Christian Stein, Partner Riverside Acceleration Capital

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In today’s episode we’ll talk about the different forms of fundraising structures available to founders with Christian Stein, Partner at Riverside Acceleration Capital.

Riverside Acceleration Capital is an American VC fund with offices in New York, San Francisco and Cologne. Unlike other VC funds, Riverside Acceleration Capital takes a flexible investment approach, offering both growth equity and growth loans, to equip founders with the right type of capital at the right timeThey also offer a proprietary growth program, and advice from experienced operators that can help businesses scale.

They invest in B2B software companies and have recently started investing in Italy with a first investment in CyberGuru, a cyber security startup based in Rome.

When we think about raising money to grow our startup, we immediately think about raising equity from a venture capital fund. But is that really the only option?

TAKE AWAYS

Do I need to raise funding at all? (00:01:13) Discussion on the necessity of raising funds and the changing perceptions of fundraising among founders.

Determining the appropriate burn rate (00:03:18) Exploration of the link between burn rate, potential, and risk, and how it varies for different companies.

Use case of the money (00:05:05) Importance of understanding the specific purpose or use case of the funds being raised.

Type of investor desired (00:05:51) Considerations related to the type of investor that aligns with the founder's goals and business model.

Considering non-equity funding options (00:16:59) Overview of different non-dilutive funding options, such as venture debt, factoring, and revenue-based financing.

Venture Debt vs. Bank Debt (00:20:02) Comparison between raising venture debt and bank debt, considering risk aversion and growth potential.

Types of Non-dilutive Capital (00:21:00) Discussion of different non-dilutive capital options, including venture loans, short-term loans, and revenue sharing.

Characteristics of Revenue Share (00:22:41) Exploration of revenue sharing as a long-term, performance-based funding option, with adjustable repayments and suitability for growing companies.

Industries for Revenue Share (00:25:15) Considerations for revenue share, including revenue thresholds and business model suitability, particularly for software as a service.

Investing in Italian Companies (00:27:19) Overview of the development of the Italian startup ecosystem and investment in Italian companies, with a focus on software businesses.

EPISODE TRANSCRIPTION

Camilla Scassellati (00:00:02) - Welcome to a new Made IT Tips episode powered by Riverside Acceleration Capital. In today’s episode we’ll talk about the different forms of fundraising structures available to founders.

Riverside Acceleration Capital is an American VC fund with offices in New York, San Francisco and Cologne. Unlike other VC funds, Riverside Acceleration Capital takes a flexible investment approach, offering both growth equity and growth loans, to equip founders with the right type of capital at the right timeThey also offer a proprietary growth program, and advice from experienced operators that can help businesses scale.

Inès Makula (00:00:37) - They invest in B2B software companies and have recently started investing in Italy with a first investment in CyberGuru, a cyber security startup based in Rome. 

We’re joined today by Christian Stein, Partner at Riverside to discuss different fundraising structures. When we think about raising money to grow our startup, we immediately think about raising equity from a venture capital fund. But is that really the only option?

Camilla Scassellati (00:00:59) - Christian can you tell us what do you see as the three most important questions that a founder should ask themselves to determine? What is the right form of financing for their startup?

Christian Stein (00:01:13) - Thank you very much for the first question. And first of all, thank you very much for having me. It's actually four questions that I would suggest a founder asks himself or herself. The first one is, and this is why I need to make four out of three questions. It is do I need to raise funding at all? I think this is a bit different today, but I can remember. I mean, I've been in this business now for over 15 years, and in the beginning I had the feeling that some founders thought that raising money was something that a founder would do. Just to do that I had sometimes I had the feeling that has changed. I think the whole ecosystem has gotten much more mature, and the founders do not fall into that trap anymore. But nevertheless, I want to mention that basically as the first thing. So ask yourself out there, do I need to raise funding at all?

