Q: When building a financial projection model for a pitch to VC’s, should you include future rounds of funding in the model or simply show what measurable goal you are trying to achieve with the current round you are seeking?
A (Brad): It depends on the stage of the company. But first, it’s important to understand how a VC is going to look at your projections in the first place.
- Early and pre-revenue: Investors are going to be most interested in your near term burn rate and how long their money is going to last. Focus on putting this information front and center – don’t hide it. Recognize that your revenue is totally speculative so the “base case” is going to be zero revenue.
- First product in the market, < $100k / month of revenue: Revenue matters here and the projections out into the second and third year will give a good indication of how you are thinking about the ramp of your business. However, if your revenue is modest, a smart investor is going to look at your gross margin also. If you are a recurring revenue business, the month-over-month growth – both of revenue and gross margin, is going to be important.
- Meaningful revenue, > $1m / quarter: You have entered the zone in which you have a real business and likely can have a credible growth plan out three or more years.
Now, in every case, a VC is going to be interested in how long the current round of financing is going to last. In early cases, they are going to focus on cash / monthly-burn-rate. In later cases, they will factor in some amount of revenue and gross margin projection, but likely discount both, viewing you as being overly optimistic on revenue as well as the gross margin percentage.
Then, building off of this, they will be interested in how much additional money you think you will need to get cash flow positive. They’ll calibrate this against whatever your current plan is. The earlier the life of your company, the more skeptical the VC will be of any projections of revenue, and any time horizon greater than one year.
Update: I just noticed a twitter comment that said “I would suggest that it should take you up to their expected exit as that is most definitely their primary concern.” While some investors may ask for this, it’s the exception as most rational investors will want to understand what it takes to be cash flow positive. It’s impossible to predict the exit as there are too many variables at play, including the notion that you can’t force an exit. However, you can run a business indefinitely without additional financing if you are cash flow positive. So I’d assert that showing the plan getting to cash flow positive is much more important than showing the plan getting to an exit.
Q: We are a Delaware C Corp registered as a Foreign Entity in Colorado our home state and we need to figure out the answers to the following questions with regards to stock certificates.
1. Who gets stock certificates issued and when?
My assumptions are that cash investments DO get certificates, warrants DO NOT.
Founders and Employees with vesting schedules DO NOT get certificates, until a portion of stock is vested.
2. Do the buy and print your own certificates follow the normal process?
3. Do private C Corps file capitalization stables with the SOS?
It’s a pretty simple answer, really. If you buy the stock, you get the certificates. So cash investors do get certificates. Warrants and options are securities that provide the holder to exercise them later by paying for the stock at a pre determined strike price. At the time of exercise, money is paid by the holder to the company for the stock subject to that warrant or option and then a certificate is issued. The options can not be exercised until vested, as you suggest.
i’m not sure what “buy and print” your own certificates mean, but there is no form that you have to follow. It just needs to be signed by the President and Secretary of the company. Furthermore, cap table are not filed anywhere. You may keep this information private.
Q: What costs are considered reimbursable to the founder of a start-up company? More specifically, if the founder has been boot-strapping his company since inception, and he agrees to a series a term sheet with a VC firm, are the operational costs incurred by the founder between this time and the closing of the round reimbursable to the founder? For example: The founder of a consumer product company and a VC firm agree to a term sheet in July. The round doesn’t close until October or November due to raising additional capital for the round, attorney delays, etc. In the interim, the founder continues to self-fund the day-to-day operations of the business – packaging design, inventory, PR firm, etc. What expenses can the founder expect – if any – to get paid back out of the series a funding?
This varies widely and is fundamentally a negotiation between the new investors and the founders who have incurred the expenses. The four variables are:
- Amount of expenses
- Amount of funding being raised
- How the expenses have been accounted for
- Attitude / style of the investor
As the amount of expenses increases, the willingness of the investor to reimburse for any of them decreases. This is directly linked to the amount of funding being raised. For example, if $1m is being raised and the expenses are $50k, an investor will likely be ok with 5% of the funding getting paid back to reimburse the founders. However, if $1m is being raised and the expenses are $500k, it’s unlikely that an investor will be ok with 50% of the proceeds going to paying founders back for expenses that have already been incurred.
