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Kaylan Pepin

First 5 Books to Read for Financing Tech Startups

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This is a list of the first five books that I recommend to anyone interested in learning about Financing Technology Startups. These are the books that were first recommended to me when I started financing tech companies.

Here they are in no particular order.

1) Zero to One

by Peter Thiel

This book is a must-read for understanding the psychology behind startups. It is a staple book in the startup community written by one of the Pay Pal Mafia’s original member’s Peter Theil (1). After PayPal, his top investments include Facebook, Palantir and SpaceX.

This book was born from a course he taught at Standford University on entrepreneurship (2). The concept of 0 to 1 is about how to build companies that create new things. The concept starts with the key questions: “What important truth do very few people agree with you on?” and “What valuable company is nobody building?”.

This book is not only for tech finance, it’s also essential reading for anyone involved in startups.

2) The Lean Startup

by Eric Reis

This book is an excellent read and a great way to get introduced to essential concepts in tech, including creating a Minimal Viable Product (MVP), Pivoting to find Product-Market Fit and Iterating continuously to grow a product off of user feedback.

These concepts have helped start many companies and launch products without the need to amass a ton of resources before getting started. I expected this book to hang out around the perimeter on a lot of these concepts but was really impressed with how deep and specific some of the advice is.

The book is a great manual for all aspiring entrepreneurs and tech founders and a great intro for language and concepts required to finance technology startups.

3) Venture Deals

by Brad Feld and Jason Mendelson

This book has basically become the textbook for understanding venture capital. It’s a deep dive into term sheets, cap tables, and raising venture capital. The Authors, Brad Feld (Co-founder of TechStars and Foundry Group) and Jason Mendelson (Managing Director and General Counsel for Mobius Venture Capital, now Co-founder of Foundry Group) go deep into the details and terminology involved.

The updated version also features a section on Venture debt added by Silicon Valley Bank. I wrote about the Pros and Cons of Equity, Debt and Bootstrapping here and have a post on venture debt coming up that will dig into more of the concepts from this chapter (3).

The book is a must read for companies that are on the venture capital route or that plan to raise capital and create a venture scale company.

4) Disrupted

by Dan Lyons

This is an amazing read on a writers “misadventures” joining a tech startup, Hubspot (4). The amount of irony in it is exceptional. I still can’t decide if the irony was intentional or not. The most amazing part of this book is that the author throughout the entire book seems to lack the self-awareness to realize that he is not actually the protagonist of his own story. If anything, a flawed main character actually added greatly to the read and a window into a hyper-growth tech startup. 

The window into the startup world is enjoyable and reading it from a perspective without rose coloured glasses on is valuable. It’s also not something you get to hear or read about often. As Dan Lyons points out there are a ton of people invested, usually quite literally (ie: financially), in promoting only the good of tech companies. The book looks at a lot of really great points that are not talked about enough at tech startups. Especially the pains that come with scaling quickly, having workforces skewed strongly towards specific demographics, and the chaos that comes from venture scaling a company.

It’s very readable, flows well and keeps you interested with great storytelling. At times it feels like a conversation where a friend is telling you about their crazy experience at their last job over coffee. You sip your coffee and do your best not to judge the company, the industry or your friend too harshly as they speak but are entranced right until the end.

While not directly a tech finance book, understanding the impact of venture capital and the window into a successful venture scaling company is worth the read.

5) The 4-Hour Workweek

by Timothy Ferris

Traditionally seen and marketed as a self-help/productivity book, I’ve included it in this list because it introduces the idea of the Lifestyle Business. A lifestyle business in tech is one that is not typically going to reach venture scale but has automated numerous processes and has achieved profitability that supports its owners’ lifestyles.

The productivity tips include the Pareto Principle (80/20 rule) for focusing on your most valuable tasks, clients, activities and D.E.A.L. (Definition, Automating, Eliminating, Liberating) which looks at how to identify and redistribute tasks to liberate yourself or your company. (5)

Since Venture Capital and rapid growth is not the only way build a successful company, I’ve included this book to highlight the concept of a Lifestyle business. Tim has a great blog and postcast too.

Summary

The list again:

  1. Zero to One by Peter Thiel
  2. The Lean Startup by Eric Ries
  3. Disrupted by Dan Lyons
  4. Venture Deals by Brad Feld and Jason Mendelson
  5. The 4-Hour Workweek by Timothy Ferris

These were the first 5 books that I read when I started in tech finance and have shaped how I look at deals and tech companies that I work with.

Have I missed any other good ones?

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Footnotes

(1) The “PayPal Mafia” is a group of former PayPal founders/employees that went on to found technology starups including Tesla, Inc., LinkedIn,  SpaceX, YouTube, Yelp, and Yammer. This was the original photo and article from the November 27 2007 Issue of Forbes.

(2) Competition is for Losers is a YouTube video that gives a great intro into some of the concepts explored in Peter Thiel’s booked from a lecture at Stanford University

(3) A section on Venture debt has recently been added by Silicon Valley Bank. Here is a sample.

