Raising Capital:
MICHAEL SHERIDAN MIKE@GDEXAUTO.COM 310-866-5103
An Entrepreneur’s View
or How you are going to get screwed by Venture Capitalists
Three Core Principles
More cash is preferred to less cash Cash sooner is preferred to cash later Less risky cash is preferred to more risky cash
Bargaining 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 venture
Factors Affecting Funding
• Founders’ goals regarding growth, control, liquidity, and harvesting/exit • Relative bargaining positions • Investor’s required terms and covenants
Types 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 offerings
Term 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 Rights
Pre 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 = $1.015
Preferred 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 – Comparables
Biggest 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 negotiating
Key Terms to Know
• • • • Free Cash Flow Operating Working Capital Burn Rate Syndication
Breakeven 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) – Less tax exposure (tax rate times EBIT) – Plus depreciation, amortization, and other non-cash charges – Less increase in operating working capital – Less capital expenditures
Operating Working Capital
• Operating working capital can be defined as follows:
– – – – Transactions cash balances Plus accounts receivable Plus inventory Plus other operating current assets (Not short-term Investments or land, but Pre-Paid Services) – Less accounts payable – Less taxes payable – Less other operating current liabilities (Accrued Salaries)
Good Source of Info
• http://www.venturehacks.com