Becoming an Investor-Ready Entrepreneur

Document Sample
Becoming an Investor-Ready Entrepreneur Powered By Docstoc
					A TechEDge Program sponsored by the City of
                   Chandler and the SBDC
   Learn more about private equity investment
    process and investor expectations at each
   Learn to target your presentation to equity
    investors to increase your chances of success
    raising capital
   Receive tools that will help you assess your
    investor-readiness at each step along the way.
   Hear from serial entrepreneurs, angel
    investors, venture fund representatives
    who’ve all “been there”
 14 Topics
 For each topic--
   Presentation
   Panelist questions/interaction
   Self Assessment
    • Tool to assess readiness
   Resources
 Workbooks

 Questions

 Facilities
Snell & Wilmer
 Founded in 1938.
 Largest law firm in Phoenix and Arizona,
  and one of the largest in the West.
 True full-service law firm
 Ranked best corporate law firm in
  Phoenix for 10th consecutive year by
  Corporate Board Member magazine.
 Ranked the #1 law firm in Arizona by
  Ranking Arizona: The Best of Arizona
Silicon Valley Bank
 Founded in 1983.
 Global client base. 33 offices in the US,
  China, India, Israel and the UK
 Recognized by Forbes as one of the top
  10 banks in 2011.
 Recognized as “Lender of the Year” by
  the US Export-Import Bank for helping
  75 small businesses generate more than
  $1.4 billion in US product sales to 30
  different countries.
 Brian   Burt, Partner and Chair of Emerging
    Business Group – Snell & Wilmer

   Dax Williamson, Deal Team Leader, Silicon
    Valley Bank

   Dee Harris, President, Arizona Angels
    Venture Group

   Jim Goulka, Director, Arizona Technology
    Investor Forum
   Marni Patterson, President – Tucson
    Transatlantic Trade and Coordinator of
    TechEDge, a series of educational
    programs for technology-based companies.

   Tom Fulcher, President – The Idea
    Gardener and Counselor for the Small
    Business Development Center (SBDC)
Walking in the Investor’s Shoes….
   Practical Research-Based Educational
    •   Investor-ready Entrepreneur for growth oriented entrepreneur
    •   AZ Angels: Investing close to home for accredited investors

   Capital Formation
    •   Support for angel and other investment funds

   Publications
    •   Support for angel and other investment funds
In the Trenches….
 Conceive  Idea
 Create business plan & executive summary
 Define the market
 Complete financials
 Determine financial needs
 Prepare due diligence materials
 Assemble management team & advisory board
 Review  L.P. potential
 Find and qualify funding sources
 Prepare the pitch
 Present to investors
 Due Diligence
 Valuation
 Structure the deal
 Close
 Execute the plan
The View and What it Means….
   What is the funding “food chain?”
   What is the funding landscape?
    Where do angels and VC’s fit?
   What other funding sources are available?
   What do investors expect?
   Are you “investor-ready?
   If not, what are your next steps?
 Debt  – typically restricted to established
  firms with a proven track record or
  substantial collateral

 Equity   – typically provided by:
   Entrepreneur
   Friends & Family
   Private (angel) investors
   Venture Capital
Source: Gerheng Kong, formerly of Intersouth Partners
   Seed/Start-up Stage
    •   Founders/Family/Friends/sometimes Angels
   Early Stage
    •   Angels/Private Equity
   Expansion Stage
    •   Venture Capital/Private Equity
   Later Stage
    •   Commercial Banks/Mezzanine Debt
   Exit
    •   Mergers & Acquisition/IPO
        100 Business Plans Received

             10 Get a Close Look

1 Makes it Through Due Diligence and is Funded
   Mutual Fund Analogy
     General Partners
      • Salaried Managers
      • Minimal Investment
      • Huge Upside
     Limited Partners
      • Corporations, pension funds, wealthy individuals
      • Totally passive involvement

   Over 500 venture capital funds
   Size: $20M to $5B
Source: NVCA Yearbook– prepared by Venture Economics
   Wealthy individuals – “accredited
   Experienced and successful entrepreneurs
   Range of involvement (passive investor ->
    Lead investor)
   $25 to $250K per investment
   Current estimate – More than 400,000
    active angels
        Potentially could be 5 million angels
   Approximately 250 angel groups in US
        70% network, 22% fund, 8% network/sidecar*
   Invest close to home
    Source: ACA
Source: Center for Venture Research (CVR/SWAG)
   Venture Capitalists
       Make money and get a return on investment (ROI)
   Angels
   Stay involved (sense of engagement)
   Help fellow entrepreneurs
   Give back to the state or local economy
   Willing to invest a portion of portfolio in high
    risk areas
   ROI is still important and is a key metric
                            Angels                       VC’s
Amount of Capital           $20.1 B (2010– 14%           $21.8B (2010– 19%
                            increase over 2009)          increase over 2009)
Number of Investors         ~ 125,000                    <900
Number of                   ~62,000                      3,277
Investors per Round         $0.3 M                       $4.7 M
Professionally              Sometimes                    Yes
Motivation                  Various                      Primarily ROI

Source: Center for Venture Research (CVR), Dow Jones VentureSource, NVCA
                Number of Deals by Industry Sector
Healthcare            Software              Biotech
30%                   16%                   15%

