Venture Capital: An Entrepreneur's Manual

Startup Finance
An Entrepreneur’s Manual

About Index Ventures
Selected Investments
Index Ventures
Over €1.5bn under management
Active investor in web / internet
Pan European Venture Fund
Based London & Geneva

Agenda
Important reflections before you start
What are the financing options?
How to attract and engage investors?
Deal structure and what to expect during the investment process

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 …

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?

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?

Agenda

Overview of financing options
Equity Financing
Non-Equity Financing
Angel Financing
Venture Capital
Self Finance /
Bootstrapping
Private Equity
Debt /
Bank Finance
Public
Stock Markets

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

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

Pre-requisites
Large Potential
Market Opportunity
Unique Product
Or Concept
Passionate
Founding Team
Implications…
Need to move
rapidly
Intense
competition
likely
VC funding supports
Hiring
Rapid Product
Development
Partnerships
Infrastructure
Internationalisation
Commercialisation
Good reasons to raise equity finance

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

Equity Financing
Growth Fund
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

Agenda

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
~ 20-25%x (Total Return – Total Amount Invested)

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

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

What does an investor look for?
Technology
Traction
Team
$$$
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

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

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

Agenda

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

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

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?

Case Study – Cap Table

but that’s 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
Venture Capital – “Typical Deal Terms”

Case Study - liquidation preference

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/(5+15.3)*€0.25) = €0.93
Narrow-based – Series A reprices €1.00–((5/(5+5)*€0.25) = €0.875

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

Revenues / Profitability
Growth rate
Team quality
Strategic fit with buyer community
Well managed exit process
Entrepreneur’s 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
Choosing the right VC - Valuation should not be the decisive factor

Key things to consider when choosing an investor
Right partner at a fair price
vs.
Any partner at best price
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

Thank you
Ben Holmes
Email: benh@indexventures.com
Skype: ben_holmes

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Venture Capital: An Entrepreneur's Manual

by Ben Holmes

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