Insider's Guide to Raising Early-Stage Capital

The “Real Deal” Behind Early-‐Stage Fundraising

JANUARY 2014

Nnamdi Okike, Founder, 645 Angels

Presenta9on to the Startup Leadership Program

The Early-‐Stage Fundraising Process In One Slide

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Raising early-‐stage capital is not too much different than this

Source: Dilbert

•  Personal Background: –  8 years experience as a venture investor, specializing in Internet and soKware companies

–  Worked on over 20 venture investments, including FolhamaPc (sold for $300m), Hitwise (sold for $240m), and Astaro (acquired by Sophos)

–  Founder of 645 Angels, an NYC-‐based angel fund focusing on Internet investments

•  Goals of this Presenta9on: –  Provide recommendaPons on how to best approach the process of raising seed/early-‐stage capital

–  Provide advice on how to deal with investors –  DemysPfy the venture funding process –  Provide advice on how to meet your personal objecPves in an investment process and opPmize your outcome

–  Answer any quesPons that you have

Introduc9on

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Agenda

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§  Why raise funding at the early stage?

§  Angels, angel groups, and venture funds

§  What to look for in a good investor §  How to pitch your company §  Nego9a9ng terms §  Due diligence and closing the deal

•  Quiz: –  If we don’t raise early-‐stage funding, we won’t be taken seriously

–  That’s a dumb quesPon. If we don’t raise capital now, we’ll run out of cash

–  A good investor can bring skills/connecPons/advice to the table, and can provide value beyond the money

–  Investment capital will enable us to execute on key objecPves/reach key milestones that will create barriers to entry and enable us to capture market share more quickly

Why Raise Funding at the Seed/Early Stage?

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•  If we don’t raise early-‐stage funding, we won’t be taken seriously

•  That’s a myth. Many great companies never raise early-‐stage equity capital. Companies such as Oracle and Spanx are two good examples

•  That’s a dumb quesPon. If we don’t raise capital, we’ll run out of cash

•  Fair enough. Some businesses require more capital than others. No one has ever bootstrapped a semiconductor plant

•  A good investor can bring skills/connecPons/advice to the table beyond just money

•  Excellent answer. Make sure to tell prospec9ve investors that

•  Investment capital will enable us to execute on key objecPves/reach key milestones that will create barriers to entry and enable us to capture market share more quickly

•  Good answer. An early-‐stage investment can be very helpful when markets are evolving quickly and crea9ng barriers to entry is important. Think Amazon in the early days of e-‐commerce

Why Raise Funding at the Seed/Early Stage?

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•  Minimizing Dilu9on: How can you minimize diluPon in early rounds? This becomes important later on if you have to raise more capital

•  Control/Economic Rights: What control/economic rights are you willing to give on? Do you want the investor to sit on your board? Are you ok with preferred stock?

•  Value-‐Add: What key skills can a prospecPve investor bring to the table? –  Ability to help with hiring – rolodex –  Ability to provide strategic advice re: market entry, posiPoning, compePPon, etc

–  Industry contacts

•  Cash Curve: What are the projected cash needs of your business? The cash curve will drive your investment requirements and the staging of investment

•  What type of investor would be best-‐suited for your business? Consider angels, angel groups and venture funds

Key Issues to Think About When Deciding Whether to Raise Capital

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Agenda

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Angels, Angel Groups, and Venture Funds

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Solo Angels Angel Groups/Networks

Early-‐Stage Venture Funds

Examples Industry veteran Former entrepreneur

Your rich uncle

NY Angels AsPa

Common Angels

Flybridge GreycroK Partners Lerer Ventures

Level of Sophis9ca9on

Varies significantly Moderate to high level of sophisPcaPon

Highly sophisPcated, this is all they do

Investment Process

Angel likes the business, does some diligence, writes you a check

You send a business plan, you present to the angel group, they evaluate, their members decide if they’re interested, they make a

proposal

You get referred to the fund, you meet them, you present, they do diligence, they give

you a term sheet, you negoPate

Terms Most entrepreneur-‐friendly

In between solo angels and venture firms

Less entrepreneur-‐friendly

Value-‐Add Depends on the angel Moderate value-‐add, good networks

Generally high value-‐add

Investment Amount

Varies widely depending on the angel -‐ $10k to

$500k is ballpark

$100k to $1m $500k to $5m at early-‐stage

•  Angel investors vary widely in terms of their sophis9ca9on, average investment size, and what they seek from the investment –  Some do it for fun, some are professionals. Angels can range from a wealthy former entrepreneur who likes working with early-‐stage startups to your wealthy aunt Jane who always believed in your potenPal

–  As a result, they will vary widely in their ability to help you beyond giving you money

•  Pros and cons of raising money from solo angels –  Pros: Less restricPve terms, easier deal process, less immediate pressure to perform post investment

