Startup Finance

An Entrepreneurs Manual

About Index Ventures

Index Ventures Pan European Venture Fund Over 1.5bn under management

Based London & Geneva

Selected Investments

Active investor in web / internet

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 / Bootstrapping

Venture Capital

Debt / Bank Finance

Private Equity

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

Unique Product Or Concept

Passionate Founding Team

Large Potential Market Opportunity

Implications Intense competition likely Need to move rapidly

VC funding supports Hiring Rapid Product Development Internationalisa tion Partnerships

Infrastructure

Commercialisati on

When NOT to raise VC

Application is a feature not a product

Market size is too small

Motivation is not financial

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

Seed Investment Size Potential Sources of Funds 0 - 1m

Early Stage Series A, (B) 2m-20m

Later Stage (B),C,D 5m-20m

Pre-IPO / Buy-out 30m+

Private Equity

Grant-funding University seed funds Friends and family Angel Investors (Venture Capital)

Venture Capital (Wealthy) Angel investors

Venture Capital

Specialist Late stage tech investment funds Hedge Funds

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
Developers Country Managers Sales CEO / CFO / COO Advisory Board

Trusted service provider relationships

Search / recruiting Branding / PR Finance, etc

Partnerships Profile and PR Further access to capital

Exit optimisation
Knowledge / contacts with relevant buyers Experience with process

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

Excellent track record Match of Size/Stage/ Geography

Do create a shortlist Rifle is a better weapon than a shotgun

Shortlist
Similar process for identifying angels, look at VC funding press releases to identify prior Angel investors

No directly competitive investments

Relevant Portfolio

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
100 page business plan not required 20 page ppt which clearly answers main questions is best bet
Product Market Business Model Team Competition Product Roadmap Technology Overview Business Development Financial Status

Pre - termsheet
Dialogue rather than documentation expect lots of meetings Calls with current / prospective customers or partners Meeting broader team Brainstorming around strategy Identifying key hires post closing Formal presentation to VC partnership

Post - termsheet
Some additional reference calls with partners / customers Personal reference calls Legal / accounting audit (if relevant) Drafting legal documentation

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 thats so Board Representation unfair Liquidation Preference Participation rights Anti-dilution rights Element of reverse vesting Certain control and veto rights Period of exclusivity to close legals

Photo Source: Philip Greenspun, MIT

Case Study - liquidation preference

Types of Liquidation Preference
30 Payout to Series A (m) 25 20 15 10 5 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

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

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

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

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

Entrepreneurs Equation
Value at exit
Revenues / Profitability Growth rate Team quality

Strategic fit with buyer community

Well managed exit process

Fewest strategic errors made Hiring (quality & speed) Partnerships Product development

Probability of getting there

Valuation at initial round

% share of business at exit

Valuation and dilution at subsequent rounds

Option grants

Key things to consider when choosing an investor

Relationship
With key individual(s); and broader team

References
Speak to other founders

Right partner at a fair price vs. Any partner at best price

Portfolio
Relevant experience Non competitive Community you want to be part of

Valuation and associated deal terms

Thank you

Ben Holmes Email: benh@indexventures.com Skype: ben_holmes

Artwork (Transparent Layers)