Camilla Scassellati (00:02:08) - I feel like the reason why some founders might feel like they need to raise money is because fundraising rounds have become such a metric of success. So I am a successful founder because my company raised $40 million in the series A, and so we feel like that is the metric of success, and we feel like that is what we need to be doing to be successful. And it is true that it's such an easy way to determine whether a startup has the potential to grow, because someone else says so. Right? That there's some truth in that. But it sometimes can be very dangerous if you only think in those terms. So I feel like it's a temptation that we all have. Absolutely.

Christian Stein (00:02:48) - That's absolutely right. So that's why I'm saying that's the first question. And then the second one is how much do I actually need? Or I mean, that is a bit of an old question I would say. So I would rather put it in different terms. And that also gives it a bit of a different twist, which is nevertheless very important. What is the appropriate burn rate. And I think that is the more appropriate question because burn in my experience, is linked to risk as well as what I can achieve with my company.

So the goal or the potential that is inherent in my company. So I need a certain level of burn. So the money that I burn, of course the net burn rate or whatever you want to call it, and I need that in order to achieve a goal. And that goal should be linked to the potential of my company. And that potential is higher for some companies and for some it's lower. And that does not make the company better or worse. But that's just the nature of the beast, I would say. Right. So some businesses can become a 50 million business and some can become a 500 million business, etc. but on the way you probably need you need a different burn rate to achieve that. Also, the strategic situation of your company and the market, you know, is it like a land grab situation? We can get into that in detail later. But so that's what I mean on the gold potential side. But also and I think that is something that not every founder thinks about.

Burn is also attached to risk. The higher the burn, the higher the risk that if something happens, you will not be able to act upon it in the right time frame. And that poses a big risk. And if you think about it from a more abstract point of view, you know, makes sense, right? So there's this there's the ultimate relationship, which is almost a law of nature. That return comes with risk, right? That's like a finance 101. And the same is actually true for startups I found over the years. So if you have a higher potential company, you need to run a higher risk or probably a higher burn in order to achieve that. I mean, that's not true for everyone, obviously. Right? So we are just talking in very broad brushes here, but I think this is how it goes. So then coming back to your question, a second question would be what is the appropriate burn rate that I need for the potential that I'm. Willing to accept also as a form of risk.

And then the third question would be, and that is also something that not everybody thinks about, I found is what do I need the money for? But again, not just in the standard sense of, you know, I need it for product or I need it for sales or so I mean, that's what you read and hear everywhere, but it's more like, what is the use case of the money? And I guess we'll get back into that a little bit later, because I don't want to have too much of a monologue right now, but I think that is a very important question to ask. And then, of course, number four is what kind of investor do I really want? But also maybe more detail for later. But those are the four questions right. Do any raise at all. What is the appropriate burn rate? What is the use case of that money? And what is the kind of investor that I want.

Camilla Scassellati (00:05:51) - And as we said, the whole theme of this chart is to think about different forms of fundraising, right? Not just equity. So let's say that a founder has at least a sense of the amount of capital that they need and what they needed for. How can they start thinking about how to determine which financing options best supports their operational investment case? So how do we start thinking about what type of financing do I need if it's not just equity?

Christian Stein (00:06:18) - Yeah, that actually already brings me back to the notion of the use case. So what is the money for. And I think it depends on again what is the goal that you're trying to achieve. Do I require a lot of cash in a very small time, or am I maybe at the seed stage where, you know, for example, equity can carry the risk basically that a very, very young company inherently brings to the table? Or am I just in a situation where I'm very close to break even or a very close to an exit, or do I need a very big chunk of money? Let's say, for example, a land grab situation? And I would say these are the questions that you need to ask yourself what is the money for? And depending on that, you would actually go into determining what kind of capital you might want to raise.

Camilla Scassellati (00:07:11) - Before we go into the actual types of sources for capital, you said that one important thing that a founder should think about is what type of partner do they want? What type of fund or investment fund do they want to work for? So can you dig a little deeper into that and tell us what are some of the questions that a founder can ask to understand if their own interests align with those of their partners, and what type of partners they should be looking for?