–  Cons: Need to manage many of them, low average value-‐add, smaller average investment than angel groups and venture funds

•  Typical angel investment terms: –  ConverPble note structure (with discount to price of future equity round) –  Minimal control rights, generally not seeking board seat

•  How to find them: –  Tap your personal network –  Akend angel events (Angel Vine in NYC is a good example)

Angel Investors

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Angel Groups

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•  How angel groups work: –  Angel group members pay a fee to be part of the angel group and get access to its deal flow

–  Group members don’t invest in all deals, can choose which deals they want to invest in –  Angel funds may specialize in certain types of companies (for example, AsPa focuses on female-‐founded companies)

•  The angel group inves9ng process: –  The staff at the angel group will vet inbound business plans and choose the best companies to present to the group

–  AKer you present, if there is interest from the group, a member of the group will become the “lead” and will round up investors

–  They will then present you with a term sheet. The member lead will then manage the due diligence process, which will include reference checks, compePPve analysis, and market analysis

•  Angel group pros and cons: –  Pros: Larger average investment than individual angels, they oKen have large professional networks that you can uPlize

–  Cons: Longer process than solo angels, venture-‐like terms without as much of the venture firm value-‐add

Venture Capital Firms I

12 Source: Dilbert

•  Venture capital firms are dedicated pools of capital that typically focus on a specific stage and type of investment (for example, early-‐stage Internet deals) –  Keep their focus in mind as you assess which funds might be a good fit

•  Venture funds are typically made up of partners, principals/VP’s, and associates/analysts. –  Partners and principals will lead deals, associates/analysts will primarily help with deal veong and due diligence

•  Most venture funds have an established process by which they source and evaluate deals –  Most early-‐stage funds source their deals via referrals –  Some will read inbound business plans, but they won’t do many deals from this pool

•  Typical early-‐stage venture process: –  You get referred to the venture fund, or you send in a business plan –  IniPal phone call/meePng where you present your business –  If the fund is interested, this is followed by one or mulPple follow-‐up meePngs –  A term sheet is presented. You negoPate the terms – valuaPon, investment amount, security, etc. Due diligence is ongoing and conPnues post term sheet signing

–  Lawyers draK the final docs and you close the deal

Venture Capital Firms II

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•  Pros and cons of raising money from a venture firm: –  Pros:

§  Venture firms can typically invest larger amounts of capital than solo angels/angel groups

§  Venture firms are generally well-‐connected, with ability to help with hiring, strategic partnerships, business strategy

§  An investment from a good fund can be a posiPve signal to the market

–  Cons: §  They desire more control rights/protecPons: preferred stock, blocking rights, drag-‐along rights, board representaPon

§  A bad venture investor can make your life difficult

•  Ques9ons to ask venture funds: –  What types of deals does the firm specialize in? Have they invested in similar companies before?

–  What is the firm’s typical deal process (Pming, due diligence requests, etc) –  Which partner at the firm will I be working with? Will they provide porqolio references?

–  What is the firm’s typical approach to follow-‐on investments?

Venture Capital Firms III

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Agenda

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•  When it comes to venture investors, the quality of the investor can have a major impact on your future success. The following are ques9ons to ask yourself as you evaluate a poten9al investor: –  Do I get along well with this person/group? Do I get a good vibe from them? Would I want to work with them when Pmes are tough?

–  Do they understand my business? Are they asking the right quesPons? –  Will the investor provide references, and if so, what do they say about the investor?

–  What is this investor’s track record? Have they invested in similar companies? Have those companies been successful?

–  What relevant connecPons does this investor have? Can they (and will they) introduce me to people that can help me?

–  What is the firm’s reputaPon in the marketplace? –  What is this investor’s Pme horizon to exit?

What to Look for in a Good Investor

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Agenda

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•  Rules of Thumb: –  Everyone pitches differently. Be yourself and present your company in the way in which you feel comfortable. Investors can see through B.S.

–  Be able to explain what your company does and its value proposiPon in a concise way, ideally in a few sentences

–  Think about what quesPons the investor is likely to have, and have answers prepared

–  Don’t make wild claims/projecPons that you can’t support – prospecPve investors will see through those sooner or later

How to Pitch Your Company

18 Source: Dilbert

•  Be able to answer the following ques9ons in an ini9al mee9ng: – What problem is your company solving and why is it important?

§  Why is your approach to solving this problem either beker/faster/cheaper than alternaPves?

– Who is your compe99on? §  Why are you beker than your compePtors?

–  How large is your market? §  What segment of the market is addressable by your product/service today.

– What is your product development plan? §  If you are pre-‐product today, when are you planning to release your product?

– What does your financial plan look like? §  What is your revenue plan for the year? How much cash will you burn this year? When will you hit break-‐even?

