Fundraising Basics Flashcards
You: "What's a liquidity preference?" The VC: "Hmmm, this founder is not very savvy." Don't let this happen to you. Get smart *before* you talk with the big guys. (39 cards)
What is the difference between an Angel investor and a Venture Capital firm?
- Angel investors are high net-worth individual investors
- A Venture Capital firm is a (group of) professional investor(s) who invest(s) in startups on other people’s behalf (i.e. with a “fund”)
- Many VCs started as successful Angel investors whose friends wanted to start giving them their own money to invest, thereby forcing them to institutionalize into a formal VC fund
What are the usual sizes of investments made by Angel investors vs. Venture Capital firms?
Traditionally, Angel investors have invested in smaller increments (generally $25-500k), while Venture Capital firms have invested in rounds with a minimum size of $2m
However, many “micro VCs” and “super angels” have recently emerged, blurring these lines significantly.
What is a “syndicate” of investors?
A “syndicate” is when one investor (typically a savvy Angel investor or a VC firm) leads a round of several other investors to invest together on the same term sheet.
What does it mean to raise a “Series A” round versus a “Seed” round?
- A “Series A” round is the term generally used to describe the first institutional round of equity financing, usually for at least $2m
- Small amounts of “friends & family” equity investments (e.g. < $200k), or early investments typically raised in the form of Convertible Debt, are generally thought of as “Seed” rounds
- However, the lines are often blurry, and the distinction between what is “Seed” and what is “Series A” really doesn’t matter
What are some benefits to raising early rounds of financing from [a syndicate of] Angel investors rather than from a Venture Capital firm?
- You don’t give up as much management control
- You don’t have to raise as much money (so you get diluted less), since most VCs have a certain minimum investment
- You usually get your cash up front rather than only in tranches when you hit certain milestones (which is how many VCs operate)
- You’re probably not ready to raise from a VC anyway
What are some benefits to raising early money from Venture Capital firms rather than angels?
- You usually get more money
- It shows the market good signaling (“social proof”)
- VCs have very deep networks of useful connections for you and can help with strategy, hiring, etc
- VCs have “deep pockets” and can usually participate in future financing rounds (if you are successful)
Typically, how large is the largest round of convertible debt raised at the seed stage?
Seed rounds of convertible notes are typically under $1m, but they can sometimes be larger if the founders have very strong track records or traction
Financing rounds of $2m and up are usually raised from institutional investors who require equity.
What are generally accepted to be the Top 3 things that early-stage startup investors are looking for?
- Great Founding Team
- Large Market
- Product Traction
True or False: Investors prefer investing in a company where the entrepreneur has paid his core team in cash, rather than equity, since it is easier to deal with just one main shareholder.
False
- Investors are investing in the PEOPLE above all, and they like teams where the core members are properly incentivized with equity
- This is especially true for tech startups; it is very important that the technical founders (or early tech employees) be core equity partners, rather than expendable consultants, to ensure long-term commitment
What is the difference between a Share Grant and a Stock Option for employee compensation, and when should each be used?
A Share Grant is equity that is directly given to founders, while Stock Options represent the right to purchase that equity at a discounted price (likely the price at the time of issuance) in the future
Once a company has raised equity at a priced valuation, it generally begins to issue new employees options rather than direct share grants, for tax reasons.
What is Convertible Debt (aka convertible loans or convertible notes), and why is it used?
Convertible Debt is when a company borrows money from an investor or a group of investors with the intention to convert the debt to equity at some later date (usually a later round of financing, once the company is properly valued)
It is a popular financing method for seed-stage startups because (1) It avoids having to set a valuation at such an early, uncertain stage, and (2) It generally involves much less paperwork & legal fees than issuing equity directly.
What is a “cap” on a convertible note?
A “cap” is a provision on a convertible note that limits the valuation at which the note will convert to equity
- This essentially protects the investor from a ridiculously high valuation at the next round of financing
- Ex: If you issue a $500k seed note with a $4m valuation cap, then even if your Series A valuation is $10m, the note converts to equity as if the valuation had been only $4m. So the note-holder gets 12.5% of your company ($500k/$4m).
Is it “normal” to raise money in many small amounts at a time (e.g. $50k), at incrementally higher valuations?
Not really
- That said, while many traditional startup advisors caution against a “drip-feed” fundraising model, the advent of Convertible Notes and more standardized financing documents has been making this model more fashionable
- Critics warn that ongoing fundraising may divert a founder’s focus and limit decision-making flexibility
Between founders/employees and investors, who usually gets common stock and who gets preferred stock?
- Founders & employees receive common stock (or options)
- Seed investors sometimes receive common stock (or convertible notes that turn into common stock)
- VCs almost always receive preferred stock (at higher prices per share)
What is “crowdfunding”, and can it be used to fund startups?
Crowdfunding is the practice of raising money by posting a project publicly and soliciting hundreds - sometimes thousands - of micro-donors or investors
- It is typically used for causes and creative purposes
- Crowdfunding is difficult for startups to use as their sole method of raising finances, as the legal/compliance costs of managing so many investors becomes increasingly prohibitive to a small company
When raising the first round of equity financing for a startup, how do you know how much of the company to give to the investor(s)?
The % of the company awarded to the investor(s) depends on the Valuation of the company
- For example, if the company is valued at $1m, and the investor invests $100k, then he will receive 10% of the company
- A way to avoid the tricky question of determining such an early valuation is to raise the first round of capital as Convertible Debt, rather than giving away explicit equity so early
What is a “down round” of financing?
A “down round” is a round in which the company’s valuation is lower than it was in a previous round
This is generally very disadvantageous and dilutive to founders and previous investors.
Why is it important for previous investors to participate in subsequent financing rounds?
It is best for previous investors to participate in subsequent financing rounds for two reasons:
- To protect themselves against dilution; and
- To provide a strong positive signal to incoming investors
What is the purpose of a term sheet?
The purpose of a term sheet is to outline the quantitative and qualitative terms for a financing deal between a company and a qualified investor (e.g. an Angel Investor or a Venture Capital firm).
Is a term sheet binding?
No, a term sheet is not binding
It is more of an honest agreement that guides the subsequent drafting of securities documents resulting from the financing, as well as any necessary modification of bylaws or articles of incorporation.
When, and by whom, is a term sheet usually first drafted?
A term sheet is usually initiated by the lead investor in a round, once it has been determined that the investor(s) would like to move forward in negotiating a deal.
Can an entrepreneur participate in term sheet negotiations with more than one investor at a time?
Not really
- Many term sheets include an “exclusivity clause” requiring the company to stop soliciting other term sheets
- Although there is little legal recourse for a company breaking this agreement, simultaneous term sheet negotiations are generally shunned upon as a shady practice
Does a term sheet for a new round of financing create a new class of stock?
Not necessarily, although the usual case is that Founders and Seed Investors have common stock, while incoming Venture Capitalists get preferred stock
Sometimes a new class of stock is created at each round of financing, with the terms varying depending on the stage & strength of the company.
Do owners of previously issued stock have to approve of the creation of new classes of stock with preference over theirs?
Usually, but it depends on provisions in the corporate bylaws or any previous investors’ rights
The approval of a new class of preferred stock is generally done either by vote of existing shareholders and/or by vote of the Board of Directors.