Industrial/Energy     Retail                IT Services
8%                    5%                    5%
Lush Tropics   or      Moonscape

    Or Somewhere in Between……
90% of outside equity capital
funding for seed/early stage
entrepreneurs comes from angel
investors, not VC’s
Seed Gap   Early Stage
   Revenue
   Reduction in Overhead
   Equity for Services
   Research Grants (NIH, SBIR/STTR)
   Specialty Loans (NCNB, Self-Help, Local)
   Licensing
   Partnerships/Strategic Investors
   Customers/Suppliers
   Venture Backing
   Loans
   Understand risk/return issues
   Treat investors as “customers of equity”
   Ask them what they’re looking for
   It’s a small world… word gets around
   A secret idea never sees the light of day
   Fundraising takes more time than clients think.
    So, start early.
1)   How do lifestyle and “growth” opportunities
     affect funding choices?
2)   What deals are right for individuals?
3)   What deals are right for angel groups?
4)   What deals are right for VC’s?
5)   How does an entrepreneur approach this
1)   Do I understand the funding gap?
2)   Do I see the difference between angel capital
     and institutional venture capital?
3)   Do I see the difference between giving up
     equity and building equity?
4)   Do I know the full range of funding
5)   Do I think that equity capital is right for me?
   “SBDC Capital Opportunities Report” – Chapter 6
    (Equity Funding) –
   “Early Exits” – Chapter 2 (When to dance with an
    angel), May & Simmons
   “Business Angels: A Guide to Private Investing,” (in
    your workbook)
   Angel Capital Association,
   Angel Capital Education Foundation,
   “Early Exits,” Basil Peters
What’s the Big Idea?
The Essence and Context
   It all starts with your idea, but it’s much
    more than that!

It’s the basis of everything else
   your client does
Key Questions
 Are    you solving a REAL problem
  • “So What?”
  • “Who Cares?”
 Willthe business model create value?
 Does the business plan make sense?
 What do investors expect?
 Are you “investor-ready?”
 What are the next steps?
Investor Expectations –
The Idea
 Are   you solving a REAL problem? (Don’t be
  a solution in search of a problem)
 Is it clear, concise and compelling?
 Can you communicate it?
 Does it grab attention or capture the
 Is your idea truly unique (this is rare)
 Is it high growth- scalable?
 Is there an exit strategy for investors?
Investor Expectations –
The Model
 Value  proposition: Needs to be clear and
  solve a real problem
 Will the market pay money for the idea?
 Milestones, Assumptions, Action Steps
  should be identified and listed
 A unique model is tougher to sell
Investor Expectations – The Plan
 Provide a range of financial outcomes (low to
 Make the plan realistic and believable
 Know the dynamics—what affects the plan?
 Addressable market– know it from the bottom
 Positioning and competition—where and who?
 Backup plan – Survival is the key
 Exit plan—How does the investor “get off the
 Concise format –Use words carefully
Questions for Panelists
1)   The idea: What grabs your attention? What
     makes you yawn?
2)   The biz model: What excites you? What
     stops you from giving further consideration?
3)   Change the World: Leading edge or bleeding
     edge? What role does timing play?
4)   What do you say to a social entrepreneur who
     has a good idea for society, but may not
     make much money?
Self-Assessment Questions
1)   Does my idea capture investor imagination?
2)   Does my business model make sense?
3)   Does my business plan paint an easy-to-
     understand, clear, concise and compelling
4)   Can you describe the essence of your idea in
     or business model in 15 seconds or less—
     ”elevator pitch”?
5)   Do I have backup/survival plans?
Additional Resources
   “The Art of the Start” – Chapter 1 (The Art of
    Starting) – Guy Kawasaki
   “Fire in the Belly” – Chapter 2 (Jerry Neal with Jerry
   “What I Learned Before I Sold to Warren Buffet,”
    Chapter 24, Barnett C. Helzberg. Jr.
, ABC’s of Business Plan,
    Opportunity, Exit Panning
 your business,
    growing your business
Getting a Share
 Who are the customers?
 Why do/will they buy from you?
 Why would they leave their current suppliers?
 How much will it cost to convince them to buy,
  and how long will it take?
 If there are no current providers, why will they
  have to have your product since they’ve been
  doing without?
 Who are your competitors? What are their
  strengths and weaknesses compared to you?
 What is your sustainable advantage?
 Adequate    detail to convey understanding
 Total Market vs. Addressable Market
 Is the market large enough for adequate
 Is it growing?
 Is it scalable? (How much will it cost to
  double the size of the company?)
 Avoid the “1% of Universe” Syndrome
  (Count bottom up, not top down)
 What are their characteristics?
 How do they buy?
  • Why do they buy?
  • Describe the decision-making process from
    your customer’s point of view
 Hint:   “Everybody” is NOT the right answer
   How do you help them?
    • What “pain” does your product/service alleviate?
    • How does your product/business model work
      compared to your competitors?
    • Explain how/why your product/service is customer
   Provide proof that customers agree– don’t
   What is required to make a sale?
   What are the steps? (i.e. qualify, present,
    propose, negotiate, close, deliver)
   How long does it take to get a new customer?
   How much does it cost?
   Investors are more interested in How than
    claims of What
    •   Communicate the plan to successfully attack a
    •   Establish a position
    •   Predict and respond to competitor reactions
    •   Maintain or strengthen your position

