Startup Finance An Entrepreneur’s Manual

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Startup Finance

• An Entrepreneurs Manual

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About Index Ventures
Index Ventures

• Over 1.5bn under management
• Active investor in web / internet

• Pan European Venture Fund
• Based London Geneva

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Agenda
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A big undertaking

• Starting a business is a big commitment
• Energy Passion
• Time
• Financial resources (yours and your investors)
• Before thinking of financing, is worth taking a
  deep breath

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Key questions about you

• Why am doing this
• Make money
• Lifestyle
• Change the world
• How long do you want to commit?
• What level of financial risk are you prepared to
  take?

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Key questions about the business

• Be honest with yourself about the risks /
  unknowns
• Do customers want the product / service?
• Do you have the competence to build the product
  and the team
• Can you monetise the product / service?
• How competitive is / will the space be?
• How big can the overall market become?

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Agenda
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Overview of financing options
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Self financing / bootstrapping

• Financing growth from previous cashflow and
  personal funds
• Obviously need to have cashflows
• Most good bootstrapped companies emerge from a
  service or consulting companies that are
  productising their offering
• Pros
• Bootstrapped companies almost always spend cash
  more effectively than equity financed companies
• Already being close to existing customers, give
  excellent ability to understand problems and
  define good solutions
• Cons
• Resources for product and market dev constrained
  by cashflows
• May miss a big opportunity if other players raise
  finance and invest heavily

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Debt / bank finance

• Relatively limited funds will be available
  likely to want security anyway
• Banks only lend to predictable businesses they
  can understand
• If your capital requirements are limited and your
  business is following a well trodden path, can be
  a useful source of finance
• Not particularly useful web or high growth tech
  industries

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Good reasons to raise equity finance
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When NOT to raise VC
Application is a feature not a product
Market size is too small
Motivation is not financial

• Risk is not that you waste time unsuccessfully
  trying to raise finance
• real danger is that you do succeed in raising
  VC funds
• Lose opportunity for small exit which could be
  personally lucrative
• Lose opportunity to run lifestyle business
• Get bound in to 3 yrs work you may not enjoy

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Equity Financing
Seed
Early Stage Series A, (B)
Later Stage (B),C,D
Pre-IPO / Buy-out
Private Equity

• Investment Size

0 - 1m
2m-20m
5m-20m
30m
Potential Sources of Funds
Grant-funding University seed funds Friends and
family Angel Investors (Venture Capital)
Venture Capital (Wealthy) Angel investors
Venture Capital
Specialist Late stage tech investment funds Hedge
Funds
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Agenda
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Venture Capital How the VC makes money

• Raise fund every 2-4 years
• Pension funds, financial institutions and
  specialist fund of fund investors
• Invest money over 3-5 years
• 1/2 of investments lose money
• 1/3 of investments break even
• 1/6 of investments make (lots) of money
• Very small management fee on funds managed
• 1-2.5 pa
• Carry
• 20-25x (Total Return Total Amount Invested)

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Angels How the Angel investor makes money

• Unlike the VC the Angel invests their own money
• Much smaller absolute returns can be very
  meaningful to an angel
• The Angel approach is to invest small amounts at
  a very early stage / low valuation
• 50-250k at valuations of 500k-4m
• Two exits for angel
• Firm might be sold quickly for 5-10m or less
  where the Angel can make 2-5x money
• Firm raises VC money, after which Angel typically
  becomes more passive but has built up exposure
  very cheaply to a venture backed enterprise
• The key thing when selecting an Angel therefore
  is whether they can help you raise VC finance
• See which Angel investors have invested with
  which VCs

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Venture Capital What a good VC will add

• Advice and Strategy
• Hiring
• Developers
• Country Managers
• Sales
• CEO / CFO / COO
• Advisory Board
• Partnerships
• Profile and PR
• Further access to capital

• Internationalisation
• Trusted service provider relationships
• Search / recruiting
• Branding / PR
• Finance, etc
• Exit optimisation
• Knowledge / contacts with relevant buyers
• Experience with process

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What does an investor look for?

