Article about a company from startup to IPO
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ENTP325-Spring2018-Week6.pptx
ENTP 325 Early Stage Venture Financing Week #6
This week (slight change from syllabus)
Tuesday
Getting in front of Angels
Thursday
Guest speaker: Angel investor Glenn Gaddy
Sunday
Angel investor paper
Angel math (what investors want)
Early-stage risk assessment
Pitchbot team exercise
Angel investor analysis paper
Using what you’ve learned from the David Rose book, the lectures, guest speakers and suggested resources, develop a 4-5 page paper on your perspectives of angel investing.
Specifically address topics such as:
what does it take to be an angel investor
what types of companies qualify for angel investing
what do angel investors look for
when do they invest
how do they invest (evaluate their investment decisions)
how can startups most effectively pitch to angel investors
Including examples, references, interviews (startups and investors) and other information to support your analysis
Compare investment scenarios w/examples and cap tables at http://captable.io
Start NewCo with 12M authorized shares
Founders at 4M shares each
Option pool with 2M shares
Review cap table
Click “quick create” button
Add convertible instrument
Review note type to see different options
Principal $100,000 with maturity date two years out
Conversion discount 20%
Valuation cap $2M
Review cap table. What do you notice?
Now go to Scenarios
New investment $1M with $4M post money and effective date and keep existing option pool
What did convertible debt investor get with this round?
Now edit the note (go to cap table / timeline) and lower valuation cap to $1M and go back to scenario
What is the new convertible debt investor % ?
Getting in front of Angels with effective investor pitches
Warning signs in pitches
12
This is absolutely going to be 100X return
Our financials are conservative
We have no competition
We’re unique in the mobile/social/web space
I know investors want to steal my idea
We’re Uber for X
All we need is 2% market share
Our competitive advantage is that we’re first to market
Other investors just don’t get us
Our competitor had a big valuation so we deserve one too
Angel math
What investors want
Truths
Most startups fail
No one knows which are not going to fail
Investing in startups is a numbers game
What ends up, usually went down first (J-curve)
All companies always need more money
If you understand the above, you can make money as an angel investor
Investor concerns in getting started
How much should you invest?
How do you choose the right company in which to invest?
How should you make your decisions?
How do you get dealflow?
How do you construct a portfolio?
How much should you hope to own of a company?
How does dilution work?
What’s the difference between a safe, a convertible note, and equity?
Are those the same thing as options?
How is a cap table structured?
How should investors work with companies?
Four numbers for angels’ bottom line
The amount of money invested
The value of the company when sold
The number of years between those two events
The value of the company when invested
Example: Return on Investment
Investment of $100 for 10% of the company
One year later the company is sold for $10,000
Investor will receive $1,000
Return on Investment = $1,000 / $100 = 10% (10x)
What other factor is important?
Answer: time value of money
The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.
Would you rather have one investment return 100x in ten years or have an investment return of 10x every year?
Example: Internal Rate of Return
Internal Rate of Return factors in time
That 10x return is great for one year ~900% but maybe not so great if you had to wait 4 years (77%)
Why?
The longer you wait, the higher the return on investment needs to be
How much should angels invest?
No more than 10% of their free cash flow
~$15-25K per deal (though may be higher)
Invest across many (e.g. 30) deals
Seek IRR ~25%
Angel Math: Ten investments
Five likely to fail completely
Two return just the capital invested
2 decent successes
1 great success
Angel math
Without going into the detailed math, one company needs to return 3 times the value of the entire angel’s investment in all ten companies meaning that is needs to have a 30x return
Example, if I have $1M to spend across ten companies equally then one needs to return $3M to me
Means a $10M post-money valuation must exit for $300M to return sufficient capital
So pressure is to negotiate a lower valuation/cap from the startup
E.g. $1.5M valuation instead of $10M means exit at $45M which will be easier
And this isn’t even figuring in later investment dilution and other deal provisions
Captable.io exercise
Start with new cap table
Add Common Stock
11M Authorized Shares
Allocate 10M to self or split with co-founders
Add Stock plan
1M shares
Review cap table
Investor has purchased a SAFE for $100,000 with Valuation Cap at $5M
Go to Securities / Convertible Instruments and issue instrument
Note type – Y Combinator SAFE
Principal $100,000
Cap $5M
0% discount
Go to Stockholders and review ownership
Note the SAFE holder has 0% ownership
Go to Securities and review stock setup
The company negotiates to sell $1M worth of Series A Preferred Stock at $10M pre-money
What will be the post-money valuation?