                  …All while making a profit
   Don’t count your eggs before the contract is
    •   Investors pay for what is and ignore or discount
        heavily what may be
    •   Show traction
   Recognize that missed milestones are
    •   Best to under-promise and over-deliver
   Who are your competitors in this market?
   What are their strengths and weaknesses compared
    to you from the customer’s perspective?
    •   What do you do better than each one?
    •   What do they do better than you?
    •   How do you know?
    •   Must demonstrate ability to evaluate competition realistically
        and objectively
   How will each respond to your success?
   How easy/difficult is it to enter the market?
   Don’t underestimate the other guys
   Competitors might turn out to be potential acquirers
   Primary
    •   Talk to customers/competitors
   Secondary
    •   Research reports
    •   Evaluate comparables (similar companies/markets)
   Remember. Investors have experience in
    markets they invest in
1)   What do you listen for when entrepreneurs
     describe their current and prospective
2)   How do you distinguish scalable
     opportunities from exaggerated claims?
3)   What are the most important
     representations regarding the market?
4)   What are the most common errors you
1)   Can I describe my market so an uninvolved
     party can understand it (and describe it back to
     me accurately)?
2)   Have I tested my competitor descriptions with
3)   Do I know how our customers describe us?
4)   Can I substantiate my market claims (i.e. share
     of market, timelines, competitor response patterns)
5)   Do I have validated evidence of my claims of
     customer appeal?
Additional Resources

 “Conducting an Industry Analysis,”
 Marketing Plan Worksheet, SBTDC

 Market Assessment Checklist

 The Frugal Guerilla, Levinson
Who will get it done?
The buck stops here.
Recognize the skills and traits you
DON’T possess and hire (find)
people who DO possess them.
-- Howard Schultz, Chairman, Starbucks
 What  talent/skills/experience is needed?
 Who is on board?
 What is missing?
 What do investors expect?
 Is your company “investor-ready?”
 What are the next steps?
 Capacity  to change with a changing world
 Track record
 Balanced team
 Engaged, passionate, positive, realistic
 Builders of trust
 Knowledge of industry/science
 You  can’t do it alone
 Your role will likely change
 Build an adaptable team
 Founders and CEO’s are different over
 Anticipate a “Fredo” moment
   (Remember The Godfather)
 Vision
 Leadership
 Integrity
 Openness
 Listening Skills
   Coachable
   Great at communicating product, service or
   High degree of passion/perseverance
   Can manage the execution, or can hire those
    who can
   Know yourself
    •   Wants
    •   Capabilities
    •   Avoid “Founders Disease Syndrome”
   Confidence vs. Arrogance
   No one expects you to be all things to all
   Ask for help
   Be curious -> Radar always on
   Detective, intelligence officer and analyst
1)   What excites you about a management
2)   What are the biggest mistakes
     entrepreneurs make when selecting a
     management team?
3)   What are your management team “deal
4)   What activates the “BS” detector?
1)   Can I manage my optimism?
2)   Have I made an objective assessment of my
     team’s strengths and weaknesses– starting
     with myself?
3)   Do I know what is missing today, and what will
     be needed tomorrow?
4)   Do I truly recognize the value of outside help?
5)   Do I actively seek it?
Additional Resources
   Art of the Start – Chapter 6 (Art of Recruiting),
    Guy Kawasaki
   Good to Great, Jim Collins
   How to Build a Power Team,
   TEC Online, Best Practices: Management
 – 2010 CEO Compensation
    Study (for venture-backed tech and life science companies)
   Experienced entrepreneurs/investors – select
    ones you can trust as coaches/advisors
Passing the “Sniff” Test
 State the financial need
 Represent the vital signs
 Demonstrate the depth and quantity
  of your planning
 Indicate expected ROI
 How   much money is needed?
  • For what? How soon? For how long?
 What are the stages of need??
 What do investors expect?
 What are key financial reports?
 How do you demonstrate credibility?
  • What supports your assumptions?
 Areprofits enough?
 What are your key milestones?
 Like   the 3 Bears’ porridge:

