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Understanding Venture Capital




                       Daniel Drouet
                     McGill University
                           April, 2012
About Me




Blog: danieldrouet.ca
Twitter: mtlluo
Email: daniel@montrealstartup.com
Financing options
 Right tool for the job
  • Self-finance (Bootstrapping)
  • Loans
  • Selling Equity
 Options available depend on
  • Stage the company is at
  • Type of business
What is Equity Financing?
 Trading shares of your company for cash
 Taking on a new partner!
 When to consider it
  • Up front costs not fundable from cash flow
  • Need to move fast
  • Unique product or technology with large potential
    market
  • Exit possible in 5-7 years for $30M+
Equity Types
 Common shares
  • Simple
  • Founders and investors have similar rights
 Convertible Loan
  • Simple and avoids valuing the company
  • For Seed or Bridges
 Preferred shares
  • Can be complex, typically used by VCs
  • Provides special rights
Equity financing pros and cons
 Pros
  • Have resources to move quickly
  • Help with strategy, critical hires, fundraising,
    partnerships, exits, etc.
 Cons
  •   Give up control
  •   Locked in for the next four years
  •   Higher rate of failure
  •   Give up possibility of lucrative small exit
  •   Give up possibility of running lifestyle business
Angel investors
   Successful business people
   Invest their own money often in groups
   Typically more involved than VC
   Usually only invest at Seed level
   Small exits can be wins
Venture Capital (VC)
 Raise funds that have 10 year lifespan
 Risk reduction based on
  • Funding over multiple rounds
  • Portfolio approach
      50% investments lose money
      30% break-even
      20% make (lots of?) money
 Large funds require large exits
  • Swing for the fences
VC fund example (simplified)
 $100M fund. Goal is $200M or 2x
 15 investments. Aim for 30% ownership at exit
  • 50% (7) lose money = $0M
  • 30% (5) break even = $30M
  • 20% (3) make money = $170M
 $170 / 3 = $57M per company
 Own 30% => Need three $189M exits!
Investment stages
Startup          Seed           Early Stage      Late Stage       Mezzanine /
                                (Series A, B)    (Series C, D, E) Buy-Out


$0 - $50K        < $500k        $1M - $5M        $5M - $30M      > $50M



Friends &        Friends &       Angel Groups,   VC, Expansion   Specialized
Family, Angels   Family, Angels, VC              funds           funds
                 Seed Funds

Validate idea,   Launch Beta    Build team,      Ramp up         Exit or remain
Prototype                       grow users,      growth, sales   private
                                first revenues
Investors are looking for:
 Team
   •   Doers
   •   Complementary
   •   Deep knowledge of sector
   •   Coachable
 Technology / Product
   • Unique, disruptive
   • Defendable is nice
 Market
   • Big to huge
   • Growing fast or ripe for disruption
   • Traction
What you should look for
   Has funds to invest
   Invests in your sector
   Complement existing portfolio
   Track record / reputation
   Share common vision
   Good relationship with Partner
Approaching investors
 Do your homework
   • Shortlist of investors
   • Get an introduction through your network
   • Show how you would be a good fit
 It’s like dating
   • Compatibility matters
   • You can’t force it
 Build the relationship before you need it
Fundraising process
                  Initial Meetings        Term Sheet           Closing


What’s involved   Short list investors,   Agree on roadmap     Legal and financial
                  Prep deck and           and use of funds,    due diligence,
                  other docs.             Lots of back and     Reference checks,
                  Get introductions       forth over terms,    Haggling over
                                          Some due diligence   details
Goal              Get investor excited Get signed term         Close, i.e. cash the
                                       sheet                   cheque!

Time              3 weeks to prep         6 weeks              6 weeks
                  3 weeks for mtgs
Valuation
 Driven by the investors
  • How much money they think you need
  • Percentage they want to own
 Entrepreneur controls one thing
  • How much risk has been removed from the business
 Miscellaneous
  • Pre and Post Money
  • Option Pools
  • Avoiding valuation with Convertible Debt
Valuation example: Seed
Share-    Money   Common      %     Money In    Common      %
holders   In      shares                        shares
Jack      $0      500,000     50    $0          500,000     35

Jill      $0      500,000     50    $0          500,000     35



                                    Pre = $1M
ESOP                                n/a         143,000     10

Angels                              $250,000    286,000     20

Total     $0      1,000,000   100   $250,000    1,429,000   100

                                    Post =
                                    $1.25M
Valuation example: Series A
Share- Common        %             Money   Common      Preferred   %
holders Shares                     In      Shares      Shares
Jack     500,000     35                    500,000                 26.25

Jill     500,000     35                    500,000                 26.25

Angel    286,000     20                    286,000                 15

Options 143,000      10                    143,000                 7.5

Total    1,429,000   100


Pre =                      VC      $2M                 476,190     25
$6M
Post =                     Total   $2M     1,905,190               100
$8M
Resources
 Finding investors
   • http://www.cvca.ca/membership/directory/it.aspx
   • http://www.angelinvestor.ca/Find_Angels.asp
   • http://angesquebec.com/
 Fundraising
   • http://www.slideshare.net/startupcfo/investor-readiness-
     workshop
 Pitching investors
   • http://venturehacks.com/pitching
 Understanding Term Sheets
   • http://www.feld.com/wp/archives/2005/08/term-sheet-
     series-wrap-up.html