Christian Stein (00:07:38) - I think in that respect, the most important recommendation I can give is think about the business model of the investor or to say, how do they make money? So is it a fund that is, for example, out to hunt unicorns? Right. So is it reasonable to assume that also the fund is more into accepting a higher failure rate in their portfolio because, you know, 1 or 2 very large hits will make it right? And I'm not saying that this is good or bad. No investors, good or bad, and no kind of funding is good or bad.

But this is about, you know, does it align with my ideas of how I want to run my company? Because if I have a fund, for example, that is hunting for very large exits, that will also mean the fund will be also breathing down my neck as the founder to achieve that goal. And that is very good if that aligns with my goals. But that might also not be so great if I have different goals. So that might be one thing. Or also how many investments are being done per year, which might hint at a at a support level. Or you know what the attitude to general investments are. And I think there is a lot to be learned. Basically when you look at investors between the lines, how many investments did they do? What were their exits and how many do they do per year? Right. So again, it's coming down to it's all just a question of incentives, right. So depending on how the investor is trying to make money, that probably gives us a strong hint on how it might behave.

Inès Makula (00:09:18) - Oh that's really interesting. And the fact that, as you said, there are some funds that make hundreds of investment per year, some that make just one. So you kind of already know how much time they will dedicate to your startup. But as well raising money from VC then, you know, it means you got to grow at a certain rate. It means and one of the founders that we had interviewed put it in a really good way. It was like, it's like putting rocket fuel. But if you don't have a rocket, it's like, maybe it's not like you shouldn't be raising money from from VC. There's a lot of other ways to, to raise money. And sometimes we talk about it on the podcast crowdfunding banks, you know, government grants, revenue financing. There's like a lot of, a lot of different ways. So it's really about also understanding what the. Rules of the game of of, you know, raising money from a VCR. And sometimes you're definitely right. Some founders may not, research that enough or understand that well enough. And, to reiterate some of the points that you just made, when should a family then think just beyond raising funds from a classic venture capital? And when is raising funds from a venture capital not a good idea?

Christian Stein (00:10:23) - Let me first say that we at Riverside invest both equity and a non-dilutive form of capital, which is a revenue share. So this is why I feel comfortable speaking for both sides. Basically if you want to if you put sides here between let's say dilutive and non dilutive investments i.e. equity and other forms of funding basically. So I just want to emphasize what you said. I also see it with myself. Right. I see myself having a different attitude towards the companies that I take care of in a portfolio, whether I invested a lot of equity or some form of debt. Right. It shapes my expectations, basically, of the company and therefore also the role I play. Right? I mean, think about it. An equity investor needs to have an exit. A debt investor doesn't need an exit. It's not, as you know, just putting this as a, as the the simplest example that I can give, but there are a number of, let's say layers to that kind of thinking. And that goes all the way through and even within a certain class or within a certain kind of capital, as I said before, how do they, you know, how does an investor behave and what is he making his money off? And that's what I meant. Exactly. A different layers that that you can drill through if you like. But getting to your question, when should a company consider raising or not raising equity. Right. Looking at a different form. So I would say the most obvious is I guess if you're close to an exit or close to break even, I think that's a bit of a no brainer. why give away a share of the company if you are close to, you know, one of these goals, if that is your goal.

But on the more interesting aspects, I'd say in general, the situation between A and B round is can be a very expensive situation for raising equity, I found. Right. So what I mean by that is let's say a company has already raised equity, from early stage VC investors, let's say a pre a high reward. I mean those this non Pletcher always gets a fuzzier over time. Right. So whatever an A round is these days. But you know somewhere between let's say the first institutional money and the first expansion stage money. That is usually when equity is pretty expensive and also when there's a, let's say a special situation. So for example, I was recently talking to this company from the Nordics, which was very sure that it had a big jump in top line. so in revenues basically that they would expect for this coming year for 24 and they were about, or they were just into raising a big round of equity like, look, guys, why are you actually trying that? Right? I mean, if you really reach your goals that you put forward here, then you will get a tremendously different deal or better deal just in a year's time.