How the expenses have been accounted for also matters a little, if only for optics. If it has been treated as debt advanced to the company by the founders and is documented in an arms length transaction, it sometimes has more impact on the investors. The issues of amounts far outweighs the structural issues, but the structural issues sometimes signal that there was an intent to see the money get paid back at the close of the financing.
Finally, the attitude and style of the investor matters the most. Some investors are adamantly opposed to the idea of paying the founders back any expenses and view this simply as contributed capital to the business. Other investors will view this as part of the investment required by the founders to justify the pre-money valuation. Other investors will simply not want any of their new investment to pay for past expenses. In contrast, you’ll run across other investors who are more flexible, or who are happy to get a little more money into the company at what they believe is a relatively low valuation.
Ultimately, there is no rule – it’s just part of the negotiation.
Question: I have a startup concept for a services agency (not a software or online business). I have previously helped launch PR agencies, one of which was subsequently acquired by a national agency. Are there angels/VCs that would be interested in my services concept?
Typically not. While there are some VCs that like services businesses, especially consolidations or rollups of services companies, most VCs aren’t interested in funding services business, especially around PR or marketing.
While there was a rash of VC financings for web agencies in the late 1990’s, when the Internet bubble burst VCs were reminded that these are companies that – at best – end up being valued at 1x revenue based on the underlying economic characteristics of the businesses. This tends not to create risk / return investment dynamics that are interesting for most VCs.
Of course, what VCs fund cycles in and out of favor, so there might be a point in the future where there is a particular type of “next generation services agency” that appeals to so VCs. But for now, most of these companies will have to rely on bootstrapping or angel financings.
Well – I fell off that particular horse. That would be the “I’ll blog daily about the best VC blog post of the past 24 hours.” I could make some snarky comment about how there weren’t any for the last few weeks, but that wouldn’t be true. I just fell of the horse. But yesterday, when I was at an SVB event talking to a bunch of SVB people, a long time friend said “thanks so much for writing the VC Post of the Day – it saves me a ton of time looking through all the VC blog posts.” So I got back on the horse.
Today’s post of the day is from Nic Brisbourne (DFJ Esprit) and it titled What is anti-dilution/downround protection? Nic covers narrow-based, broad-based, and full ratchet anti-dilution with real examples using real math.
Note to self: that was easy – five minutes, done.
Question: Does one need to switch an LLC to a corporation to raise VC funding? Would you recommend starting out as a corporation pre-money or as an LLC?
The short answer is yes, you have to be a corporation to raise VC funding
VCs will want you to be a C-Corp for a few specific reasons. The main advantage of an LLC over a C-Corp is that the taxes are not flow through. In other words, your company’s tax situation will not hit the bottom line of the VC. As VCs are generally structured to be flow through tax entities, if your company was a LLC, your tax situation would flow through the VC and directly to their investors. This is not a good place to be and VC investors demand that we only invest in C-corps to stop this problem.
And you should be happy, because if this wasn’t the case you’d get nagging phone calls every year from every investor in a VC fund looking for that tax documents. 🙂
The second issue is issuing stock to employees. Since stock options are the chief motivator of employees at a startup, you need have a stock option plan. In a LLC, there is no concept of stock ownership. It’s about “unit” ownership and it’s nearly impossible to mimic a standard stock option plan in the world of “units.”
Before raising money, you should feel free to start off as a LLC. In the “old days” (ten years ago, it was time consuming and costly to convert from a LLC to a C-corp, but these days it’s much much easier.
Question: What is your take on entrepreneurs who have young children or otherwise active family lives? Is this a factor in funding decisions? I try to live with a family-first mentality but find it hard to compete with young unattached entrepreneurs who can put startup-first.