– What is your sales and marke9ng plan? –  How much capital do you plan to raise and what is the use of proceeds?

Things to Think About in Your Pitch

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•  The VC pitch process: –  First call/mee9ng: This is really a “get to know you” session. The investor is trying to get a read on your company and whether it is a fit for their fund. Provide your company teaser/execuPve summary deck and use it as a guide. Expect to get interrupted frequently with quesPons

–  Second mee9ng: There will likely be more people from the venture fund in the room. Be prepared to go into more detail – you should have a more detailed business presentaPon deck (20 to 30 slides) §  You will likely be asked to present to all of the firm’s partners or a subset of the partners before they sign a term sheet. This may happen in a second or later meePng, depending on the firm’s process

–  Materials to prepare: §  Company teaser/execuPve summary that is 15 slides or less, that you can send to prospecPve investors and use in your iniPal meePngs

§  More detailed business plan/investor memorandum that you can use for the more detailed pitch meePngs

§  Financial projecPons that you can provide to investors –  I prefer to see key assumpPons in order to sanity-‐check the figures

How to Pitch Your Company

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Agenda

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The Deal Nego9a9on Process

22 Source: Dilbert

•  General advice: –  VC’s do this for a living. Make sure you’re fairly well-‐versed in the terms they use so that you can even the playing field §  If you’re negoPaPng with a venture investor or angel group, hire a lawyer that has experience with the specific of deal you’re doing –  Growth-‐stage deal terms are different than early-‐stage deal terms –  Venture investors will ask for more control rights that angels –  You want to understand what is “market” for your specific type of deal

§  Read up on deal terms if you have some Pme. Good resources include Brad Feld’s “Venture Deals” and Alex Wilmerding’s “Deal Terms” and “Term Sheets and ValuaPons”

–  Think about what deal terms are most important to you: §  How important is valuaPon? §  What terms are you willing to give on? §  Try to figure out what terms the VC is flexible on

–  The term sheet is the template for the final deal docs: §  Term sheets are generally not binding, but they are the guidelines for the final investment agreement that is created in the definiPve documentaPon

Nego9a9ng Terms

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•  Valua9on –  Much more art than science

§  Having a finished product, customers and revenues will increase your valuaPon

§  Think pre-‐money and post-‐money valuaPon, they are different §  Think percentages and investment amounts:

–  For example, We’re looking for $500k and we’re not looking to give up more than than 10% of equity

–  Think about the amount the investor typically invests and tailor your pitch to that

–  How to negoPate valuaPon: §  Investors will ask you what valuaPon you’re expecPng

–  One strategy is to be somewhat aggressive but not unreasonable, factoring in that VC’s will negoPate you down

–  Another strategy is to say that you’re leong the market price the round §  Be prepared for some back and forth §  Both valuaPon and structure are important. Contract a common equity deal vs. a parPcipaPng preferred deal at the same valuaPon

Nego9a9ng Terms

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•  Investment Amount: –  Raise enough capital to give you runway (with a cushion) to reach key milestones, where you can then raise more money at a higher valuaPons if you so choose

–  Think about the cash curve

•  Form of security: –  Venture investors typically will insight on preferred stock –  Be careful with giving them more than that: parPcipaPng preferred, dividends on preferred, etc

•  Control rights: These include blocks on sale of the company, drag-‐along rights, approval rights for key hires, maximum capital expenditures, etc

•  Board Seats: –  VC’s will usually (but not always) want at least one board seat

Nego9a9ng Terms

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Agenda

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§  Angels, angel groups, and venture funds §  What to look for in a good investor §  How to pitch your company §  Nego9a9ng terms §  Due diligence and closing the deal

•  Amount of due diligence undertaken will depend on the investor. Venture funds will typically do the most diligence, although angel groups may also do detailed diligence –  Due diligence is an opportunity for investors to validate their key assumpPons and make sure there are no surprises

–  You can also do your own due diligence on the venture firm in the form of porqolio company references

•  Typical due diligence requests: –  Requests to speak with your customers –  Detailed technology analysis (some venture funds may do this) –  Founder references –  Detailed financial projecPons and discussion around key growth assumpPons –  Total addressable market (TAM) discussion and analysis –  Review of sales and markePng plan

•  One strategy is to make more informa9on available as you see more commitment from the prospec9ve investor –  For example, no need to provide customer references unPl you see that the investor is serious, to avoid wasPng your customers’ Pme

Due Diligence and Closing the Deal

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Final Advice: Try to Avoid Situa9ons Like This One

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“You look a lot different than your website photo”

Source: Ibusinessangel

You Prospec9ve Investor

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Thank You!

Contact Email: [email protected]

Economy & Finance

Insider's Guide to Raising Early-Stage Capital