Early Stage Funding

Terry W. Smith

Transcript

1. German Silicon Valley Accelerator 1 Funding Early Stage Technology Companies January 2014 Terry W. Smith
2. Topics Covered • Why raise funding • Managing to be fundable • Preparation for funding • Funding sources • Types of value propositions • Stages of company maturity • Funding presentations and business plans • Funding deal terms • Stock options • Boards of directors and advisors 2
3. Why Raise Funding • Accelerate growth – Beat established competition • Build barriers to entry for new competition – Re-invent your company continuously • Innovate to obsolete your own products • Financial resources yield leverage – Opportunity to chase bigger deals – Agility to expand and respond quickly 3
4. Managing To Be Fundable • Focus on building asset value of the company – Competitive differentiation (IP, trade secrets) – Validation of adoption, traction with decision- leaders – Create barriers (high costs, steep learning curves) for late entrants • Build a team of deep experts in your market • Strategic value to potential acquirers 4
5. Preparation For Funding 5 • Key ingredients of a ‘fundable’ business… – Qualified leadership – Addressing a valuable problem – Delivering a valuable solution • Good Product-Market fit • Defensible IP, trade secrets, or complexity as a barrier • Manageable technology and partnering risks • A roadmap of future product expansion • An appropriate go-to-market strategy
6. Funding Strategy Guidelines 6 • Match the stage of your company, product value proposition, and type of funding source • Raise enough to get to a milestone that supports the next funding, plus a safety margin (more money is better) • Have third party references to validate your product and technology • Identify investors carefully, get help with personal introductions • Focus on finding a lead investor early
7. Funding Sources 7 • Founders, family, friends • Incubators • Revenue, pre-sales via crowdfunding • Angel investors • Seed funds • Equity crowdfunding • Corporate partners • Venture capital firms • Late stage institutional investors
8. Funding Sources • Founders, family, friends – Limited amounts and ability to do multiple rounds – Negative events damage important relationships • Dilution, modified rights, inability to maintain stake • Revenue – Good if the product is robust and support is ready • Crowdfunding (kickstarter, Indiegogo, RocketHub, etc.) – Equivalent to pre-selling product before deliverable, at a discount to planned retail price – Creates an obligation to ship – Fits consumer products best (broad appeal) – Works if development & production costs and risks are low 8
9. Funding Sources 9 • Angel investors – Small investments typically $25K to $250K per person • Market and technical due-diligence shared – Preferred stock (same as seed or venture round) – Convertible debt with discount on next equity round (typical: 20%) • Becomes a debt that must be re-paid with interest if next round delayed • Organized groups, lists and forums – AngelList, Keiretsu, Band of Angels, SV Angels, Sand Hill Angels… – Best to target specific individuals, not groups
10. Funding Sources 10 • Seed investors – Seed funds invest up to ~$1.5 Million per round • Typically $150K to $500K per fund • Typically 2 - 3 co-investors split a seed round • VC partners may personally seed a deal – Structured as Series A preferred equity rounds – Seed money from VC firms does not guarantee follow-on investment – If you are early stage, with a good quality deal, seed money may be much easier than angel money
11. Funding Sources • Corporate partnerships – Ideal model is payment of fees for delivery against milestones • No equity, no claim on IP, conditional exclusivity • Use performance triggers to release exclusivity in licenses • Corporate venture funds – Typically coupled with a strategic interest • They want to use, make, or re-sell your product – Typically will not lead a syndicated round, usually follow VC as lead – May make a solo investment if really strategic technology 11
12. Funding Sources 12 • Venture capital firms – Typical minimum of $2m to $3m per fund in a Series A round • Require ~15 to 20% minimum initial ownership • Reserve 2X to 4X for future rounds, depending on fund size – Series A pre-money valuations typically $4m to $20m – Will only co-invest with one or more other funds whose interested partner is known and acceptable – An interested lead investor will offer a terms sheet after several meetings and due diligence research process • Leads want to syndicate (control) who else co-invests • Leads do most of the due diligence work • Followers need to be convinced by an enthusiastic lead – Most Silicon Valley funds need to start at Seed or ‘A’ round and will continue to invest – Funds only lead in categories where the partner has experience – Watch out for competition in their portfolio
13. Types of Value Propositions • ‘Boil the ocean’ – Too broad, too many buying decision makers, too much technology or market risk, taking on large established competition • Slight Improvement – Close to existing solutions, subtle benefits • More like a new feature, less like a whole new product • Valuable Improvement – Adoption proven or obvious • Better performance, lower cost, more complete solution, easier to use • Paradigm Shift – Adoption needs to be validated • Entirely new way of solving a recognized problem • Solves multiple problems with one new solution 13
14. Stages of Company Maturity • Concept, idea, architectural proposal • Proof of concept demo • Alpha release product, incomplete, not validated • Revenue-ready product, validated • Revenue or adoption started • Cash generator • Acquisition or IPO – Institutional investors need a path to liquidity 14
15. Funding Presentations & Plans • Important fund-raising tools – A two-page company summary – A <20-slide presentation (see list of topics) – A short video demo (if applicable) – A corporate entity (C-Corp), web page, business cards • Backup materials – References (personal, market, technology) – Technology due diligence presentation – Competitive analysis (detail) – Financial operating plan (described below) 15
