EF - 1. lecture

What to remember?

Not using CAPM (Capital Asset Pricing Model) to know how much to demand for the investment risk (as this is useful for corporate finances), VC funds use “hurdle-rate”, which is a flat minimum of 30x return or 50% IRR (= Internal Rate of Return), which is an annualized return rate.

Things to remember:

• Agency problems = investor and entrepreneur have different goals and different information
• Moral hazard problem = after raising, will the entrepreneur act in the investor’s best interests?
• Adverse selection problem = entrepreneurs desperate for money often ask for investments, whereas the best entrepreneurs often don’t need to raise that much
• Investors don’t bet on product/service, they often bet on the team
• Raise as least as possible (keep it lean and retain equity, but raise more often and stress over money and resources) OR raise as much as possible (to become a market leader, hire talent and do not raise that often)

Entrepreneurial finance

Entrepreneurial finance is about valuing and financing unquoted entrepreneurial companies - startups, new ventures, and growth-oriented businesses. It covers venture capital (VC), deal-making, and financial decision-making by entrepreneurs, as opposed to corporate finance which deals with public companies.

“I can’t promise to turn you into entrepreneurs or investors, but I can provide you the tools to deal with them.”

Who is an entrepreneur?

Entrepreneurs are system breakers and creative disruptors who can deal with uncertainty and build something new with limited resources. Key defining characteristics:

• Opportunity recognition and creation (disrupting existing systems)
• Operating under high uncertainty
• Working with limited resources

Key definitions across time:

• Cantillon (1755): “An entrepreneur is someone who exercises business judgement in the face of uncertainty.”
• Schumpeter (1936): Entrepreneurship = new combinations causing discontinuity; the process of creative destruction.
• Penrose (1959): “The ability to discover new ways of dealing with known problems or new combinations of given knowledge.”
• Howard Stevenson (HBS): “Someone who pursues opportunities with no regard to resources currently controlled.”

A common tension: entrepreneurs often don’t understand the language of investors - they want to build and ship fast. Investors, on the other hand, care about legal practices, preferred shares, anti-dilution clauses, etc.

Why entrepreneurial finance is different from corporate finance

Corporate finance can rely on history, public information, track records, and collateral. Entrepreneurial finance operates in a very different reality:

• High uncertainty
• Almost no collaterals
• Lack of track record
• Very high cost of outside capital

Debt vs. equity

Debt = fixed claim, you stay in control, but you must pay regardless of outcome. Not suitable for early-stage startups - banks won’t lend without collateral or cash flow.

Equity = variable claim, you share control and upside, but owe nothing if things go badly. Used by startups; investors essentially bet on your success and exit later via sale or dividends.

Funding comparison

Topic	Entrepreneurial finance	Corporate finance
Funding sources	FFF, crowdfunding, angels, VC, PE	Banks, capital markets
Funding process	Deal sourcing, financial plan, valuation, term sheet	Standard due diligence, collaterals
Growth	Monitoring, KPIs, IP protection	CapEx, M&A, IPO
Harvesting	Exiting (selling), IPO	Dividends

FFF = Friends, Family & Fools - people who give you money before you have proof it works, either because they love you or because they don’t know better. This is also why later-stage investors are much harder to convince.

Why traditional models fail in entrepreneurial finance

Agency problems

There is a principal-agent problem at the core of startup investing:

• Investor = Principal
• Entrepreneur = Agent

They have different goals (investor wants maximum gains, entrepreneur wants a good product, autonomy, personal wealth) and different information (the entrepreneur knows far more about the product and their true intentions).

This leads to two classic problems:

Adverse selection - will the best entrepreneurs seek outside finance, or treat it as a last resort? The best founders with strong ideas and solid plans may have options and self-select out. What’s left may be the most desperate, not the most promising.

Moral hazard - will entrepreneurs work in the best interest of investors after the money is wired? Once the contract is signed, the investor’s leverage drops. They now bear the risk but must trust the entrepreneur to work hard, focus on commercial viability, and not pay themselves a generous salary.

Ways to reduce agency problems:

• Reduce information asymmetry via pre-investment screening, due diligence, and post-investment monitoring (regular reporting, milestones)
• Align goals: entrepreneurs invest their own savings, become shareholders, bear risk alongside investors - skin in the game

Information problems

Information is incomplete and uncertain for both entrepreneurs and outside investors:

• Investors lack information on the value of the idea and the founder’s skills and true effort
• Even with the same information, they interpret the future differently due to massive uncertainty

Why CAPM doesn’t work for startups

CAPM (Capital Asset Pricing Model) answers: what return should I demand for taking on this investment’s risk?

