What do I need to know about fundraising/ investment vocabulary?

Take-aways on a talk in the Trust Center on 8/9/16

Did you know? Early stage startups

  • Put effort in knowing your investors! Investors are not just a synonym for money. It makes a lot of difference who you choose.
  • Ways to raise early stage capital today: Angels, friends and family, grants, crowd funding, debt, customers, competitions, banks, VCs and more…
    • There are a lot of different flavors to each one, for example:

Clients- vendor financing

Crowd funding – lots of different platforms

  • Half of the startups in the US exit after they get their seed. The ones who grow and make a difference also need to take the larger bet.

Investments through the life cycle of startups                                     

  • Investment opportunities change over time
    • Early stage startups are the most crowded space. You have a lot of options for investments.
    • Investment trends change over time. Today, the seed stage is running much longer than in the past - you need to get more progress to get to round A

Angels, VCs and bootstrapping

  • Angels: individuals who invest out of their own check book. Are usually not able to follow on since their pockets are not deep enough
  • VCs: Range across the “whole umbrella” (various stages/ rounds). Don’t invest their own money but rather money that comes out of a shared fund (institutional investors).
  • Bootstrapping: Getting money without reaching out to external investors (grants, competitions, customers payments)
    • Non-dilutive = “free”. Your shares do not get diluted over time - grants, prizes. The only con for these types of money streams is that getting them is very time consuming… “Money value of time”

Convertible notes (debt)

  • This should not be your end game. You want to take convertible notes when you need to gain some cash quickly and in a simple way to fill specific gaps between raising priced rounds.
    • If you have time – invest in raising seed funds instead!
    • Priced rounds = Equity rounds (series seed/ A/B…)
  • This is a loan, a promise to pay back money that someone gave you with stocks + interest instead of cash.
    • Pay attention to this commitment – don’t give away too much equity before even raising an A round
  • Two main concepts
    • Discount: an extra incentive for the investors that helps alleviate concerns around risky deals.
    • Valuation cap: this is a concept that was raised since the note holder’s share was almost washed out completely when a priced round was closed.
      • Setting a very high valuation cap this might make it harder for you to raise funds later (depends on how strong your product is and how the market changes).
      • Setting a very low one gives the note holders an incentive to see you raise low valuation for future rounds because this way they suffer less dilution
    • You’ll need to negotiate both the discount and the valuation cap to get money from the note holder. As a note holder you don’t get both but you most likely will choose the better out of the two.
  • Selling your company or bankrupting before raising series A funds
  • With Bankruptcy, convertible notes are just another line of obligation you have to your lenders (and will most likely will just be wiped out)
  • If you sell your company, there’s no one clear way that the market deals with it. There will be a formula set in advance between you and the note holder depends on projections you make.

Surprising facts about early stage VC investments

  • It’s all about relationships! The human being connection is extremely important and much more important than you can ever expect.
  • The amount of money is not that big: Don’t expect all deals to be unicorns. $6B total a year is raised across the US
  • Late stage financing does not usually come from VCs: 87% of the money that goes to unicorns in that stage comes from PE/ public investors (VCs can’t afford it)
  • Learn to give up some control: when you raise funds from outside investors you company is no longer 100% yours so you need to accept it!
  • You’re not just “paying” to get money: Giving up control is also for getting guidance, networking, and credibility. As a CEO, you need someone to make your job less lonely. All of these are not on the term sheet but are added values

How do VCs make their money?

  • It’s a very ritualized process:
    • you pitch
    • there is a decision made behind locked doors: decision making process varies but needs to be a decision of the firm and not just individual
    • you receive a term sheet: this shouldn’t be a surprise, you should discuss the terms in advance with your potential investors
    • financing documentations are processed: lawyers included
    • sign up and close: sometime the money is received upon achieving milestones

Who are the VCs

  • There isn’t that much diversity in this community.
  • Very rare for an individual partner to close more than a couple deals a year.
  • Investors put ~1% of the company’s total fund when closing a deal.
    • Limited partners: they will put in 98%-99% of the money and the VCs will kick in the remaining 1%.the LP will be able to attract investments from other funds as well.

How do the VCs make their money

  • IRR = internal rate of return (this is a rate of return with a time component to it)
  • 2% fees and 20% carry are what VCs get
    • Fees- % VC gets of the total funds size, regardless of the deals they close
    • Carry- the VCs split on the profit from return on investments. LPs will get 80% and the VCs get the remaining 20% and split it.
    • It’s usually 1-2 deals that will make the profit out for the entire fund.
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