General Questions Flashcards
Due diligence Steps
- An initial screening process to ensure companies fit with the fund’s views on any sectors, geographies, and/or stage
- An estimation of the Total Addressable Market size
- A review of the strengths and weaknesses of the founding team
- Assessment of the product and relevant KPIs and metrics
- Uncover if there are any potential competitive advantages being developed
- A review of financial projections for reasonability and soundness
TheCapitalization Table
TheCapitalization Tableis tracked by venture capital (VC) firms to provide a summary of the current capitalization (i.e. equity ownership) in a startup or venture-backed business.
Let’s look at the calculations required to update the cap table with an example:
- Assume a VC is asking for 10% of a company with an investment of $1 million (valued at $10M)
- The company already has 100,000 outstanding shares (50% held by the founder and 50% held by an angel investor)
Question: How many new shares do the new Series A investor get with the investment?
Let’s look at the calculations required to update the cap table with an example:
- Assume a VC is asking for 10% of a company with an investment of $1 million (valued at $10M)
- The company already has 100,000 outstanding shares (50% held by the founder and 50% held by an angel investor)
Question: How many new shares do the new Series A investor get with the investment?
Their new ownership stake can be calculated as:
- New Ownership Stake = New Shares / (Old Shares + New Shares)
Solving for their new shares: New Shares = [Ownership Stake / (1 – Ownership Stake)] * Old Shares
Now applying the assumptions:
- New Shares = [.10/(1-.10)] * 100,000
- New Shares = 11,111
Checking the calculation, we can see their shares represent 10% of the new company:11,111 / (100,000 + 11,111) = 10%
How do growth equity investors protect against the downside risk?
Growth equity investments involve:
- Minority Stakes (i.e., < 50%)
- Using No Debt (or Minimal) Debt
Those two risk-mitigating factors help diversify the portfolio concentration risk while reducing the risk of credit default by avoiding the use of financial leverage. In effect, these companies can be more flexible and better endure periods of cyclical headwinds
Two main types of preferred equity investments
- Participating Preferred:The investor receives the preferred proceeds (i.e., dividends) amount plus a claim to the common equity afterward (i.e., “double-dip” in the proceeds)
- Convertible Preferred:Referred to as “non-participating” preferred, the investor receives either the preferred proceeds or the common equity conversion amount – whichever is of greater value
How do you source startup investments?
I believe the first one is to continue building out my network. Great investor need strong networks and relying on them to source credible deals.
The other sources can be :
- Go Where Start-ups Congregate
- Mentor at Start-up Accelerators and Incubators
- Find Them on Internet Platforms
- Host Events / Diner
- Develop you brand name, build your expertise and attract talents and founders
- Could you build a tool, or start a newsletter?
- Help new entrepreneurs by offering to lend a hand if you’ve got relevant skills
What terms would a VC firm negotiate with a founder?
When a VC firm invests in a startup, there are several terms they would negotiate with the founder. These terms include:
- Valuation: The valuation of the startup is the most important term that a VC firm would negotiate with the founder. The valuation determines how much the VC firm would invest in the startup and how much equity they would get in return.
- Equity: The equity a VC firm would receive in exchange for their investment is another term that would be negotiated. Typically, a VC firm would want a significant amount of equity in the startup, usually between 20-30%.
- Board Seats: VC firms would usually ask for a seat on the board of the startup. This would give the VC firm a say in the decision-making process of the startup.
- Liquidation Preference: VC firms would also negotiate the liquidation preference of their investment. This means that they would get their money back first if the startup is sold or goes public.
- Anti-Dilution Protection: VC firms would negotiate anti-dilution protection to ensure that their equity stake is not diluted in the event of future fundraising rounds.
- Vesting: Vesting is another term that a VC firm would negotiate with the founder. This means that the founder’s equity would vest over time, usually over a period of four years.
- Exit Strategy: The VC firm would also negotiate the exit strategy for the startup. This would determine how and when the VC firm would exit their investment in the startup.
In conclusion, when a VC firm invests in a startup, they would negotiate several terms with the founder. These terms include valuation, equity, board seats, liquidation preference, anti-dilution protection, vesting, and exit strategy. It is important for founders to understand these terms and negotiate them carefully to ensure that they get a fair deal.
What would you look for in a startups financial statements?
When evaluating a startup, it is essential to review its financial statements to determine its financial health and potential for growth. Here are some key elements to look for in a startup’s financial statements:
- Revenue: Revenue is the money a company earns from its operations. It is essential to determine whether the startup’s revenue is growing or declining over time.
- Expenses: It is crucial to review the startup’s expenses to see if they are in line with its revenue. If expenses are higher than revenue, it could be a red flag that the startup is not financially sound.
- Profitability: Profitability is a key indicator of a startup’s financial health. It is essential to review the startup’s net income to determine if it is profitable or not.
- Cash Flow: Cash flow is the amount of cash a company generates and uses in its operations. It is essential to determine whether the startup has positive or negative cash flow.
- Debt: Debt is the amount of money a company owes to creditors. It is essential to review the startup’s debt to determine if it is manageable or if it could be a burden on the company’s finances.
- Investments: Investments are the amount of money a company has invested in other companies or assets. It is essential to review the startup’s investments to determine if they are adding value to the company.
In conclusion, reviewing a startup’s financial statements is crucial to determine its financial health and potential for growth. When evaluating a startup’s financial statements, it is essential to look at revenue, expenses, profitability, cash flow, debt, and investments to gain a comprehensive understanding of the company’s financial position.
