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Venture Capital Financing Basics

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Basics of Financing
HBS Startup Bootcamp
Jeff Bussgang
General Partner and Co-Founder, Flybridge Capital
Senior Lecturer, ...

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Context For My Perspective
Professor @HBS:
- Launching Tech Ventures
- Rock Venture Partners
Venture
Capitalist
@Flybridge...

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Confidential Presentation
Fundraising Patterns and Players
Confidential Presentation
$250-$500k pre-seed
- Convertible not...

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Venture Capital Financing Basics

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A primer for founders on how to raise that first round of venture capital from Harvard Business School professor and Flybridge general partner Jeff Bussgang

A primer for founders on how to raise that first round of venture capital from Harvard Business School professor and Flybridge general partner Jeff Bussgang

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Venture Capital Financing Basics

  1. 1. Basics of Financing HBS Startup Bootcamp Jeff Bussgang General Partner and Co-Founder, Flybridge Capital Senior Lecturer, Harvard Business School @bussgang JANUARY 2021
  2. 2. Context For My Perspective Professor @HBS: - Launching Tech Ventures - Rock Venture Partners Venture Capitalist @Flybridge 2x Author: - Mastering the VC Game - Entering StartUpLand 2x Entrepreneur: - NASDAQ: OMKT - Upromise (acq: SLM) Confidential Presentation 2
  3. 3. Confidential Presentation Fundraising Patterns and Players Confidential Presentation $250-$500k pre-seed - Convertible note/SAFE at $5-$7m post cap - If your friends, family and ex-colleagues won’t back you — why should I? 3
  4. 4. Confidential Presentation Fundraising Patterns and Players Confidential Presentation $250-$500k pre-seed - Convertible note/SAFE at $5-$7m post cap - If your friends, family and ex-colleagues won’t back you — why should I? $1-$3m seed at $8-$15m post - Either note, SAFE/SAFT or priced round - Micro-seed funds, seed funds, super angels 4
  5. 5. Confidential Presentation Fundraising Patterns and Players Confidential Presentation $250-$500k pre-seed - Convertible note/SAFE at $5-$7m post cap - If your friends, family and ex-colleagues won’t back you — why should I? $1-$3m seed at $8-$15m post - Either note, SAFE/SAFT or priced round - Micro-seed funds, seed funds, super angels $5-$10m Series A at $20-$50m post - Priced round, board, control structure - Seed, Series A, Series B funds 5
  6. 6. Confidential Presentation Fundraising Patterns and Players Confidential Presentation $250-$500k pre-seed - Convertible note/SAFE at $5-$7m post cap - If your friends, family and ex-colleagues won’t back you — why should I? $1-$3m seed at $8-$15m post - Either note, SAFE/SAFT or priced round - Micro-seed funds, seed funds, super angels $5-$10m Series A at $20-$50m post - Priced round, board, control structure - Seed, Series A, Series B funds $20-$40m Series B at $80-$200m post - Priced round, board, control structure, seniority? - Series B funds, growth funds, crossover PE 6
  7. 7. Confidential Presentation Expectations and Milestones 7 Have well-documented milestones that represent what you expect to achieve during the initial funding period - Team building - Technical progress/product development - Customers, revenue - Budget Talk to the investor about the next round before you close this round - Expectations, amount, price What experiments are you going to run and what results do you expect from those experiments? Informs how much you raise: get to a valuation inflection point
  8. 8. Confidential Presentation Investor Decision Making 8 Confidential Presentation - Most VCs and Angels have ADD — operate on “BLINK” instincts • Want to SEE everything, but actually INVEST in very, very few deals • Make their decision within the first 10-15 minutes - Typical VCs and Angels will invest in one out of every 300-500 deals they see • Long odds — you need to really stand out • Like college applicants — triage quickly Blink: The Power of Thinking Without Thinking, by Malcolm Gladwell
  9. 9. Confidential Presentation 9 Unconscious Bias - Behavioral psychology research shows that our brains are “prediction machines”, which helps with pattern recognition but frequently leads to bias • E.g., HBS study that male and female entrepreneurs get asked different questions by VCs • E.g., “Harvard dropout in a hoodie” founder - As an entrepreneur, you want to be aware of these biases to avoid some and exploit others
  10. 10. Confidential Presentation VCs vs. Angels 10 Can be total disasters Will want some control (voting, board, veto) Will want to own 10-20% Very actively engaged (they get paid to do this), leveraging the power of the firm’s network Can add tremendous value and be great business partners Typically, rational actors, commercially-driven, but if inexperienced can do great harm VCs
