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Early Stage CapitalAN OVERVIEW OF FINANCING OPTIONS FOR EARLY STAGE COMPANIES

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82% of Businesses Close
Due to Inadequate
Cash Management

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Your survival as
an early stage
startup is
dependent on
your ability to
effectively
navigate
through the
“Valley of Death”
Image Credit: Kmuehmel, VC20 - https://commons.wikimedia.org/wiki/File:Startup_financing_cycle.svg

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Early Stage
Company
Personal:
Founder Funds, Credit
Card, Life Insurance,
Home Equity Line of
Credit
Equity:
Equity for Services,
Love Money, Angel,
Venture Capital, Public
Market
Debt:
A/R Financing,
Collateral Financing,
Trade Credit, Line of
Credit
Non-Dilutive:
AZ Innovation
Challenge,
Crowdsourcing,
Grants, SBIRs,
STTRs, Contracts
EARLY STAGE FINANCING OPTIONS
MULTIPLE FUNDING TYPES DEPENDING ON YOUR BUSINESS

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Revenue/Investment (Cash In)
• Services before Product
• Pre-sales
• Upfront Fees
• State/Federal Programs
• Founder, Friends, Family Funds
• Crowdfunding
• Equity Investment
• Loans and Lines of Credit
Expenses (Cash Out)
• Salaries
• Product Development Roadmap
• Free/Discounted Resources
• Service Providers
• Payment Schedules
• Equity in Lieu of Cash
CROSSING THE CHASM
MANAGING THE FLOW OF CASH

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Your company
life cycle must
match the
metrics
expected by the
type of investor
you are seeking.
Image Credit: Aswath Damodaran,
https://seekingalpha.com/article/2689195-twitters-bar-mitzvah-is-social-media-coming-of-age

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• If it looks like a duck, quacks like a duck, it’s a duck, but you better be a duck!
• You must look like the industry average to get the average, no participation
credit!
• Round Size:
• Pre-Seed: $50K-$250K
• Seed: $500K-$2M
• Post-Seed: $3-$12M
• Equity Stake:
• 20%-33%
MATCHING THE INVESTMENT THESIS
INVESTORS USE THEIR THESIS TO IDENTIFY AND DISMISS DEALS

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Amount
Valuation
Investors
Team
Product/
Market Fit
Tech MRR
Sales/
Marketing
Defensibility
Market/
Potential
Pre-Seed
$50-250K
$250K-2M
Friends/
Family/Angels
Smart,
committed,
relevant
experience
Market
Research
indicates
strong need
for the
product
Strong tech
co-founder
with relevant
experience
---
Understand
best practices
in market
Plan for
Funnel
---
Believe in
$10M+ ARR
potential
Seed
$500K-$2M
$2-6M
Angels, Micro
VCs
Founder/
Market Fit
Strong
indications of
PMF from
early
customers
Proven ability
to move fast
and deliver,
starting to
think about
scalability and
process
$0-50K
Strong
indications of
demand
Established
Funnel
Tech
Product
Development
Velocity
Conviction
there is
$100M+ ARR
potential
Post-Seed
$3-12M
$10-40M
VCs
Directors
No VPs
Demonstrated
ability to
attract good
hires
Clear PMF
and increasing
evidence in
Market, low
churn rate
Proven ability
to attract
great talent,
product
scales, fast
iterations
$100-250K
Strong organic
demand
Disciplined
Sales Process
First Signs of
Emerging
Brand
Expected
$300M+ ARR
potential
EARLY STAGE VENTURE FINANCING
INVESTOR METRICS AND EXPECTATIONS

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• Runway
• 6-18 months
• Traction
• Achieve “x”% growth
• Validate Experiments
• 1-3 depending on complexity
• Achieve Next Valuation Inflection Point
HOW MUCH CAPITAL DO YOU NEED?
HOW TO COMMUNICATE YOUR USE OF CAPITAL