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Understanding VCs

  • 1. Understanding Venture Capital Daniel Drouet McGill University April, 2012
  • 2. About Me Blog: danieldrouet.ca Twitter: mtlluo Email: daniel@montrealstartup.com
  • 3. Financing options  Right tool for the job • Self-finance (Bootstrapping) • Loans • Selling Equity  Options available depend on • Stage the company is at • Type of business
  • 4. What is Equity Financing?  Trading shares of your company for cash  Taking on a new partner!  When to consider it • Up front costs not fundable from cash flow • Need to move fast • Unique product or technology with large potential market • Exit possible in 5-7 years for $30M+
  • 5. Equity Types  Common shares • Simple • Founders and investors have similar rights  Convertible Loan • Simple and avoids valuing the company • For Seed or Bridges  Preferred shares • Can be complex, typically used by VCs • Provides special rights
  • 6. Equity financing pros and cons  Pros • Have resources to move quickly • Help with strategy, critical hires, fundraising, partnerships, exits, etc.  Cons • Give up control • Locked in for the next four years • Higher rate of failure • Give up possibility of lucrative small exit • Give up possibility of running lifestyle business
  • 7. Angel investors  Successful business people  Invest their own money often in groups  Typically more involved than VC  Usually only invest at Seed level  Small exits can be wins
  • 8. Venture Capital (VC)  Raise funds that have 10 year lifespan  Risk reduction based on • Funding over multiple rounds • Portfolio approach  50% investments lose money  30% break-even  20% make (lots of?) money  Large funds require large exits • Swing for the fences
  • 9. VC fund example (simplified)  $100M fund. Goal is $200M or 2x  15 investments. Aim for 30% ownership at exit • 50% (7) lose money = $0M • 30% (5) break even = $30M • 20% (3) make money = $170M  $170 / 3 = $57M per company  Own 30% => Need three $189M exits!
  • 10. Investment stages Startup Seed Early Stage Late Stage Mezzanine / (Series A, B) (Series C, D, E) Buy-Out $0 - $50K < $500k $1M - $5M $5M - $30M > $50M Friends & Friends & Angel Groups, VC, Expansion Specialized Family, Angels Family, Angels, VC funds funds Seed Funds Validate idea, Launch Beta Build team, Ramp up Exit or remain Prototype grow users, growth, sales private first revenues
  • 11. Investors are looking for:  Team • Doers • Complementary • Deep knowledge of sector • Coachable  Technology / Product • Unique, disruptive • Defendable is nice  Market • Big to huge • Growing fast or ripe for disruption • Traction
  • 12. What you should look for  Has funds to invest  Invests in your sector  Complement existing portfolio  Track record / reputation  Share common vision  Good relationship with Partner
  • 13. Approaching investors  Do your homework • Shortlist of investors • Get an introduction through your network • Show how you would be a good fit  It’s like dating • Compatibility matters • You can’t force it  Build the relationship before you need it
  • 14. Fundraising process Initial Meetings Term Sheet Closing What’s involved Short list investors, Agree on roadmap Legal and financial Prep deck and and use of funds, due diligence, other docs. Lots of back and Reference checks, Get introductions forth over terms, Haggling over Some due diligence details Goal Get investor excited Get signed term Close, i.e. cash the sheet cheque! Time 3 weeks to prep 6 weeks 6 weeks 3 weeks for mtgs
  • 15. Valuation  Driven by the investors • How much money they think you need • Percentage they want to own  Entrepreneur controls one thing • How much risk has been removed from the business  Miscellaneous • Pre and Post Money • Option Pools • Avoiding valuation with Convertible Debt
  • 16. Valuation example: Seed Share- Money Common % Money In Common % holders In shares shares Jack $0 500,000 50 $0 500,000 35 Jill $0 500,000 50 $0 500,000 35 Pre = $1M ESOP n/a 143,000 10 Angels $250,000 286,000 20 Total $0 1,000,000 100 $250,000 1,429,000 100 Post = $1.25M
  • 17. Valuation example: Series A Share- Common % Money Common Preferred % holders Shares In Shares Shares Jack 500,000 35 500,000 26.25 Jill 500,000 35 500,000 26.25 Angel 286,000 20 286,000 15 Options 143,000 10 143,000 7.5 Total 1,429,000 100 Pre = VC $2M 476,190 25 $6M Post = Total $2M 1,905,190 100 $8M
  • 18. Resources  Finding investors • http://www.cvca.ca/membership/directory/it.aspx • http://www.angelinvestor.ca/Find_Angels.asp • http://angesquebec.com/  Fundraising • http://www.slideshare.net/startupcfo/investor-readiness- workshop  Pitching investors • http://venturehacks.com/pitching  Understanding Term Sheets • http://www.feld.com/wp/archives/2005/08/term-sheet- series-wrap-up.html