Jaime Medina
In the previous newsletter, we discussed how a misalignment between the business model, financing model, and the founder’s personal vision can lead to a startup’s failure. We previously studied which types of business models should follow one model or another, and today we will focus on financing models, specifically for startups or SMEs.
It is clear that, in order to achieve any financial return, an initial investment of time or money is essential. This idea is often encapsulated in phrases like “no pain, no gain,” the well-known J-curves in startups, or the concept of sacrificing short-term gains for long-term returns in the stock market. In any case, let’s take a step back to see how to finance a business. Does a consulting business, a bar, or SpaceX require the same type and amount of financing? Obviously not. The amount and timeline for the return on investment are vastly different for these three types of businesses. Consulting would be on the low end, requiring minimal investment with returns expected within a month, while SpaceX demands hundreds of millions of dollars with returns expected over years or even decades.
There are different sources of financing, each suited for a specific amount and return timeline, and these must align with the project. It’s a mistake to finance a long-term project with short-term funds and vice versa. In a startup, returns are likely achieved over a very long period. We are disrupting a large market with significant inefficiencies using new technology, so returns will probably be seen in the long term. The longest-term financing form is equity, which isn’t even expected to be repaid but rather participates in the future profits of the company.
However, in a startup, while the overall project is long-term, certain aspects like collections or some expansion plans might be short or medium-term. This is where other financing types, such as bank financing for working capital, venture debt, etc., can come into play. In a traditional business that doesn’t aim to solve uncertainty in a large industry, more conventional sources like long-term loans may be perfectly adequate. In such cases, long-term equity investment might result in poor returns for the entrepreneur.
In summary, many projects pursue venture capital when they shouldn’t. Only if your business model genuinely requires that type of financing due to the amount and return timeline should you go down that path. In any case, this must align with your personal project, which we will discuss in the next article.
