Allan Chao Startup Consultant Startup V8 allan@startupv8.com UC Berkeley Extension, Summer 2012

Question of the day:

How much does it cost to raise money?

The Agenda Quiz

Quick review of last session

Startup Legal Issues

Finance and Incubation

Guest Speaker: Justin Hovey (attorney)

Guest Speaker: Jorden Woods (fundraising consultant)

Quiz Time

Good luck!

10 minutes max

Quick review of prior material Positioning and Targeting

Demographics

Psychographics

Segmenting

Value Proposition / Unique Selling Proposition

Differentiation

Competitors

MySpace vs Facebook

First Mover Advantage

Risk and myth

Niche

Critical Mass

Two-sided markets

Source Data Analysis

Conversion Funnels Search Engine Optimization (SEO)

Organic

Techniques

Blackhat marketing

Pay-per-click (PPC)

Google Adwords

Social Media (SM)

Blogging, Twitter

Public Relations (PR)

Launch Strategy

Analytics

Virality

Offline Marketing

“on-the-ground” campaigns

Events

Traditional marketing TV, radio, magazines

Referrals

Revenue vs Profit

Business Models: B2C, B2SMB, B2E

Revenue Models

Advertising

Subscription Models

Freemium

Churn rate

Product Market Fit

Pivot

Most common Legal Issues Non-disclosure Agreement (NDA)

Contracts

With cofounders, employees, vendors, customers, clients, etc.

Incorporation

General advice

NDA Non-disclosure Agreement

Most commonly “Mutual Non-disclosure Agreement”

Used for protecting your ideas and execution

Tends to be overused by novice entrepreneurs

Most professionals in the startup environment do not sign NDAs unless there is another agreement in effect Investors

Consultants

Contractors

5 Legal Entities to do Business Non Incorporated:

Sole Proprietorship

Partnership

Incorporated

C-Corporation

LLC

S-Corporation

Non-incorporation (not companies) Sole Proprietorship

Individual doing something.

Requires minimal paperwork

Taxes apply to individual

Personal liability

Partnership A few partners with equal ownership of the company

Requires much less paperwork than incorporation

Taxes apply to partners

Personal liability for all partners

Benefits of Incorporation More “formal” and professional

Make purchases on behalf of the company, without giving out personal information

Liability shield Company is liable, avoid personal liability

Clear ownership and rules of rights and responsibilities E.g. reporting requirements

Raising money from investors

Lasts longer than the owners

Types of Incorporation LLC

The “simplest” legal entity No stock, no shares, only “members”, loosely organized Very poor organizational structure for investors Pass-through taxation

C-Corporation The “most organized” legal entity Company owned by stock and shares. Clear rights and ownership. Best organizational structure for investors. Double taxation

S-Corporation Similar to C-corporation Limited number and types of shareholders Pass-through taxation

Shares Company is owned by its shareholders

Shares give voting rights for major issues Profits distributed according to shares

E.g. 1,000,000 shares outstanding (100% of ownership) Founder 1: 400,000 shares Founder 2: 400,000 shares 200,000 shares reserved for first round of investors

Common Stock Standard ownership and voting rights

Preferred Stock Many variants, e.g. first pay-out in case of closure or acquisition This is one of the causes for the “how high are you aiming” issue

Stock options Used for less important employees, option to buy stock at a low strike

price. No ownership yet, so no voting rights.

Vesting Vesting

“vest” fraction of shares each month over time Usually 4 years (1-yr cliff) for employees Usually 2 years (no cliff) for advisors No vesting for investors

E.g. 1,000,000 shares (100% of ownership) Founder 1: 400,000 shares vesting over 4 years Founder 2: 400,000 shares vesting over 4 years 200,000 shares reserved for first round of investors

Founder 1 vesting example After 1-11 months: no ownership After 12 months: 100,000 shares (reached cliff) After 13 months: 108,333 shares (1/48th per month) After 48 months: 400,000 shares (fully vested)

Dilution Dilution

After all outstanding shares have been distributed In order to raise money, create new shares and issue them to next

round of investors All existing shareholders get diluted

Started with 1,000,000 shares (100% of ownership) Original

Founder 1: 400,000 shares = 40% Founder 2: 400,000 shares = 40% Seed investors: 200,000 shares = 20%

E.g. 700,000 shares created for Series A Founder 1: 400,000/1,700,000 = 23.5% Founder 2: 400,000/1,700,000 = 23.5% Seed investors: 200,000/1,700,000 = 11.7% Series A investors: 500,000/1,700,000 = 29.4% ISO pool: 200,000/1,700,000 = 11.7%

Patents When is the right

time to file a patent?

Patent Trolls

Methods of Financing a startup “organic” growth versus “land-grab” growth

How high are you aiming?

Personal Wealth

Debt Financing Bank loans are very unlikely because startups fail

Personal loans are much more common Frequently in the form of convertible debt

Equity Financing Venture capital

Equity Financing Goal = Give away significant ownership of your

company to raise money and bring on talent.

