Insiders’ Insight
5 Things Startups Need To Know About Securing Investment From Venture Capital Firms
A
s a startup founder, it’s important to understand the process of raising capital from institutional investors. In the early stages of your startup, it’s recommended to secure investment from family and friends. However, once you get to the stage where you’re seeking institutional investment, it becomes a much more complex process. To shed some light on this topic, one of Betatron Startup Accelerator’s founding partners, Roland Yau – Managing Director of CoCoon Ignite Ventures – shares his advice on the typical due diligence process. Here are the five biggest takeaways:
1. Due Diligence Is Focused On Four Main Areas a) Target Market (Competitors, Size, Total Addressable Market, Industry Dynamics, Growth Rate, etc.) b) Team (Founder — Market Fit, Employees, Roles & Responsibilities, etc.) c) Legal (Shareholder’s Agreement, Articles of Association, Corporate Governance, etc.) d) Finance (Revenue Channels, Burn Rate, Margins, Churn, LTV, CAC, etc.) For early stage startups (Seed), the main due diligence (DD) focus is on the target market and your team.
For later stage startups (Series A), the DD has more of a focus on your financials.
2. The Investment Process
The following is an example of a common investment process between a VC firm and a startup. a) First Meeting. Investors meet the startup for the first time, with the goal of learning as much as possible about the business and its team. b) Initial Investor Due Diligence. If the investor is interested in learning more, then they go away and perform their own due diligence. They test the assumptions made by the startup by validating topics such as the market size, researching competitors, and asking for references. c) Indication of Interest (IOI). If the investor is potentially interested in investing, an Indication of Interest (IOI) will be sent to the startup. This is a non-binding indication and should come in written form. IOI’s usually provide an approximate target company valuation and outlines general conditions for completing a deal. d) Two — Four Week Follow Up Meetings. If the startup decides to proceed, meetings with the investor will be arranged to dig deep into items like the financials, product roadmap, customer pipeline, and company structure. This process can take anywhere between 2–4 weeks.
e) Term Sheet. If the investor likes what they see, a term sheet will be sent outlining an investment. The term sheet usually covers items such as valuation, equity option pools, liquidation preferences, participation rights, control, and investor rights. Don’t forget, though, term sheets are also non-binding documents. f) Formally Binding Agreement. Once the term sheet is signed, the lawyers then step into perform more due diligence and create a formally binding agreement between both parties. Once this is signed, the investment capital can finally be deployed.
3. The Lifecycles Of VC Funds
Venture Capital firms invest using funds. These funds are pools of money which the VC firm invests on behalf of their own investors. The funds have a defined lifecycle of usually 10 years. Years 0–3 — VC firm deploys investment capital into multiple startups. Years 4–7 — VC firm grows the startups and manages their investments. Years 8–10 — VC firm “harvests” their investments and plan their exits, via methods such as acquisition or IPO. It’s important to understand the typical lifecycle of an investment fund. VCs don’t want to invest in startups which only have the potential to exit after their fund is scheduled to close. Ideally, they look for an exit in the next 4–5 years. Therefore, when you speak with an investor, it’s important to talk about your 4–5 year vision. In terms of your execution plan, you should use a timeframe of the next 12 months. If you talk about a timeframe much longer, it’s unlikely to be relevant.
4. Understand Your Legal Documents
Institutional investors look into the legal structure of your startup before investing because they may want to understand the corporate governance of a company. It is therefore crucial to know your company’s structure
20 JUMPSTART May/June 2017