(4) While writing this review in 2020, Hubspot is still a top employer and is now worth ~10x what it was at IPO ($HUBS). The owners and investors have all made money and this book is used as a recruitment tool. Dan Lyons has a best-selling book and has worked on an incredible HBO show Silicon Valley for several seasons. Seems everyone made off pretty well.

(5) Pareto Principle is the concept that for many outcomes roughly 80% of more of consequences come from 20% of the causes. It is also called the 80/20 rule.

Pros and Cons of Tech Financing Options – Debt, Equity and Bootstrapping

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Teammates not competitors

This conversation is often explored as a “Debt versus Equity” debate. I’m not a fan of this debate. I find that the “versus” really misses the point. Equity and debt financing methods are not at odds with each other, they are different financial tools that can be leveraged in different ways and at different times. The same way a hammer and a screwdriver are not at odds with each other.

There is a right times and place for each method of financing. They can even be leveraged together or in various combinations throughout the lifecycle of a venture. In this post, I will look at benefits and setbacks for consideration that come with each financing source.

I’ve made a point of including Bootstrapping in this conversation too, which is not discussed often. The virtues of bootstrapping are well known and (rightfully) celebrated but it is important to discuss and consider the constraints associated with this method of financing a tech company too.

Financing by Raising Equity

Equity is the most well-known way to finance a tech company by far. It includes fundraising from Family and Friends, Crowdsourcing, Angel Investors and Venture Capital.

Pros

  1. Patient Capital: Equity investments are incentivized by large exits or liquidity events. When things don’t go according to plan in the short term but the long term vision is still attainable, equity is patient with the company. It can continue to support a company while the company pivots or through difficult economic periods.
  2. Early Investment: Equity raises are available to early-stage companies starting with pre-seed Angels, VC’s and family and friends fundraising rounds. It can be used to start the company and to build and create products that cannot be financed in any other way.
  3. No Negative Impact on Cash Flow: Equity investors will assume a portion of ownership and are in turn compensated by the companies growth and increasing valuation. There are no payments that take from cash flows.
  4. Access to Network and Expertise to Scale fast: Equity investors will often come to the table with additional resources, bring additional expertise to the table or have industry connections that can benefit the company. This is possible from both angel and venture capital investors.

Cons

  1. Ownership dilution: Taking on an investor by raising equity requires that a portion of the company is sold which leaves the founders with less of their company.
  2. New Partners Opinions may not match Founders: When a new investor is taken on, they may require a board seat to monitor their investment. The new investor’s opinions for the company may not always match those of the founders.
  3. Higher overall cost than debt: If the company is growing quickly then the cost of equity is actually much higher than the interest rate on a loan (I’ll explore this cost of capital in detail in a future post).

Financing with Debt

While debt financing is becoming more and more popular (1) it is still considered to be the new kid on the block. Lenders include Banks, Credit Unions, Private Lenders, and more.

Taking a look specifically at Venture debt activity in 2019, there was over $25 billion in lending across 3,066 companies. (1) This might seem like a lot but it is barely scratching the surface. Keep in mind this is only for Venture debt deals for Venture Capital backed companies. There is still a significant amount of loans made to angel-backed or bootstrapped companies too. Still, the trend from the graph shows the rising popularity of this method of financing.

According to Pitchbook: In the USA, 3066 Venture Debt deals were completed in 2019 for just over $25B. (1)

Pros

  1. Non-Dilutive: This is by far the number one reason that founders chose to use debt as a tool for financing their company, the capital does not dilute their ownership percentage. (2)
  2. Control of management decisions stays with current ownership groups: Control is a very close second reason to use debt. Many founders want to continue to grow with the current ownership group without adding additional partners and just need more capital to do it. This ownership group could already include equity investors or just the original founders.
  3. Cheaper overall cost of capital than equity investment: If the companies valuation is increasing year over year, as most startups are, the cost of equity is usually higher than debt (I’ll do a deep dive into this in another post).
  4. Ability to end the relationship: If for any reason, including deciding to switch to strictly equity-only financing model, a loan can be repaid. Most loans will likely have a prepayment cost to ending the relationship but it is way easier to drop a debt provider than an equity investor that is on your cap table.

Cons

  1. Repayment can Interfere with Growth: Debt will have to be paid back. There may be a principal postponement period, but interest will likely start being paid immediately. When the payments are due the company will need to have sufficient cash flows to support the payments and continue to grow their business.
  2. Interest Cost & Fees: Loans will often have fees for set up and security registration as well as an interest cost to be paid on a monthly basis.
  3. Requires collateral and covenants: Loans will require security. General Security Agreements, Specific charges on Intellectual Property, Personal Guarantees, Postponements from Shareholders, and more are all potential security that could be required to secure a loan. Some lenders required covenants, which are performance metrics that are monitored.
  4. Default Potential: If loan payments are not made, the loan goes into default. This could require credit restructuring and if no resolution is reached, the lender can collect on the security taken.