Right? So why do it now? Why don't you think about something alternative that forms a smarter bridge? I would say right. So it's between A and B rounds. It is also when let's say you're actually going for a B round, but you feel like maybe I can get a little bit better on a few KPIs. So again, you know, building on this notion of maybe pushing out that next funding round a little, I think those are the those are the typical very concrete situations. On a more general thought, when it's always a good idea, when you think that optionality has a high value for you, what do I mean? What do I mean by that? Right. So when you raise equity and again, keep in mind I'm also an equity investor. So I've never arguing against equity. I just want to explain how you know how these things work. So when you raise equity then the new equity investor has a very clear idea, you know, what you have to achieve in order to raise the next round.

So the previous round always gets to the next round. And the investor of the next round will always get will always want to see the advances for the round that is then coming. So sometimes it's also called like a treadmill, right? The venture capital treadmill. Although I find that a little bit, a little bit exaggerating, but it kind of gives an idea what I'm talking about. And so when you don't know whether that is really the right path for your company, then, you know, immersing yourself into that, let's say, maybe we should call a conveyor belt right where you jump on and it spits you out at the end, but only after a bunch of rounds, basically, and an exit. You know, if that optionality is important for you, where you can still decide. You know. Should I go? Basically left. Should I go right? Do I rather want to go for an early break even? Do I want to go for more? Let's say a less risky lower burn rate scenario, I really do.

I don't really want to go all in like a high, you know, high burn, high investment rip all the, all the, the opportunities that the market has to offer. So when that optionality is also important for you, it's not the best idea, I would say, if you already have a lot of debt, for example, if you have little revenue or a little cash flow because then repayments will hurt, right? They will there will be some form of repayment at some point in time associated that might hurt. Right. So it might look very sweet today to not give equity away. But you know, the cash flow or the cash outflow might hurt. And also if you truly have, let's say a super high opportunity company, big market through ocean, I don't know, you know, this can become really, really big. Well, of course, almost all founders think that, but it's not always the case. So you gotta ask yourself, but nevertheless, if that is really, if that is really the case, then debt or any other form of non dilutive capital will not be able to provide as much funding as you need, because the higher the funding, the higher the risk for the investor usually unless you're in very late stages.

And that means that, equity will be the only instrument that can provide boatloads of money and taking like, tons of risk. which other forms of funding cannot.

Inès Makula (00:16:37) - But talking about other options of non dilutive options, we've only ever spoken to VCs that offer equity. So it's really interesting to see what the other options to work with a VC without giving away equity is. So if you could talk us through a little bit more of the second branch or arm of your of Riverside, that'd be really interesting. What are some of the non-equity funding options that exist?

Christian Stein (00:16:59) - So in general, I would say the bad news here is that there is even more to wrap your head around and even more to learn than on the equity side. And that's that's the unfortunate part, because those non dilutive instruments or different forms of debt actually fall into a bunch of categories, and each of them is actually is actually very specific. So I would say the the level of maturity that I see in the market today in Europe is usually that people consider two sides of the coin, one is dilutive and one is non dilutive.

But when they think about non dilutive they have like one let's say password in their mind it's like venture debt or venture loan or factoring or revenue based financing RBF. And they lump that all into one bucket. And the reality is they're all very different. Again coming back to that notion of the use case, all of them are ideal for a different kind of use case. And, you know, coming back to the what I said initially is you've got to figure out what your use cases and then you get, you know, then you can narrow down what is actually good for you. But just to give you a couple of broad buckets here. So I guess at least in Europe, what's been around first was venture debt and venture debt. It's a loan basically usually with some form of equity option mostly called a warrant. So that means that the venture debt investor does not only get an interest rate repayment from you, but also some form of option that lets the investor participate in the value of the company.