My answer is simple – this shouldn’t be a factor in funding decisions.
Unfortunately, I know plenty of investors who have lots of inappropriate (at least in my book) biases. This is one of them. There are also plenty of gender, race, and age biases out there. There are endless discussions in the blogosphere about this so I won’t add to the discussion other than to express my opinion, which is that these biases suck.
I’ve worked with many entrepreneurs covering a huge age range, gender dynamic, ethnic mix, and family size. Success comes in many forms, with many styles, and many different dynamics. While each person is constrained by having multiple priorities, balancing conflicting priorities is an essential skill of any entrepreneur. Being able to shift between commitments is vital over the course of an entrepreneurial life span.
As an entrepreneur, you’ll just have to work through it. And search for investors who don’t have these biases – fortunately they exist!
It’s Monday and that means – yup – that Fred Wilson (USV) once again claims the VC Post of the Day due to his excellent MBA Mondays series titled Pricing A Follow-On Venture Investment. In it, Fred walks through an example, with real numbers, of how USV thinks about valuing an inside-led round for a company that is doing well.
Historically, many VC firms wouldn’t lead internal rounds at increased valuations except in extraordinary cases. When we started Foundry Group in 2007, we decided that was nonsense. It never made any sense to us why a firm wouldn’t pay a higher price than the last round for a company that it was already an investor in, especially if the companies in the portfolio were relatively capital efficient.
In our case, as in Fred’s, we try to offer a fair price, but expect to get some level of discount since we enable the company to bypass the fundraising process which is often incredibly distracting, time consuming, and often not much fun. Fred does a really nice job of explaining – both qualitatively and quantitatively, how he thinks about this. While our math is somewhat different, it’s super useful to get inside the head of an actual VC as he thinks this through.
Rand Fishkin, the CEO & co-founder of SEOmoz, has an long, thorough, and incredibly detailed blog post up about The $24 Million Moz Almost Raised. Rand does an awesome job of providing extensive details while maintaining confidentiality of the participants.
The story covers the full lifecycle of the VC fundraising process, beginning with Rand and his teams’ discussion about whether or not to raise money. He documents the fundraising dance, including providing lots of juicy email correspondence to underscore his points. He lays out the numbers for his company, the terms for the deal, and his view of when he was negotiating effectively vs. stumbling around.
Ultimately he gets to a signed LOI and that’s where the fun begins (in the section titled “Then Things Got a Little Weird”.) The deal ultimately falls apart and Rand does a nice postmortem where he speculates on what happened. He then wraps it up with how his team responded and what’s next for SEOMoz.
If you are an entrepreneur, go read this post now. It’s probably the best and most detailed description of the VC fundraising process that I’ve read. Well done Rand – on many levels. Even though this particular deal didn’t close, I love your statement at the end:
“What I can say is that this experience makes me and the rest of the Moz team even more inspired and motivated to build an amazing company. We can’t help but feel passion for proving doubters and naysayers wrong. The greatest revenge is to execute like hell, bootstrap all the way, and do what we said we’d do – become Seattle’s next billion-dollar startup, and make the world of marketing a better place.
I know we can do it.”
Entrepreneurs – if there is one post you read today, read this one. And Rand, email me anytime if I can be helpful. Even though you are too late stage for us to invest in, you just earned a bunch of karma points in my book by sharing this experience with all the entrepreneurs in the world.
Jeff has done a nice job building a site that both models a cap table and provides a lot of information to empower entrepreneurs both with educational resources and software tools. In addition to modeling a cap table and ownership of the company, Jeff’s software helps answer questions like “if I sell for $100M, how much money does everyone receive.”
In addition, he’s created a variety of interactive examples that help you understand things like:
- Anti Dilution – Broad-based Weighted Average
- Anti Dilution – Narrow-based Weighted Average
- Anti Dilution – Full Ratchet
The LearnVC site has a bunch of other interactive examples for some of the basics of venture financing including:
To see their product in action, check out their videos.