Week 9: Raising Capital

Early stage term sheet: investor protections Antidilution (non-price-based) antidilution (price-based) Liquidation Preference 2 things?

Antidilution (non-price-based) - conversation price is adjusted to ensure that the preferred shareholder will receive a number of common shares upon conversion so that the shareholder's original percentage of ownership is maintained - right of first refusal Antidilution (price-based) - full-ratchet antidilutoin protection (i.e. protects against down rounds) - weighted average anti dilution protection Liquidation preference 1. convention liquation ("single Dip") - choose b/w receiving the liquidation preference or converting to common stock in order to share pro rata (in proportion, equal) in the total proceeds 2. participating preferred ("double dip" - receive the liquidation preference and "as-if-converted" basis with the common stockholders

what are unicorns?

venture-backed private companies that value at $1billion or more

Financing new ventures Questions for Funding sources? Pitching strategies? financing Tactics?

Funding sources - from whom should you raise money? - potential sources: Banks, VC's, Angel investors Pitching strategies - what are funders looking for and how should you structure your business model to be attractive to them? Financing tactics - how much money should a venture raise? - how is value determined?

What is crowd funding gaol? 4 different crowd funding based

Goal: to enable companies to raise funds from individual investors online 1. reward based (kickstarted) 2. Lending based (Kiva) - focuses on peer to peer lending 3. Donation-based (indieogogo) 4. Equity-based (seed ups)

Convertible preferred stock

a form of stock that can be redeemed at the face value of investment, or converted into common stock to get a pre-nogotiated share of a company

business accelerator

a program that provides office space, proximity to other startup entrepreneurs, mentoring, access to investors, and some see funding

Down round

a round of financing in which the value of a venture has dropped since the previous round

up round

a round of financing in which the value of a venture has increased since the previous round

flat round

a round of financing in which the value of a venture has remained the same since the previous rounds

angel groups

associations of angel investors who collectively screen and invest in startup venture

Funding sources and business models differences in financing options are influenced by... some ventures can be cleverly designed to reduce... what can jeopardize its financing? what does past funding decisions effect? where do most businesses remain?

- differences in financing options are influenced by the location decisions for startups - banks are everywhere but VC investments are clustered - some ventures can be cleverly designed to reduce the capital needs or the uncertainty faced by financiers - changes in the risk and uncertainty profile of a project can jeopardize its financing - past funding decisions, especially to equity investors, have lasting implications on subsequent business model decisions - most businesses remain in the same "quadrant"

Seed and Early-stage investing overview who?

- friends and family - angel investors - super angels - incubators (control environment) - accelerators - crowdfunding

Friends and family? what are the benefits and issues of Friends and family

- group of investors (friends/family/fools) - small $ from close relatives Benefits: - usually friendly investor terms - willing to invest in you vs. the idea / company - higher classes of investors (i.e. angels and VS's) want to see them. shows you have "skin in the game" Issues: - may negatively impact relationship - no way to scale up as funding needs increase

Convertible financing structures Convertible preferred stock when it is greater or less than negotiated valuation?

- looks like debt if company liquidates < its negotiated valuation - converts to shares if company at > negotiated valuation

VC Factors: control - what or who do they control? what does it include?

- one extensive area of negotiation - venture captialists > angels - need to show returns to investors - past returns impact raising new investment funds - greater amount of $$$ includes - seat on the board - influence direction of the company - convenants the prevent major undertakings - different direction, asset sales, merger - replace CEO

What are super angels? what is the average investments?

- they are micro VC firms, investing their own funds as well as money from limited partners eg. ron conway and mike maples 25K to 1M

Venture capitalists investment strategy - they reduce - they induce

- they invest in stages, why? reduce: - risk - financial exposure - uncertainty induces: - pressure to achieve milestones - test of management to deliver

Initial public offering (IPO) what is it a transition from and to? shares of a company are sold to? used for? investment banks are used to underwrite the investment by?

- transition of private company to a public company shares are sold to institutional investors (banks, pension funds) - shares are then resold to the general public used for: - raise expansion capital - monetize investments by early private investors Investment banks used to underwrite the investment - perform diligence - help to price shares accurately

Bootstrapping - what does it utilize? - limits? - retains ...

- utilizes quick cash flow and personal resources - limits - pace of growth - excess spending - chasing too many ideas/ products - retains full ownership (no dilution)

What was the big due diligence for Friendster?

- was all about the business angle, the model and the momentum - there was no engineering problem being solved - the big due diligence we did for friendster was to identify the competitors with the most momentum and look at usage and membership statistics

FINANCIAL IMPLICATIONS OF BUSINESS MODEL three factors that determine financial needs

1. Underlying profitability - value of the output vs. costs of the input 2. asset intensity - amount of assists tied up in the business - machinery and plants - working capital : inventory and Accounts payable vs. accounts receivable 3. pace of growth - speed at which company needs to grow

6 myths about venture capitalists and the truth

1. Venture capital is the primary source of startup funding - <1% of US companies have raised capital from VC's 2. Vc's take a big risk when they invest in your startup - VC's are risking other peoples money too ( limited partners) 3. Most VC's offer great advice and mentoring - experience varies significantly between VC's 4. VC's generate spectacular returns - the majority of returns in the industry and provided by the top performing funds, everyone else fails to beat the market 5. in venture capital bigger is better - larger VC funds fail to outperform the market 6. VC's are innovators - innovative models of financing startups have come from outside the industry (crowd funding, platforms like angel list)

What are the 3 financial models?

1. bootstrapping 2. Debt Financing 3. Equity financing

What are the 2 schools of thought for evaluating potential opportunities?

