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Elements for assessing and structuring venture capital financing


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Key topics and resources for those new to venture capital financing basics.

Elements for assessing and structuring venture capital financing

  1. 1. Elements for Assessing/ Structuring Venture Capital Financing
  2. 2. OVERVIEW  This is a high level breakdown of elements for venture financing including assessing an opportunity and elements of structuring a deal.  The slides below highlight key terms/ concepts and provide additional resources  This is not meant to be an in-depth discussion/ analysis of each concept but instead provide new entrepreneurs and investors a brief understanding of each topic and concept for further study.  For any comments or additional resources please reach out to me at the contact below: Nathan J Fink Email: LinkedIn:
  3. 3. DEAL FUNDING ELEMENTS  Team: Management, gap analysis, board of directors  Customer: Customer value proposition, segmentation, acquisition costs  Product/ Technology: Minimum viable product, roadmap, intellectual property  Market: Segmentation, go-to-market, barrier to entry, growth  Competitors: Direct, indirect, point of differentiation  Financials: Financial statements, unit economics, cash burn, cash requirements  Risks: Organizational, operational, market, financial  Deal Structures: Convertible debt, preferred/ common equity, warrants, royalties  Term Sheet: Key terms  Valuation: Basic terms to valuations  Discount Rate: Risk free rate, systematic risk, value added, cash flow, liquidity StructureAssessment/Diligence
  4. 4. TEAM Resources  management-teams-before-its-too-late/   Key Concepts  Management: Getting a well balanced experienced team appropriate for the company’s stage  Gap analysis: Understanding the team’s current capabilities and what is missing to achieve the next company milestones  Board of directors: Providing well balanced and useful direction (technical and commercial) where each member brings something different to management. Team is one of the most important elements to a successful company Finding a winning team that works well together, develops sustainable solutions and delivers them to market is often elements of a promising company. Thinking through a combination of skills, experience, and culture fit are important to getting the right team. Hiring mistakes can cost distraction, money, and time which are all costly
  5. 5. CUSTOMER Key Concepts  Customer value proposition: Articulating and delivering something the customer needs that causes actions (purchase/usage)  Segmentation: Defining the different customer groups by key qualities, attributes, and size (E.g. need, geography, etc.)  Customer acquisition costs: The total cost associated with finding, obtaining, and retaining a customer (cost to acquire and retain customers) Resources   class-4-customer-hypotheses/  Customer Analysis Customer analysis is about finding and determining what the customer needs and how to deliver it in a unique and sustainable way that’s difficult for competition to replicate. The key to successfully understanding the customer is to continuously engage the consumer and solicit feedback.
  6. 6. PRODUCT/ TECHNOLOGY Key Concepts  Minimum viable product (MVP): A version of a new product which allows a team to collect the maximum amount of validated learning about customers with the least effort  Roadmap: An outline for developing the MVP into a commercially ready product and/or product suite  Intellectual property: Patents, trademarks, copyrights, trade secrets, know-how, etc. Resources   Entrepreneurship-and-Innovation---Intellectual-property-for-startups Purpose of a product The product/ technology is the solution to the customer need and requires customer engagement. The Lean Startup Method
  7. 7. MARKET Key Concepts  Segmentation: Breaking down a large market into targeted/ defined subsets of customers  Go-to-market: An operational plan of how to reach the targeted customer segments  Barriers to Entry: High Barriers to Entry: “Good if you can get in” Low Barriers to Entry: “Good if you can stay in”  Growth: Understanding the market trends and health of the market participants Resources    Managing Markets Market analysis is able to direct efforts and find near-term adopters and long- term growth opportunities Michael Porter 1996
