24-07-2020 14:21

How to manage financial risk when starting and growing a business

Nordea’s leading Startup & Growth experts walk you through the most common financial risks when launching or growing a business and how to avoid them.
Standing on a pier

An estimated 90 percent of startups fail. While there are risks inherent in launching any new venture, there are steps you can take to avoid becoming another statistic.

As an entrepreneur trying to get a new business off the ground, what can you do to mitigate the financial risk and improve your odds? We asked members of Nordea’s Startup & Growth team for their best advice for how to manage financial risk when starting and growing a business.

Develop a capital strategy to reduce financial risk

One of the biggest financial risks for any new or growing business is running out of operational cash flow, according to Håvard Lindtvedt, who heads the Norwegian arm of the Nordea’s Startup & Growth unit, which specialises in serving startups seeking to scale fast as well as high-growth companies. Not only is cash flow important for staying afloat and avoiding bankruptcy, it is also critical for obtaining new financing.

“You need to have a good strategy for your capital journey to ensure you have enough cash to reach the milestones necessary to attract new investors,” says Lindtvedt.

That’s what he and his colleagues on Nordea’s Startup & Growth unit spend a good deal of time on – helping companies structure their capital strategy to ensure they will be attractive to investors at every stage of their lifecycle. The team can help entrepreneurs and growth companies ask the right questions, evaluate their financial situation and design the best financing approach for their specific needs.

Lindtvedt recommends having a capital runway of 18 to 24 months: “During the corona crisis, we’ve seen that companies with professional investors on board who have enough cash to run for 18 to 24 months have been able to weather the storm. On the other hand, companies with capital runways of only three or six months have run into trouble. We also see that companies with professional investors on board have been able to raise some capital to ride out the storm and wait for the capital market to normalise.”

Seek diverse funding channels and opportunities

When building your capital strategy, remember to consider all of the available funding options, advises Anni Ylismäki, who works on the Startup & Growth team in Finland.

While the first money is often said to come from “family, friends and fools,” there are plenty of alternatives for raising startup capital. In addition to business angels, pre-seed funds and venture capital funds, Ylismäki points to bank financing as well as government support programs for entrepreneurs. In the Nordics alone, there is Finnvera in Finland, Almi in Sweden, Innovation Norway and the Danish Growth Fund.

“Today there are a huge number of different funding sources. It’s worth taking the time to find a sizeable entity and to combine the different alternatives into an optimal capital strategy,” she says. That’s where the Startup & Growth team can help, not only with bank financing options but also by connecting entrepreneurs with a broad network of business angels, pre-seed funds and venture capital funds.

Do background checks and enter a shareholder agreement to manage financial risk

In addition to considering all of the financing options, don’t forget to do you your due diligence on potential investors and new team members, says Ylismäki. A problematic credit history, for example, could come back to haunt your company’s financials, making it more difficult to get a bank loan down the line.

She also emphasizes the importance of entering into a proper shareholder agreement from the start, preferably with the help of lawyers. Such a document spells out the rights and obligations of the individual shareholders, such as how and when any capital should be repaid as well as ownership and veto rights. It can help set expectations and prepare for issues before they arise as well as prevent disputes over who gets how much if the company is sold.

Learn more about what the Nordea Startup & Growth experts consider as the top 12 risks every business owner should know.

Choose the right investor

Beyond compliance and background checks, it’s also important to do some soul searching when choosing your investors. What kind of investors do you want to have on board? Not giving this thought ahead of time can result in misaligned expectations.

What’s more, the right investor can dramatically increase a company’s chances of success, for example, by lending critical competencies in the field or giving the founders access to their professional network and boosting the company’s visibility, according to Axel Bruzelius, head of Startup & Growth Sweden.

“Too many companies take the money right away when they should use more time to define what the right investors are for them. The investor’s contribution to this company can be very different, and that’s important to define,” he says.

Also consider whether the investor is able to provide more cash in a stress scenario, Bruzelius advises, noting the companies with investors that are willing and able to provide more capital often succeed over those that don’t.

Do your market research and develop a solid business plan

When launching a new product or service, you need to know your business and its logic inside out. You also need a thorough knowledge of the industry and competitor landscape. Is there market demand for what you’re planning to sell? While the question may seem obvious, an estimated 42 percent of businesses fail due to lack of demand for their product or service. That makes the concept of “product-market fit” crucial for companies in their early stages.

Launch a minimum viable product (MVP), a bare-bones version of your product, test it on your customer target group and get feedback to ensure people actually want what you’re planning to sell.