So some form of shares or virtual shares or optional shares or whatever, whatever that might be. And by the way, I must say that probably if an investor is listening to that, you know, he might probably cry foul because, you know, no, we are doing it different or that's not entirely true or so. But the point is just to give an intro here. Right? So reality is always a bit more nuanced and messy. So that's the one thing venture debt and venture debt is really a leverage on equity, I would say, because most of those events, traditional venture debt investors, they would also focus on companies that already have very strong equity investors and probably also invest only in the temporal proximity to an equity round that has just happened or is about to happen. So that means like the typical thing is, equity investors invest 10 or 15 million and or maybe just five or whatever, but then the venture debt provider would put a loan on top of that. Right. And the idea is that, of course, then the risk situation for that debt provider is a little bit more advantageous.

I would say here, you see, it is something that you put on top of equity, and therefore it's more a leverage, a form of leverage on equity. And therefore coming back to the use case, it's more for companies that raise equity and that which would like to crank up their burn rate even more to reap all the growth potential, but don't want to dilute as much. And then they put that on. Of equity.

Inès Makula (00:20:02) - And why would you raise venture debt rather than go to a bank and raise debt from the bank? Is it because it's too risky in the bank, wouldn't give it to you and venture gives you that? Or is there any other reason why you would, as a founder, go for that?

Christian Stein (00:20:16) - Yeah, there might always be a special case, of course. But I would say in general, my experience is that banks yes, they are a little bit risk averse. Right. And companies that raise a lot of equity in order to go for a big growth goal.They also burn a lot, and burn is usually the number one worrying factor for banks, right? That's what makes them nervous. And I guess that's why venture that came up in the first place. Because, you know, these are presumably people who know software or whatever industry we're talking about, and therefore they are able to better understand the company and invest in more risky situations, basically.

Inès Makula (00:20:51) - And then in terms of it's interesting what you guys do, though, revenue sharing, does it mean that's a different form as well of right of non-equity.

Christian Stein (00:21:00) - That's a different form. Right. So maybe just very quickly there's for example also like the classical venture loans which are mostly for more stable companies, you know closer to even closer to an exit. Usually the last money in right also usually a lower cost of capital. But that's also because the risk of this investment is lower. And then thinking about use cases. And then there's also like short term loans or more like things that are closer to factoring. That is, you know, that's usually what all of these newcomers over the past 2 or 3 years in Europe that are offering, non dilutive capital are up to.

Right. And these are so that means that you, you get a form of loan which is more akin to factoring that you will have to pay back a short time frame, let's say 1 or 2 years. And there you also have the challenge with that. Right. So it's something if you need to pay back the loan very quickly, that also needs you can only put the money into something that yields the return very quickly. Right. So it's more something that you would need to step up the gas quickly. But you have to know when the, when the cash from your initiative is coming back so that you can repay basically. So it's a short term funding thing. And getting to your question that revenue share what we do is trying to offer, let's say something that is a bit more that works a bit more like equity in the sense that usually the repayment periods are very long. So with us it's five years and it's not a fixed interest rate, but it is a revenue share in the in the original sense of the word.

So that means we would invest, for example, million or 2 or 3. And then we would get a share of monthly revenues. For example 5% can be less, can be more depending on the situation in the investment. And that has, from our point of view, of course, a couple of of positive aspects. First of all, the repayments adjust to the performance of the company, right? So in a good month you pay back more, but you can't afford to. In a bad month you pay back less. And then that's that also makes sense for the company, but also over the long term. And I think that's the most important aspect of this kind of funding is for growing companies. That means, you know, companies small today and much larger in five years. That means also the repayments are smaller today and then larger in the future. That's the revenue share. So that means in the beginning you pay back relatively little and only in the end when the company has grown, you pay back more.