  • Not Too Little

  • Not too Much
  • But just Right

 What     Drives the Need?
 Be  specific about how you plan to spend
  the funds
 Include projected acquisition schedules for
  equipment, employee hiring timetables,
  marketing expenditures, etc.
 Save detail for projections
 Major use of funds should be projected over a
  ramp-up period
 Instead of simply stating a need for $1 million,
  itemize as follows:
    •   $200,000 – fixtures and equipment
    •   $250,000 – prototype development
    •   $300,000 – year 1 production and operations, and,
    •   $250,000 for marketing campaign (provide
        beginning and end dates)
   May want to include a visual timetable of
    capital infusion needs
 Should   use multi-scenario projections
  • Most likely, survival, upside
 Time to reach positive cash flow
 Overly optimistic sales projections lead to:
  • Worst Case -> perceived as unsophisticated
    and unrealistic
  • Best Case -> Missed milestones and
    disappointed investors
 Understand    realistic exit issues
 Financials   indicate the need and the
 Entrepreneur thoroughly understands the
  business model and financial metrics
 Assumptions have been tested and
 Conventional format
 Multiple scenarios are represented
 No overkill
 Clarity of reports
 Assumptions clearly articulated, credible
  and justified
 Market-based and customer-focused
 Error free, no obvious omissions
 Current data
 Income Statements
 Balance Sheets
 Cash Flow Statements
 Other Reports of Key Indicators
  • Sales, Margins, Inventory, Other key ratios
   Represent a clear business model
   Convey understanding of industry segment
   Projections are connected to realistic
   Reasonable timeline
   Investors’ questions/concerns are
   Multiple scenarios
   Most likely, Survival, Upside
   Worst case doesn’t exceed likely best
   Must accommodate the “what if”
   Risk not represented if deemed unknown:
Must  demonstrate understanding of cash
vs. profit
Must be connected to market realities

Must exhibit understanding of impact of
growth on capital requirements
Must accommodate the “what if”
  •   Relationships—Sales: Inventory; Sales: AR;
      Sales: other assets
       Milestones, Credibility and Cash
        •   Performance must be measured as prototype
            completed, sales targets met, key team
            positions filled, etc.
       Tranches
    •       Staged infusions of cash that are part of a single
            round of investments
       Planning for Subsequent Rounds
        •   Understand and anticipate downstream
   Hitting milestones will likely be key to
   Revenue targets will be primary
   Others may include:
    •   Prototype development
    •   Beta testing
    •   Product shipments
    •   Management team hires
    •   Breakeven or positive cash flow
   Should represent major inflection points –
    significant, value enhancing developments
   Should clearly represent increase in value
    •   To the customer, marketplace, etc.
1)   What do you consider in evaluating true
     funding need?
2)   How much financial detail is enough?
3)   What do you look for when examining the
     assumptions? Any differences for pre-
     revenue companies?
4)   Describe the importance of milestones
     and inflection points.
5)   Discuss “top-down” vs. “bottom-up”
     approach to sales projections
1)   Do I know my true funding needs?
2)   Do my assumptions sound credible to financial
     experts? Bottom-up sales, realistic
3)   Have I compared my projections to industry
     standards? (margins, inventory/AR level &
4)   Have I adequately addressed questions posed
     by my financial advisors?
5)   Do I know my cash flow breakeven point under
     various scenarios? In units? In $$?
Additional Resources
   Sample Income Statement, Balance Sheet &
    Cash Flow Budget Worksheet
   “About Milestones”
   Samples
    •   Sources & Uses of Funds Statement
    •   Capital Needs Timeline
    •   Key Milestones Timeline
 (annual reports)
 (compensation ranges)
When & how does it matter?
 What    is a patent and what does it do?
 What will it not do?
 Copyright or Trademark?
 Trade secret?
 Is it all worth it?
 How does an investor value patents,
  copyrights and trademarks (if at all)
 Entrepreneursshould NOT be discouraged
  rom proceeding with a patent application.

 They  SHOULD have a comprehensive
  overview and review the pros and cons so
  they can make an informed decision.

 Evaluating the market potential will
  determine IF the time and cost of obtaining
  a patent will be worthwhile.
Which would you rather have?
 Inreality, there are a lot of new ideas out
 Only about 2 patents in 100 are
  commercially successful (according to the US
  Patent & Trademark Office [USPTO])
 What it Isn’t – A guarantee of success,
 wealth or value– if not defended, inventor
 UtilityPatents – These may be granted to
  anyone who invents a process, machine,
  article of manufacture or composition of
  matter that is

