VC for Hackers

hackNY Summer 2013

20 June 2013

License

All slides provided under the CC-BY-SA license

To Venture or Not To Venture?

Why raise venture?

Some clues

• You want to to grow very fast very quickly
• You want to expand into new territory
• Your main differentiator is the market
• 10x growth is a failure
• You forsee an exit in 5-10 years (or less)
• You (and your cofounders) don't mind owning 20% or less of a company

Why not raise venture?

Some clues

• You are already profitable (or near profitable)
• You have found a profitable business model that works
• Your main differentiator is your advantage
• 10x growth is a success
• Your exit is 10+ years down the road
• You (and your cofounders) want to own 100% of the company

So you want to raise money. Now what?

Different sources of investments

• Bootstrapping (ie, 'founder investment')
• Friends & Family ('FF', sometimes jokingly 'FFF')
• Angel Investors
• Venture Firms (Series A, B, etc.)

These categories have gotten fuzzier in recent years

Angel Investors

• Angel investors are wealthy individuals who invest their own money
• Angels tend to be more involved with early-stage companies and provide mentorship and other resources
• Angel investors may be less concerned with ROI than institutional investors

Venture Firms

• Venture firms are institutional investors who invest others' money
• Venture firms raise money from limited partners (LPs)
• Venture firms are expected to provide a substantial ROI to their investors
• After returning this money, VCs receive carried interest ('the carry')

Equity

• Equity represents ownership of the company, just like public stock (NYSE)
• Main difference (vs. NYSE/NASDAQ) is liquidity and dividends

Deciding on a valuation

• Decide how much money the company is worth, based on market size and revenues
• Decide how much money you want to accept
• Take the ratio => that's how much equity you give up.

It's so easy - can it really be so sensible?

Nope

Deciding on a valuation (in practice)

• Decide how much money you want to raise
• Investors decide how much equity (%) they need for that amount of money
• Divide money by equity => that's your valuation
• Be careful of premoney vs. postmoney valuations

Valuations are tough!

Convertible debt

(ie, punting on a valuation)

• Deciding on a valuation is tough, esp. for early-stage companies
• Investors may want to commit money before they are ready to value the company
• Converible debt is a loan which converts to equity (generally preferred stock) when another round is raised
• Advantage for startups: Easier to negotiate
• Advantage for investors: Discounted price on future round (ie, '20% discount uncapped')
• Common in early rounds, but sometimes later rounds too (see Foursquare's Series D)

To cap or not to cap?

Capped & Uncapped Convertible Notes

• Convertible notes can be capped or uncapped
• Capped notes will cap the price that investors pay in subsequent rounds
• Caps put an implicit valuation on the round, and a lower bound on investors' equity

Pro Rata

Pro Rata

• Subsequent rounds of investing dilute existing investors
• Pro rata provides existing investors the right to purchase enough shares to maintain existing ownership
• Some investors (e.g. Joanne Wilson) will refuse to invest without pro rata rights
• Be careful of super pro rata rights - the right to double (or more) ownership in subsequent rounds

Giving It All Back: Vesting

Vesting

• It is generally a bad idea to assign equity and options without a vesting process
• Vesting spreads out stock earnings over four years (usually) and allows founders to earn them back
• This addresses the problem of a 'missing founder' owning most of the company
• Employee stock options are also typically vested
• Upon merger/acquisition, vesting may be accelerated

Liquidation Preference

• Stock may be preferred or common
• Typically, investors receive preferred stock and employees receive common stock

Other Terms & Concepts

• Transfer rights
• Secondary sale

Futher Reading

• Venture Deals by Brad Feld and Jason Mendelson
• AVC (Fred Wilson's Blog): http://www.avc.com/

Thank you