Christian Stein (00:23:36) - So the point here is the the cash flow characteristic of this form of financing is a bit more in tune, I would say, with the development stages of early companies. Right. Because in the beginning you don't want to borrow money and pay it back in a very short time, but you actually want to use that money to invest in your operations and growth. And so therefore, you know, something that has a repayment that is back end loaded is advisable. I would say. And so that would be a revenue share agreement. So it's more, you know, for things that require a bit more long term breath, you know, for example prolonging runways investing to the product, investing into into the sales team. You know, it's a bit more more an alternative to the traditional VC. And this is also how we see it. Right? So when we look at a company, we try to determine what is the strategic situation of the company. And is equity now the right thing to do or is maybe or non-equity non dilutive funding the right way to do right now? and that gives us more flexibility to react to the company in the right way.

Inès Makula (00:24:44) - Yeah. And you can work with, with more companies and especially I would say like even instead of talking about like necessarily maybe seed or series A stage companies, because if they're in different sectors, they have completely like let's say a seed company in biotech or hard tech is looking at such a. Longer spectrum of when they will start generating revenue, right? So that might not be good for them. But what what would you say are like in terms of like industries where revenue share could be like a really interesting option?

Christian Stein (00:25:15) - Well, the bare minimum I would say is you need to have revenues, right? Because without revenues there is no revenue share. And of course you want to have the right relationship between between the money that you get and also the money that you pay back. What I mean is, if you get a very large investment and have very little revenues, then of course the revenue share as a percentage has to be very high in order to pay back all this big investment, to the investors.

So that means, you know, you have to have significant revenues in order to get a significant investment. Usually one would say maybe half of annual revenues is is typically, something, you know, that would be required. So for so that means if you want if you need a million as an investment, you would have to have at least 2 million, probably a bit more depending on the business model of revenues. Right. Or something to keep in mind as a, as a rule of thumb, maybe, 200 K, at least for us, that's the case of 200 K of monthly revenues is the lower bound. Otherwise the revenue share would be too heavy. And then it doesn't make sense anymore. The other thing that you need is let's say a little volatility in revenues. What that means is recurring business models work better. You know if you have a true and also a high gross margin also for mathematical reasons. Right. You can it's easier for you to give 5% away of a high gross margin than of a low gross margin business. And so this is why mostly this form of funding works best for software as a service, just because of, you know, of how math works out. In that case.

Inès Makula (00:26:55) - Yeah, the business model of B2B software as a service definitely takes the boxes that you, you just mentioned and to wrap up, and actually, one of the main reasons that you're also on the show is that you started investing in Italian companies as a fund. so we wanted to ask you, in which companies do you invest and why have you started looking at Italy? What type of companies that you're interested in looking here in this market. 

Christian Stein (00:27:19) - Yeah. Well, first of all, I must say that I am absolutely thrilled and I really mean it about the development that has happened in Italy over the past, I don't know, 3 to 5 years again, when I, when I started, which was as an investor, which was actually in 2007, we always also yet and again looked at at Italy, there was never really, I would say a critical mass of, of interesting businesses. And that has changed tremendously. So I think there is it is super important how like former entrepreneurs have returned either as serial entrepreneurs or also as supporters in the form of a business angel or, or the like. so I'm really thrilled about the stage that Italy is in as of now, the only investment that I can tell you, because it's the only one that that's public at the moment is Cyber Guru. It's, it's a wonderful cybersecurity company, based out of Rome. And we love that one. and we think it has a, has a really great future. But tell you again, you see, it's, it's software and that's what we're looking for mostly.

Inès Makula (00:28:27) - Well thank you. We couldn't finish on a better note. And, the Italian startup ecosystem growing. We've definitely even just as being part of this ecosystem for the last four years with the podcast, I've seen such tremendous growth. So exciting to see funds like you're starting to to invest more and more into our market and really excited to see what the next few years bring for us. But thank you so much, Christian, for coming on and sharing all of your, your expertise, on everything fundraising and also kind of teaching or opening, the eyes of our listeners to different types of fundraising options that that they have. So we really enjoyed talking to you.

 Christian Stein (00:29:04) - Thank you. My pleasure. Thanks for having me.