Standard formula: Ke = rF + β(rM - rF)

• rF - risk-free rate (e.g. government bonds), typically ~1%
• (rM - rF) - market risk premium, historically ~5%
• β - how volatile the asset is compared to the market
• Example: 1% + 1.6 × 5% = 9% minimum required return for a very volatile company

Why it breaks down for startups:

• No diversification - VCs have only a few bets, often concentrated in one market or geography; founders often have all their savings in the venture
• Low liquidity - startup capital is locked up for 5-10 years, which demands extra compensation not captured in the formula
• High transaction costs - monitoring, negotiations, board participation are significant but ignored by CAPM

What VCs actually use: a hurdle rate - the minimum return multiple they are willing to accept (e.g. 3x the fund, or 30-70% annual returns). Expectations are high because a large portion of startups fail, so the winners must make up for all the losses.

Key risks in growth-oriented innovative startups

• Technological risk: will the technology actually work?
• Market risk: will customers buy at a viable price and when will the market take off?
• Competitive risk: can we withstand competition and protect IP?
• Execution risk: can the team deliver? (customer acquisition, talent, team conflicts)
• Regulatory risk: can we overcome legal and institutional barriers?
• Funding risk: can we secure enough capital?

This is why investors must be selective and cautious, and entrepreneurs must be direct and honest.

Stages of venture development and financing

Cash flow pattern

Startups typically follow a J-curve: negative cash flow through Seed → Startup → Early Growth, turning positive during Expansion → Exit.

Five steps in the financing process

1. Determine how much and when financing is required
2. Choose the type of financing
3. Choose the source of financing
4. Structure the deal
5. Harvest the investment

Jockey vs. horse

At early stages, investors often bet on the jockey (the team), not the horse (the product). The product/service may pivot many times over the coming years - the team is the constant that provides the real value.

How much money should you raise?

Two conflicting perspectives: “More is better” vs. “Less is more.”

Insight from Inc. 5000: companies started with less than $1,000inseedcapitalwerejustaslikelytobeprofitableasthosestartingwithover$100K - though the latter had more employees and higher revenue on average.

Arguments for raising as little as possible

• Avoid dilution
• Stay lean and creative (constraints drive innovation - e.g. DeepSeek vs. OpenAI)
• Maintain control
• Avoid premature scaling

Arguments for raising as much as possible

• Scale the proven business model
• Become market leader and set the rules
• Build runway and buffer
• Avoid distraction from repeat fundraising
• Attract top talent

When and how much to raise

Should you even raise money?

“If you don’t know, the answer is no!”

Bootstrap first: prove concept, attract early customers, assemble the team. Valid reasons not to raise:

• Cash-efficient business model
• Lifestyle or control preference
• Small market size
• No product-market fit yet
• No clear return vision

Milestone-based fundraising strategy

• Raise no more than you need to hit the next milestone, so you earn a higher valuation for the next round
• Once the business model is proven and you’re ready to scale, raise as much as you can - to dominate the market, attract top talent, and avoid distraction from future rounds

Investors don’t release everything at once - they spread capital across rounds while monitoring progress, which preserves their leverage and limits downside.

Key milestones that unlock funding

• Customer traction: successful beta testing, monetization working, repeat customers, large strategic client
• Technology proof: prototype completion, clinical trials, production scaling
• Execution proof: hiring a proven CEO, reaching profitability, becoming market leader

Early-stage strategies to reduce perceived risk before first funding round

• Show proof of customer traction (crowdfunding, pilots, pre-orders, prototyping)
• Assemble a balanced team (business + technical expertise)
• Get top technical experts to endorse the project

The LaLaLand principle: build a track record first, then use that credibility as leverage with investors.

DIY / Bootstrapping

Bootstrapping = starting and growing without outside funding, letting founders play by their own rules.

“The biggest challenge for many entrepreneurs is not raising large amounts of outside money, but having the wits and hustle to do without it.”

“Do you really need to raise money? If you don’t need money, that’s when people will want to give it to you.” - Michael Seibel (YC)

EU startup facts and figures

• 23 million existing companies in the EU
• 2 million companies created per year
• ~200,000 are growth-oriented with ordinary return potential
• ~20,000 are high-growth startups
• Only ~3,000 receive VC funding
• Less than 2 out of 1,000 startups in the EU get VC

Key questions in entrepreneurial fundraising

1. How much money do you need? What’s the impact of business model design on funding needs? How to avoid dilution while maximizing value?
2. When do you need it? What is the trajectory to stay funded?
3. What type of investors to target? Accelerators → Angels → VC → IPO?
4. How to provide attractive returns? What financial instrument? How to price the company at each stage?
5. How to approach and pitch investors?

Core takeaways

• Entrepreneurial finance addresses specific issues not covered in corporate finance
• Raising capital is a strategic exercise - it impacts wealth, control, and venture success
• Picking the right investor at the right stage often makes the difference
• Different development stages require different funding approaches (pre vs. post product-market fit)
• Be creative in attracting resources early to avoid dilution
• Customer traction is always the most important milestone
• Link funding rounds to specific milestones