technical solution. It is rather an estimation of how much money is needed, for what and when.
For example, Epsilon needs to hire a developer and pay salaries before reaching positive cash flows.
That sum is then used as the base for the valuation. The other parameter is how much ownership the
founders want to distribute. For example, if case A needs 10 mSEK and is willing to give away 10% of
the equity in the deal, the valuation of case A would be 100 mSEK. This strategy is used extensively in
the first round. If the investors do not agree with the valuation, the firm will typically propose a lower
valuation, or seek smaller amounts of money. Here we see variations among the cases. Beta and Zeta
did not care about the level of ownership in the beginning, All we wanted was to see if it worked. In
other cases, the equity split among owners and founders is of vital concern, not least due to an
unwillingness to lose control, We will never let external investors interfere with our business. If
control is central, the distribution of ownership will be low. If it is not so, the share of equity given to
the new owner would be higher.
The first valuation has short-term effects on the venture, but also long term implications since
it tends to impact the firm for a long time. Even in situations where the underlying performance
31
indicators are not reached, the valuation is the starting-point for the next round of investments. Getting
a too high valuation in round one can be problematic. In case the entrepreneurs do not fulfill set
expectations, investors may lose confidence in the case and are not willing to fund the company in
following rounds. Or the valuation set in subsequent rounds increases based on vague promises rather
than the actual company status. Eventually new investors are likely not to accept such high levels, which
could severely limit the firms ability to get more funding. This is the problem that Beta faces. Getting
a too low valuation could obviously also be problematic, typically leading to small investments. The
result is scarcely funded young ventures with founding teams constantly seeking for more capital. These
activities take away focus and time spent on developing the core business. This is also evident in
situations where the company has many owners. The transaction cost per owner is high in the beginning,
almost similar to the situation for a public company with many small owners demanding information
from the founders.
Contracts are supposed to be the investors control vehicle, in order to reduce and prevent
agency problems. It is clear from our cases that the investors are not actively involved in shaping and
developing contracts or other formal agreements. That is, contracts are often developed by the
entrepreneurs themselves, with some help from an accounting or law firm. Beta and Zeta report that
they do not have any contracts at all. They have oral agreements, but not written ones. All the other
firms in this study developed their own contracts and then invited investors to suggest adjustments.
However, the investors tend to accept the proposed terms, conditions and valuations levels to a high
extent with only few objections. These contracts are later used in subsequent rounds of investments.
5.4.
POST INVESTMENT
Since the equity investments in these cases predominantly are made by business angels, the finding that
the entrepreneurs have control over the contract process to some extent supports Van Osnabrugge (2000)
and Wong et al. (2009) ideas of that business angels typically uses an incomplete contract approach.
According to this theory, business angels instead control there investments ex post, meaning that they
exercise control by post investment activities and assistance. However, a number of the investors in the
current study are not particularly active after the deal has been settled either, which is rather surprising.
Hence, the agency risks associated with investing in opaque startup firms are not balanced neither ex
ante nor ex post the investment.
The dependency on public funding sources is significant in the innovative startup firms
nascent phases. Our study clearly shows that there is a funding gap for young firms, which is not catered
for on the private market. This leads to high transaction costs for the entrepreneurs. They spend a lot of
time searching, writing, and applying for public funding. A general concern is that many of these
programs seem too small.
6.
CONCLUDING REMARKS
This qualitative study has provided new insights about how founders of innovative startup firms view
and approach funding. Similarities as well as differences were identified, where the area of financing is
one of the more important processes in young firms. Experienced entrepreneurs in general have a more
strategic and long-term approach to funding and to a limited extent deviate from their pre-set plans.
32
These entrepreneurs seem to be more concerned about getting early customer payments. Furthermore,
in general they are keener to keep control of their ventures. The other group of entrepreneurs, here
referred to as ad hoc entrepreneurs, did not have any specific funding plans, and were constantly
searching for funding. To some extent, this group was trapped into a situation where the effort and time
spent on financing issues tended to have negative effects on the development of their ventures.
It was also interesting to note the control that the entrepreneurs in this study exercised not only
