Many technology ventures are focused on securing funds from venture capitalists (VCs). This lecture focuses on understanding the motivation of private venture capital firms and how it affects the structure of their term sheets and legal agreements. We explore common pitfalls in dealing with VCs, as well as success stories regarding VC investment.

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What do VC’s want?
Michelle McBane
@michellemcbane
Investment Director
Investment Accelerator Fund
@MaRSIAF
iaf.marsdd.com

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Investment Accelerator Fund (IAF) - Purpose
• Seed stage funding is critical for job creation and a vibrant VC infrastructure
• IAF provides seed investment to promising, emerging technology companies
throughout Ontario
• Provides technology companies with the resources, skills and networks to
validate their ideas and bring products and services to market
• Bridges the funding gap between new technology companies and the wider
investment community
• For more info go to: iaf.marsdd.com
Bridging the Funding Gap for Seed Stage Companies in Ontario

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Who can raise venture funding?
• Venture capital is a very specific thing.
• It’s not what all technology businesses should think of when they
need capital.
• It only really works for businesses with:
• High potenUal for escape velocity
• A large potenUal market
• A team capable of building a large company
h)p://www.startupcfo.ca/2012/08/top-­‐10-­‐signs-­‐your-­‐business-­‐is-­‐not-­‐vc-­‐fundable/

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Deal killers
• Services, not product
• You are a sole founder
• You don’t know any VCs
• You have no tracUon
• You have outsourced development
• You serve a niche market
• You don’t know the market
• You are disorganized
• You move slowly
• You lack that founder magic
h)p://www.startupcfo.ca/2012/08/top-­‐10-­‐signs-­‐your-­‐business-­‐is-­‐not-­‐vc-­‐fundable/

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Goal
• VC moUvaUons
– Driven by their model
– Impacts their terms and expectaUons
• Most companies aren’t VC’able
– Just don’t fit the “Big Money” model
– May be good companies and businesses
• But if you are then you’ll be be]er equipped than most because
of tonight

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Its all about the frogs

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The Numbers
• 1,000 companies
• 10 investments
– 2 may be widely successful (usually 1)
– 6 “land of the living dead”
– 2 fail horribly
• Winners to offset my losers
• Start ups 10-­‐12x return in 5-­‐7 years
• ExisUng companies 5-­‐7x in 4-­‐5 years

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What does that mean for you?
• A company that doubles isn’t enough…
• Every opportunity has to have the potenUal to be a home run

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You Tube & Sequoia

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Deal Stats
• You Tube sold to Google for $1.65 Billion
• Sequoia invested $11.5M received $495M
– 30% of the company
• 43x return
• Great deal!

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ExpectaUons
• 6-­‐9 months to raise capital
• Several meeUngs
– Want to get to know you
– Assess your “Say/Do” factor
– Close to truth
• Builds confidence

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ExpectaUons
• Personal RecommendaUon:
– Get to know the VC
• Process (who makes the decision, when & how oren)
• Where are they in their fund life cycle
• What was their last deal
• Talk to their exisUng CEO
• Cash available to invest/reserves

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ExpectaUons
• Personal RecommendaUon:
– Rise above the noise
– Remember the frogs
• 1,000’s of deals

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Fit
Have
to
be
able
to
live
with
them
…
“Dl
exit
do
you
part”

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Ni]y Gri]y…
• The term sheet…

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What is a Term Sheet
• Non-­‐binding offer to invest
• Outlines the general terms and condiUons of investment
– Which may change
• Not the definiUve agreement simply a place to start
• Everyone uses it
– Understand WHEN a fund issues a term sheet in their process

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Basic Terms
• Non-­‐heart ache
– Company name
– Investors
– How much
– Date

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ValuaUon is an Art

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Company’s Growth Forecast

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RaUonalized Forecast
On
average
it
takes
about
6
years
for
a
so7ware
company
to
get
to
$10
million
revenue.
Far
more
realis?c
to
get
to
$50M
in
10
years
(50%
growth
rate
from
years
6
to
10).

