Start Up Finance

Startup Finance An Entrepreneur’s Manual

About Index Ventures Over €1.5bn under management Active investor in web / internet Pan European Venture Fund Based London & Geneva Index Ventures Selected Investments

Agenda What are the financing options? How to attract and engage investors? Deal structure and what to expect during the investment process Important reflections before you start

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?

Overview of financing options Angel Financing Venture Capital Private Equity Public Stock Markets Self Finance / Bootstrapping Debt / Bank Finance Equity Financing Non-Equity Financing

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 Large Potential Market Opportunity Unique Product Or Concept Passionate Founding Team Pre-requisites Intense competition likely Need to move rapidly Implications… Hiring Infrastructure VC funding supports Rapid Product Development Internationalisation Partnerships Commercialisation

When NOT to raise VC 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 Application is a feature not a product Market size is too small Motivation is not financial

Equity Financing Investment Size Seed Early Stage Series A, (B) Later Stage (B),C,D… Pre-IPO / Buy-out Private Equity Potential Sources of Funds 0 - €1m Grant-funding University seed funds Friends and family Angel Investors (Venture Capital) € 2m-€20m Venture Capital (Wealthy) Angel investors € 5m-€20m Venture Capital € 30m+ Specialist Late stage tech investment funds Hedge Funds Growth Fund

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

Advice and Strategy Hiring Developers Country Managers Sales CEO / CFO / COO Advisory Board Partnerships Profile and PR Further access to capital Venture Capital – What a good VC will add Internationalisation Trusted service provider relationships Search / recruiting Branding / PR Finance, etc Exit optimisation Knowledge / contacts with relevant buyers Experience with process

What does an investor look for? 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 Technology $$$ Traction Team

Identifying relevant VC partners Do create a shortlist Rifle is a better weapon than a shotgun Similar process for identifying angels, look at VC funding press releases to identify prior Angel investors Has funds to invest Match of Size/Stage/ Geography Relevant Portfolio No directly competitive investments Excellent track record Shortlist

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

Sharing relevant information 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 - first meeting Pre - termsheet Post - 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 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?

Board Representation Liquidation Preference Participation rights Anti-dilution rights Element of reverse vesting Certain control and veto rights Period of exclusivity to close legals Venture Capital – “Typical Deal Terms” but that’s so unfair… Photo Source: Philip Greenspun, MIT

Case Study - liquidation preference

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 Value at exit Probability of getting there % share of business at exit Entrepreneur’s Equation 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 Valuation at initial round 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 Portfolio Relevant experience Non competitive Community you want to be part of Valuation and associated deal terms Right partner at a fair price vs. Any partner at best price

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

Artwork – (Transparent Layers)

Start Up Finance

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