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Our 5 year growth projections
show $AA revenue, BB%
profit, and we reach a cash
flow neutral position in month
CC after $DD invested.
We intend to do this
by offering a solution….
We expect to achieve EE% of our
TAM by year 5.
Our TAM is calculated by….
The size of our initial target market
is FF and we intend to capture GG%
of this group who currently spends
$HH on the problem we are solving.
We expect to meet our revenue
projections through our marketing/sales
efforts.
Our forecasts for year 1 are derived from
these campaigns and yield II% conversion
on $JJ spent.
We are spending $JJ on….
In years 2-5, we made the following
assumptions….
We intend to offer the following
solution….
We expect to invest $KK on the
development of….
Once this is developed, our cost to
deliver the solution to the each
customer is $LL.
Our future development roadmap is….
and will cost $MM
Overall, our current spend is
$NN in the first year.
Based on our forecasts, we
will need funding in months
OO, PP, QQ….
We plan to get this funding
through….
You can see the overall use of
funds by category and our
overall headcount by year
here.
A STORY BOARD MODEL
TELL A GREAT FINANCIAL STORY

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• Specificity on use of funds during funded period
• Integrity during due diligence
• Enough skin in the company that it hurts, but is not distracting
• Funding connected to milestones
EQUITY INVESTOR EXPECTATIONS
WHAT HAPPENS AFTER THE PITCH

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How Invested are Founders?
• Personal Guaranties
• Personal Loans and Credit Cards
• Mortgages and Home Equity Line
of Credit
• Friends and Family
• Retirement Accounts
• Equity Investors
• Bankruptcy
How Qualified is Team?
• Friends and Family
• Serial Entrepreneur
• Experience with Market
• Experience with Technology
• Investors from Previous Company
involved
• Advisors to Team
EVALUATING THE TEAM
FUNDING THE BEST JOCKEYS

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• CEO-centric
• Family and Bros
• No hurt money
• Capital provides only short runway
• Hockey Stick Forecast without specifics
• Percent of Market without Milestones
• No competition, no research, no disclosure
WARNING SIGNS ON A TEAM
GREAT HORSE, WRONG JOCKEY

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• Beta Users is not Traction
• Current Sales
• Sales Pipeline
• Metrics: DAUs, MAUs, Subscribers, Conversion Rate, Churn Rate
• Understand Customer Acquisition Process
EVALUATING TRACTION
METRICS TO DEMONSTRATE PRODUCT-MARKET FIT

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• Product Components and Architecture
• Scalability and Reproducibility
• Product Development Team Qualifications
• In-Source vs Out-Source Development
• Product Roadmap
EVALUATING PRODUCT ROADMAP
CAN THEY BUILD IT, SO THEY WILL COME?

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• Identify Comparable Public Companies or Public Acquisitions
• Create Multiples for EV/EBITDA and EV/Revenue
• Understand Competition Tools and Target Customers
• Product Roadmap to Market Segmentation Analysis
EVALUATING THE MARKET
VALUE BASED ON NICHE MARKET, MONOPOLY, LARGE SIZED MARKET

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Management Motivation and Capability 90%
Market Demand 90%
Customer Acquisition Plan 90%
Product-Market-Fit 90%
Product Development Plan 90%
Capital/Cash Flow Plan 90%
Legal and IP Concerns 90%
Success Probability (Adjusted Risk) 48%
RISK MANAGEMENT
RISK DRIVES THE VALUATION DISCUSSION
Risk factors are compounding and have multiplicative effects, risk is not an average of all of the potential risks.

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Management Motivation and Capability 90%
Market Demand 90%
Customer Acquisition Plan 90%
Product-Market-Fit 90%
Product Development Plan 90%
Capital/Cash Flow Plan 50%
Legal and IP Concerns 90%
Success Probability (Adjusted Risk) 27%
RISK MANAGEMENT
JUST ONE CORE FACTOR CAN DRAMATICALLY INCREASE RISK
Risk factors are compounding and have multiplicative effects, risk is not an average of all of the potential risks.

