V3. - October 2015 - (CC) BY NC SA

Fundraising for startupsRodrigo A. Sepúlveda Schulz

Source: http://twistedsifter.com/2009/11/how-to-lose-193-million-in-7-hands-of-poker/

http://www.RodrigoSepulveda.com

Summary

✤ how much to raise ?

✤ what valuation ?

✤ how a fund works & what VCs look for

✤ risk management

1. how much to raise ?

PnL projections is the basis*

Please see my presentation on P&L for startups on http://www.slideshare.net/rodrigo1971

2.2 million

insight 1 = cashflow > 0, around month 21

insight 2 = the business needs about 2.2m

✤ You need to adjust for uncertainty in the assumptions. 3 methods :

✤ Montecarlo simulation : use Crystal Ball (excel plugin)

✤ Create 3 scenarios : min / max / target

✤ Just add a rule of thumb of 20-30%

option 1 : Monte-Carlo simulation on the variables !

option 2 : create 3 versions by adjusting the variables :best-case, worst case, target scenario

-750 000€

-250 000€

250 000€

750 000€

1 250 000€

1 750 000€

january

march

may july

septem

ber

november

january

march

may july

septem

ber

november

january

march

may july

septem

ber

november

january

march

may july

septem

ber

november

january

march

may july

septem

ber

november

CashConsumption

MAXScenario

CashConsumption

MINScenario

Nota: adapted from a real business plan

2.8 million

Option 3 : Adjust the model for uncertainty : rule of thumb 20-30%

how much money? key take-aways

✤ careful financial planning is necessary

✤ tells you exactly how much money is required

✤ (adjust for uncertainty with analytical tools)

✤ forces the entrepreneur to test his hypothesis and business logic

✤ gives before-hand many of the answers to investor questions

✤ Allows for scenario building (high, low, target)

2. what valuation ?

http://www.ownyourventure.com/equitySim.html

the good (theoretically)

the bad (your projections)

the ugly

Series Seed

Series A

solution: raise in tranches

series seed :12 mo. cash, no options

great execution commands higher pre-money valuation 4 next round

Series A : add an option pool !

example of an exit price (2x revenues, after 4-5 years)

(fully diluted)

how many VCs?

Excellent discussion by Mark Suster :http://techcrunch.com/2011/02/22/how-many-investors-is-too-many/

“So in order to get a two-handed deal you need to dilute by 40% which is an awful lot at the start of your company. When you consider that they’ll also want a 15-20% option pool in the

company you’re talking about founders owning as little as 40% after just one round. That wouldn’t be bad if you had just one founder, but if you have 4 you’re already at 10% each and you have 7-10 years more work left (not to mention 3 more funding

rounds!).”

recommended reading : Fred Wilson MBA Mondays at http://www.avc.com (and Brad Feld at http://feld.com)

valuation take-aways

✤ 1st round (seed)

✤ not a real life valuation, it’s only about how much you want to give away for the amount of money you need > implied valuation

✤ minimize dilution by raising in tranches

✤ 2nd round (series A)

✤ you need to prove execution to raise at a higher valuation

✤ raise enough to reach cash-flow positive status

✤ 3rd round+ : growth (organic or acquisition)

specific clauses affect capital-gains more than valuation...

✤ liquid preferences

✤ participating or not

✤ multiple or not

✤ http://privateequityblogger.com/2007/06/liquid-preference.html

✤ ratchet

✤ http://www.startupcompanylawyer.com/2007/08/04/what-is-full-ratchet-anti-dilution-protection

3. how funds work & what VCs look for

fund lifetime ~10 yearsextension

up to 2 years

let’s assume for this example a $100m fundwith 4 investment professionals

$

LPs = Limited Partners put money in

GPs = General Partners = the VCs :‘manage the money’ =

they invest over 4-5 years

$

money has to be returned to LPs with an IRR

= Internal Rate of Return

Less than 50% is invested in NewCos,

rest kept as “dry powder”

10 years

✤ there are usually investment rules:

✤ ex: only 5% of a fund in a company

✤ ex: no cross-fund in a single company

✤ which means for ex. 100*5%= 5m MAX in the life of the company from your VC !

✤ it also means 20 companies max/fund

✤ with 4 investors, investing over 5 years, that’s 1 new company / investor per year !

✤ statistically 60% of companies fail, 30% do just OK, 10% do great...

10 year fund

startup : 5y with VC

understand why there is a liquidity clause after 5 years !

investment period

10 year fund

startup : 5y with VC

understand the age of the fund

investment period

how LPs make money

1) hurdle rate ~6-8%, c. 1.8x (gross)min. required…

100m * (1+6%)^10 = 179m to be returned minimum

2) carried interest : any upside above the hurdle rate is shared :

80% for LPs, 20% for GPs

there are subtleties: hurdle rate or not, on invested money or not,

% might change if you are a great fund, etc.

how GPs make money

1) management fees ~1,5-2,5% of fund/year100m * 2% = 2m/year.

usually 16-18% over life of fund(on committed money first, then assets under management)

means 2m * 10y = only $84m left to invest

2) carried interest : any upside above the hurdle rate is shared

($179m in previous ex. - with catch up or not): 80% for LPs, 20% for GPs

there are subtleties: % on invested money or not, % might change if you are a great fund, etc.

http://www.avc.com/a_vc/2008/08/venture-fund--1.html

Why VCs raise more than 1 fund

management fees add up, before making money on capital gains

Fund I

Fund II

Fund III

they need however to show success before raising a new fund

10 year fund

startup : 5y with VC

understand you are competing for the same cash with a different risk/ return profile

investment period

startup : 5y with VC

startup : 5y with VC

low risk / medium return

high risk / high return

medium risk / medium return

VCs key take-aways

✤ understand why there are liquidity clauses

✤ understand the “age” of the fund : money for you or not

✤ understand “dry powder” for subsequent rounds

✤ understand that you are one of many startups. What matters is the performance of the fund

✤ understand VCs make money only if you do really great (in the top 10%) after paying for the hurdle rate, on 20% of carried interest...

4. risk management

it’s all about minimizing risk first

✤ Execution risk => team

✤ Opportunity risk => market size, market traction

✤ Business model risk => business plan

✤ Technology risk => prototype, launched site

✤ All the rest => business plan, reference calls, due diligence

✤ The only thing left should be the market risk (competition, growth)

Team risk

Market risk and B-model

Technology risk

Legal risk, etc.

Summary

✤ how much to raise ?

✤ valuation & tranches

✤ how a fund works & what VCs look for

✤ risk management

Rodrigo Sepúlveda SchulzFounding Partner, Expon Capital

rodrigo@exponcapital.com

https://www.linkedin.com/in/rsepulveda@rodrigo