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Start-up Finance An Entrepreneur’s Manual

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					  Startup Finance

An Entrepreneur’s Manual
About Index Ventures
Index Ventures

• Pan European Venture Fund   • Over €1.5bn under management

• Based London & Geneva       • Active investor in web / internet


Selected Investments
Agenda

         Important reflections before you
         start


           What are the financing options?



            How to attract and engage investors?



               Deal structure and what to expect
               during the investment process
A big undertaking


 • Starting a business is a big commitment
   – Energy & Passion
   – Time
   – Financial resources (yours and your investors)
 • Before thinking of financing, is worth
   taking a deep breath …
Key questions about you


 • Why am doing this
   – Make money
   – Lifestyle
   – “Change the world”
 • How long do you want to commit?
 • What level of financial risk are you
   prepared to take?
Key questions about the business


 • Be honest with yourself about the risks /
   unknowns
   – Do customers want the product / service?
   – Do you have the competence to build the
     product and the team
   – Can you monetise the product / service?
   – How competitive is / will the space be?
   – How big can the overall market become?
Agenda

         Important reflections before you start



           What are the financing options?



             How to attract and engage investors?



               Deal structure and what to expect
               during the investment process
Overview of financing options

     Non-Equity Financing   Equity Financing


                            Angel Financing



       Self Finance /
                            Venture Capital
       Bootstrapping


          Debt /
                            Private Equity
        Bank Finance


                                Public
                            Stock Markets
Self financing / bootstrapping


 • Financing growth from previous cashflow and personal
   funds
 • Obviously need to have cashflows…
 • Most good bootstrapped companies emerge from a service
   or consulting companies that are productising their offering
 • Pros
    – Bootstrapped companies almost always spend cash more
      effectively than equity financed companies
    – Already being close to existing customers, give excellent
      ability to understand problems and define good solutions
 • Cons
    – Resources for product and market dev constrained by
      cashflows
    – May miss a big opportunity if other players raise finance and
      invest heavily
Debt / bank finance


 • Relatively limited funds will be available ;
   likely to want security anyway
 • Banks only lend to predictable businesses
   they can understand
 • If your capital requirements are limited
   and your business is following a well
   trodden path, can be a useful source of
   finance
 • Not particularly useful web or high growth
   tech industries
Good reasons to raise equity finance

        Pre-requisites

                                                   Large Potential
         Unique Product         Passionate
                                                       Market
           Or Concept         Founding Team
                                                    Opportunity




        Implications…

                       Intense
                                          Need to move
                     competition
                                             rapidly
                        likely



        VC funding supports


                              Rapid Product
               Hiring                             Partnerships
                               Development


                              Internationalisa   Commercialisati
           Infrastructure
                                    tion             on
When NOT to raise VC


       Application
                          Market size is        Motivation is
      is a feature
                           too small            not financial
     not a product


     •   Risk is not that you waste time unsuccessfully trying
         to raise finance …
     •   … real danger is that you do succeed in raising VC
         funds
          – Lose opportunity for small exit which could be
            personally lucrative
          – Lose opportunity to run lifestyle business
          – Get bound in to 3+ yrs work you may not enjoy
Equity Financing


                                Early Stage     Later Stage     Pre-IPO /       Private
                 Seed
                               Series A, (B)     (B),C,D…        Buy-out        Equity

Investment   0 - €1m           €2m-€20m        €5m-€20m       €30m+
Size

Potential    Grant-funding     Venture         Venture        Specialist Late
Sources of                     Capital         Capital        stage tech
Funds        University seed                                  investment
             funds             (Wealthy)
                               Angel                          funds
             Friends and       investors                      Hedge Funds
             family

             Angel Investors

             (Venture
             Capital)




                                                                Growth Fund
Agenda

         Important reflections before you start



           What are the financing options?



             How to attract and engage investors?