Do you think investors value revenue or profit more?
Investors are always looking for ways to maximize their returns, and one of the key indicators they use to evaluate a company’s potential is its financial performance. While both revenue and profit are important metrics, investors tend to value profit more than revenue.
Profit is the amount left over after all expenses have been paid, including taxes and interest. It is a more accurate measure of a company’s financial health than revenue because it takes into account the cost of doing business. Profitability is a key factor in determining a company’s ability to generate cash flow, pay off debt, and provide returns to investors.
On the other hand, revenue is simply the total amount of money a company brings in from its operations. While high revenue is desirable, it does not necessarily mean a company is profitable. In fact, some companies with high revenue may be operating at a loss or have thin profit margins.
Ultimately, investors want to see a company that is able to generate consistent profits over time. While revenue growth is important, it is not sustainable if a company is not able to turn that revenue into profits. Therefore, it is generally the case that investors value profit more than revenue when evaluating a company’s potential for investment.
In conclusion, while revenue is an important metric, investors tend to value profit more when evaluating a company’s potential for investment. Profitability is a key factor in determining a company’s financial health and ability to provide returns to investors.
What makes a startup stand out to you?
For me, for a startup to stand out, it needs to have innovative ideas, a solid business plan, a talented team, and a focus on customer satisfaction.
Firstly, innovative ideas and solutions are essential for any startup to stand out. Startups that offer a unique product or service that solves a particular problem in the market have a higher chance of success. Additionally, startups that use cutting-edge technology or apply it in a new and innovative way can also gain attention and stand out in a crowded market.
Secondly, a solid business plan and strategy can set a startup apart from competitors. This includes having a clear understanding of the target market, identifying the competition, and developing a well-defined marketing strategy. Startups that can demonstrate a clear path to profitability and scalability are more likely to attract investors and succeed in the long term.
Thirdly, having a talented and motivated team is crucial to the success of any startup. Investors look for startups with a team with a diverse set of skills, experience, and expertise. Additionally, a team that is passionate about the product or service they are offering can be a driving force behind the startup’s success.
Lastly, startups that prioritize customer satisfaction and experience can differentiate themselves from competitors. By focusing on delivering a high-quality product or service, providing excellent customer support, and listening to customer feedback, startups can build a loyal customer base that can drive growth and success.
What is your approach to risk management in your investments?
- Conducting thorough due diligence before making any investment decision
- Diversifying our portfolio by investing in a range of industries and companies
- Structuring our investments to minimize downside risk
- Staying actively involved in the companies we invest in to monitor their progress and address any potential issues
- Building relationships with the management teams of our portfolio companies to ensure open communication and transparency
- Maintaining a long-term perspective and being patient with our investments, allowing time for them to mature and reach their full potential
- Continuously reevaluating our portfolio and adjusting our strategy as needed to adapt to changing market conditions
Drag-along provision
The drag-along provision protects the interests of the majority shareholders (usually the early, lead investors) by enabling them to force major decisions such as exiting the investment.
This provision will prevent minority shareholders from holding back a particular decision or taking a specific action, just because a few shareholders with small stakes are opposed to it and refusing to do so.
Full ratchet provision / weighted average provision
- Full Ratchet Provision:A full ratchet is an anti-dilution provision that protects early investors and their preferred ownership stakes in the case of a down-round. The investor with the full ratchet’s conversion price will be re-priced to the lowest price at which any new preferred stock is issued – in effect, the investor’s ownership stake is maintained at the expense of substantial dilution to the management team, employees, and all other existing investors.
- Weighted Average:Another anti-dilution provision used far more often is called the “weighted average” method, which uses a weighted average calculation that adjusts the conversion ratio to account for past share issuances and the prices they were raised at (and theconversion rateis lower than that of a full-ratchet strategy, making the dilutive impact less severe)
Redemption rights
A redemption right is a provision of preferred equity that gives the holder of the security the right to force the issuer of the security to buy back the shares from the holder. Redemption rights are often put in place to protect investors in case the company’s prospects turn bleak. In these cases, investors can trigger their redemption rights, forcing the company to buy back their shares at a pre-specified price. However, redemption rights are rarely exercised, since most of the time, the company would not have sufficient funds to make the purchase even if legally required to do so.
What is a convertible note and a SAFE note?
What is a convertible note and a SAFE note?
A convertible note is a type of short-term debt that can be converted into equity in the future. It is commonly used by early-stage startups to raise capital. Convertible notes typically have a maturity date and an interest rate, but the most important feature is the conversion rate, which determines how many shares of stock the investor will receive when the note converts to equity.
On the other hand, a SAFE note (Simple Agreement for Future Equity) is a newer type of financial instrument that is also used by startups to raise capital. Unlike convertible notes, SAFE notes do not accrue interest and do not have a maturity date. Instead, they offer investors the right to convert the note into equity at a future date, typically when the company raises its next round of funding.
Both convertible notes and SAFE notes allow startups to raise capital without having to immediately determine a valuation for their company. However, each has its own unique features and considerations that startups should be aware of before deciding which type of financing to pursue.
Attrition Rate
TheAttrition Rate measures the employee turnover within a company, i.e. the number of individuals that leave their positions over a specified time frame.
CAC Payback Period
The CAC Payback Period refers to the number of months needed by a company to recoup the initial costs incurred in the process of acquiring a new customer.
