"how to maximize your potential to attract us capital" by john bautista
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Private and ConfidentialOrrick, Herrington & Sutcliffe LLP
John V. Bautista (Silicon Valley) and Ben Cichostepski (Paris)
May 4, 2015
How to maximize your potential to attract US capital
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Prototyping Product or Service
Building Team
Seeking Capital
Working with Advisors
Where are you now?
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Delaware
• Going global quickly
• Investors will be US or French investors who can invest in Delaware companies
• Advantages: Access to more capital ($)
Ease of Company sale
Avoid Cost and Time needed for Flip
Set up SAS as wholly-owned subsidiary for French employees
Required for YC, not required for 500 Startups or others
Easy to set up: Clerky.com
• Disadvantages: May close the door to certain investors
Setting up the Company - Delaware or French SAS?
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French SAS
• Initial focus is European market (customers and employees)
• Smaller capital requirements
• Seeking local investors, government grants and loans
• Expand in US by setting up a wholly-owned Delaware subsidiary to employee US sales and marketing
Setting up the Company - Delaware or French SAS?
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• Incorporate Delaware company – French citizens can be directors and officers
• “Flip” is the exchange (contribution) of French shares for Delaware shares
» Ownership ratios don’t change but usually we do a stock split (Usually 10 million shares for 1,000 shares,)
» Ordinary Shares become Common Stock, usually subject to vesting
» Preferred Shares become Series A Preferred Stock with standard preferred rights
» Set up Preferred Stock Financing Documents (IRA, Voting and ROFR/Cosale)
» French subsidiary remains a wholly-owned or controlled company
» Set up US Option plan for employees globally with subplan for French employees
» Intellectual Property
– French employees assign IP to French company
– US employees assign IP to Delaware company
Flip Process
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• Exchange Agreement – for stockholders who will not incur tax now
» Individual founders or their holding companies - Case by case analysis Tax filing necessary for founders’ holdings.
» French VC’s who are structured as investment funds (FCPI, FPCI)
» Most other US and international VC’s
• Deferred Exchange Agreement – for stockholders who would incur tax, but sale is deferred until (i) stockholder elects to Flip, (ii) IPO or (iii) Company sale.
– Founder retirement accounts (PEA’s)
– French VC’s who are not FCPI or FPCI or which have investment restrictions
• Term Sheet – Important that all constituents agree before implementing
Flip Process
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• Convertible Notes
• SAFEs and KISSs
• Series Seed Preferred Stock
• Crowfunding (Kickstarter and AngelList)
Financing Trends
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• Historically the most common way to raise seed capital
• Converts automatically at Preferred financing at fixed valuation cap, discount or both
• Rolling closings at any time, amount and valuation
• Limitations:
» Term usually does not exceed 1 year (Lender laws)
» Repayment risk on maturity date
» Interest rate
» Phantom liquidation preference
» Debt on balance sheet
Financing Trends – Convertible Notes
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• Co-Authored with Y Combinator and Launched in March 2014 (500 Startups created the KISS)
• Over $200M raised to date for YC companies, some $5M per company, and average is $1M per company
• Converts automatically at Preferred Stock financing at fixed valuation cap, discount or both
• Rolling closings at any time, amount and valuation
• No matury date(a SAFE is equity) and no phantom liquidation preference
• Investors have pro rata rights equal to Series A investors (regardless of investment size)
• See sample term sheet
Financing Trends – SAFEs(Simple Agreement for Equity)
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• Pro Rata or Participation Rights in Series A financing
• Most Favored Nations (MFN) provisions
• Information Rights
• Issuance of Common Stock (Sweetener) for Advisors
Financing Trends – Side Letters
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• Usually requires a Lead Investor
• Limitations:
» Costly Negotiation of Preferred terms, including board composition,, price per share, size of employee stock pool, founder vesting, and other standard investor rights
» Conversion of existing convertible securities
» More investor due diligence
» Less flexibility on different prices per share/valuations
» Higher legal transaction costs
» Sets precedent for future Preferred terms
Financing Trends – Seed Preferred
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• Partner with incubators: The Family, YC, 500 Startups
• Practice your 30 second pitch for networking with Angels: Angels “flock” together
• Angels are usually people you know
• Ron Conway (SV Angel) – Super Angel
• AngelList and Kickstarter
• Minimize number of investors
• All investors need to be accredited - $200k in income in last 3 years ($300k with spouse) or $1M in assets (excluding house)
• Usually $500k - $1M and avoid more than 15% dilution
Process to Raising Seed Capital
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– Leverage your peers and publically available info
– Meet VC’s at networking events
– Sector and stage fit with VC’s
– Find your best intro (such as successful entrepreneur who has made money for the VC or who is Founder of successful portfolio company)
– Maintain momentum – keep investor updated with good news throughout process
Process to Raising Venture Capital –Engaging Investors
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Inbound Introductions (mostly via email)
• Business plans are increasing by ~50% year-over-year.
