Investing for Early-Stage Entrepreneurs

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The German venture capital scene has come a long way since I moved to Berlin in 2018. I still remember how a 10M€ Series B was considered massive then - today, we regularly see Seed rounds larger than that.

Yet one notable change that I’ve personally noticed, and appreciate, is how funds treat (or have to treat) their founders. Back in the day, it wasn’t uncommon for founders to receive a minimal salary (3-4K€ per month before tax, comparable with an entry level business salary), or not to receive one at all - often requiring them to dip into their savings, or to live on minimal spend. Today, founders regularly insist on (and receive) salaries that allow for an appropriate lifestyle of someone for their age, with some serial founders rightfully asking for low six-figure salaries that allow them to provide financial support for their family (including children). 

In my eyes, that is only fair - after all, it’s the founders who take the most risk: They have the realistic downside of missing out on any financial gain if their sole project doesn’t work out, while their business angels and venture capital investors get to diversify across many bets. (Remember the Power Law.) Hence, investors should ensure that their founders are at the very least not worried about finances - and as the company starts to do well, remain focused on its success.

So let’s tackle a frequent question from founders that are just starting out: How to invest their money at the earliest stages of their start-up journey - prior to the prospect of a secondary transaction, or even an exit.

What To Do Before Investing

Companies at this stage still have a long way to go. They might be working on their first product, looking to provide a solution that customers are willing to pay for - the coveted ‘product-market fit’. Companies might’ve raised funds from business angels and/or early-stage venture capital funds, but typically are too early in their life to make an assessment on a potential outcome.

Unsurprisingly, at this stage, the risk for a founder is the highest. Without clear product-market fit, it is unlikely that their shares would be worth anything in the case of a sale of the business - if the company is even acquired at all and not just simply liquidated. If a company is bought at this stage, they are typically ‘acqui-hired’, with the company purchased in an all-stock transaction in which the founders don’t take any cash off the table (except maybe to pay for incurred taxes). If there is a cash component, it is likely paid to investors to satisfy their liquidation preferences. Or in other words: At this stage, founders shouldn’t plan that their shares will be worth anything.

With that in mind - how should they think about their finances and investments?

Taking note from my introductory paragraphs, I would recommend that founders prioritize their personal finances. During the first months prior to an initial financing round, founders will likely not be able to draw a salary from the company, meaning they have to dip into their savings. Here, the lever is less in how these savings are invested (frequent readers know I am very cautious when it comes to short-term liquidity requirements), but how to lower your expenses to make those savings last longer. I personally also find it warranted to not dive in fully from Day 1, but perhaps to start the company on the side while still drawing a salary, or while freelancing one or two days a week. I would also recommend that founders look into subsidies (Fördermittel) that take some of the strain of this first phase away (in Germany, there’s the Gründungszuschuss or the Gründungsbonus).

After a financing round, this changes somewhat. Keeping a tight budget is always recommended (even after you sell your business). But as mentioned before, initial funding typically allows founders to pay themselves a modest salary that ideally should at least cover their ongoing expenses. After all, a financing round means that they commit themselves fully to their start-up, with other work typically no longer committed, so if they have the option when negotiating their round, they should negotiate firmly for a salary that allows them to sleep well at night.

Some early-stage founders that I know try to maximize every basis point of dilution in order to maximize their proceeds at an exit. In mind of our topic, that often means taking less funding for less of a dilution while also paying themselves little to no salary. I understand the intention, but I would be cautious: While it might feel different in the early stage of a company, especially shortly after a financing round, the hard truth is that most companies fail - and if you take little to no salary, you will feel the most pain when your personal funds run low. Or even worse: When the company goes bankrupt, you lose your equity and all of your savings. When your company does well, you either have room later to negotiate for additional equity to offset early dilution, or the difference will be marginal in a substantial exit. So if you can ask for it: Get yourself and your co-founders a fair salary.

What Investments To (Not) Consider

Only if that salary allows you to fully cover your ongoing expenses should you think about actual investments. In this case, I would always focus on the first two buckets of the Aspirational Investor Framework: Your Safety Bucket (or in German, your Notgroschen) in which you keep three to twelve months of expenses in safe assets (cash, money market funds, short-term fixed income) for emergency expenses, or your Market Bucket, in which you save for the long-term for your retirement. In the latter case, I would greatly encourage founders to focus on simplicity, meaning simply, proven investment strategies for the long-term, such as a ETF or index fund savings plan investing into a globally diversified equity ETF.

Also consider if you can use some of your excess savings to make your life easier. It could be a cleaning company, a meal kit delivery service, or a personal trainer - anything that you can pay reasonable money for to take some of that mental load off your shoulders is a great investment, as I know from personal experience. Or if you don’t want or need any of that, at least use that money to take your mind of what is likely one of the most stressful times of your life, whether that is a date night with your partner, something for a personal hobby or (time permitting, of course) a short vacation. At that stage of your company, any of those things are likely to provide you a significantly higher perceived return than putting a three-figure amount into a long-term ETF.

If not already in place (as is typically the case within over-protected Germany), make sure that you are properly insured for any adverse scenarios. While we Germans benefit from statutory health insurance, there are other bad possibilities. I know more than one founder that has faced burnout even when their company was going well, and see how some of my entrepreneur friends are struggling when their company isn’t doing well. Hence, it can make sense to look into  occupational disability insurance (Berufsunfähigkeitsversicherung) that provides you with income if there is ever a period when you can’t work. I would also advise looking into D&O insurance (although typically taken at company level) to protect you and your co-founders from legal claims of unhappy investors if things don’t work out, or a Rechtsschutzversicherung that provides you privately with legal support when needed. I found insurance to be a uniquely complex topic of its own, so make sure to discuss such matters with a trusted (and ideally fee-based) insurance broker - for my Berlin-based readers, I recommend Sebastian.

And lastly, make sure you avoid anything that negatively impacts your most important asset: Your time. The most successful founders that I know have been razor-focused on the drivers that are the most impactful on the success of their business, radically avoiding any project or initiative that would take time away from these key priorities. The same applies to tasks outside of your business: Don’t spend time on distractions that either provide less impact than your company, or that don’t provide impact at all. On the investment side, that is focusing on high-effort investments such as individual stocks or angel investments, but in which you can likely only invest so much money that even an outlier success wouldn’t move the needle significantly. 

But it also applies to side projects such as advisory work (if not prohibited by your investors), helping fellow entrepreneurs that ‘just want to pick your brain for 15 minutes’, or a newsletter or other PR projects unless they are absolutely important to the success of your business. I am a big believer in social media and newsletters, but I can tell you from first-hand experience that they take a long time and lots of work to be meaningful - don’t be yet another founder that starts a podcast or newsletter to share ‘things that I found interesting’. Focus on your business - don’t get distracted by alternative yet unproven paths. It is something that I personally still struggle with, as I really like to pay it forward - but before you know you’re on stable ground, focus on your business.

And when things go well, your hard work will hopefully pay off -  whether that is a salary raise, a secondary transaction, or even the coveted exit. But more on that in a later installment.

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