Startup Finance

An Entrepreneur’s Manual
About Index Ventures
Index Ventures

• Pan European Venture Fund • Over €1.5bn under management

• Based London & Geneva • Active investor in web / internet

Selected Investments
Agenda

Important reflections before you

start

What are the financing options?

How to attract and engage investors?

Deal structure and what to expect

during the investment process
A big undertaking

• Starting a business is a big commitment

– Energy & Passion
– Time
– Financial resources (yours and your investors)
• Before thinking of financing, is worth
taking a deep breath …
Key questions about you

• Why am doing this

– Make money
– Lifestyle
– “Change the world”
• How long do you want to commit?
• What level of financial risk are you
prepared to take?
Key questions about the business

• Be honest with yourself about the risks /

unknowns
– Do customers want the product / service?
– Do you have the competence to build the
product and the team
– Can you monetise the product / service?
– How competitive is / will the space be?
– How big can the overall market become?
Agenda

Important reflections before you start

What are the financing options?

How to attract and engage investors?

Deal structure and what to expect

during the investment process
Overview of financing options

Non-Equity Financing Equity Financing

Angel Financing

Self Finance /
Venture Capital
Bootstrapping

Debt /
Private Equity
Bank Finance

Public
Stock Markets
Self financing / bootstrapping

• Financing growth from previous cashflow and personal

funds
• Obviously need to have cashflows…
• Most good bootstrapped companies emerge from a service
or consulting companies that are productising their offering
• Pros
– Bootstrapped companies almost always spend cash more
effectively than equity financed companies
– Already being close to existing customers, give excellent ability
to understand problems and define good solutions
• Cons
– Resources for product and market dev constrained by
cashflows
– May miss a big opportunity if other players raise finance and
invest heavily
Debt / bank finance

• Relatively limited funds will be available ;

likely to want security anyway
• Banks only lend to predictable businesses
they can understand
• If your capital requirements are limited
and your business is following a well
trodden path, can be a useful source of
finance
• Not particularly useful web or high growth
tech industries
Good reasons to raise equity finance

Pre-requisites

Large Potential
Unique Product Passionate
Market
Or Concept Founding Team
Opportunity

Implications…

Intense
Need to move
competition
rapidly
likely

VC funding supports

Rapid Product
Hiring Partnerships
Development

Internationalisa Commercialisati
Infrastructure
tion on
When NOT to raise VC

Application
Market size is Motivation is
is a feature
too small not financial
not a product

• Risk is not that you waste time unsuccessfully trying

to raise finance …
• … real danger is that you do succeed in raising VC
funds
– Lose opportunity for small exit which could be
personally lucrative
– Lose opportunity to run lifestyle business
– Get bound in to 3+ yrs work you may not enjoy
Equity Financing

Early Stage Later Stage Pre-IPO / Private

Seed
Series A, (B) (B),C,D… Buy-out Equity

Investment 0 - €1m €2m-€20m €5m-€20m €30m+

Size

Potential Grant-funding Venture Venture Specialist

Sources of Capital Capital Late stage
Funds University seed tech
funds (Wealthy)
investment
Angel
funds
Friends and investors
family Hedge Funds

Angel Investors

(Venture
Capital)

Growth Fund
Agenda

Important reflections before you start

What are the financing options?

How to attract and engage investors?

Deal structure and what to expect

during the investment process
Venture Capital – How the VC makes
money

• Raise fund every 2-4 years

– Pension funds, financial institutions and specialist “fund of
fund” investors

• Invest money over 3-5 years

~ 1/2 of investments lose money
~ 1/3 of investments break even
~ 1/6 of investments make (lots) of money

• Very small management fee on funds managed

~ 1-2.5% pa

• Carry
~ 20-25%x (Total Return – Total Amount Invested)
Angels – How the Angel investor makes
money
• Unlike the VC the Angel invests their own money

• Much smaller absolute returns can be very meaningful to an angel

• The Angel approach is to invest small amounts at a very early

stage / low valuation
– €50-€250k at valuations of €500k-€4m

• Two “exits” for angel

– Firm might be sold quickly for €5-10m or less where the Angel can
make 2-5x money
– Firm raises VC money, after which Angel typically becomes more
passive but has built up exposure very cheaply to a venture backed
enterprise

• The key thing when selecting an Angel therefore is whether they

can help you raise VC finance
– See which Angel investors have invested with which VCs
Venture Capital – What a good VC will
add

• Advice and Strategy • Internationalisation

• Hiring • Trusted service
– Developers provider relationships
– Country Managers – Search / recruiting
– Sales – Branding / PR
– CEO / CFO / COO – Finance, etc
– Advisory Board • Exit optimisation
• Partnerships – Knowledge / contacts
• Profile and PR with relevant buyers
– Experience with process
• Further access to
capital
What does an investor look for?

Team Technology Traction

• Can evaluate each as

– Exceptional
– Good / credible
– Mediocre / incomplete

• Misconception that being good / credible across the board is

what VCs look for
– Can always add credible attributes to the mix later

• We focus on finding opportunities which rate as exceptional in

one attribute
Identifying relevant VC partners

Has funds
to invest
• Do create a shortlist
• Rifle is a better weapon
Match of than a shotgun
Excellent
Size/Stage/
track record
Geography
Shortlist
• Similar process for
identifying angels, look at
VC funding press releases to
No directly identify prior Angel
Relevant investors
competitive
Portfolio
investments
Getting on radar screens

• Out of the blue email is a longshot

• Try to build context
– Analyse portfolio companies – are there any links
there?
– Analyse contact network and advisors
– Analyse press coverage
– Participate in blog conversations
– Attend events and conferences
– Relevant PR around product also helps
• VCs spend their time looking for businesses
with momentum
Agenda

Important reflections before you start

What are the financing options?

How to attract and engage investors?

Deal structure and what to expect

during the investment process
Sharing relevant information

Pre - first meeting Pre - termsheet Post - termsheet

• 100 page business plan • Dialogue rather than • Some additional

not required documentation – expect reference calls with
lots of meetings partners / customers
• 20 page ppt which
clearly answers main • Calls with current / • Personal reference calls
questions is best bet prospective customers or • Legal / accounting audit
– Product partners (if relevant)
– Market • Meeting broader team
– Business Model • Drafting legal
– Team • Brainstorming around documentation
– Competition strategy
– Product Roadmap
– Technology Overview • Identifying key hires post
– Business Development closing
– Financial Status
• Formal presentation to
VC partnership

2-4 weeks 1-2 Months

Types of investment

• Ordinary Share investment

– Simplest form, often used by angels
– All shareholders have similar rights
– Company Board composed according to

• Convertible Loan
– Sometimes used by both Angels and VCs
– Typically when another financing is anticipated soon
– Loan will convert (with a discount ~25%) into the next
financing round

• Preferred Share Investment

– Typical Structure used by VCs and occasionally larger Angels
investing as a group
Understanding a termsheet –
case study

• Anything between 2 and 15 pages (if points are

spelt out in fuller legalise)

• Sample phrasing is
– “[XXX fund] proposes to lead a Series A preferred share financing
of €5m at a €8m pre-money valuation. As part of the investment
process an employee option pool of 15% on a post money basis will
be put in place. Typical venture capital terms including
participating liquidation preference, etc. etc …”

• What does it all mean?

Case Study – Cap Table
 Venture Capital – “Typical Deal Terms”

but that’s 
• Board Representation so 
unfair…
• Liquidation Preference
• Participation rights
• Anti-dilution rights
• Element of reverse vesting
• Certain control and veto rights
• Period of exclusivity to close legals

Photo Source: Philip Greenspun, MIT

Case Study - liquidation preference
Case Study - liquidation preference
Case Study - liquidation preference
Case Study - liquidation preference
Case Study - liquidation preference
Case Study - Antidilution

• If a subsequent investment round is done a price lower

than the previous investment round then the previous
investment round is repriced (more stock issued to Series
A)

• Two flavours
– Broad-based – Series A price ratchets down based on size of
Series B relative to Previous post-money valuation
– Narrow-based – Series A price ratchets down based on size of
Series B relative to Size of Series A

• Say €5m Series B done at €0.75 per share

– Broad-based – Series A reprices = €1.00–((5/(5+15.3)*€0.25)
= €0.93
– Narrow-based – Series A reprices €1.00–((5/(5+5)*€0.25) =
€0.875
Case Study – Reverse Vesting

• The value of startup is

typically in the promise of
future labour from the
founders
• Investors seek to secure this
by reverse vesting founder
stock, typically over 3 or 4
years
• For startups typically all
founder stock is subject to
reverse vesting.
• For later stage companies
perhaps half the stock might
be subject to vesting
• NB – this also protects
founders from each other
Choosing the right VC - Valuation should
not be the decisive factor
Entrepreneur’s Equation • Revenues / Profitability

• Growth rate

• Team quality
Value at exit
• Strategic fit with buyer community

• Well managed exit process

• Fewest strategic errors made

• Hiring (quality & speed)

Probability of getting
• Partnerships
there
• Product development

• Valuation at initial round

• Valuation and dilution at

% share of business subsequent rounds
at exit
• Option grants
Key things to consider when choosing an
investor

• Relationship
– With key individual(s); and
– broader team

• References Right partner at a fair

– Speak to other founders price
vs.
• Portfolio Any partner at best
– Relevant experience price
– Non competitive
– Community you want to be part of

• Valuation and associated deal terms

Thank you

B e n H o lm e s
Email: benh@ indexventures.com
Skype: ben_holmes
Artwork – (Transparent Layers)