2020 was a turning point for the Italian venture capital ecosystem. In fact, the total amount of funds raised hit 569 million euro, tallying +59% growth over the previous year, a figure that shrinks the gap between our country and other major European economies.
The effects of the pandemic have made it more urgent than ever before to promote and encourage all behaviors that contribute to the development of our economic system. This reality forces us to reflect on the forms of available business financing, especially for innovative startups, the true driver of growth in Italy.
To find out more on this topic, we reached out to Alberto Dell’Acqua to ask him about some of the main takeaways from his latest book, Startup finance. Strumenti finanziari, metodi di valutazione, aspetti legali, published by Egea in July 2021, and co-authored with John Shehata, a partner at PwC Legal–PwC Italy.
In the introduction of the book, the president and CEO of PwC Italia Giovanni Andrea Tosselli writes that in the next few months, due to the effects of the pandemic, “the way we do business will very likely change - the procurement models, the consumption models and the production models.” How can this book be useful for understanding this change, which every manager and every company will have to face?
We’re really living in a time when extraordinary changes are taking place, and in companies, when conditions are uncertain, project management requires similar changes in the approach to corporate financing. In the book, we talk about the main tools and assessment methods for financing startup projects, which have to face high risks. Our content can be applied effectively to startups as well as to more mature, consolidated companies which all have to open or run businesses in a context marked by tremendous discontinuity and uncertainty.
In your book, you talk about the limits to raising equity for financing startups. What is the reason for these limits? And what valid alternatives might there be?
It’s an age-old issue from a practical standpoint for people who need to raise capital when they’re starting a business. The trade-off centers on the need to find fresh capital and at the same time curb ownership dilution. Often the practical solution is to multiply what’s called the “pre-money” value when raising capital. But doing so could run the risk of an over-valuation, which makes it hard to raise more funds later on, because if the company’s value is too high, this tends to scare off investors.
The most effective alternative for handling this trade-off is using a convertible debt instrument called a “convertible note,” following international best practices. But this route is a bit more complicated to embark on in the Italian context, seeing that the current body of legislation is lacking a specific regulation that designates and incorporates convertible debt into the framework of corporate finance tools.
A solution may lie in “participating financial instruments.” But these contracts must be properly designed to make them de facto convertible debt instruments, and to make them appealing to investors.
In one chapter, you write that “the valuation of a startup can be a real puzzle.” Why? What tools are available today to make an objective valuation?
Startup valuation is a puzzle because, unlike with more mature, consolidated companies, it’s hard to find economic and financial fundamentals on which to base a valuation methodology. Often, in fact, companies in the startup phase take in limited revenues and close the year at a loss. In the book, we review the main instruments that are being used, the ones that have wide institutional acceptance by academia, to solve the valuation puzzle. The methods we’re talking about are essentially evolutions of the most common methodologies for company valuations, tailored to fit the specific context of startups: the three-stage DCF, the VC Method, Risk-Adjusted NPV and Decision Tree Analysis.
You dedicate an entire chapter of your book to the legal aspects of investing in startups. What are the biggest roadblocks for an entrepreneur in this respect? And what are the advantages?
Legal aspects are vitally important within the context of investment deals in startups, because a solid legal foundation makes it possible to bring together the contrasting needs of the company founders and the investors. Contract conditions and the legal provisions can enable better risk allocation and related incentives between the people who are running the company and the ones who are providing the financial support.
The obstacles that entrepreneurs typically have to face tie into establishing reasonable recognition of investor expectations as far as profitability and monetization, but without disrupting the industrial and commercial development of the entrepreneurial project. At the same time, they should strike the right balance between the amount of capital they raise and the involvement of investors in the ownership structure of the company.
So, we can sum up all these aspects in three key elements: rights, incentives, and governance. And they can be clearly established in an investment contract that is correctly drawn up from a legal standpoint.
SDA Bocconi School of Management