Founders Very generally, founders start with an equal split 50-50

or 33-33-33

More complicated ways to calculate… google “founder equity calculator”

Thinking that the idea is worth significantly more (e.g. 80-20) shows inexperience and lack of understanding

Capitalization tables to predict effects of dilution

Employees expect to get vesting stock

Equity Fundraising Rounds

Friends and Family $50-250k Convertible notes

Angels up to $1 M

Super angels up to $2.5 M

VCs Series A $3+ M

Normally 2-3 rounds… ABC exit.

Rounds DEF = “cramdown” rounds… bad terms

The one goal of investors is to exit. $$$$$

Convertible Notes Basically, straight debt that has a maturity date

If the startup raises venture capital, the debt “converts” into equity

The conversion rate is based on the valuation at the time of venture capital, with some discount for the additional risk

Convertible notes are easy (fewer terms, less paperwork), and do not require valuation of the company

Most commonly used with Friends and Family and Angel investors.

Investors want to Exit Option 1: IPO = Initial public offering

Makes the most money ($1 billion +) Hardest to do (very few companies make it this far) Notables: Facebook, Groupon, LinkedIN

Option 2: Acquisition Usually makes less money ($10 million - $1 billion) “Easier” to do Notables: YouTube (Google), Skype (Microsoft), Instagram

(FB)

Option 3: “Lifestyle business” Makes the least money (recurring “passive” income of <$1 M) “Easiest” to do No angel or VC investor will invest in a lifestyle business. Notables: 4-hour workweek

The Startup Lifecycle

http://www.netvalley.com/silicon_valley/Legal_Bridge_From_El_Dorado_to_Silicon_Valley.html

Venture Capital history

http://techowtest.files.wordpress.com/2012/03/historyofstartupsandbubbles1.png

Equity Financing caveats Takes a long, long, long time to raise money.

Very involved process

Prepare to spend money to raise money

Preparation workshops

Preparing Presentations

Flights to investors

Dinner

Beware of losing your company

Term sheets must be reviewed by your lawyer!

Tools for calculating equity Equity Calculator

Determining equity split between founders

http://foundrs.com/calculator/index.php

Capitalization Tables http://www.askventure.com/download-sample-share-cap-

table-template-of-a-venture-capital-term-sheet/

Dilution Calculators http://www.ownyourventure.com/equitySim.html

http://hackfwd.com/dilution

Alternative Financing Crowd Funding

Kickstarter.com

Rockethub

Competitions / Grants

Solo Funding

Bank loans unlikely

Second mortgage

Credit cards!!??

Start eating ramen noodles

Incubation Programs that help entrepreneurs get started on their

projects in exchange for 5-10% equity

Very small seed capital ($20,000)

Networking and relationship building

Presentations to angel investors

Application based… very competitive (internationally)

Incubator Examples Incubators

Y-combinator (Mountain View, CA)

Techstars (Boulder, CO)

Excelerate Labs (Chicago, IL)

Graduates of Incubators Dropbox

Scribd

Reddit

Justin.tv

Posterous

Crunchbase, AngelList Crunchbase

Useful for finding funding status of startups

http://crunchbase.com/

AngelList

Useful for finding info about individual investors

http://angel.co/

Justin Hovey Bio Mr. Hovey focuses on venture financings, mergers and

acquisitions and corporate and securities matters. Mr. Hovey's practice includes advising entrepreneurs and start-up companies, venture capital financings, mergers and acquisitions and initial public offerings as well as counseling public companies in securities and compliance matters. Mr. Hovey’s startup practice focuses primarily on companies in the gaming, social media, online advertising and entertainment space.

Questions to ask Justin When should a startup incorporate?

How can cofounders protect themselves from bad breakups?

What do you think about using LegalZoom to incorporate?

What’s the most common legal problem that startups face?

What’s the difference between a good attorney and a great attorney?

Jorden Woods Bio Jorden Woods is a Silicon Valley serial entrepreneur who

has founded and led 3 IT-focused companies over the last 12 years: two enterprise software companies and a management consultancy. He very much enjoys working with entrepreneurs and fast-paced high-tech companies in either a consulting or operational capacity.

As a Silicon Valley serial entrepreneur he has significant experience in the areas of mobile/wireless solutions, Web 2.0/3.0, online/mobile video gaming, enterprise software, networking, medical software/devices, Ajax/RIA technologies, and globalization.

Questions to ask Jorden What are the most common fundraising issues that

startups face?

What are investors looking for in entrepreneurs and startups?

What’s the best way for an entrepreneur with a qualified startup to find investors?

What is the process of raising money and how long does it take?

What are the personal liabilities for an entrepreneur who receives funding for his company?

Homework

(Team) Prepare your Final Presentation

Final Project Presentations Present your startup to an investment firm

Target a 15 minute presentation

Pitch deck

Business plan

Demo (wireframes, mockups?)

How far you’ve gotten in your project (code, deployed?)

5-10 minutes of questions and discussions

Alternative Final Project Presentation

15 minutes about a startup case study or research subject