  8. 8. COMPETITORS Key Concepts  Direct competitor: Company with the same products delivered to the same customers  Indirect competitor: Company with a substitute product delivered to the same customer  Point of differentiation: Key attributes that are better or differentiated from what competitors deliver to customers Resources    competitors/ Competitor Analysis Building an understanding of the broad competitors and their capabilities are important for market differentiation.
  9. 9. FINANCES Key Concepts  Financial statements: Income statement, balance sheet and cash flow statement  Unit economics: Understanding revenue, costs, and allocated overhead to deliver a single product to the customer  Cash burn: Gross cash burn is cash out per month excluding cash in, net cash burn is cash out per month including cash in  Cash requirement: Each company should look to raise/ have 12-24 months of cash on hand to help them achieve set milestones. Resources   startup-company/  Seven Line Financial Analysis
  10. 10. RISKS Key Concepts  Organizational: Risk the team is not able to fill gaps and deliver on their plans  Operational: Company specific risk around the ability to deliver to customers and partners  Market: Broader high level shifts in the market which a company can’t control but will impact their business  Financial: Misalignment with expected financial performance and actual financial performance. Resources  Risks Both investors and early employees will work to reduce risks and find a strong risk/ reward profile to fit their needs
  11. 11. DEAL STRUCTURES  Convertible Note: Debt security that contains a predefined converted terms. Gets paid before equity players  Preferred Equity: Senior equity that has preferential terms over common equity. Gets paid before common equity  Common Equity: Equity that doesn’t contain any preferences and is paid last. Typically founders and some employees hold common equity in the capitalization table  Warrants: Security issued by the company providing the right to purchase securities at a specified price and time.  Royalties: Payment from the sale or a product/ service that doesn’t include transfer of ownership  Capitalization Table: Detail of company ownership Resources  http://www.startupcompan ertible-note-bridge- financing/  http://www.bothsidesofthet convertible-debt-preferable- to-equity/
  12. 12. TERM SHEET Key terms Pre-money, post money, liquidation preference, board of directors, protective provisions, drag along, anti-dilution, pay-to-play, dividends, redemption rights, conversion, conditions precedent to financing, vesting, right of first refusal, voting rights, employee stock option pool, indemnification, assignment, co-sale agreement, etc. Understanding the terms in detail and how these terms can impact future rounds/ different parties is important before signing Resources   Term-Sheet A term sheet is issued by investors to a company and outlines the terms of the deal (e.g. price, control, etc.)
  13. 13. VALUATION  Post-money = Pre-money + Investment  Exit value = Multiple * Exit year metric  Required return factor = (1+ Discount Rate)Years to harvest  Final equity percentage = (Required return factor * Investment)/ Exit value  Retention percentage = 100% - Future expected dilution of ownership  Retention percentage = Final percentage/round percentage  Final percentage = (Required return * Investment)/Exit Value  New shares = (Round percentage/(100%- Round percentage))* Old shares  Exit share price = Exit value/final total shares Resources  Display.aspx?SectionName=practi ce/venturecapital.htm#  orts/1h-2015-vc-valuations- trends-report
  14. 14. DISCOUNT RATES  Risk Free Rate: Rate earned on an investment with no default risk. This rate is comprised of an expected inflation component and a real return component.  Systematic Risk Premium: Capital Asset Pricing Model (CAPM) defines this as the sensitivity of the return to changes in the overall market. Any other risk can be diversified away.  Value Added: Venture Capitalists are “active” investors adding value to the their investments through assistance in managing, recruiting, and financing and thus demand additional return in exchange for services rendered.  Cash Flow Adjustment: Difference between the forecasted cash flow and expected cash flow. A high discount rate is used as a “haircut” to inflated entrepreneurial forecasts.  Liquidity Premium: Almost all Venture Capital investments are “illiquid” securities. Securities of this type often sell at a discount of 50 % under those of comparable marketable or liquid securities. Seed Stage: Concept Exploration: 80% and Up Start Up Stage: Commencing Operations: 50 - 70% First Stage: Unprofitable Going Concern: 40 - 60% Second Stage: Growth of (Profitable) Going Concern: 30 -50% Bridge: Carry through IPO: 20 - 35%