on contracts and valuation levels, but also on the operations of their firms after a deal had been settled.
This contradicts both the agency literature and theories about how business angels and venture capital
firms exercise ex ante and ex post control in startup firms (Van Osnabrugge, 2000).
The fact that capital arriving from family and friends is absent in the current study, while
public funding instead is of vital importance to a vast majority of the firms, seems to point at a particular
national characteristic of the Swedish mentality and institutionalization. While US entrepreneurs to a
high extent rely on funding from family and friends, Swedish ditto turn to the government for support.
We also found a path dependency pattern in the choice of funding, where the firms tend to use
the same types of funding over and over again based on a positive early response. For example, it seems
like early public funding directs search processes to that source until it is emptied. Then more formal
investors are approached, typically business angels, and this source becomes the main funding
alternative.
The high number of transactions and the low amounts in each funding transaction is also
noteworthy. Innovative startups spend a large part of their management resources on searching,
applying, negotiating, and reporting in relation to time spent on developing more operational aspects of
their businesses. A priority that potentially have a negative impact on the business development process.
The results have clear implications on entrepreneurs, policy makers and scholars alike. First,
entrepreneurs are better off if they have a clear financing plan from the beginning. Some sources and
investors should potentially not be approached in the earliest stages, such as VC firms. It is better to
focus on public funding, smaller private investors and business angels. Second, we can to some extent
see a market failure that is being corrected by a large number of public initiatives. The challenge for
policy makers and entrepreneurs alike is that there are many programs, with slightly different rules and
aims, which all distribute fairly small amounts of money. This means that the time spent on each
transaction is high from both the governmental agents and the entrepreneurs side. Potentially a smaller
number of programs with larger budgets would be more efficient for both entrepreneurs and policy
makers. The scholarly interest in the field is dominated by studies about formal venture capital, and to
some extent business angels. Our study shows that venture capital is an almost absent source of capital
for innovative startups in Sweden. Researchers could develop new knowledge in case giving more
attention to other sources of capital and focus more on the demand side of venture funding.
33
Figure 4. Illustration of funding used over the years in the eight companies. Note that the firms respective ages differs from two to ten years, meaning that the number of cases
included reduces over the years.
<20.000
Founder
Friends and family
<10.000
Subsidy
Public loan
<5.000
Commercial loan
Business angel
<3.000
Venture capital
<1.000
<500
<300
<100
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
THE FINANCING PROCESS IN INNOVATIVE ST ARTUP FIRMS
7.
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36
Appendix 1. Interview template
1.
2.
Plan
o Funding plan
Has the company a funding plan? Has it changed over time? How?
How has the funding plan been documented?
Does the company have a dedicated person responsible for funding? Who?
Who are involved in funding activities and decisions?
How much time is used for funding related questions today? For what activities?
o
Purpose of funding
Did the company have an early need for external funding?
What should the funding be used for?
Choices of funding sources
What knowledge and experience did the founder have about various funding sources?
What sources of funding was discussed at the time for the companys founding? Why/why not?
How important was a particular choice of funding? Why/why not? For whom?
Search
o
o
o
How did you identify potential financiers? What information sources were used?
What did the process look like? Was it structured? Was it formal/informal?
Did you follow a predefined funding plan, or was it a more ad hoc process?
3.
Evaluation and Negotiation

o What is your level of competence/experience related to negotiating shareholders agreements?
o What did the negotiation process look like? Did you make use of any advisors?
o What information did the potential investor ask for?
o What terms and conditions were particularly important? From your perspective? From the investors
perspective?
o Equity capital: How was the valuation made, i.e., what techniques were used?
o Why (or why not) did you receive funding?
o How long time did it take from initial contact to final agreement?
4.
Post investment activities

o Describe how the relation with the investor works after a deal has been settled
5.
General
o How much time is used for funding-related questions today? For what activities?
o Do you consider that your funding strategy/situation has affected the development of you company? How?
o In hindsight would you have acted differently if you would start over again?
37

The Financing Process in Innovative Startup Firms

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THE FINANCING PROCESS IN INNOVATIVE STARTUP FIRMS

TALES FROM THE ENTREPRENEUR PERSPECTIVE EIGHT SWEDISH CASES

PhD Anna Sderblom, PhD Mikael Samuelsson & PhD Pr Mrtensson