 Design   Patents may be granted to anyone
  who invents a NEW, ORIGINAL and
  ORNAMENTAL design for an article of
 It ONLY protects the appearance of an
  article, not its structure or utilitarian
 While assessing the market, clients will
  want to be careful about protecting their
 Use non-disclosure and/or confidentiality
  agreements when appropriate
 Patents   are key to life sciences, medical
 Less important for software as a service,
  social media (fast-moving environments)
 Funding  a Patent: There are no grants or
  free money to fund a patent
 Enforcing a Patent: It is up to the patent
  holder to monitor and enforce a patent. The
  USPTO does not do this.
 The patent is only the beginning
   Trademark
    • Distinctive sign or indicator (name, phrase, logo,
      design, image)
    • Relates to the market
   Copyright
    • Set of exclusive rights granted to author or creator of
      an original work
   Trade Secret
    • A formula, practice, process, design or compilation
      of information
    • Classic example – Coca Cola
 Determine  market potential before spending
  time and money filing a patent
 Develop a patent strategy that is tied to
  business and investment strategy
 Consider perceived vs. real value
 Research patents already issued
 Engage a qualified patent attorney
 Use a trademark to connect with customers
 Register a copyright
1)   What is the average cost to file a patent?
2)   How long does it take?
3)   Will the government help protect my
4)   When does IP REALLY matter? Can it be
     a deal maker or breaker?
1)   Do you have an idea worth protecting?
2)   Have you obtained legal advice?
3)   Have you completed a benefit/cost analysis on
     filing a patent or trademark?
4)   Are you basing your company’s future on a
5)   Have you assessed ways to leverage your
     intellectual property?
Additional Resources
   US Patent & Trademark Office –
   Google Patents –
   SBTDC User’s Guide to Intellectual Property –
   TEC Coach –
   “The Mechanics of Patent Claim Drafting,”
    John Landis
“….but liability could eat you up”
Who’s Got the Money?
 What  is a “qualified funding source?”
 Where do angel investors live?
 How to avoid the “angel from hell.”
 What do angel networks look like?
 What due diligence can an
  entrepreneur conduct?
 What is the most common mistake
  committed when seeking funding?
 In the angel investor world, it starts with
  being an “accredited” investor– a person
  with a net worth of at least $1M or an
  annual income of at least $200K (excluding
  primary residence)
 •     Revised definition in 2010 Dodd-Frank bill
 This    should be the first screening criteria.
 Angel investors don’t advertise
 They don’t hang out a shingle
 You could be surrounded by angel
  investors and not even know it.
 Careful networking is required.
 Angel investors tend to form networks either
  by design or chance
 Some key entry points to these networks can
  be found through wealth management
  specialists, attorneys, bankers, accounting
  firms and universities
 You should have your executive summary
  ready before you begin to talk to angel
 Research   the angel group’s focus area(s)
  or area(s) of interest. (i.e. web site, word of
  mouth, etc.)
 Make certain the angel group is interested
  in your industry/business type
 Expertise is as important as the money
  • Interesting tidbit: ROI for companies with
    involved angel investors is 3x that of firms with
    uninvolved angel investors.
 Failureto research the interests of the angel
  group properly
 Not being prepared when invited to make a
 Accepting investment funds from non-
  accredited investors
 Paying angel group “brokers” (waste of
1)   What questions should entrepreneurs ask
2)   What can an entrepreneur do to get in
     front of you? What is the best way to grab
     your attention?
3)   What makes you dismiss an entrepreneur
4)   What factors are important beyond
     money relationships, trust,
1)   Does your company have strong contacts with
     attorneys, bankers, CPA’s through whom
     networking can be conducted?
2)   Have you identified potential investors?
3)   Have you done due diligence on investors?
4)   Do you know what you want from investors in
     addition to money?
Additional Resources
   SBTDC Capital Opportunities Report – Chapter
    6, Equity –
   Finding Angel Investors –
   “Every Business Needs an Angel: Getting the
    Money You Need to Make Your Company
    Grow,” Simmons & May
The Teaser
The night before the big meeting, Frank receives a visit from
the PowerPoint Fairy
 What   does it take to present
 What do investors expect?
 What is an appropriate level of
 Are you ready to present to
 Introduce Yourself
 State the problem, “pain point,” or
  opportunity. (This sets the context for the rest of
  your presentation)
 Test   your opening statement.
   • Do friends, family and others understand the
 Follow quickly with the solution (This is critical
  for building momentum and interest)
  • Problem + Solution is the “1-2 Punch.” No
    room for color commentary here
 Definethe addressable market. Be certain
  you understand what your relevant and
  addressable market is….the investor will
 You’ve stated the problem, solution & market
  size. Now….
 Talk about your market position and your
 Turn a critical eye on the management team
 Review your projected P&L and basic
  financial assumptions
 Explore feasible exit options
 Then… the all important “ASK”
 Observe the 10-20-30 Rule (From Guy
  Kawasaki’s “Art of the Start)
  • 10 Slides
  • 20 Minutes
  • 30-point Font
 A picturecan be worth 1000 words
 Use stories, analogies and testimonials
