Session 5-6 Flashcards
Why is venture capital challenging from the entrepreneur side?
Getting funding is hard.
Diversity of investors and reaching out is not easy
Why is venture capital challenging from the Investor side?
Deal sourcing is hard, there are too many proposals. (1000+ a year)
Its a long and costly process to get their money back
What is the average survival rate of a VC?
10%
What % of VCs survive one year?
20% in the US & France
25% in Germany
30% in HK, UK and Switzerland
What are the main reasons why start ups fail?
38% ran out of money
35% Markets did not need them
20% gets outcompeted
18% had legal issues
( the reasons can be cumulative)
What is the FIRE stand for? (start up journey w investor)
Fit
Invest
Ride
Exit
What does the โFitโ mean on FIRE?
This means that the entrepreneur and the investor need to be a mutual fit.
What is done on the FIT stage of FIRE?
Search: Networking, info gathering and processing
Selection: Screening, signalling, due diligence
What does the โInvestโ mean on FIRE?
The two parties agree on the investment structure
What is done on the INVEST stage of FIRE?
Term Sheet is drafted and signed
The terms depend on preference, the market and bargaining power.
What does the โRideโ mean on FIRE?
The two parties work together to improve the company.
Ride or die bitch
What is done on the RIDE stage of FIRE?
Learning: Build trust, learn about the market, pivot as needed
Governance: Address any disagreements, conflicts of interest
What does the โExitโ mean on FIRE?
Investors and entrepreneurs part ways as the venture is sold (or it completes its IPO)
What is done on the EXIT stage of FIRE?
Success: First funding to trade sale is 5.6 years, IPO 6.3 years
Failure: Dead, โzombieโ with low valuation, somewhat alive
What does FUEL stand for? On how to select an investor.
Fundamental structure
Underlying Motivation
Expertise & Network
Logic & Style
What question does the โFundamental structureโ part of FUEL ask?
What is its organizational structure, resources (whose money)?
What is the investorโs governance structure, decision-making process?
What question does the โUnderlying Motivationโ part of FUEL ask?
What is its investment horizon, risk tolerance?
How does it value financial v non-financial (strategic, social) returns?
What question does the โExpertise & Networkโ part of FUEL ask?
What expertise, knowledge and skills does it have?
What networks can it draw on, how does it stand with its peers?
What question does the โLogic & Styleโ part of FUEL ask?
How does it pick startups (industry, location, stage, ticket size)?
How does it interact with investee startups?
What are the key player defining the business opportunities of the Venture matrix?
The customer (demand)
The Company (Supply)
Entrepreneur (Implement)
What are the metrics to evaluate opportunities of the Venture matrix?
The Value proposition (micro-Environment)
Industry (Macro-Environment)
Strategy (Capturing Value)
What should we ask from the key players when using Value proposition as an evaluation reference? (micro environment)
Customers => NEED โ Know your customer
Company => SOLUTION โ Know your product
Entrepreneur=>TEAM โ Bet on the jockey, not the horse. (Experience and skills of team)
What should we ask from the key players when using Industry as an evaluation reference? (macro environment)
Customers => MARKET โ Scale of the business opportunity
Company => COMPETITION โ Know your competitors
Entrepreneur=> NETWORK โ Access to information and critical resources
What should we ask from the key players when using Strategy as an evaluation reference? (capturing value)
Customers => SALES, โ Customer acquisition to generate revenue
Company => PRODUCTION โ Structuring the startupโs value chain
Entrepreneur=> ORGANIZATION โ Operations and management
How do you calculate the ownership of the investor?
๐นinv = ๐ผ / ๐post
๐นinv = Fraction of ownership
๐ผ = Investment
๐post = Valuation Post money
How do you calculate Valuation Pre investment?
๐pre = ๐post โ ๐ผ
๐ผ = Investment
๐post = Valuation Post money
๐pre = Valuation Pre money
how do you calculate the price of the share?
๐ = ๐pre / ๐pre
P=Price of share
๐pre = Valuation Pre money
๐pre = # Share Pre money
How do you calculate the number of shares issued ?
๐inv = ๐ผ / ๐
P=Price of share
๐ผ = Investment
๐inv = # Share issued for the investment
How do you calculate the number of shares after the investment?
๐post = ๐pre + ๐inv
๐inv = # Share issued for the investment
๐pre = # Share Pre money
๐post = # Share Post money
How do you calculate the exit value of an investor?
๐๐ = ๐น๐(๐ธ๐๐ผ๐) * ๐
Xi = The exit value the investor i will take
F(i) = Fraction of ownership of the investor i at the time of exit
X = Exit value of the company
Who conducts the start up valuation?
Both the Investor and the entrepreneur
What is the conflict of interest when valuating companies between VCs and Owners?
VCs want to have lower post valuation so they can have low starting point when calculating the CCM and IRR. (More space to grow up)
The Owners want to have high Vpost meaning they sell less equity for more money
What are the four factors that have an impact on the companyโs Valuation?
- The business opportunity itself: the better the higher the valuation
- The market context: hot vs. cold market
- Deal competition: more competition, higher valuation
- Investor quality: better investor, higher valuation
What are the different types of valuation?
Venture Capital Method
Discounted Cash Flow Method
Comparables Method
How do you calculate the Venture capital method (VCM) for a single investment round?
๐post = ๐๐ / (1 + ๐)^๐
๐๐ = Expected exit value
ฯ = hurdle rate
T = expected time-to-exit
What is the typical Hurdle rate value
40-80%
What are the components of the Hurdle rate?
+ Market risk premium (higher ฮฒ for smaller, less diversified investors)
+ Illiquidity premium
+ Failure rate premium
+ Service premium for services (monitoring, mentoring, network)
How do you what are steps of the Discounted Cash-Flow (DCF) method?
- estimate free cash flows for a time horizon, normally 2-4 years
- estimate a terminal value for the end of the time horizon, which assumes some constant FCF growth rate into perpetuity
- discount everything back with investor hurdle rate ฯ, or a more standard discount rate d for all-equity startups
How do you what are steps of the comparables method?
- find a set of comparable companies
- choose performance metrics to compare startup to set of comparables
- calculate valuation multiples based on performance metrics
What is the limitations of the comparables method?
Uses little internal startup info, only to construct comparison set
What kinds of comparables can one choose?
Investment comparables โ compare similar deals done by investors
Exit comparables โ compare similar firms that have already exited
What are some important things to consider when choosing the comparable?
Similar companies, dont pick a multibillion company against a start up.
keep industry aligned.
What are the different performance metrics you can choose?
EBITDA โ Earnings
EBIT โ net income
Cash flows
Sales / revenue
Operating metrics
When do you use โEBITDA โ Earningsโ as a performance metric?
All the goddam time, its the most common metric (unless the start up is too small)
When do you use โCash flowsโ as a performance metric?
Whenever you have them, they are hard to get from competitors
When do you use โSales/Revenuesโ as a performance metric?
Useful for startups with negative or highly volatile earnings/cash flows
When do you use โOperating metricsโ as a performance metric?
Useful for pre-revenue startups
What are some operating metrics performance metric if you have nothing?
Number of users, website visitors, patents, strategic partners
How do you calculate the expected Exit value using the comparable method?
๐๐ = ๐๐๐ * ๐๐ถ๐๐๐
๐๐ = Expected Exit value
๐๐๐ = Expected exit Performance Metric
๐๐ถ๐๐๐ = Multiple of comparables
Which is the most popular valuation model?
VCM is the most widely used
When is the Discounted CashFlow (DCF) valuation used most?
widely used for later-stage startups
Why is DCF not more popular?
- Too much data required, too strong assumptions
- Not set up for modelling startup uncertainty and staged investments
What are the problems comparables valuation method faces?
- But it relies almost entirely on external information
- Exit comparables problematic because startups may not be comparable
- Investment comparables use more immediate peers, but info hard to get
What is an important assumption when making valuations regarding the equity obtained?
Its assumed its common equity.
If its preferred shares the valuation methods is completely different and more complicated.
What are the main things covered on the Founders Agreement?
- Ownership structure
- Transfer of ownership
- Salaries (typically low) and other forms of compensation
- Rights and obligations towards founders (e.g. prior loan, transferring IP)
- Contingencies under which some founders obtain stronger or weaker
rights (e.g. vesting, personal milestones e.g. prototype, first customer) - Confidentiality
- Decision-making and dispute resolution
- Representations and warranties
- Choice of law
How does the CONVERTIBLE preferred shares work?
You purchase preferred shares at a certain value. These have preferred terms, meaning that you will receive all the cashflows until a certain threshold.
When you meet it you do not gain any more cash beyond the PT.
However, if the common shares become more valuable than your preferred shares you just convert them and start gaining the cashflows based on your % of ownership. (Finv)
How do you find the Preferred terms in Convertible preferred shares?
Simple dividends: PT=I+Div=I+IDT
Compounded dividends: PT=I+Div=I+ID^T
If multiple liquidation preference (M):
PT=MI + Div
How do you find the Conversion Threshold?
CT=PT/(inv. Ownership)
What are the CFs to the investor in convertible preferred shares?
If X<PT: X
If PT<X<CT: PT
If X>CT: ownership inv * X
What are the cashflows to the investor in participating preferred shares?
CF=PT+(X-PT)*ownership inv
What happens if participating preferred shares have a cap?
Once X>Cap then investors doesnโt get PT, just ownership fraction * exit val (X)