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Valuation is not NOT an evaluation how much the
company is worth or going to be worth.
• It is the agreement between an investor and company
on the price for a share of the company that an investor
receives for an investment.
• The enterprise value of the company requires liquidity
and market.
WHY CREATE A VALUATION?
ALLOCATION OF EQUITY FOR INVESTOR RISK

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• Discounting exit valuation or pro forma financials
• Venture Capital Method
• Chicago Method
• Comparing target to typical funded startup
• Scorecard Method
• Dave Berkus Method
• Risk Factor Summation Method
• Online questionnaire
• Cayenne Calculator
VALUATION METHODS FOR EARLY STAGE COMPANIES
MATCHING RISK WITH VALUATION

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VENTURE CAPITAL METHOD
INVESTMENT ROI BASED ON STAGE OF COMPANY
Exit Year: 5th Year
Exit Year Revenues: $6.2M
Exit Year Earnings: $4.4M
Exit Year Value: $37M (6x Revenues)
$66M (15x Earnings)
Ownership Requirement: $3M / $37M = 8.1%
Ownership Requirement: $3M / $66M = 4.5%
Post-Money Valuation: $150K / 8.1% = $1.875M
Post-Money Valuation: $150K / 4.5% = $3.3M
Expected Rates of Return
(5 year multiple)
• Pre-Seed: 100% (20X)
• Startup: 60% (10X)
• Post-Seed: 50% (8X)
• 2nd Stage: 40% (5X)
• 3rd Stage: 30% (4X)
• Bridge: 25% (3X)
Investment: $150K
Required ROI (%): 100% (20X)
Required ROI ($): $3M

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Appraise startups using comps
• Start:
• Median Valuation of similar startups
• Similar stage of development,
business sector, location
• Adjustments:
• Use weightings to adjust median
Criteria Weighting
Entrepreneur, Team, Board 30%
Size of Opportunity 25%
Product/Technology 15%
Competitive Environment 10%
Sales/Marketing 10%
Need for More Financing 5%
Other 5%
SCORECARD METHOD
EARLY STAGE COMPARATIVE EVALUATION

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23Scorecard Method Example
Criteria Weighting Comparison Adjusted
Entrepreneur, Team, Board 20% 80% 16%
Size of Opportunity 20% 100% 20%
Product/Technology 20% 60% 12%
Sales/Marketing 20% 40% 8%
Competitive Environment 10% 80% 8%
Need for More Financing 10% 60% 6%
Total 100% 70%
$3.5M (HALO Report Median Value)
x 70% = $2.45M Pre-Money Valuation

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24Berkus Method Example
If Exists:
Add to Company
Value:
Self-Evaluation Value
Sound Idea (basic value) $500K 5 $500K
Prototype (reducing
technology risk)
$500K 5 $500K
Quality Management Team
(reducing execution risk)
$500K 3 $300K
Strategic Relationships
(reducing market risk)
$500K 2 $200K
Product Rollout or Sales
(reducing production risk)
$500K 1 $100K
Total $1.6M
Intended for Companies sub-$2M

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25Bill Payne Method Example
Rating Scale Risk Category Allocation Total
+2 Very
Positive
Technology +2
+1 Positive Exit Potential +1
0 Neutral
Political, Manufacturing, Competition, International,
Reputation, Funding/Capital
0
-1 Negative Litigation, Management -2
-2 Negative Stage of Business, Sales/Marketing -4
Total -3
Regional Pre-Money Valuation Median (HALO Report): $3.8M
Multiply $250K by Total: ($750K)
Self-Evaluation: $3.05M

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If early stage valuation is too high:
• Financial contribution undervalued
• Smart money will walk away
• Time to close extended
• Likelihood of a down round is
higher
• Not able to get exit at size needed
for risk stage
If early stage valuation is too low:
• It always takes 2X times as much
and will over-dilute founders
• Entrepreneurs are less motivated
• Founders feel over diluted and exit
the company
IMPORTANCE OF GETTING A FAIR VALUATION
IMPACTS TO INVESTORS AND FOUNDERS

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The objective of an angel investor or
any private equity investor is to exit!
Start planning early, the more
fundraising the more difficult it is to
exit.
Most exits <$30M
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Year 1 Year 2 Year 3 Year 4
Investment Return (X)
Inflection point
for growth capital
$25M exit
6-18 month
exit process
EXIT PLANNING
PRIMARY GOAL FOR AN INVESTOR

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Over 80% of
exits are
through
acquisition or
buyout

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Once you take
funding, you are
on the clock to
get to an exit.
Time requires a
higher exit
multiple to
account for the
tradeoff in IRR

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• Liquidation Preference
• Option Pool
• Board Representation
• Redemption
• Voting Rights
• Anti-Dilution
OTHER FACTORS ON A TERM SHEET BEYOND VALUATION
MULTIPLE LEVERS TO MANAGE RISK AND EXPECTATIONS