  11. 11. Confidential Presentation VCs vs. Angels 11 Can be total disasters Will want some control (voting, board, veto) Will want to own 10-20% Very actively engaged (they get paid to do this), leveraging the power of the firm’s network Can add tremendous value and be great business partners Typically, rational actors, commercially-driven, but if inexperienced can do great harm Can be total disasters Will want no control (“send me an annual email”) Will want to own 1-10% Maybe engaged or not (often a hobby, sometimes a personal mission) Can add tremendous value and be great business partners Typically, rational, but if unsophisticated: naïve, irrational, emotional VCs Angels
  12. 12. Confidential Presentation VC Is Not the Only Option 12 Confidential Presentation VC Decreases Runway VC is raised to fund higher burn rates. An increased burn rate is a great investment when used to fuel a working model. More often, burn is used to search for a model that works, and the company quickly learns that capital has no insights. When startups cannot sustain the burn, and cannot manufacture enough VC enthusiasm to keep the dream alive, crash landings ensue. 1 Venture Capital increases risk for founders in two ways VC Limits Exit Options Probabilistically, the most likely exit for a startup is an acquisition for less than $50 million. This outcome has little benefit to VCs, and they will happily trade it for an improbably shot at a bigger outcome. Billions of dollars have been outright wasted by founders selling future value that didn’t materialize, while surrendering present value that could have been navigated to great success. 2
  13. 13. Confidential Presentation A Game of Outliers (“Power Law”) 13 Confidential Presentation 0 10 20 30 40 50 60 70 0-1X 1-5X 5-10X 10-20X 20-50X 50X+ Right-Skewed Distribution of U.S. Venture Returns By % of financings in companies going out-of-business, acquired, or IPO 2004-2013 n=21,640 financings % of Financings Gross Realized Multiple Range Ridiculously large returns (> 10x) are very, very rare (4%) — but are always the goal In statistics, the power law is a functional relationship between two quantities where one quantity varies as a power of another. Source: Includes data from Dow Jones VentureSource and other sources
  14. 14. Confidential Presentation VC Fund Math 101 14 Confidential Presentation Prototypical, $100M Early Stage Fund ($ in mm) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Fund End AVG Deployment Pace 19.4% 20.1% 15.7% 16.4% 9.8% 7.0% 3.2% 2.2% 2.7% 1.0% 1.3% 1.3% 100.0% AVG Proceeds from Exits 0.0% 0.1% 0.9% 1.5% 2.2% 4.3% 6.8% 8.5% 13.1% 18.9% 21.8% 21.8% 100.% Capital Called $19.4 $20.1 $15.7 $16.4 $9.8 $7.0 $3.2 $2.2 $2.7 $1.0 $1.3 $1.3 $100.0 Gross Proceeds $0.0 $0.6 $.3.3 $5.7 $8.5 $16.6 $26.1 $32.6 $50.0 $72.2 $83.4 $83.4 $382.5 Management Fees $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $2.0 $0.0 $0.0 $20.0 Carry $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $13.1 $13.1 $13.1 $13.1 $52.5 Net Proceeds for Distribution ($21.4) ($21.5) ($14.4) ($12.7) ($3.3) $7.6 $20.9 $28.5 $32.3 $56.1 $69 $69 $310.0 Net IRR (10.%) (8.7%) (3.8%) 2.2% 9.9% 25.6% 51.1% 82.5% 116.4% 173.8% 242.8% 310.0% 310.0% Gross Return Multiple Net Return Multiple Net IRR 3.8x 3.1x 20% To achieve target of 3x the fund, need to see multiple big exits (>10x) in years 9-12 Source: Industry Ventures
  15. 15. Confidential Presentation When Do You Talk to Investors? 15 Confidential Presentation - Never too early to build a relationship (and get advice) — especially when you’re not asking for money. - That said, there is no such thing as a casual meeting — every meeting with an investor is a pitch/presentation. - Leave them with your next milestones…and achieve them! - Only when you’ve established a relationship and operational credibility should you ask for money. “Ask for money, get advice. Ask for advice, get money twice.” - Pitbull, Musician
  16. 16. Confidential Presentation 16 Confidential Presentation Find the Sweet Spot Don’t downplay risk Mutual due diligence is fair play Arrange for a warm introduction Scope out the firm size matters, as does the — individual 16 Confidential Presentation Prepare, be brief (VCs “BLINK)
  17. 17. Confidential Presentation Kiss Many Frogs 17 17 Confidential Presentation 58 Investors Contacted 40 Investor Meetings $1.3 M Capital Raised 12.5 Weeks to Close Stats From an Average Series Seed Raise Source: Docsend
  18. 18. Confidential Presentation VC Introduction Algorithm 18 Confidential Presentation Entrepreneurs who have made them money 1 2 3 4 5 6 Entrepreneurs in their portfolio Entrepreneurs they respect Customers/Partners they respect Service providers they respect Existing investors - Cold emails/social networks - Investors who are not investing
  19. 19. Confidential Presentation Investor’s Decision Tree 19 Confidential Presentation Worth 3 minutes (email, phone)? Yes No Ignore/decline to engage Worth 30 minutes (phone, in person)? Yes No Pass gracefully Worth 60-90 minutes (in person)? Yes No Pass but stay in touch Worth follow-up meeting (in person)? Yes No Pass but be helpful Serious Due Diligence
  20. 20. Confidential Presentation Elements of the Pitch 20 Confidential Presentation 1 2 3 Intro - Who are you? - Why are you here? - Why are you special? Problem - What is the customer pain? Solution - What’s your disruptive, breakthrough compelling solution? - Is the “Gain vs. Pain” ratio 10x? 4 5 6 Opportunity /Market Size - Top down and bottoms up Competitive Advantage - What is your unique differentiation? - What’s your “competitive moat”? Go-to-Market Plan - How are you going to reach the customer? 7 8 9 Business Model - How are you going to make money? Financials - What’s the bottom line, what are your key assumptions? - How are you going to make ME money? The Ask - How much do you want, how long will it last you and how much will you achieve?
  21. 21. Confidential Presentation Top 3 Things to Do 21 Set Context Be Crisp and On Point Know Your Stuff - Tell your narrative to prove founder-market fit – i.e., why you? - Tell industry context to prove why now? - Personal intro < 5 minutes - Team intro < 5 minutes - Make it relevant — don’t go off on tangents - If you can’t show good summarization skills, how will you handle a board room? - Know competition, show domain expertise - They will push you to test you - John Doerr/Upromise case study
  22. 22. Confidential Presentation Top 3 Things to Avoid 22 Do Not Exaggerate There’s No “I” in Team Do Not Name Drop - Assume everything you say will be verified in due diligence - Assume the listener is a cynic and a professional BS detector - If you are self-aggrandizing, investors will assume you can’t build teams, attract great talent - No one is going to be impressed with who you know unless the relationships are both real and relevant - Assume everyone does their due diligence
  23. 23. Confidential Presentation Typical Investment Criteria - Tangible things investors like to see: • Very big market (> $500M? $1B? — support $100+M revenue) • Unfair advantage (why you? why now?) • Attractive business model (recurring, high margins, network effects) • Unique technology or business model approach 23 - Intangible things investors like to see: • “Pied Piper” — an ability to recruit and retain a great team, partners • Interpersonal chemistry • Movie, not a snapshot • X-Factor/Super power
  24. 24. Confidential Presentation So You’ve Had a Good Meeting… Then What? 24 - Treat fundraising like a sales process — build a pipeline, work people through the pipeline, build up to crescendo - VCs get distracted — typically only pursue 2-3 high priority new investment opportunities at any given time - Stay connected, top of mind, build a sense of momentum - Need to sell the individual “champion”, then the help them sell the partnership - Address objections with specific data • Make the investment case for them • Give them tools/materials to share with their partners • Create a sense of urgency (run a competitive process)
  25. 25. Confidential Presentation Then, Expect More Due Diligence 25 25 Confidential Presentation As you would do in a sales process, package up the information, make it easy on the VC — provide reference list, financial models, detailed market size analysis — all in readable, compelling, digestible form Customers /Partners Team Business Model Market Size/Analysts
  26. 26. Confidential Presentation Partners Meeting 26 Confidential Presentation Ask your champion where they’re at (Strong positive? Slight positive? Still questioning?) 1 Ask your champion for the main objections in advance 2 Customize your pitch to address them 3 Command the room 4 Be open about risks — and your plan to mitigate 5
  27. 27. Confidential Presentation 27 The Vote Partner A Partner B Partner C Partner D Average Market 4 4 4 4 4.0 Team 4 4 3 5 4.0 Product/Tech 2 4 4 2 3.0 Business Model 5 5 3 3 4.0 Competition 4 3 3 4 3.5 Deal/Cap Markets 4 4 3 3 3.5 Disruption 4 4 4 4 4.0 Network Effects 2 3 4 4 3.3 Total 29 31 28 29 29.3 Two most important criteria Who’s your champion? Know what they think beforehand
  28. 28. Confidential Presentation Term Sheet Time - FAQs 28 1. Should I include VCs in my seed round or just angels? 2. Should I do a convertible note/SAFE with a cap, no cap or a priced round? 3. How big should the option pool be? • How much do I set aside for team, advisors, board? 4. How should I think about valuation? • “Promote” definition 5. How should I think about control?
  29. 29. Confidential Presentation Who’s Ready to Raise Money? 29 Confidential Presentation
  30. 30. THANK YOU! Jeff Bussgang General Partner and Co-Founder, Flybridge Capital Senior Lecturer, Harvard Business School @bussgang JANUARY 2020

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