16. Presenting to Investors • CEO as presenter – Presenter delegate questions to other team members when needed – Avoid switching presenters – Look at each member of your audience as you speak – Be comfortable and calm (smile) – Do not read your slides: paraphrase and summarize • Qualify your audience before you start: • How familiar are you with this space? • Based on what you know about us already, where would you like us to focus? • Listen carefully to questions or suggestions – Avoid long or over-detailed answers or any story-telling – After you answer, ask if their question was answered – Exhibit a ‘teachable’ behavior; ask for feedback • The first meeting is NOT about selling – It is all about relationship building – Selling comes after they understand and are interested in learning more 16
17. Funding Presentations & Plans • Management Team • Explain core team’s experiences that are relevant to the success of your current venture – in 3 – 4 bullets/person. • Mission Statement • Explain your company’s positioning and charter (scope) in clear high-level terms. • Opportunity • PAIN: what painful issue are you addressing and how extensive is the issue? • Your Solution • Why your venture will not only solve the pain, but will also make a ton of money for your investors in the process. – Video demo 30 – 60 seconds • Market • Clearly define the addressable market for your pain reliever, which is a subset of the total number of people who are feeling the pain; the total market size is not so relevant. • Product • What does your pain reliever look like, how is it implemented by the customer and what future products do you expect to roll out? • Distribution and Sales • How do you profitably get the pain reliever to the consumers experiencing the pain? Channel strategy, pricing model. • Patents and Trademarks • Describe any defensible intellectual property associated with the pain reliever. • Competition • Who else offers similar pain relief and why is yours so much better? • Financials • Revenue, expenses, and cash consumption for first 3-years. • Capitalization • How much money are you looking for, what will you do with it and what other funding sources (if any) do you already have secured? If a valuation has been established by investors, what is it? • Summary Slide • List the 4 key strengths that make this a great investment. 17
18. Investor Due Diligence Process 18 • Team credibility, willingness to take advice – Personal interactions, references • Market adoption – Proof that decision makers will buy your product under the planned pricing model • Either actual referenceable adoption or • Testimony of credible customer references • Technology risk reduced – Proof of concept prototypes, demos – Testimony of third party technical experts • Competition • Intellectual property (patents, core technology)
19. Financial Operating Plan 19 • A three-year detailed Excel model – 2-years by month, 3rd year by quarter • Income statement – Revenue, COGS, warranty cost >> net income – Expenses (partial list): • Headcount (salaries, taxes, benefits) • Commissions, travel, marketing • Contractors, outsourcing, services • Facilities, telecom, hosting, non-capital expenses • Monthly depreciation of capital expenses • Cash flow statement – Financing assumptions (Cash-In: equity, debt, NRE) – Uses of cash (operations, capital expenses) – Cash balance (each month or quarter)
20. First Meeting Financials 20
21. Funding Deal Terms • A terms sheet is a negotiable proposal from an interested lead investor – It is NOT a financing until: • The entire syndicate has accepted the lead’s proposed terms • Final docs are signed by all and checks are in escrow with your attorney • Pay close attention to these terms – Liquidation preference: may determine whether employees get anything in a liquidation or low-value acquisition – Redemption or buy-back provisions – Board of directors composition – Non-standard terms make future rounds more difficult • Reserved option pool – Typically 20 – 25% of total, does not dilute the investors, covers all hires until next round – Includes ‘refresh’ grants 21
22. Option Pool Impact • Creation of the pool only dilutes the founders • Issuance of pool shares dilutes everyone to the levels shown • ‘Saving’ pool shares helps everyone 22
23. Stock Options & Compensation • Stock is the most valuable resource – Use as a long-term incentive • Build a stock option budget by position – VP (2 – 3%), Sr. Engr (1 – 2%), Jr. Engr (.25 - .5 %), etc. • Err on the side of under-sizing initial grants; use re-fresh grants to adjust and reward proven contribution – Avoid using stock as compensation for part-time or non-permanent employees (contractors) – 48-month vesting with 12-month ‘cliff’ is traditional – Pricing of employee options has tax and legal impacts – get legal advice • Founder’s stock – Only for 2 – 4 key founders; amounts set by expected long-term contribution – Impossible to take back vested shares or make large increases – Some vesting acceleration is OK (for pre-funding contribution, on change of control, termination without cause) – Get founder’s stock issued before you get a terms sheet! 23
24. Boards & Board Meetings • Board of directors – Usually the CEO plus major investors (Seed, Series A, B, C, etc.) • Only one other co-founder if right personal skills – Keep it small; usually an odd number of directors – Monthly meetings: 2-hours maximum, written material – Investors will want to approve an outside director – American investors depend on management to make decisions and run the company (not the board) • Board of advisors – Not a good fit for all startups – Advisory relationships best if kept flexible – Keep stock grants small, with 1-year vesting 24
25. Conclusions • Work closely with mentors and advisors to develop an optimal funding strategy for your company – It might be a sequence of funding amounts and methods • Refining your business strategy is key to fundability – Success with investors is the result of • A fundable team • A differentiated business strategy • A technology advantage • Carefully choose who you approach as investors – Domain knowledge, individual’s focus, non-conflicting investments – Screen them before you schedule a meeting • Personal referrals by someone who knows you and your deal will get you meetings with the right investors 25