Raising Venture Capital

Raising Capital: An Entrepreneur’s View or How you are going to get screwed by Venture CapitalistsMICHAEL SHERIDANMIKE@GDEXAUTO.COM310-866-5103Three Core PrinciplesMore cash is preferred to less cashCash sooner is preferred to cash laterLess risky cash is preferred to more risky cashBargaining PowerBurn rateTime to OOC (Out Of Cash)TTC (Time To Close)Competition for FundingYour Team’s PedigreeYour Idea (Disruptiveness Factor)Factors Affecting Financing•Accomplishments and performance to date•Investor’s perceived risk•Industry and technology (protection/differentiation)•Venture upside potential and anticipated exit timing•Venture anticipated growth rate•Venture age and stage of development•Investor’s required rate of return or internal rate of return•Amount of capital required and prior valuations of the ventureFactors Affecting Funding•Founders’ goals regarding growth, control, liquidity, and harvesting/exit•Relative bargaining positions•Investor’s required terms and covenantsTypes of Investors•Bootstrap (You and Chase)•FF&F•Angels ($10K-$250K)•Super Angels ($250K to $5M)•Private Equity–Seed Funds ($50K to $250K)–Early Stage VCs ($250K to $5M)–Growth-Stage VCs ($2M to $20M+)–Late Stage VCs ($10M to $50M+)How it Works•Idea Incubation (Seed Stage Capital)•“Build” (Seed Stage Capital)•Beta (Seed Stage Capital)•Go-To-Market (First Stage Capital)•Growth or No Growth (Second Stage Capital)•Sale/Continuation/Exit or Liquidation (Third Stage Capital)Funding Rounds•FF&F (Seed Round)•Angel Round or Series A (First Round: Money Infused by Outside Investors)–Outside “Professional” Investors•Series B-Z–Subsequent Rounds of Preferred Stock offeringsTerm Sheets•The terms of an investment agreement are spelled out on what is called the term sheet. (Non-Binding)•Key Terms–Lead Investor–Pre-Money Valuation–Post-Money Valuation–Dilution–Preferred vs. Common Stock–Conversion RightsPre and Post Money Valuation•Pre-Money Valuation= $1,000,000•Seed Round Investor Raise= $250,000.•Post-Money Valuation= $1,250,000•If I own 100% of the Company Pre-Investment,how much of the company do I own after investment?•How much does this investor (s) own?Calculations Even Lawyers Can Do!•Entrepreneur Ownership–1,000,000/1,250,000 = .80 or 80%•Investor Ownership–250,000/1,250,000 = .20 or 20%Amount of Investment/Post-Money Valuation= Ownership %.Dilution Example (Crude Example)•Pre-Money Valuation= $2M•Raising $1M•Post-Money Valuation= $3M•Owner: 2,000,000 Shares•Investor purchases 33% of the company: –New Shares Need to be Issued–X=New Shares Needed to be issues–x/(2,000,000+x)=.33 or 33%–x=985,075•Owner is Diluted Down to 67% ownership even though he still owns same amount of shares.Price per Share•Investor Shares= Investment/Share Price•985,075=1,000,000/Share Price•Share Price = $1.015Preferred vs. Common & Conversion•All Outside Investors want Preferred Convertible Stock•Liquidation Preferences•Dividend Preferences•Conversion Rate is usually 1 to 1 with Common Stock•Converts whenever an investor wants to or upon specific events (i.e. acquisition or most exit strategies)Valuation Determination•More Art than Science•Clearly State Assumptions•Clearly Define Revenue Model–Related it to other companies•Financial Models to Use–DCF Model–ComparablesBiggest Mistakes•I’ll take any investor. No….•Instead of pay for my employees, I will just handout a bunch of equity. •Having that guy on my Board of Directors will look really good.•Not negotiatingKey Terms to Know•Free Cash Flow•Operating Working Capital•Burn Rate•SyndicationBreakeven Point•Total Sales=Total Costs•Usually determined as a point in time (i.e. “we expect to breakeven in Month 16 when our sales exceed our burn rate or total costs)Free Cash Flow•The cash flow generated by a company or project is defined as follows:–Earnings before interest and taxes (EBIT)–Lesstax exposure (tax rate times EBIT)–Plusdepreciation, amortization, and other non-cash charges–Lessincrease in operating working capital–Lesscapital expendituresOperating Working Capital•Operating working capital can be defined as follows:–Transactions cash balances–Plusaccounts receivable–Plusinventory–Plusother operating current assets (Not short-term Investments or land, but Pre-Paid Services)–Less accounts payable–Less taxes payable–Lessother operating current liabilities (Accrued Salaries)Good Source of Info •http://www.venturehacks.com