Venture Capital: An Entrepreneur's Manual

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  • 1. Startup Finance
    An Entrepreneur’s Manual
  • 2. About Index Ventures
    Selected Investments
    Index Ventures
    Over €1.5bn under management
    Active investor in web / internet
    • Pan European Venture Fund
    • 3. 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
  • 4. 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 …
  • 5. 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?
  • 6. 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?
  • 7. 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
  • 8. Overview of financing options
    Equity Financing
    Non-Equity Financing
    Angel Financing
    Venture Capital
    Self Finance /
    Bootstrapping
    Private Equity
    Debt /
    Bank Finance
    Public
    Stock Markets
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. 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
  • 13. 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
  • 14. 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
  • 15. 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)
  • 16. 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
  • 17. 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
    • 18. Trusted service provider relationships
    • 19. Search / recruiting
    • 20. Branding / PR
    • 21. Finance, etc
    • 22. Exit optimisation
    • 23. Knowledge / contacts with relevant buyers
    • 24. Experience with process
  • What does an investor look for?
    Technology
    Traction
    Team
    $$$
    • Can evaluate each as
    • 25. Exceptional
    • 26. Good / credible
    • 27. Mediocre / incomplete
    • 28. Misconception that being good / credible across the board is what VCs look for
    • 29. Can always add credible attributes to the mix later
    • 30. 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
  • 31. 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
  • 32. 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
  • 33. 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
    • 34. Calls with current / prospective customers or partners
    • 35. Meeting broader team
    • 36. Brainstorming around strategy
    • 37. Identifying key hires post closing
    • 38. Formal presentation to VC partnership
    • 39. Some additional reference calls with partners / customers
    • 40. Personal reference calls
    • 41. Legal / accounting audit (if relevant)
    • 42. Drafting legal documentation
    2-4 weeks
    1-2 Months
  • 43. 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
  • 44. 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?
  • 45. Case Study – Cap Table
  • 46. 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”
  • 47. Case Study - liquidation preference
  • 48. Case Study - liquidation preference
  • 49. Case Study - liquidation preference
  • 50. Case Study - liquidation preference
  • 51. Case Study - liquidation preference
  • 52. 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
  • 53. 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
  • 54.
    • Revenues / Profitability
    • 55. Growth rate
    • 56. Team quality
    • 57. Strategic fit with buyer community
    • 58. Well managed exit process
    Entrepreneur’s Equation
    Value at exit
    • Fewest strategic errors made
    • 59. Hiring (quality & speed)
    • 60. Partnerships
    • 61. Product development
    Probability of getting there
    • Valuation at initial round
    • 62. Valuation and dilution at subsequent rounds
    • 63. Option grants
    % share of business at exit
    Choosing the right VC - Valuation should not be the decisive factor
  • 64. 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
  • 65. Thank you
    Ben Holmes
    Email: benh@indexventures.com
    Skype: ben_holmes
  • 66. Artwork – (Transparent Layers)