• ~300 new investment opportunities per month. An active VC firm makes 1 investment per month.
Behind the Scenes – Inbound Introductions
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What Happens When You Send A Pitch to a VC
Behind the Scenes – What Happens When You Send a Pitch Deck to a VC
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E-Mail toVC
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• Common reasons for passing without a meeting
» Too early: No product or customers
» Market: outside of VC’s sector focus / area of interest
» History: raised a lot of money, went nowhere, needs a recap
• Common reasons for passing after one meeting
» Team: “CEO” is not a CEO, team doesn’t inspire confidence
» Deal terms: unrealistic raise amount/valuation relative to traction
» Competition: company is too far behind a set of well-funded competitors
» Market: Market is too small to build a $100MM company
Behind the Scenes – Why investors pass?
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• Common reasons for passing in diligence
» Financial: high churn (loss of customers)
inconsistent sales, plan is fiction
» Tech: product instability, technical risk
» Background: management references don’t look good
Behind the Scenes – Why investors pass? (Cont’d)
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• How to get investors’ attention » Repeat entrepreneur – built successful company before with high quality
team
» Early traction and growth
– $100k/month in revenue for software company
– $200kk/month for a commerce company
– 1M+ users for consumer web business
– Fast growth
» Low Paid-in Capital
– Thoughtful approach to fundraising, not “take all you can get”
– Seed round at normal valuation, views investors as partners
» Big market with few incumbants
Process to Raising Venture Capital – Company Status
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• Manage timeline to receive term sheets from multiple investors
» Do not disclose identity of investors to each other
» First term sheet creates lots of leverage for future negotiations
• Model Tem Sheet: Decide in advance the terms that are most important to you
» Get quality advice (lawyers, advisors, other founders), and those who know the VC’s you are talking to
» VC’s will first propose terms orally – set their expectations
• Continue focus on building your business
Process to Raising Venture Capital – After Initial Engagement
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• Not understanding valuation (how it is calculated)
• Getting caught in the weeds (missing the big picture)
• Getting star-struck by a big name, focus on the VC partner who will be your board member
• Not looking down the road (Series A as a precedent for future rounds)
• Not respecting the process (relationship with potential investors)
Process to Raising Venture Capital –Common Mistakes
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• Pre-Money and Post-Money Valuation
• Control (Board and Stockholder)
• Exit Mechanics
• Founder Restrictions
Process to Raising Venture Capital – Key Terms
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• Capital Needed - Next 12-18 months or until next major milestone
» Series A are usually $5M in new capital
• Each VC will want at least 20% ownership
• Series A stock pool size ranges from 8-15%
• 15% dilution (on average) associated with earlier Seed investors
• Result = Founders as a group usually own 50% of the company after Series A
Process to Raising Venture Capital – Key Terms - Valuation
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• At Board level (implemented through Voting Agreement)
» 3 members (2 founders and 1 investor)
» 5 members (2 founders, 2 investors and 1 independent nominated by founders)
» Investor representative will have veto power on certain matters
• At Stockholder level (implemented through Restated Certificate of Incorporation)
» majority or supermajority votes and class votes are better than series votes
» Preferred Stock veto power on Company sale, next round financing, debt
» Pro Rata Rights – right to maintain percentage ownership in next round
Process to Raising Venture Capital – Key Terms - Control
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• Most sales are merger transactions instead of shares sales
• Drag- Along provisions – to prevent minority stockholders from blocking a Company sale and achieve 95% consent to Company sale
• Preferred Stock liquidation preference – 1X non-participating preferred versus fully participating preferred
Process to Raising Venture Capital – Key Terms – Exit Mechanics
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The Term Sheet – Exit Mechanics
Liquidation: 1x, non-participating
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The Term Sheet – Exit Mechanics
Liquidation: 1x, Fully-Participating
26* Additional examples attached.
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• Reverse vesting of Founder shares (push for double trigger acceleration of vesting on termination in connection with Company sale)
• Right of First Refusal and Co-Sale Rights on Founder liquidity with de minimums exceptions (10-15%)
• Secondary transactions where Founders sell shares to investors
• No Founder representations should be made to the VC’s
Process to Raising Venture Capital – Key Terms – Founder Restrictions
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Questions?
John Bautista : [email protected]
Benjamin Cichostepski : [email protected]
Process to Raising Venture Capital
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