$11,000,000
What will be the price per share?
$0.909
Calculated as $10M/$11M
What price will the SAFE holder get?
The company negotiates to sell $1M worth of Series A Preferred Stock at $10M pre-money
To make this happen, the company will need to issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the new investors.
Securities / Create New Class / issue 1,100,110 preferred shares
Issue stock to new shareholder – Quick Create, Grant Stock
The SAFE will convert so the company will issue and sell 242,002 shares of Series A-1 Preferred to the safe holder, at $0.4545 per share.
Securities / Create New Class / issues 242,002 preferred shares
Securities / Convertible instruments / Convert All to Stock
Review cap table and shareholders
Early-stage risk assessment
Startups are a collection of risks
Technology Risk
Single indication vs. platform technology
Market Risk
Small, niche market vs. large and growing market
Addressing key unmet needs vs. crowded, competitive market
Intellectual Property
Crowded, well patented space vs. open white space
Regulatory Risk
NDA
Management Risk
Experience in similar industry / product / technology
Existing relationships with investor base
Financing Risk
Investment activity in technology sector
Financing risk at next stage; ability to achieve key milestones
PMA vs 510(k)
Freedom to Operate
CE Mark
Exit strategy – IPO, acquisition, license, trade sale, etc.
Few, provisional applications vs. several issued patents
Early feasibility work vs. built and functional prototypes
Technological Killer Experiment(s)
Is it reimbursable
Risk spectrum analysis tool
The entries on each risk spectrum analysis are rated from 1 (high risk) to 5 (low risk).
Your goal is to move away from the 1's and toward the 5’s.
For example, if you were trying to prove to a friend that you could bake a great cake, then the risk spectrum might look like this:
[1] You've never baked a cake before, but you're sure you could do a good job.
[2] You show your friend a picture of a nice cake you made in the past.
[4] You introduce your friend to people who have previously tasted your cakes and loved them.
[5] You let your friend taste an amazing cake that you just made.
High-level risk assessment
Principle #1: showing is better than telling.
[1] You think you can do XYZ.
[3] You've done XYZ in the past.
[5] You're currently doing XYZ, and doing it well.
Principle #2: external validation is stronger than your personal opinion.
[1] You claim XYZ.
[3] Numerous people who affiliated with you (friends/accelerator/etc.) claim XYZ.
[5] Numerous people who are completely unaffiliated with you claim XYZ.
Principle #3: more data is better.
[1] Your product has 0 sales.
[3] Your product has 5 sales.
[5] Your product has 50 sales.
Product/Market Fit Risk Assessment example
[1] You think people will want to use your product.
[2] You have some early users, but they're all affiliated with you
[3] You have some early unaffiliated users, but user acquisition economics aren't great.
[4] Your user base is growing organically at a moderate rate.
[4] Your user base is growing quickly through affordable paid acquisition.
[5] Your user base is exploding through referrals and word of mouth.
Handling risk
Remember that investors want to see the opportunity but they will be evaluating you based on the risks
The more you know about your risks the more professional you come off and ready for investment
Enables you to have open and honest conversations with your team and investors
More on Risk spectrum analysis at https://codingvc.com/how-to-de-risk-a-startup/
Guest speaker: Angel investor Glenn Gaddy
This week’s readings (complete by end of week)
Best Practice Guidance for Angel Groups – Deal Structure and Negotiation
36
Angel investor analysis paper – due Sunday by midnight
Using what you’ve learned from the David Rose book, the lectures, guest speakers and suggested resources, develop a 4-5 page paper on your perspectives of angel investing.
Specifically address topics such as:
what does it take to be an angel investor
what types of companies qualify for angel investing
what do angel investors look for
when do they invest
how do they invest (evaluate their investment decisions)
how can startups most effectively pitch to angel investors
Including examples, references, interviews (startups and investors) and other information to support your analysis
Next week
Tuesday
Venture capital overview
Thursday
Term sheets 1: overview
Sunday
Quiz #3 (focus on angel
Team exercise: equity
investment simulation
investing)
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