how to close investment deal (an introduction)

Benno Groosman

www.groosman.info

A first introduction on

How to close an investment deal

www.groosman.info

Twitter: @Benno_Groosman

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BENNO GROOSMAN

RELEVANT EXPERIENCE

• The Netherlands

• Master in Business Adminstration

• Entrepreneurship & New Business Venturing

• Specialization: entrepreneurial finance

• Experienced startup entrepreneur

• > 10 years

• Involved in startups and incubation/acceleration

• Award winning healthcare company

(3 international patents, 3 products,

€1.4M funding, 2 termsheet negotiations) © www.groosman.info

DISCLAIMER

▶ This presentation is based on investor studies in

USA, UK, Germany, Israel and The Netherlands,

▶ combined with my own experience in my company

in The Netherlands.

© www.groosman.info

TYPES OF INVESTORS

• Friends, family and fools.

• Governments, universities, larger companies.

▶ We will talk about:

• Business angels (informal investors)

• Venture capital funds


BUSINESS ANGEL / INFORMAL

▶ Individual with personal capital and experience in

entrepreneurship or a certain branche available.

▶ Typically wants to use his money AND time for your

company: “smart capital”.

Indication of investment range $10-100k.

Can make syndicates with other investors to expand

network and make bigger total investments.


VENTURE CAPITAL FUND

Fund collects money from companies, governments,

investors, pension funds, etc.

Funds typically have a 5-7 year investment range and

do multiple investments in that time. $500k and more

per investment.

Fund managers and investor managers are responsible

for ROI on the fund capital. Investors in the fund want

to monitor this, so there’s more “paper work”.


OTHER FUNDS

• Investing pension funds;

• Corporate venture capital;

• Government seed and growth capital;

• Equity funds ($10M and up)

And many more, but usually for the high-growth stage

of a company (for example: after 3 years, $10M+ in

revenues).


STAGE AND TYPE OF MONEY


SIZE OF INVESTMENT

Ask the money that you really need,

not too little,

and about 15-25% extra for unforeseen expenses.

Informal investors don’t like to pay for marketing, big

office space and high salaries. They want to build the

business by investing in prototypes, production, sales,

patents, strategic positions etc.

Use the money to grow the value of your company.


TIMING OF INVESTMENT

Best position to negotiate is when you don’t really

need the money yet.

Investors can delay the dealmaking, so make sure you

have a financial buffer.

Informal investors / business angels: 3 months.

VC funds: 6 to 12 months.

+ time you need to get to get them in your network!


POSTPONE AN INVESTMENT

Get money from:

• Selling your test product

• Make customers pay in advance

• Use governmental subsidies and grants

• Consultancy (but don’t loose your focus!)

▶ ... TO BE ABLE TO MAKE A BETTER DEAL.


INVESTMENTS AND THE BANK

In later stages you can use the investment as a

multiplier to get bank a bank loan.

Example:

€300k investment could enable a €600k bank loan.

Banks don’t like risks. Investor money reduces their

risk. Banks finance working and growth capital, not

marketing, salaries and research and development.


STAGE AND TYPE OF MONEY


MULTIPLE INVESTMENTS

You might need more investments to start, grow,

expand your company.

First investment deal is considered to be the most

important,

as the terms determine the ease of acces for future

investments,

and the dilution of shares starts here.


EQUITY DILUTION


WHAT DO INVESTORS WANT

• Control

• Preference rights for future rounds

• Big percentage of shares


WHAT DO YOU WANT TO GIVE

• No control

• No preference rights

• Only a small percentage of shares

▶ So… a negotiating process is needed to make the

deal.


COMPANY VALUATION

▶ Valuation of startups is not just a numbers game.

It’s more about expectations, feelings, investment

limits etc.

▶ But, start to quantify your value by:

• Real option pricing;

• Discounted cash flow;

• Comparing to other startups.

▶ Science, art or random?© www.groosman.info

REAL OPTION PRICING


DISCOUNTED CASH FLOW


OTHER VALUATIONS

• Investor policy, e.g. “the maximum post-money

valuation for seed money is $2M”

• Investor divides the numbers the entrepreneur

provides by 10

▶ Entrepreneur knows, so multiplies by 10, etc.

• Profit times 5, revenue times 2 (or any number),

industry multipliers, β

• Tens of other methods


DEAL MAKING PROCESS

▶ GO / NO GO decision after every stage:

• First contact, pitch

• Personal connection

• Business plan and/or presentation

• Term sheet

• Negotiations

• Signing term sheet (exclusivity phase investor)

• Due diligence

• Participation contract

• Deposit of money and changes of legal structure


KEY NEGOTIATION POINTS (1)

Valuation

• With VCs it’s easier to ask more money than give away

less shares, with informal investors it’s the other way

around.

• Investment in multiple stages (one contract) can lead

to better valuation. E.g., $200k at once will come at

lower valuation than $100k upfront and $100k after

first customer.

▶ More risk for you: what if the customer comes too

late?



Preferred stock and influence rights

• Tag-Along right

• If big shareholders sell, small shareholders are

forced to sell too

• Pre-emption right

• Before another shareholder comes in, the existing

shareholders can buy shares at the same price

• Right of first refusal

• Like the previous, but with pre-specified terms



Preference rights, exit options, and penalties

• What if it goes very good?

• More important: what if it goes bad?

• Will you lose your shares?

• Will you lose your management position?


TRY TO TAKE CONTROL

• It is your business

• Don’t get controlled and sucked up by the game

• Be hard on the content, but soft on the relationship

• Don’t get intimidated by negotiating tactics

• If you don’t like the deal, take time to negotiate

• Use an experienced and trusted

advisor/mentor/lawyer

▶ … and dare to walk away and cease the deal. Be

nice though, it gives you credits.© www.groosman.info

AFTER THE INVESTMENT

• Keep working on the relationship

• Get used to an extra decision maker in your team

• Prepare for more financial and strategic reporting

• Use the network and time of the investor wisely


Benno Groosman

www.groosman.info

www.groosman.info

Twitter: @Benno_Groosman

Pinterest: bennogroosman

how to close investment deal (an introduction)

Small Business & Entrepreneurship