Bootstrapping

Bootstrapping is financing growth by using a founder’s own funds or reinvesting profits from previous years. Some like to refer to it as funding your company with your revenues. I love this statement because it is simple and true. Bootstrapping involves covering the expenses with the revenues and funding opportunities with what is left.

To be clear, Bootstrapping is actually a form of equity financing. It’s just that the equity is either injected by the owners or created from the profits of the company. I’ve given it its own section to separate it from raising equity as an option.

Pros

  1. No Interest Cost: Great.
  2. Retain Equity: Amazing.
  3. Full decision making control: Even better!

Cons

  1. Not always possible: Unfortunately not all companies have the ability to bootstrap. There are significant capital costs related to starting a company and building a competitive product.
  2. Can limit Growth: Unless a company is making more money than it can spend, choosing to bootstrap can actually impair decision making by limiting opportunities to cash available.
  3. Owners Assume all Capital Risk: The founders have assumed all the capital risk in a bootstrapped business. This risk is not shared with a bank or an equity partner when it could be.
  4. Miss out on access to Professional Partners: This one will likely be the most disputed, but there are many examples of investors bringing connections to the table that advance a companies growth significantly. Lenders may also find potential risks in their assessments that had not been noticed. Founders could be missing out on valuable expertise and connections.
  5. No Cushion or Insurance for challenges: Depending on how much cash is kept on hand, bootstrapped companies may not have the ability to absorb challenging periods.

Recommendation

It is important to remember that there are success stories with all three methods and with various combinations of the three. Also, each method may have a better use depending on the use of financing and growth stage of the company. For example, I have seen both: Bootstrapped -> Debt -> Venture Capital Raise and also Angel Investment -> VC -> Debt work out successfully for scaling a company (among many other combinations).

A few tips for when you are looking at each financing option:

  • Consider the right option for your company based on the pros and cons weighted to which one is most important to your current ownership group (3).
  • Make sure you use the right financial instrument at the right time and business stage.
  • Talk to your financial partners frequently for advice and to be prepared for opportunities.
  • Dig into potential investors’ or lenders’ backgrounds before making a commitment to understand the reputation of who you are about to partner with.

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Footnotes:

(1) Chart from Pitchbook report: Venture Debt Set to Increase Role During Crisis by Kyle Stanford and Van Le

(2) Venture debt may contain warrants in which case this would be minimally-dilutive by comparison to equity.

(3) This includes consulting with existing equity investors.

External Resources:

Check out this article from BDC and Forbes on Debt vs Equity

A calculator for the cost of capital of debt and equity from Lighter Capital

Here is list of all External Links and a list of new Terms are in the Glossary

Start with Why – A Blog about Financing Technology Startups

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“Hello World!” and welcome to my blog.

I love tech startups. How they work, how they scale, and especially how they are financed.

I’ve met with and analyzed financial statements for hundreds of technology startups. Each meeting I learn something new and get to discuss financing options available to tech companies. I’ve started this blog to share these discussions (and debates) with as many people as possible. Here is a bit more about me.

My goal for this site is to simplify complex financial concepts to:

  • Help founders to assess options and access financing
  • Support financial partners working with tech startups
  • Prepare a candidate for an interview to move into tech finance

To Support Founders

When it comes to tech startups, it’s not uncommon that a CFO is hired when the company is at 10+ employees, or even later. This means a lot of the heavy lifting related to the finances is often done by the founders. While most founders are already exceptional in their field and at building their product, a lot of their financial knowledge has to be learned along the way. I want to help simplify these concepts and improve access to knowledge for founders.

To Support Financial Partners

When I talk to colleagues in banking, accounting or students that want to enter the field, I find that (unless they have specialized in technology and startup finance) there is a gap of knowledge around how startups are financed. This is especially true from a debt (lending) perspective.

Tech startups don’t follow the rules and patterns of traditional businesses, so applying the same metrics to them just doesn’t work. Common financial metrics like EBITDA, Debt-Servicing and Leverage, shift to Burn, Churn, MRR and CAC/LTV for analysis. As this knowledge becomes more common, financing startups will become easier – I want to help with this too.

Most Popular Posts

Articles in the Pipeline

  • SRED Financing in Canada – The Fast Forward Button
  • The True Costs of using Equity and Debt Financing for a Startup
  • A Founders’ Guid to Venture Debt in Canada

The Site

  • The Blog – I’ll add posts regularly on various topics related to financing technology startups.
  • External Links – Here you will find links to external resources that I have come across that could be helpful to continue the conversation or grow your knowledge. Anytime I refer to an external source I’ll add it here too.
  • Glossary – As I use terms and words in posts, I will update this page with any terms that could require additional explanation.2
  • Downloads – This section will have calculators and spreadsheets available for download – Coming soon

If the resources in this blog can be used to help even one founder, student, financial partner, or lender to navigate financing tech startups, then creating it will have been worth it.

This is Why I write this blog. I hope it can be helpful to you.

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If you have questions or would like advice for your startup please reach out: