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What do VC’s want?
Michelle McBane @michellemcbane
Investment Director
Investment Accelerator Fund @MaRSIAF
iaf.marsdd.com
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Investment Accelerator Fund (IAF) - Purpose
• Seed stage funding is critical for job creation and a vibrant VC infrastructure • IAF provides seed investment to promising, emerging technology companies
throughout Ontario • Provides technology companies with the resources, skills and networks to
validate their ideas and bring products and services to market • Bridges the funding gap between new technology companies and the wider
investment community
• For more info go to: iaf.marsdd.com
Bridging the Funding Gap for Seed Stage Companies in Ontario
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Who can raise venture funding?
• Venture capital is a very specific thing. • It’s not what all technology businesses should think of when they
need capital.
• It only really works for businesses with: • High potenUal for escape velocity • A large potenUal market
• A team capable of building a large company
h)p://www.startupcfo.ca/2012/08/top-‐10-‐signs-‐your-‐business-‐is-‐not-‐vc-‐fundable/
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Deal killers
• Services, not product • You are a sole founder • You don’t know any VCs • You have no tracUon • You have outsourced development • You serve a niche market • You don’t know the market • You are disorganized • You move slowly • You lack that founder magic
h)p://www.startupcfo.ca/2012/08/top-‐10-‐signs-‐your-‐business-‐is-‐not-‐vc-‐fundable/
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Goal
• VC moUvaUons – Driven by their model
– Impacts their terms and expectaUons
• Most companies aren’t VC’able – Just don’t fit the “Big Money” model
– May be good companies and businesses
• But if you are then you’ll be be]er equipped than most because of tonight
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Its all about the frogs
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The Numbers
• 1,000 companies • 10 investments
– 2 may be widely successful (usually 1)
– 6 “land of the living dead” – 2 fail horribly
• Winners to offset my losers
• Start ups 10-‐12x return in 5-‐7 years • ExisUng companies 5-‐7x in 4-‐5 years
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What does that mean for you?
• A company that doubles isn’t enough… • Every opportunity has to have the potenUal to be a home run
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You Tube & Sequoia
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Deal Stats
• You Tube sold to Google for $1.65 Billion • Sequoia invested $11.5M received $495M
– 30% of the company
• 43x return • Great deal!
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ExpectaUons
• 6-‐9 months to raise capital • Several meeUngs
– Want to get to know you
– Assess your “Say/Do” factor – Close to truth
• Builds confidence
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ExpectaUons
• Personal RecommendaUon: – Get to know the VC
• Process (who makes the decision, when & how oren)
• Where are they in their fund life cycle
• What was their last deal
• Talk to their exisUng CEO • Cash available to invest/reserves
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ExpectaUons
• Personal RecommendaUon: – Rise above the noise – Remember the frogs
• 1,000’s of deals
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Fit
Have to be able to live with them … “Dl exit do you part”
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Ni]y Gri]y…
• The term sheet…
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What is a Term Sheet
• Non-‐binding offer to invest • Outlines the general terms and condiUons of investment
– Which may change
• Not the definiUve agreement simply a place to start • Everyone uses it
– Understand WHEN a fund issues a term sheet in their process
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Basic Terms
• Non-‐heart ache – Company name
– Investors – How much
– Date
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ValuaUon is an Art
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Company’s Growth Forecast
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RaUonalized Forecast
On average it takes about 6 years for a so7ware company to get to $10 million revenue. Far more realis?c to get to $50M in 10 years (50% growth rate from years 6 to 10).
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Long Term Financing Strategy
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Build Value
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Typical Seed Stage Investment Structure
• ConverUble Debenture • Common Shares
• Preferred Shares
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What is a converUble note?
• Short-‐term debt that converts into equity • For seed financing typically converts upon a larger financing • Why use it?
– Defer the valuaUon discussion (think Dragon’s Den) – Can be faster, simpler and cheaper to paper
– May or may not contain protecUve provisions
• Key Features – Conversion discount – ValuaUon Cap – Interest Rate
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ConverUble notes
• Key features:
– Conversion Discount • Usually 10-‐30% -‐ average is 20%
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ConverUble notes
• Key Features:
– Conversion ValuaUon Cap:
• A ceiling on the value of the start-‐up to determine the conversion price
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If a note includes a discount and a cap – conversion price is the lower of…….
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How do cap and discount work togehter
• If a note includes a discount and a cap – conversion price is the lower of…….
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Preferred Shares
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Dividends
• Accrue • Price + dividend convert
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LiquidaUon Preference
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AnU-‐diluUon
• Protects an investor from down round – As if their investment had been done at the current lower price
– Keeps the investor whole in bad Umes
– Full-‐ratchet – Weighted average
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RedempUon
• VC can ask to have the company buy back shares – Life of the fund – Investors in funds want their money back
• Outcome: – Forces a sale – Get minimum investment back (P+dividends)
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Approvals
• 60-‐66 2/3% – Change nature of the business (acquire/divest) – Change capital structure/arUcles
• Default approval over future financing – Approve business plan/operaUng plan – Change in key employees (defined term)
– CreaUon of ESOP – Unbudgeted expenditure in excess of $5,000 – Non-‐arms length transacUons
– ….
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InformaUon Rights
• Monthly prepared financial provided – 20-‐30 days from month end
• Quarterly financials – Analysis vs. budgets
• Board material
• Yearly operaUng plan – (30 days prior to beginning of fiscal year)
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Share RestricUons
• Founder restricUons • Drag Along
– VCs need exit • Tag Along
– I can sell a porUon if you can
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Board
• Friends and family • Move to 5
– 2 investor – 2 founder – 1 independent – Expect material in advance of meeUng
– Only a meeUng if the VC is there • Defer once
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IP Assignment
• Founders • Employees
• Consultants • Students/universiUes/research organizaUons etc • Avoid convoluted IP structures
– Only going to be unwound
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Key Employee Agreements
• Non-‐compeUUon • Non-‐solicitaUon
– Customers
– Employees
• IP Assignment
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ESOP
• Ensure one common moUvator • Need to a]ract talent • 15%-‐20% (low as 10%) • New CEO • New execuUves • Board members
– Non-‐VC • Pre-‐$
– DiluUve to you
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Other Rights and Privileges
• Power of “OPM” – Get to know your VC – Won’t ma]er in good Umes
– Can’t tell you what to do but prevent you from doing things
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Non-‐Binding Except for…
• Acceptance & Exclusivity – Deadline for acceptance – Use the Ume to negoUate with other parUes
– No “shop”
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Series Seed
Non-‐parUcipaUng preferred liquidaUon preference: The investor receives their money back and the remainder goes to the common.
Limited protecUve provisions: Among other things, the company can’t be sold without consent of a majority of the Series Seed.
Future rights. If new investors get be]er rights in a future equity financings (such as registraUon rights, price-‐based anU-‐diluUon, redempUon rights, etc.), then the holders of the Series Seed get these be]er rights.
Right of first offer on future financings: Self-‐explanatory.
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Take Away
Be careful what you ask for …don’t send the wrong message