6. Pitchbook Conclusions
Deal, fundraising, exit activity and (with exceptions) deal values
were down
VC Industry is well capitalized
Advances in AI, life sciences, and clean tech are attracting
significant levels of public and private investment
6
8. Basic Principles
Investors are partners
Stage your financing
Most funding is dilutive
Your valuation might have little to do with what you are worth
Valuation is not your biggest issue
Avoid early mistakes
Take cheap money over expensive money
Common stock is for service providers
Get a data room
Do the cleanup ahead of time
8
9. Sources of Funding
Founders – savings, IRAs, credit cards, mortgage equity
Debt Financing
Government Grants
Friends and Family
Angels or Seed Investors
Incubators
Pitch Competitions
Institutional (VC or Private Equity)
Alternative Financing:
o Rewards-Based Crowdfunding
o JOBS Act Crowdfinancing
o ICOs, STOs, IEOs
o Royalty Financing (SEALS)
9
10. Founders
77% of startups rely on personal savings (and their parents) for their initial funds
10
Source: Wells Fargo/Gallup Small Business Index
11. How Much?
Angels - $25,000
Angel Groups - $250k to $750k
Early-Stage VC - $1.5 M and up ($3m to $5M)
Later-Stage VC - $10M and up
11
12. The Lead
Smart Money
Chemistry
Commitment
Deep Pockets
Network
12
14. Government Grants and Loans
Free Money from the Government
https://www.usa.gov/grants
https://www.aprise.org/
https://www.sba.gov/funding-programs
SBIR program
STTR grants
14
15. Friends and Family
38% of startup founders raised money from their
friends and family
$23,000 was the average amount invested by friends
and family per startup
15
16. Outside Money
Angels, VCs, crowdfunding, private equity, etc.
How much to raise?
Milestones
Burn rate
Target runway
Equity percentage and valuation
16
21. Angels
The Good:
Connections to VC funding
Mentorship
Risk capital
The Bad:
Hostage takers
Whiners
Demanders
The Ugly:
Potential plaintiffs
Disturbers
21
22. SAFEs and Convertible Notes
Convertible Notes and SAFEs
Debt obligations that convert to preferred stock
Conversion feature – automatic, optional, prepayment
Valuation Cap
Sets a maximum valuation at which note will convert
Discount
Early investors get a discount to the preferred price
Change of Ownership
Investors convert to common or get a multiple on a sale of the company prior
to a priced financing round
Shadow Preferred
Pre and Post Money
MFN
22
25. Effect of Valuation Caps
25
Founders 4,000,000 100% 4,000,000 100%
Stock Pool 0 0% n/a
total 4,000,000 100% 4,000,000 100%
Fully Diluted % Issued
%
Company sells a $1,000,000 SAFE with a $4,000,000 pre money valuation cap
That means that the SAFE will take 20% of the capitalization ($1,000,000/$5.000,000)
26. The UNSAFE
Valuation Caps + SAFE = Unknown Dilution
Pre–Money – SAFEs take dilution of other SAFEs
Post-Money – SAFEs do not dilute for other SAFEs
https://safegenie.io/ is a tool that helps project pre money SAFE valuation
26
27. Pre and Post Money Valuation Caps
27
Founders 4,000,000 100% 4,000,000 100%
Stock Pool 0 0% n/a
total 4,000,000 100% 4,000,000 100%
Fully Diluted % Issued
%
Company sells a $1,000,000 SAFE with a $4,000,000 pre money valuation cap
That means that the SAFE will take 20% of the capitalization ($1,000,000/$5.000,000)
28. Series Seed Stock
Watered down preferred stock
Justifies low common stock price
28
29. SAFE and Conv Debt Traps
Post Money SAFEs
Valuation caps and excessive dilution
Securities law violations
Cap Tables
29
31. “Avoid venture capital unless you absolutely need it.” Randy
Komisar, venture capitalist*
*Straight Talk For Startups
31
32. Should You Take Venture Capital?
Must give up Equity
No near-term cash flow
Risky
Illiquid
Can the business scale?
Explosive growth
Huge market
32
33. Which VC should I approach?
Thematic Investors bet on their thesis of what is next
Domain Investors focus on an industry that they know well
Quant Investors focus on data
People Investors bet on the jockey, not the horse
Tech investors bet on the horse
33
34. Venture Capital Economics 2/20 Formula
2% management fee on committed capital
20% carried interest
7-to-10-year terms
LPS want 2 1/2 to 3 times investment return
VC fund must earn 3 to 4 times investment to return that amount
34
35. Venture Capital Economics – Expected
Performance
50% lose money
20% – 30% are singles or doubles
The rest must be home runs (10X to 100X)
35
36. General VC Fit
Large potential market
First Mover or first to market advantage
Long term scale over short term profits
Not able to service debt
Traction!
36
37. Venture Capital Economics –
Management
Venture capital will participate in management
Board seats
Board Observer
Management rights letter (for VCOC exemption)
Seven-to-ten-year term (and longer)
Precludes small investments
Board meetings
Management
37
38. Venture Capital Metrics
Team
Domain expertise
Technical co-founders
Technology or product
Solve problems, address pain points
Customer validation
Market size
Must be a huge market
38
39. Picking a VC
Reputation
Likelihood of closing
Stage of fund
Size of fund
How much dry powder?
Is there a fund 2, fund 3 etc.?
Are they litigious?