 Prepare pitches of 1, 10 and 30 minutes
 Carnegie Hall
 Anticipate questions (have a few additional slides
  prepared in advance)
 Limitanswers to 45 seconds
 Stay on point—resist the temptation to take
  “side trips”
 Don’t answer questions that weren’t asked
 Use as opportunity to re-state conclusions
  or key points
1)   What do you normally see missing from
2)   What are the most common mistakes?
3)   How would you advise entrepreneurs to
     prepare for their presentation?
4)   What impresses you most in
5)   What are some credibility killers?
1)   Can you describe your business in 2 minutes
2)   Can your management team do the same?
3)   Do non-involved professionals agree?
4)   Have you developed the first 30 seconds of
     your presentation into a “killer” problem-
     solution scenario?
5)   Have you thoroughly anticipated investors’
Additional Resources
   “Presentation Guidelines,” Seraph Capital
   “Seven Tips for Successful Investor
    Presentations,” Edward Segal
   “How Venture Capital Works,” Harvard
    Business Review, Article #98611, Bob Zider
   “Take the Money….. or Run” Harvard Business
    Review, Article #0411A, John W. Mullins
   “Creating the Perfect Pitch,” Evan Carmichael
The Ultimate Test
 Verifies the business plan
 Attempts to uncover the missing
 Tries to assess the unknown
 Attempts to contain the risk of a new
  business investment
 The type of deal
 The risk profile of the investors
 The industry knowledge of the investors
 Ifinvestors have done their homework
  properly, the due diligence process will not
  be undertaken unless the deal is:
  • Within the investor’s “sweet spot”
  • The investor can bring industry knowledge to
       the deal
 Now  is the time for the entrepreneur to
  present an NDA for the investor to sign
 Be aware that many investors do not sign
  NDA’s because they see too many deals
 This is usually not an issue because
  investors aren’t in the business of stealing
  business ideas and trying to develop them
 Most  angel investment groups have a due
  diligence checklist
 The checklist usually includes basic
  business and market information
 Much of the checklist will focus on the legal
  organization of the business, capitalization,
  structure, contracts, debt, etc.
 See sample in workbook
 Quality of Management
 Size of Opportunity
 Rate of Market Growth
 Product Quality
 Competition
 Barriers to Entry
 Stage of Development
 The Management
 The Market
 The Business Model
 The Money/Financials
 Proven Track Record
  • Relevant business experience
  • A failure is significant (learning on someone else’s
 Integrity, dedication and commitment
 Vision and the ability to articulate it
 Knowledge, skill level, intelligence
 Coachable leadership
 Ability to assemble a team
 Size
 Growth  Rate
 Barriers to Entry
 Customers
 Segmentation
 Differentiation
 Competition
 Distribution Channels
 Revenue   Model
 Value  Proposition
 Distribution Strategy
 Competitive Differentiation
 Growth Strategy
 Financial   Strategy
 Capital Requirements
 Structure
 Valuation
 Exit Strategy
 Business   Plan Review
 Management   Presentation
 SiteVisit(s)
 Reference Check
 Competitive Analysis
 Financial Analysis
 The Deal
 Management Track Record/Reputation
  • Former Employers
  • Direct Reports
  • Industry Leaders or Peers
 Board Members
 Advisors
 Competitors
 Credit Reports
 “Spy” Services
 Actual   vs. Plan
 Sales (Are they real?)
 Leverage (operating, financial)
 Valuation (Is it reasonable?)
 Returns (ROI, IRR, etc.)
 Term   Sheet is Presented
 Entrepreneur Should Get Legal
 Document Preparation
 Closing
 Post-Closing Actions
 Startpreparing due diligence notebook,
  web site or data room early
 Time line– 60 to 90 days - maybe longer
 Know the business, market and financials
 Have a strong team
 Prepare references
 The deal may be just around the corner!
1)   How long does due diligence take?
2)   What are the odds of making it through
     the process?
3)   Name two things an entrepreneur can do
     to make the DD process successful?
4)   What is the worst thing an entrepreneur
     can do during the DD process?
1)   Do you have detailed documentation to back
     up your claims?
2)   Is your legal house in order?
3)   Are you willing to admit that you simply don’t
     know the answer to something?
4)   Have you been thorough in your due diligence
5)   Do you tend to oversell your idea?
Additional Resources
   Due Diligence Checklist
   “The Art of M & A Due Diligence,” Lajoux &
   “Venture Capital Due Diligence: A Guide to
    Making Smart Investments,” Justin Camp
   Astute Diligence –
What’s it all worth?
 What are the factors used in valuing a company?
 What is vs. what might be
 Overview of methodologies
 Revenue vs. Pre-revenue
 What about multiples?
 What resources are available for use in valuation?
 Shouldn’t I be compensated for my “sweat equity.?
 Opinion of value vs. negotiating skills vs. the market
 An example
For Acquisition of Ongoing Firms
Book Value – Assets less Liabilities (limited
Market  Value – Comps of similar
Income Value – Free cash flows, discounted
Average of Relevant Methods – Weighted as
Characteristics of Early-Stage Ventures
 Limited track record
 Highly variable or negative profits
 Negative cash flows
 Partial management team
 Additional risks associated with startups
Valuation Without a Track Record…
May apply public multiples with discounts
  • Limitations of multiples
Factors   beyond projections
  • Management team experience
  • Industry appeal
  • Trends & current market reality
 Investors   are participants in a marketplace
  • Expectations will vary
  • Choices are many
  • Angel investments are part of a portfolio