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Long Term Financing Strategy

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Build Value

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Typical Seed Stage Investment Structure
• ConverUble Debenture
• Common Shares
• Preferred Shares
2015-­‐05-­‐06

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What is a converUble note?
• Short-­‐term debt that converts into equity
• For seed financing typically converts upon a larger financing
• Why use it?
– Defer the valuaUon discussion (think Dragon’s Den)
– Can be faster, simpler and cheaper to paper
– May or may not contain protecUve provisions
• Key Features
– Conversion discount
– ValuaUon Cap
– Interest Rate
2015-­‐05-­‐06

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ConverUble notes
• Key features:
– Conversion Discount
• Usually 10-­‐30% -­‐ average is 20%
2015-­‐05-­‐06

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ConverUble notes
• Key Features:
– Conversion ValuaUon Cap:
• A ceiling on the value of the start-­‐up to determine the conversion price
2015-­‐05-­‐06
If
a
note
includes
a
discount
and
a
cap
–
conversion
price
is
the
lower
of…….

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How do cap and discount work togehter
• If a note includes a discount and a cap – conversion price is the
lower of…….
2015-­‐05-­‐06

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Preferred Shares

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Dividends
• Accrue
• Price + dividend convert

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LiquidaUon Preference

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AnU-­‐diluUon
• Protects an investor from down round
– As if their investment had been done at the current lower price
– Keeps the investor whole in bad Umes
– Full-­‐ratchet
– Weighted average

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RedempUon
• VC can ask to have the company buy back shares
– Life of the fund
– Investors in funds want their money back
• Outcome:
– Forces a sale
– Get minimum investment back (P+dividends)

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Approvals
• 60-­‐66 2/3%
– Change nature of the business (acquire/divest)
– Change capital structure/arUcles
• Default approval over future financing
– Approve business plan/operaUng plan
– Change in key employees (defined term)
– CreaUon of ESOP
– Unbudgeted expenditure in excess of $5,000
– Non-­‐arms length transacUons
– ….

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InformaUon Rights
• Monthly prepared financial provided
– 20-­‐30 days from month end
• Quarterly financials
– Analysis vs. budgets
• Board material
• Yearly operaUng plan
– (30 days prior to beginning of fiscal year)

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Share RestricUons
• Founder restricUons
• Drag Along
– VCs need exit
• Tag Along
– I can sell a porUon if you can

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Board
• Friends and family
• Move to 5
– 2 investor
– 2 founder
– 1 independent
– Expect material in advance of meeUng
– Only a meeUng if the VC is there
• Defer once

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IP Assignment
• Founders
• Employees
• Consultants
• Students/universiUes/research organizaUons etc
• Avoid convoluted IP structures
– Only going to be unwound

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Key Employee Agreements
• Non-­‐compeUUon
• Non-­‐solicitaUon
– Customers
– Employees
• IP Assignment

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ESOP
• Ensure one common moUvator
• Need to a]ract talent
• 15%-­‐20% (low as 10%)
• New CEO
• New execuUves
• Board members
– Non-­‐VC
• Pre-­‐$
– DiluUve to you

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Other Rights and Privileges
• Power of “OPM”
– Get to know your VC
– Won’t ma]er in good Umes
– Can’t tell you what to do but prevent you from doing things

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Non-­‐Binding Except for…
• Acceptance & Exclusivity
– Deadline for acceptance
– Use the Ume to negoUate with other parUes
– No “shop”

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Series Seed
Non-­‐parUcipaUng preferred liquidaUon preference: The investor receives
their money back and the remainder goes to the common.
Limited protecUve provisions: Among other things, the company can’t be
sold without consent of a majority of the Series Seed.
Future rights. If new investors get be]er rights in a future equity financings
(such as registraUon rights, price-­‐based anU-­‐diluUon, redempUon rights,
etc.), then the holders of the Series Seed get these be]er rights.
Right of first offer on future financings: Self-­‐explanatory.
2015-­‐05-­‐06

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Take Away
Be careful what you ask for …don’t send the wrong
message