1. i invest in people first and foremost - smart people will find great opportunities and i will never know the sectors or tech. as well as the smart people 2. i don't care about people; i care most about markets - look for big opportunities, big painful problems that customers have

Convertible financing structure What is convertible equity

Convertible equity (newer method) - similar to convertible note - removes interest provisions and repayment at maturity

option pool

shares of stock reserved for present and future employees

Pitching strategies for financing ventures understand who? is raising money important? when should you build a relationship? Demonstrate...

DO YOUR HOMEWORK! " pitch right for your type" - build a sense of desire and urgency in investors understand the investor - industry focus - size of fund and investments - where they are on their fund cycle - passion Who you raise money from is extremely important - less money from a better partner may be critical Demonstrate leadership - ability to hire - lead - recruit and inspire

Debt vs. Equity Capital upside downside and result

Debt investors - lend a fixed amount of money for a specific period of time at a given interest rate - downside is complete loss of principal - upside is bounded - result: debt investors primarily concerned about downside protection and only lend to less risky ventures Equity Investors - "VC's and Angel investors - receive a longterm ownership claim over the venture - downside is complete loss of investment - upside is unbounded - results: companies with significant uncertainty must rely on equity investors

What are 3 things in the early-stage term sheet: investor protections 1. Dividends - when are cumulative dividends paid? 2. Redemption 3. Control Rights

Dividends: the right of the preferred shareholders to an annual or quarterly dividend, to be paid in preference to the holders of any other class of stock - cumulative dividend are usually paid: at discretion of the board, upon redemption, upon liquidation Redemption: The right of the investor to force the company to redeem (buy back) the investor's stake at a specified time in the future Control Rights: investors may exercise additional control over companies decision in 2 main ways - may have right to designate members of the Board of directors - protective provisions require a vote by the holders of the preferred stock before the company can take certain actions

asset intesity

the amount of assets that must be tied up in a business to generate cash

crowdfunding

the pooling of resources by many individuals to invest in private companies or projects

Boostrap

to draw only on personal resources to achieve cash flow and become profitable

Tactical Strategies for financing ventures what homework should you do? what has value? Do not run out of... Understand what?

Homework - know how much you need to achieve critical milestones - raise appropriately Deal terms have value (and sometimes are easier to negotiate) - ex. board seats Do not run out of cash Understand that VALUATION is in the context of a financing negotiation - valuation is the result of the relative bargaining power of the counter parties - a certain % equity for a specified $ amount - its NOT what the company is worth, but the value you are willing to sell

incubator and accelerators examples

Incubators - help entrepreneurs launch companies by providing office space, assistance with access to funding and basic business services etc. - can be non-profit or profit driven Accelerators - famous accelerators: tech stars, angel pad - instead of office space, provided "boot camp" like intensive coaching networking - hold "demo days" at the end of each session - almost always for profit

Private Equity when does it occur? reasons for investments?

Late stage capital - large $ investments often > 100M Reasons for investment - support a mature company's growth restructure the company - changing management - taking a public company private again - allows for the company to make changes without impacting "value" of the company - save $ as no longer have to follow SEC rules for a publicly traded company - save from bankruptcy Merge with other companies

Technical due diligence Customer due diligence industry due diligence entrepreneur due diligence

Technical due diligence: big part of the data considered when engineering innovation is involved Customer due dilligence: find out what the customers' real needs are and their willingness to pay. but its all sketchy and really hard to do Industry due diligence: Probe industry experts about the idea, the team, the market, and the market needs Entrepreneur due diligence: on the entrepreneur and team, call their references and blind references

How do you evaluate opportunities? what is most important requirement?

The most important requirement is a large market opportunity

What determines the terms of a particular deal? 3 questions

leverage! - the relative bargaining powers of the 2 parties is all that matters - how critically are the funds needed? - how well the company is doing? - how many other potential investors are there?

Angels benefits and issues? Networks?

benefits from angels - connections to customers - industry knowledge - advisors - do not require a board seat Issues - distractions to keep various investors informed (and happy) angel networks - pool together accredited investors, share due diligence and knowledge base - invest individually

Convertible financing structures What is a convertible note? pros and cons when does convertible note convert to shares?

convertible note - looks like debt or a loan - usually occurs with seed rounds - duet to unknown valuations pros: quick, easy, no negotiation value cons: - accumulation of interest rates (can be different for different investors) - startups show large debts on books (hard to raise bank loans) - reaches maturity may bankrupt startup converts to shares on the 1st round of financing - usually given a discounted rate and cap due to risk put in

who are strategic investors and what is their motivation? what are the benefits to startup companies?

corporations motivation - exposure to important new tech. - pipeline of new products (pharmaceutical products) - options for first-right-of-refusal to purchase - blocking mechanism, prevent competitors from entering market or gaining - access to new markets benefits to startup companies - exposure to key partners - higher valuation - ROI is not as critical an element

Equity investors - What is the downside and upside? - who does it consist of? - receive a ... - what is the result?

downside: is complete loss of investment upside: is unbounded - venture capitalists and angel investors - receive a long-term ownership claim over the venture Result: companies with a significant uncertainty must rely on equity investors

Financing new ventures and the questions of funding sources? Pitching strategy? Financing tactics?

funding sources - from whom should you raise money? banks, vc's, angel investors What are funders looking for? How should you structure your business model to be attractive to them? How much money should a venture raise? how is value determined?

angels

individals, or groups of individuals, who invest in their own money in startup ventures

debt investors

individuals or organizations that lend a fixed sum of money for a specified period at a give interest rate

Debt financing - lends a fixed amount of money for... - what is the downside and the upside? what are debt investors primarily concerned about?

lends a fixed amount of money for a specific period of time at a given interest rate downside: is complete loss of principal upside: is bounded debt investors primarily concerned about the downside protection and only lend to less risky ventures