A conversation about the F-word: Funding

16 May 2012G Craig Vachon

Craig.Vachon@gmail.com

@c_ster

Overview:

• Why pursue investment?• What type of investment is best for you?• Who are the best investors for your start-up?• PE/VC traits – know your audience before asking for a

meeting• What are the five keys that investors look for in your

business?• Researching investors and how to get introduced• The Pitch – what to present – what not to present• Terms sheets and legal stuff

Why pursue investment?

• Investment = selling your company– Loss of control – Give away some of your up-side rewards– Earning investment is a huge distraction of

many resources– Investors are a huge distraction

• Goal: Sell as little of the company as possible

What type of investment is best for you?

1. No investment [use revenue for growth]

2. Revenue/Investment from your customers [pre-payment on future sales]

3. Kickstarter and Crowd-Sourced [non-equity]

4. Crowd-sourced [equity]

5. Friends and Family

6. Incubator

7. Angel

8. VC

9. PE

10. IPO/Exit

No Investment or pre-payment from your customers

• Allows you to maintain control of all aspects of your business

• Growth may be modest but “steady performance often wins the race”

• Customers like to have a close connection with suppliers– Offer great terms – look to leverage their

customer/supplier base for your own growth

Crowd-sourced funding like Kickstarter [non-equity]

• Typically you can raise between $1000-$50K [there are some outliers]– No equity is given to “investors”

• 70K projects have applied– approximately 1% accepted by Kickstarter – and of those, ~30% funded [~210 projects]

• Know and follow the rules

• Rewards seem to be key

Crowd-Sourced selling Equity“Jumpstart Our Business Startups” Act

• Timing: EOY 2012 or 2013

• Start-ups can raise up to $1 million annually,

• Small investors can invest up to $2,000 [larger investments will require Accredited Investor credentials

• Start-ups, before they sell stock, must file financial statements with the SEC and disclose any risks related to the offering. [Your competitors are going to get your plans/finances].

• Start-ups should only use credible platforms for their investment raising.

• Start-ups also need to make available to potential investors their income-tax returns for the most recent year, as well as certified financial statements.

• Small companies should be specific about how they plan to use the funds that they raise from investors.

• Valuing the company? [have a well-thought out plan]

• While not technically required, it will be a good idea to give investors regular updates every quarter, perhaps in the form of a webcast or an email newsletter.

• It's also important to spell out investor ground rules early on. For example, let them know that you will be providing quarterly updates, but you will not be returning phone calls because you need to focus on your business.

• The largest concern is that most investors will know that when a professional investor looks at your business for further investment, will/can you protect those original investors?

VC’s - Talk only to the right investors

• Gun-Shot approach is not effective – Wasting someone’s time is perhaps the biggest “sin” in the industry– VCs love to gossip and share “deals”– If one says no, many will follow…. VCs have a chronic herd mentality

• Select, qualify and approach only “compatible” firms/partners– Do they already have an investment in your space, whether complimentary or

competitive? If it is competitive – do you really want to give them your business plan?

– Have they made money or lost their shirts in the industry? – What’s the general mood around your type of companies within the

VC/partnership?– Can the General Partner understand, appreciate and properly evaluate your

project / business?– Does the GP have the ability/stature to push the deal through his/her

partnership?

• Look for truly value added players who will work hard to help you build value– Connections with customers, vendors, partners, investors– Entrepreneurial experience

Who owns what – “best case”

70%

15%

15%

Investors

Founders

Employees

60%

40%

Founders

Investors

@ series a @ typical exit

The 5 keys to earning investment

1. Team

2. TAM

3. Scale/Virality

4. Sustainable Differentiation

5. Customer/Revenue Visibility

Team

• Does the best team usually win?

• What are you doing to hire, develop, and retain the best team?

• Is this new hire someone you’d bet your paycheck on? 100 paychecks?

• What are the team’s ethics and values?

• Can every new hire be a utility player?– What are the keys to a great team?

TAM

• Do large TAMs mean more opportunities for course correction?– Only one in five VC-funded businesses have

the same business as they did when they first presented to the VC

• How well do you know your TAM?• Are you hiring experts from the TAM?• How focused is your business on this

TAM?

Scalability/Virality

• Does you business scale?– Efficiently and effectively

• What are the valuations of similar-value chain businesses?– How well do they scale?

• How capital efficient are you?

Sustainable Differentiation

• How do you avoid being copied by competitors if you are a success?

• Do you understand the strengths and weaknesses of things like trade secrets, patents, copyrights et al?

• How many companies have beaten GOOG?

Customer/Revenue Visibility

• Are you ready to have the investors talk to your customers?