           … the High Risk portion
The Market
Risk-adjusted for Stage of Development

Stage of Business   ROI     5-Year X-Factor
Seed                60%           10x
Startup             50%            8x
Early-stage         40%           5x
2nd stage           30%           4x
Near exit           25%           3x
ROI       Yr. 1      Yr. 2       Yr. 3 Yr. 4           Yr. 5 Factor
10%      110%       121%       133% 146%             161% 1.6X
25%     125%        156%       195% 244%            305% 3.1X
50%     150%        225%       338% 506%            759% 7.6X
100%    200%        400%       800% 1600%           3200% 32.0X
                                 [1 + Rate of Return] years to exit
  Multiplier (X-Factor) = ______________________________

  e.g. 50% ROI = ___________________________________ = 7.6N
         Another Look at the

From an Individual investor’s perspective…
Invest      X Factor   5-Year   Invest   X Factor       5-Year
                       APR                              APR

1           Zip        0%       6        1.6            10%

2           Zip        0%       7        1.6            10%

3           Zip        0%       8        7.6            50%

4           1.3        5%       9        20.0           82%

5           1.3        5%       10       Life Support

    Portfolio Return on Investment 1-9 ---- 3.7x = 26%

Mergers & Acquisitions               65%

Bankruptcies                         27%

IPO                                  4%


Average                              27.7%

Range                                20-40%

Source: Center for Venture Research - 2007
Investors aren’t necessarily greedy. They
simply require a high rate of return to make
up for their portfolio investments that don’t
hit it big.
Investment                         $1 Million
Exit Year                          5th Year
Revenues (5th Year)                $20 million
Net Profit (5th Year)              10% = $2 million
P/E (industry)                     12.5X
Company Value                      $25 million
Required ROI                       40% = 5X
Required Valuation                 $5 million
% of Company Required              20%
Pre-Money Valuation                $4 million
Post-Money Valuation               $5 million

   Note: Annotated version in workbook
 It   helps to understand the numbers
 Potential investors will run various models to
  validate (but not set) a valuation
 At the end of the day, investors are …
  • Looking for reasonable value
  • Good return
 Don’t   expect a lot of room for negotiation
 Some   valuables shift with the investment
 • Total value of the company
 • Relative balance of ownership
 Example   demonstrated
Unit Holders   Units       Valuation    Pre-           Post-
               Issued                   investment %   investment
                                        Ownership      % Ownership
John Doe       500,000     $500,000     25%            19%
Bill Smith     400,000     $400,000     20%            15%
Jane Brown     800,000     $800,000     40%            31%
ESO Pool       300,000     $300,000     15%            15%
Total Issued   2,000,000   $2,000,000   100%           80%
               Post        Investment
Investors      500,000     $500,000     0%             20%
Total Issued   2,500,000   $2,500,000                  100%
 Shareholder   Dilution
 Eachround can be unique
 Downstream Considerations
Unit Holders      Units       Valuation    Pre-           Post-
                  Issued                   investment %   investment
                                           Ownership      % Ownership
John Doe          481,250     $240,625     19%            7.9%
Bill Smith        381,250     $190,625     15%            6.6%
Jane Brown        781,250     $390,625     31%            13%
ESO Pool          375,000     $187,000     15%            15%
Total Issued      2,500,000   $1,250,000   100%           62%
                  Post        Investment
Investors – Rd2   1,500,000   $2,000,000   0%             37.5%
Total Issued      4,000,000                               100%

$750,000 raised at $0.50 per share or a decrease in valuation of 50%
 Current   investors = “Cramees”
  • Upset because overpaid -> lose support
 Prospective   investors = “Cramors”
  • Will walk away -> the invisible “no”
 Entrepreneur
  • Self-inflicted wound
 Aim  for a “fair market” valuation
 Don’t overprice early rounds – will likely get
  hurt in the end
   Focus on the dollars (#) vs. the equity stake (%)
    • 10% of $20 million is a lot better than 100% of $200K
   For first time entrepreneurs, average ownership
    at liquidity event is 7-8% (upper 20’s for second
 Management   Team                        0-30%
 Size of Opportunity                      0-25%
 Product/Service                          0-10%
 Sales Channels                           0-10%
 Stage of Business                        0-10%
 Size of Round                            0-5%
 Need for More Funding                    0-5%
 Quality of Plan                          0-5%

    Source: The Power of Angel Investing – Kauffman Foundation
 Learnwhat investors look for and expect
 Know why they are important to investors
 Understand the factors that influence value
 Consider all areas of importance– not just those
  within your comfort zone
 Anticipate investor questions
 Look at comparative deals (comps)
 Learn from the process (listen well)
1)   Who really drives the valuation process?
2)   How can entrepreneurs best prepare for
     the valuation process?
3)   How do you handle pre-revenue firms?
4)   What do you consider to be the most
     important factors in the valuation?
5)   What are the downstream implications of
1)   Do I understand typical valuation methods?
2)   Have I tested my opinion of value with
     unrelated parties?
3)   Do I understand how investors are affected by
4)   Am I familiar with my industry standards and
     financial performance indicators?
5)   Am I willing to accept the going market
Additional Resources
   ROI and X Factors
   Valuation Worksheet
   Capitalization table and explanation
   “Business Valuation Methods”
   “Business Valuation: The Art”
Assembling the Puzzle
 Who determines the structure of the deal?
 How are stock types significant?
 What is the Term Sheet?
 What are tranches?
 Does the type of legal entity matter?
 Funds likely have templates—individuals may
  or may not.
 Negotiations will determine ultimate structure
 The stronger the critical factors (mgt team,
  proven market, etc.), the stronger the
  negotiating position
 Remember. Investors think early about exit
  strategy, and it’s not likely to be an IPO
 Become familiar with deal structure concepts
  before approaching investors– Preparation is
  key to negotiating successfully
 Common    Stock
 Preferred Stock
 Convertible Notes
 Spells out expectations, obligations and
 Addresses essential elements of
  agreement between investors and
   Annotated sample in workbook
 Participating Preferred Stock
 Liquidation Preferences
 Anti-dilution
 Protective Provisions
 Registration Rights
 Vesting Rights