• Can evaluate each as
• Exceptional
• Good / credible
• Mediocre / incomplete
• Misconception that being good / credible across
  the board is what VCs look for
• Can always add credible attributes to the mix
  later
• We focus on finding opportunities which rate as
  exceptional in one attribute

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Identifying relevant VC partners
Has funds to invest

• Do create a shortlist
• Rifle is a better weapon than a shotgun
• Similar process for identifying angels, look at
  VC funding press releases to identify prior Angel
  investors

Match of Size/Stage/ Geography
Excellent track record
Shortlist
Relevant Portfolio
No directly competitive investments
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Getting on radar screens

• Out of the blue email is a longshot
• Try to build context
• Analyse portfolio companies are there any links
  there?
• Analyse contact network and advisors
• Analyse press coverage
• Participate in blog conversations
• Attend events and conferences
• Relevant PR around product also helps
• VCs spend their time looking for businesses with
  momentum

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Agenda
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Sharing relevant information
Pre - first meeting
Pre - termsheet
Post - termsheet

• 100 page business plan not required
• 20 page ppt which clearly answers main questions
  is best bet
• Product
• Market
• Business Model
• Team
• Competition
• Product Roadmap
• Technology Overview
• Business Development
• Financial Status

• Dialogue rather than documentation expect lots
  of meetings
• Calls with current / prospective customers or
  partners
• Meeting broader team
• Brainstorming around strategy
• Identifying key hires post closing
• Formal presentation to VC partnership

• Some additional reference calls with partners /
  customers
• Personal reference calls
• Legal / accounting audit (if relevant)
• Drafting legal documentation

2-4 weeks
1-2 Months
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Types of investment

• Ordinary Share investment
• Simplest form, often used by angels
• All shareholders have similar rights
• Company Board composed according to
• Convertible Loan
• Sometimes used by both Angels and VCs
• Typically when another financing is anticipated
  soon
• Loan will convert (with a discount 25) into the
  next financing round
• Preferred Share Investment
• Typical Structure used by VCs and occasionally
  larger Angels investing as a group

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Understanding a termsheet case study

• Anything between 2 and 15 pages (if points are
  spelt out in fuller legalise)
• Sample phrasing is
• XXX fund proposes to lead a Series A preferred
  share financing of 5m at a 8m pre-money
  valuation. As part of the investment process an
  employee option pool of 15 on a post money basis
  will be put in place. Typical venture capital
  terms including participating liquidation
  preference, etc. etc
• What does it all mean?

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Case Study Cap Table
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Venture Capital Typical Deal Terms
but thats so unfair

• Board Representation
• Liquidation Preference
• Participation rights
• Anti-dilution rights
• Element of reverse vesting
• Certain control and veto rights
• Period of exclusivity to close legals

Photo Source Philip Greenspun, MIT
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Case Study - liquidation preference
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Case Study - liquidation preference
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Case Study - liquidation preference
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Case Study - liquidation preference
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Case Study - liquidation preference
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Case Study - Antidilution

• If a subsequent investment round is done a price
  lower than the previous investment round then the
  previous investment round is repriced (more stock
  issued to Series A)
• Two flavours
• Broad-based Series A price ratchets down based
  on size of Series B relative to Previous
  post-money valuation
• Narrow-based Series A price ratchets down based
  on size of Series B relative to Size of Series A
• Say 5m Series B done at 0.75 per share
• Broad-based Series A reprices
  1.00((5/(515.3)0.25) 0.93
• Narrow-based Series A reprices
  1.00((5/(55)0.25) 0.875

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Case Study Reverse Vesting

• The value of startup is typically in the promise
  of future labour from the founders
• Investors seek to secure this by reverse vesting
  founder stock, typically over 3 or 4 years
• For startups typically all founder stock is
  subject to reverse vesting.
• For later stage companies perhaps half the stock
  might be subject to vesting
• NB this also protects founders from each other

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Choosing the right VC - Valuation should not be
the decisive factor

• Revenues / Profitability
• Growth rate
• Team quality
• Strategic fit with buyer community
• Well managed exit process

Entrepreneurs Equation
Value at exit

• Fewest strategic errors made
• Hiring (quality speed)
• Partnerships
• Product development

Probability of getting there

• Valuation at initial round
• Valuation and dilution at subsequent rounds
• Option grants

share of business at exit
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Key things to consider when choosing an investor

• Relationship
• With key individual(s) and
• broader team
• References
• Speak to other founders
• Portfolio
• Relevant experience
• Non competitive
• Community you want to be part of
• Valuation and associated deal terms

Right partner at a fair price vs. Any partner at
best price
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Contact us
Sam Solakyan Email samsolakyan1_at_gmail.com Tumblr
https//sam-solakyan.tumblr.com/
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