• Does your pro-forma plan pass the giggle test?– How many years did it take for MSFT or

Google to break the $50m revenue mark?

VC’s – a quick tutorial

• The average VC fund has about $300 million to invest, with an average investment of around $15-20 million per company and an average return of between $45 million and $50 million.

• A $300 million fund needs to see a return of about $1 billion for it to be considered a good performer. That's about 3 to 3½ times the initial investment with about 20 to 25 companies in the fund's portfolio.

• VCs use the 80-20 rule. It means 20 percent of the companies return 80 percent of the money. If you do the math it means four to five companies have to return $200-$250 million.

Common Mistakes

• Not researching the firm/partner• Asking for too much money [or not asking for enough

money] • Not having your “skin” in the game • Trying to be profitable too soon (stunts a company's

growth)• Confusing early revenue for sustainable growth• Don't compromise hiring, always hire world-class

people• Not persevering – this is at best a 3-6 month process

for an Series A round• Remember, VC money is expensive. Use the money

wisely [or other means of funding]

Cheaper, faster, better

• Can you build your company on open-source software and cloud computing? Can social media marketing cut your marketing expenses?

• Can you crowd-source your design • Can offshore engineering [Freelancer.com] • Estimates are that today’s most ambitious

startups can take shape for $100,000 or less, a mere one-tenth of the cost a decade ago

Researching investors and how to get introduced

• www.thefunded.com• Their VC website should have plenty of

data• Ask your network/prior successful

entrepreneurs• Many Angel forums/VC firms will make time

available if they like your pitch– Using angels or a Board of Advisors to get to

the larger VCs makes the most efficient sense

The Pitch – what to present – what not to present

• The five keys [Team, TAM, Scale Sustainable Differentiation and Customer traction]

• Pro-forma financials and use of proceeds

• Do Not present:– outliers like FB, Twitter or Instagram as

examples of your future success

Term sheets and legal stuff

• Hire a professional who has done this type of deal repeatedly [legal and deal]

• Clean term sheets are rare, but the goal

• Most importantly, know what you are signing up for.

Why would you ever want to be an entrepreneur?

What motivates you?

• 92% of all new businesses never earn >$1000 of revenue (Source: CA Franchise Tax Board)

• A typical Sand Hill VC sees 1500 executive summaries per annum– The same VC takes presentations from ~300 companies per

annum– The same VC makes 4-6 investments per annum (avg.)– The same VC watches 6 of 10 investments fail outright (avg.)– The same VC watches 3 of the same 10 become plausible but

not successful (“walking dead.”) In most instances, employees will earn nothing more than a mediocre paycheck for their efforts… (avg.)

– For the statistical one-in-ten “8X winner,” only a hand-full of the top/first employees will make enough money to retire.

What’s your tolerance for pain?

• Serial Entrepreneurs have the abnormally high incidences of:– Affairs and Divorce (too many nights in a

strange/cheap hotel room or working greater than 60 hours per week)

– Hemorrhoids, deep vein thrombosis, airborne illnesses and Valsalva surgery (1 million “air miles” equals 2500 hours or 104 days of sitting in a coach class seat)

– Moving their families (the average start-up lasts only 15 months)

– “Austerity pay”

So entrepreneur-ism is hell, why consider it?

1. Every day you learn something new

2. You get to work with like-minded people (or at least you should work with these people)

3. Your actions/decisions will have an impact on the success of your efforts

4. It feels pretty good when you drive your vision to fruition

6 lessons you’ll learn

• 1. You'll have more responsibility. • 2. You'll be given more opportunities.• 3. You'll be able to do a lot of different things. • 4. Your work will be recognized (as will your failures).• 5. You'll learn to be frugal. • 6. You'll be instilled with the value of hard work,

ownership, and self-sustainability. • Working at a startup also means that you and your small

team are the only people responsible for your success. For some, that may trigger a response to go crawl into a corner. For others, it's the greatest motivation there is.

A knucklehead’s guide to finding success as an entrepreneur (there is no magic formula!)

• Say “yes” (often) [while remaining focused]• Know where you are going• Work smart and accomplish more than your peers• Hire/retain people that you’d bet your next 100 paychecks on…• Stay focused on the customer/value chain• Act with urgency• Keep your promises• Pursue respectful iconoclasm• When in doubt, do the right thing. (Ask your peers and mentors)• Learn from your mistakes (and don’t be afraid to make a few) and keep it a

blame-free workplace• Over-communicate• Celebrate the wins

• Laugh often (at yourself primarily)• Find a great partner who complements/appreciates your skills/efforts• Appreciate the journey/adventure