Note: Annotated term term sheet/glossary in workbook
 Instead of receiving entire sum all at once,
  some is held back and disbursed upon hitting
  specific milestones (i.e. revenue, product
  development, etc..)
 Still part of current round
 Pro – May instill added discipline and
 Con – May reduce some management
 Debt     instrument that converts into equity at
    first institutional round of funding
 Interest payments – often deferred
 May include warrants to purchase future shares
 May be used for family/friend and angel rounds,
  or as a “bridge”
 Pros – No need to set valuation, fewer legal
  documents, quicker
 Cons – Debt holders can call loans, investor
  concerns (limited upside)
 VC’s     will likely only invest in a C Corporation
    (institutional investors/ERISA)
 Angel investors are more flexible, depending on
 Company can begin as an S corporation or LLC
  and convert to a C corporation later
    • Discuss tax considerations with lawyer and tax
   Significant angel investors/VC’s prefer Delaware
    corporations due to management-friendly
    statutes and existing case law
1)   At what point should the entrepreneur
     involve a lawyer?
2)   What are the most common sticking points
     for entrepreneurs in negotiating term
3)   What are the pros and cons of using
     convertible notes?
4)   Should the entrepreneur avoid certain
     legal entity choices? How about LLC’s?
1)   Have I learned the tenets of deal structure?
2)   Will I appear reasonably informed to
3)   Do I understand stock classifications?
4)   Am I familiar with the basic components of a
     term sheet?
Additional Resources
   Sample Term Sheets
   National Venture Capital Association (NCVA) –
    Model Financing Documents –
   “Venture Capital Negotiations”WCSR (brochure)
Making it Work
 How  do you effectively use board members?
 What is expected of board members?
 How much engagement is needed with
 What is expected of entrepreneurs?
   Board of Directors
    • Elected by shareholders/governed by by-laws
    • Fiduciary responsibility to company (Can be held liable)
    • Serve terms – Most often compensated
   Advisory Board
    • Informal group of experts (tech, industry) and
    • Selected by CEO/management team
    • Flexible – easy to expand/reduce size
    • No fiduciary responsibility

      Can have both
 Funding  (future rounds)
 Networking
 Industry Expertise
 Guidance
 Open Doors
 Objective Sounding Board
 Avoid Land Mines
 Composition
  • 5-7 members
  • 2 management team, 2 investors, 1
 Compensation
  • Typically stock (<1%)
  • Directors & Officers (D&O) insurance
 Boardof Directors will change with each
 round of financing
 Board  members are there to help the
  enterprise succeed (i.e. look for “gaps,”
  offer expertise, contacts, etc.)
 Interests should be aligned
 Board members with a “rubber stamp” do
  not help companies succeed
 Good communication between board
  meetings is essential
 Encourage   respectful confrontation,
  disagreement and tension
 Give investors bad news along with good
 Establish an efficient, clear and concise
  reporting process
 Ask for help when necessary
1)   Who should be on a board of directors?
     Should they be compensated? Insured?
2)   What characteristic show you that you’re
     working with a savvy entrepreneur?
3)   What should a CEO expect from a board
4)   What should a board member expect fro a
1)   Do I really want help?
2)   Have I thought about the talent I need?
3)   Can I thrive on productive disagreement and
     tension among board members?
4)   Do I understand the importance of effective
     investor/board communications?
5)   Do I understand the differences between
     fiduciary and advisory boards?
Additional Resources
   “Board Basics for Entrepreneurial Companies,”
    Ken Olson
   Boards that are not Bored,” Bradley Feld
   Board Strategies -
   TEC Online –
   “The Art of the Start” – Chapter 11 (Art of
    Being a Mensch), Guy Kawasaki
…I know it when I see it
 What  constitutes the “perfect” investor-ready
 What do investors expect in a perfect world?
 Are you investor ready?
 A well written business plan that describes
  a potentially large market with high growth
  and strong margins.
 An executive summary and pitch that is
  clear, concise, compelling, correct and
 A solid, experienced management team
  and advisory board (or willingness to build
 IPfiling or strong potential
 Entrepreneurial track record
 Early stage market testing/validation
 Clear understanding of funding landscape
 “Skin in the game”
They Expect a “Prepared” Entrepreneur…

Who   has done his/her homework on
making sure investor/angel group/VC has
interest in field, product or service that s/he
Can clearly convey the opportunity and
value proposition
 The  entrepreneur has a assembled a
  management team and advisory board that
  adds value and experience to the business
 The entrepreneur knows the business and
  numbers inside and out
 Have you conducted your networking and
  homework well enough to know who the best
  investor audience is?
 Are you viewing investors as “customers of
 Do you have the right management team with
  the right experience?
 Can all of them clearly and consistently explain
  the value proposition of the business?
 Do they know the business inside and out?
1)   In a business plan and presentation, how
     do you distinguish “flash and polish” from
2)   What are the critical components?
3)   What are the “must-do’s” for
4)   What are the “must-not's?”
1)   Have I anticipated and prepared for investor
2)   Have I tested the the clarity of my plan and
3)   Can I defend and substantiate my answers?
4)   Have I learned from the questions,
     successes and mistakes of others?
5)   Have I practiced the presentation enough?
Additional Resources
   “Angel Investing: Matching Startup Funds with
    Startup Companies – A Guide for Entrepreneurs,
    Individual Investors and Venture Capitalists,”
    Osnabrugge and Robinson
   “Winning Angels: The 7 Fundamentals of Early
    State Investing,” Amis and Stevenson

Shared By: