At some point in time in your journey as an entrepreneur, you will have the need and/or the opportunity to raise money. It is never as simple nor as complicated as one thinks, but the reality is that one needs to know the key elements of a term sheet and the process associated with it, which will be critical for the success of your business.
What SLP can do is bring you the perspective of experienced investors and entrepreneurs to learn from their successes and failures in fundraising in a safe and open environment where you can integrate their views in your own journey that will help you make better decisions.
Preparation and setup of the class
We changed the way was the class was originally organized by focusing as much as possible on interactions and engagement of outside guests with the SLP Fellows. (we dropped the Term sheet competition)
Instead of having an ex-cathedra class with Steve Barnett (Partner at law firm Schoosmiths), we changed the format to a conversation (fireside chat) where I would ask Steve specific questions about his experience and the key elements that an entrepreneur should focus on. The conversation made the class livelier and the level of attention was good.
That required, preparing a high-level roadmap to make sure we would hit all the points without getting lost in details.
The second important preparation was to get the right guests, which was a bit tricky with the Christmas break when everyone disappears. We however managed to get a VC who invests in mature companies, a VC who does early stage and later stage investing and a CEO who has been through all the hoops, from bootstrapping, to raising seed, to raising Series A and B.
What happened on the day?
All of our guests showed up which was great – we went through the fireside chat in about 30 min which was ample time to keep the audience engaged without getting lost in heavy details.
We then separated into two breakout rooms (kindly provided by our sponsor Deloitte), one with the VCs and one with the entrepreneur for about 40 min each and then we swapped the groups. With breakout groups that are smaller size, it allows for a richer, easier conversations and everyone has enough air time to participate and get information that is relevant to their situation.
The feedback from the guests was positive, as they felt they had enriching conversations and good questions.
Retrospective – what did we learn?
There were interesting takeaways from the group in the final plenary session. Some of the key takeaways: preparation is key (get everything in order before you raise), take control of the process and stand your ground on certain points with your investors. Get the fundraising done quickly as it is a distraction from the day to day running of the business. Many other tips were shared.
Message to the Class of 2019
My advice to the class CEO of 2019 is that running the class takes leadership as you have to watch the clock, interacts with your guests and make sure engagement is high, but overall it was a very enjoyable experience. The key part is to get the right guests (i.e. with a variety of experiences) and confirm them well in advance as the Christmas period tends to be very quiet.
LEARNING ON THE DAY
Fundraising process: – how to prepare well for fundraising? What are the key elements to consider before embarking on the fundraising process?
· Some of the main things to have clearly in mind is what the amount is and what the funds will be used for
· The second aspect is to really have all your documents in order and ready to go for investors to go through it including exec summary, demo, all the legal part in order, cap table and financial accounts ready
Which investors should the founders approach? Who are the typical early stage investors? When can one approach VCs?
For early stage, it really is the angels, which is a growing community (ex entrepreneurs investing in new businesses)
For more mature stage, there are the VCs but there are also new investors coming from different background (corporates, other type of funds etc.)
How to come up with a valuation? What are the metrics/ characteristics that one should look at? How do you a value a pre-revenue company?
This is really tricky especially for a lawyer to come up with a valuation, but we tend to see that the use of peers is common to value a company
Also, it depends on how much equity one can give up
What are the key elements for the term sheet? What do we need a term sheet for? Is it legally binding? What are the basic elements to have in the term sheet? What are the formats to use (standard seedcamp/ European standard)?
The term sheet is important and not legally biding but it is the key document for negotiation. They can come with very different provisions depending on the stage of investment.
The main thing is to be careful about terms that give a lot protection to investors in the future (where they can get their money back at the expense of other investors or management) as other investors would require the same.
The basic elements are always the size, the terms (instruments) and provisions around board seat etc.
Now getting into the details – what are the important things to keep in mind for an entrepreneur? What should the entrepreneur absolutely have in the term sheet? What are the features you typically see at the angel stage? What are the features you typically see at the VC stage?
At the angel stage, it should be relatively straight forward and not having any provisions on the liquidation preference. Typically, the sheet is more “take it or leave it” really at the early stage because they are 10-12 investors in the roun
At a more mature stage, you would expect to see more constraining provisions around anti-dilution, board seats and liquidation preferences
What are the most important points for the investors that the entrepreneurs should be aware of? Instruments preference for investors (e.g. convertible vs. equity)? Provisions that make investors happy (e.g. warrants etc.)?
Key point is to be careful not to waste time on things that are very complex or trying to predict very complex things.
How to choose and work with your lawyer?
Tricky question – it’s important to have a lawyer with experience and good relationships – you really need a lawyer that can involved at an early stage (ready to make an investment with you) and follow you as you grow bigger and get through different phases.
That is the US approach and Steve’s approach to work with smaller firms (entrepreneurs)
What are the concepts one needs to master well before entering negotiations?
1. Liquidation preference
2. Option pools for management
3. Anti-dilutions protection
4. Drag along rights
· Negotiation tactics
1. What are the leverage points for the entrepreneur?
2. Do you need a lead investor?
· Important for the entrepreneur to project confidence
· Be able to bring several term sheets to have options
· Useful to have a lead investor as he can help attract more investors and also manage other investors in the negotiation
War stories: What are the worst deals you have seen from the entrepreneur ‘s stand point? (can we learn anything from this?) What are the best deals you have seen from the entrepreneur’s stand point? Can we learn anything from this?
Some deals that were drafted with no law firm etc. can have very bad terms in the long term for the entrepreneur and those are difficult to change in the long term. So, it’s really important to think about the long terms and use modelling (excel) to see the impact of some of the features/ options and how it will impact shareholders and valuation
Key questions for Entrepreneurs - at what stage did you decide to raise money? (pre-revenues, post-revenues, how many employees…other metrics?)
· Kevin Duffy went through the seedcamp program and has been preparing and self-funding the company for 15 months before
· The investors came in when there were tiny revenues in (60K) and participated to following two rounds
· Delivery of contracts and revenues have been successful
What were your objectives for fundraising?
· Coming out of Seedcamp valuation of around 750K and they give up between 15 and 30% of the company. The recommendation is to arrive at the VC round with at least 70% in the hands of management
How did you decide on your valuation levels (at different stages?)
· It is more driven by how much you need and how much you are willing to give up in terms of equity at the early stage
· As more metrics come in – one can use multiples and growth level to value the business
What are the key points that made the fundraising successful?
· Have all materials in order and also proactively worked with seedcamp to identify the investors that made sense for the company and get the right introductions early on
· Kevin picked investors that cared about the mission of the company so there was an “alignment of values”
How did you decide which investors to approach? How did you approach investors you did not know? Where your investors people you knew or people you did not know? Did you have a lead investor?
· They picked investors that were close to the industry and understood the problems they were solving
· Eventually the pool of investors grew and attracted more new investors
· There were a few key investors and some of them grew from one round to another
What are the demands from investors that required negotiations?
· Some of the points of negotiation were on the valuation – so important to hold your ground and project confidence in your abilities and work
How long was the fundraising process? How do you manage to run the business and fundraising process together?
· From start to finish the process lasted 6 months but could have been closed a bit faster like 3-4 months.
· The important thing is when you start raising is to do it properly and close fast as it is a distraction from the business so need to target well when you do it.
How costly was the process for each round?
Who were your advisers and how useful were they (e.g. brokers, lawyers, board members?)
- Main advisor was lawyer and there were no other advisers / board members
- Issue of bringing a Board of Advisors is that you may have to replace them as you raise.
What would you recommend to first time entrepreneur raising funds?
Key questions for Investors:
· How do you typically source your deals?
1. Lloyd Thomas: sourcing is really important and I love the activity of sourcing. Requires meeting a lot of people and participating to events.
2. Investment at any stage is possible (seed, A etc.)
3. We maintain a CRM with companies and keep score on the interaction.
4. Main issue is we see a team and product that is attractive but the market opportunity is too small to invest in.
5. Megumi: Thematic approach (digital, transport and financial data) and Corporate VC so approach is a bit different and we are more selective and tend to invest in more mature companies with the right thematic and team is spread out around the world
· What are the criteria you look at? (e.g. do you have a checklist or large freedom?)
1. Key things are the level of traction the company is getting. Obviously, the best is to have revenues but depending on the business the traction can measured differently (users, readership etc.)
How do you start your due diligence process? (what will you recommend for entrepreneurs?)
What is absolute no-no from your standpoint?
If there are disagreements on the team and you see not a good alignment it can be an issue especially if it is visible
How do you value the business?
It really depends on the stage of the business – at the beginning it is really dependent on how much to give up
In the negotiations, what are the most important points from your standpoint (liquidation preference, board seats, etc.) in the term sheet?
They are important and some investors want board seats.
How is the decision to invest made (committee, one person, etc.)?
How long does the process take typically?
Do you need several institutional investors? Who takes the lead typically in the negotiations?
It can be helpful to have an institutional lead as they can bring other investors and typically supports most of the negotiations
Which metrics do you focus the most on?
It really depends and the important one is revenues (gold standard) but depending on the business and how they communicate we would track it and track how they deliver against those metrics
What advice you give an entrepreneur in terms of negotiating the right deal?
Have your term sheet ready in terms of the deal you want (amount, valuation, points etc.) – the more prepared you are the more in control of the process you are the best outcome
It’s very easy to get distracted with the investment process and so you have to make sure you stay in control of the deal.