               Deal structure and what to expect
               during the investment process
Venture Capital – How the VC makes
money

    • Raise fund every 2-4 years
       – Pension funds, financial institutions and specialist “fund of
         fund” investors

    • Invest money over 3-5 years
       ~ 1/2 of investments lose money
       ~ 1/3 of investments break even
       ~ 1/6 of investments make (lots) of money

    • Very small management fee on funds managed
       ~ 1-2.5% pa

    • Carry
       ~ 20-25%x (Total Return – Total Amount Invested)
Angels – How the Angel investor makes
money
 • Unlike the VC the Angel invests their own money

 • Much smaller absolute returns can be very meaningful to an angel

 • The Angel approach is to invest small amounts at a very early
   stage / low valuation
    – €50-€250k at valuations of €500k-€4m

 • Two “exits” for angel
    – Firm might be sold quickly for €5-10m or less where the Angel can
      make 2-5x money
    – Firm raises VC money, after which Angel typically becomes more
      passive but has built up exposure very cheaply to a venture backed
      enterprise

 • The key thing when selecting an Angel therefore is whether they
   can help you raise VC finance
    – See which Angel investors have invested with which VCs
Venture Capital – What a good VC will
add

  • Advice and Strategy     • Internationalisation
  • Hiring                  • Trusted service
     –   Developers           provider relationships
     –   Country Managers      – Search / recruiting
     –   Sales                 – Branding / PR
     –   CEO / CFO / COO       – Finance, etc
     –   Advisory Board
                            • Exit optimisation
  • Partnerships               – Knowledge / contacts
  • Profile and PR               with relevant buyers
                               – Experience with process
  • Further access to
    capital
What does an investor look for?

     Team                       Technology               Traction




     •   Can   evaluate each as
          –    Exceptional
          –    Good / credible
          –    Mediocre / incomplete


     •   Misconception that being good / credible across the board is
         what VCs look for
          – Can always add credible attributes to the mix later


     •   We focus on finding opportunities which rate as exceptional in
         one attribute
Identifying relevant VC partners



                Has funds
                 to invest
                                               •   Do create a shortlist
                                               •   Rifle is a better weapon
                                   Match of        than a shotgun
   Excellent
                                 Size/Stage/
 track record
                                  Geography
                 Shortlist
                                               •   Similar process for
                                                   identifying angels, look at
                                                   VC funding press releases to
                                                   identify prior Angel
       No directly
      competitive
                             Relevant              investors
                             Portfolio
      investments
Getting on radar screens


 • Out of the blue email is a longshot
 • Try to build context
   – Analyse portfolio companies – are there any links
     there?
   – Analyse contact network and advisors
   – Analyse press coverage
   – Participate in blog conversations
   – Attend events and conferences
   – Relevant PR around product also helps
 • VCs spend their time looking for businesses
   with momentum
Agenda

         Important reflections before you start



           What are the financing options?



             How to attract and engage investors?



               Deal structure and what to expect
               during the investment process
Sharing relevant information

 Pre - first meeting             Pre - termsheet               Post - termsheet

• 100 page business plan       • Dialogue rather than         • Some additional
  not required                   documentation – expect         reference calls with
• 20 page ppt which              lots of meetings               partners / customers
  clearly answers main         • Calls with current /         • Personal reference calls
  questions is best bet          prospective customers or     • Legal / accounting audit
    –   Product                  partners                       (if relevant)
    –   Market
    –   Business Model
                               • Meeting broader team         • Drafting legal
    –   Team                   • Brainstorming around           documentation
    –   Competition              strategy
    –   Product Roadmap
    –   Technology Overview    • Identifying key hires post
    –   Business Development     closing
    –   Financial Status
                               • Formal presentation to
                                 VC partnership




                                       2-4 weeks                     1-2 Months
Types of investment


 • Ordinary Share investment
   – Simplest form, often used by angels
   – All shareholders have similar rights
   – Company Board composed according to

 • Convertible Loan
   – Sometimes used by both Angels and VCs
   – Typically when another financing is anticipated soon
   – Loan will convert (with a discount ~25%) into the next
     financing round

 • Preferred Share Investment
   – Typical Structure used by VCs and occasionally larger Angels
     investing as a group
Understanding a termsheet –
case study


 • Anything between 2 and 15 pages (if points are
   spelt out in fuller legalise)


 • Sample phrasing is
   – “[XXX fund] proposes to lead a Series A preferred share financing
     of €5m at a €8m pre-money valuation. As part of the investment
     process an employee option pool of 15% on a post money basis will
     be put in place. Typical venture capital terms including
     participating liquidation preference, etc. etc …”


 • What does it all mean?
Case Study – Cap Table
Venture Capital – “Typical Deal Terms”

                                              but that’s
  •   Board Representation                        so
  •   Liquidation Preference                  unfair…

  •   Participation rights
  •   Anti-dilution rights
  •   Element of reverse vesting
  •   Certain control and veto rights
  •   Period of exclusivity to close legals
Case Study - liquidation preference

                                         Types of Liquidation Preference

                           30
 Payout to Series A (€m)




                           25

                           20

                           15

                           10

                           5

                           0
                                0   10     20         30          40         50         60      70   80

                                                Valuation of Company at Exit (€m)


                                          No Liquidation Preference
                                          Non-Participating liquidation preference
                                          Participating Liquidation preference
                                          Participating Liquidation preference (capped at 3x)
Case Study - liquidation preference

                                         Types of Liquidation Preference

                           30
 Payout to Series A (€m)




                           25

                           20

                           15

                           10

                           5

                           0
                                0   10     20        30         40        50        60   70   80

                                                Valuation of Company at Exit (€m)




                                                     No Liquidation Preference
Case Study - liquidation preference

                                         Types of Liquidation Preference

                           30
 Payout to Series A (€m)




                           25

                           20

                           15

                           10

                           5

                           0
                                0   10     20          30         40         50            60   70   80

                                                Valuation of Company at Exit (€m)




                                                Non-Participating liquidation preference
Case Study - liquidation preference

                                         Types of Liquidation Preference

                           30
 Payout to Series A (€m)




                           25

                           20

                           15

                           10

                           5

                           0
                                0   10     20         30         40         50          60   70   80

                                                Valuation of Company at Exit (€m)




                                                 Participating Liquidation preference
Case Study - liquidation preference

                                         Types of Liquidation Preference

                           30
 Payout to Series A (€m)




                           25

                           20

                           15

                           10

                           5

                           0
                                0   10     20         30         40          50         60      70   80

                                                Valuation of Company at Exit (€m)




                                          Participating Liquidation preference (capped at 3x)
Case Study - Antidilution


 • If a subsequent investment round is done a price lower
   than the previous investment round then the previous
   investment round is repriced (more stock issued to Series
   A)


 • Two flavours
    – Broad-based – Series A price ratchets down based on size of
      Series B relative to Previous post-money valuation
    – Narrow-based – Series A price ratchets down based on size of
      Series B relative to Size of Series A

 • Say €5m Series B done at €0.75 per share
    – Broad-based – Series A reprices = €1.00–((5/(5+15.3)*€0.25)
      = €0.93
    – Narrow-based – Series A reprices €1.00–((5/(5+5)*€0.25) =
      €0.875
Case Study – Reverse Vesting


• The value of startup is
  typically in the promise of
  future labour from the
  founders
• Investors seek to secure this
  by reverse vesting founder
  stock, typically over 3 or 4
  years
• For startups typically all
  founder stock is subject to
  reverse vesting.
• For later stage companies
  perhaps half the stock might
  be subject to vesting
• NB – this also protects
  founders from each other
Choosing the right VC - Valuation should
not be the decisive factor
    Entrepreneur’s Equation    •   Revenues / Profitability

                               •   Growth rate

                               •   Team quality
          Value at exit
                               •   Strategic fit with buyer community

                               •   Well managed exit process



                               •   Fewest strategic errors made

                               •   Hiring (quality & speed)
      Probability of getting   •   Partnerships
             there
                               •   Product development




                               •   Valuation at initial round

                               •   Valuation and dilution at
      % share of business          subsequent rounds
            at exit
                               •   Option grants
Key things to consider when choosing an
investor

 • Relationship
    – With key individual(s); and
    – broader team

 • References                            Right partner at a fair
    – Speak to other founders                    price
                                                   vs.
 • Portfolio
                                          Any partner at best
    – Relevant experience
    – Non competitive                           price
    – Community you want to be part of

 • Valuation and associated deal terms
Thank you
Artwork – (Transparent Layers)

				
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