And when devising a business plan, make sure to do a scenario analysis, Ylismäki says, mapping out all of the potential positive and negative scenarios that could affect your cash flow.

As a bank, we’re always watching the cash flow. If there are no customers and nobody wants to pay for your product, then how can we trust this business?

Anni Ylismäki, Corporate Banking Advisor, Nordea Startup and Growth

Be ambitious and move fast through the commercialisation phase

In order to maximize your chances of success, you need a fast and ambitious journey and a team with execution power, according to Lindtvedt. When doing product development, for example, you can’t wait four years to bring a product to market, he says, or you risk being taken over by a competitor or your product or technology becoming irrelevant. Rather, you need the capital and developer power to ensure a fast run through the commercialisation phase.

“Too many companies have too slow an ambition on this,” he says, adding, “They’ll say, first we want to test the market in Oslo, then sell in Norway and maybe go to Sweden in 2 years. But the big successes wanted to do the world when they started. They raised a lot of capital, which made internationalisation really possible. Don’t underestimate the value of being a first mover.”

Manage your currency risk

For companies that choose to go international, it is important to be aware of external market factors, such as currency and exchange rate fluctuations, that can eat away profits and dent the bottom line. Given the recent market volatility and wild swings in global currencies, foreign exchange (FX) risk management should be at the top of the agenda for companies with customers, suppliers or production in other countries.

Read more about the 5 steps companies should take to manage their currency risk

Managing FX risk doesn’t have to mean more manual work. Companies big and small are discovering the benefits of automating their FX risk management with tools such as Nordea’s AutoFX, a currency robot that trades according to a predefined framework. API’s (application programming interfaces) are another solution that can be integrated into a company’s own systems and software so that FX management becomes a part of daily business, taken care of automatically. Find out more about the benefits of FX automation.

Manage your interest rate risk

Like currency fluctuations, changes in interest rates can also eat away at your revenues and increase costs. The more variable-rate debt a business has, the higher the financial risk stemming from unfavourable interest rate moves, which can make budgeting and planning uncertain. Securing your company’s finances against higher interest rates should be part of your risk management strategy, helping to make your cash flow more predictable.

Nordea offers a range of interest rate hedging solutions to help manage risk and costs, including interest rate swaps, interest rate caps and interest rate collars. These hedges can be tailored to your company’s profile, taking into account the market situation. Find out more about how to manage your interest rate risk.

Professionalise the CFO role as early as possible

While your business may still be in its early stages, it is important to have good systems in place when it comes to financial accounting, reporting and forecasting, according to Riku Tiainen from Startup & Growth Finland, who works with a portfolio of around 40 growth companies.

In the early startup phase, companies are primarily focused on research and development, testing their offering, gathering customer feedback, pivoting when needed and generally trying to limit outgoing cash flow. A professional CFO can be an expensive hire, and outsourced financial management services can carry a hefty price tag. As a result, many startups won’t see such services as a necessary cost, Tiainen explains. Yet, with a few big deals out of the gate, growth can be quite fast and sudden.

“If you don’t already have the internal systems in place for financial reporting and forecasting, it can be very difficult and expensive to start doing it when you’re already in the growth phase,” says Tiainen.

This situation can also lead to a downward financial spiral as growth usually means a need for more cash and another financing round, Tiainen explains. If the financial reporting is not in good shape, that will make the company less attractive to investors and lead to a low valuation of the business, which can mean less favourable financing rounds for the founder or owner.

That’s why Tiainen advises companies to professionalise the CFO role as early as possible.

“Understand that investors are also judging your business on its financial competence. It’s key to your success. In addition to a top sales and marketing team, you also need a top financial team,” he says. While it’s not necessary to hire a full-time CFO, bring in a hired gun or outsource the financial management services.

Act in good time to secure sufficient financing

Anders Hovaldt form Startup & Growth Denmark says one of the biggest misconceptions is how expensive it is to actually grow a business. Particularly if companies want to venture into new markets or countries, the cost is often much higher than expected.

Another big mistake is getting caught off guard by how long it can take to secure financing, he says.

“Entrepreneurs will come and say, ‘We need the money tomorrow or next week.’ Yet it can often take half a year to find the right investor and agree on the terms,” he says.

That is why it’s a common refrain across the Startup & Growth team of experts to act in good time when it comes to financing to avoid running out of cash.

Learn more about our Nordea Startup & Growth units in FinlandSwedenNorway and Denmark.

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