Deal with decision makers
39
40. Entrepreneur VC Fit
Network
Temperament
Advice
See the published email from the CEO of CircleUp to an investor
at for an example of a VC/Founder relationship that did not work
out
40
41. Company VC fit
Capital intensive business?
Follow on funding?
Time to exit
41
42. Series A is the New Series B
Series Seed
Pre-Seed
Series A-1, A-2
42
43. Types of Funds
Micro VC – angels with other people’s money
Seed Stage Fund – early, first institutional money
Mid Stage – B and beyond
Late Stage
43
46. Strategic Venture Capital
Can you pivot?
Will it affect customers?
Follow on investors
Change in management
Strategic agreements
Confidentiality
ROFR, right of first look, right of first offer
Strategic objectives
Less operational involvement
46
48. Structuring for Capital
Business Model
Choice of Law
Choice of Entity
Cap Table
Vesting
Debt
48
49. VC Considerations
1. QSBS
2. VC’s LPA will not allow investment in a passthrough
1. Tax exempt investors want to avoid UBTI
2. Foreign investors want to avoid ECI
3. VC wants to be able to manage losses
1. No K-1’s showing losses
49
51. Participation
Participating preferred stock returns its investment and then
shares pro rata in proceeds of a sale
Non-participating convertible preferred stock either gets a return of
its investment or its pro rata share of proceeds
Participation may be capped at a multiple of the investment
Conversion to common – auto-conversion and majority vote
51
52. Dividends
Preferred will have a dividend preference.
A cumulative dividend on preferred shares must be paid before
any other dividends on common.
If the company can't pay out a cumulative dividend in a year, the
amount is carried forward.
Common in private equity deals, not in venture
Non-cumulative is only paid when as and if declared.
52
54. Example of Liquidation Preference
1X Nonparticipating convertible preferred
$1,000,000 invested for 10%
Ex 1: Exit (sale) of company for $5,000,00
Ex 2: Sale for $20,000,000
54
55. Board Representation
Size of board
Founder-friendly boards
Role of the Board
Observers
Indemnification
Insurance
55
57. Protective Provisions
Class vote or majority vote
Delaware law
Separate vote for later investors
Do the interests of different investors diverge?
57
58. Protective Provisions
58
Standard:
Right to veto or block certain corporate
actions
Sale of the company
Amendment to the company’s certificate or
bylaws so as to adversely alter or change the
rights of preferred stock
Increase or decrease in the number of
authorized shares of preferred or common
Authorization or issuance of equity security
having a preference over, or being on a parity
with, preferred stock
Redemption of shares of preferred stock or
common stock
Declaration or payment of dividends
Change in the authorized number of directors
of the company
Other:
Hiring, firing or change in the compensation
of officers
Any transaction with any director, executive
or employee of the company
Incurrence of indebtedness in excess of
$[____]
Change in the principal business of the
company or the entering into any new line of
business
Any purchase of a material amount of assets
of another entity
Option plan increase
60. Registration Rights
Requires a company to list the shares publicly so that
the investor can sell
Demand rights
Piggyback rights
S-3 rights
60
61. Common Restrictions: Co-Sale
Rights, ROFR, Drag Along
Co Sale and Tag-Along Rights – right to participate in a sale
Right of First Refusal – right of company (first) and investors
(second) to require shares to be offered to each of them before a
third-party sale
Drag Along – right to force shareholders to sell in an exit
Board, common and preferred approvals
Small shareholder carveout
61
62. Founder Vesting
Term, milestones, commencement
Acceleration
Single and double triggers
Fire the Founder
62
63. Pro Rata Rights
Right to maintain, right to participate
Major investors
Limited by amount of money company wants to raise
63
65. Redemption Rights
Feature of Preferred Stock
Right to put stock to company, usually after a period of time and
over time
Is effectively a right to force a sale of the company
65
69. Planning for Later Rounds
Overly favorable terms
Valuation planning and down rounds
Reverse splits
Cap table management
Fire the CEO
69
70. Troubled Company Terms
Forced conversion to common
Full ratchet
Uncapped participating preferred
Insider rounds
Low valuations
Down rounds
Trigger anti dilution protection unless waived
Pay to play
Requires existing investors to invest on a pro rata basis in
subsequent rounds or they lose preferential rights (anti-dilution,
liquidation preferences, voting rights)
70
72. Unsuccessful Exits
Zombie Companies
In re Trados Inc. Shareholder Litigation
Bankruptcy or Insolvency Reorganizations
Fire Sales
Management carveouts
Fiduciary duties: shareholders, optionees, preferred and
creditors?
72
73. Other Unsuccessful Exit Issues
Tax Liability
Personal Liability
Tax
Employment
Fiduciary Claims
Securities Law Claims
Contractual
Pierce the veil and creditor claims
Serial Entrepreneurs and failed companies
73
74. Bibliography of Essential Reading
10,000 Startups: Legal Strategies for Startup Success, Roger Royse
Dead on Arrival: How to Avoid the Legal Mistakes that Could Kill Your
Startup, Roger Royse
Straight Talk For Startups, Randy Komisar and Jantoon Reigersman
The Startup Checklist, David S. Rose
Angel, Jason Calcanis
Venture Deals, Feld and Mendelson
The Startup Game, William Draper
Secrets of Sand Hill Road, Scott Kupor
How to be the Startup Hero, Tim Draper
Make Elephants Fly, Steve Hoffman
Getting to Wow, Bill Reichert
74