presentaciones matt barrie - ecommerce day buenos aires 2016

How to not get screwed in a venture financing

Matt Barrie,Chief ExecutiveFreelancer.com

What is the best place to raise money from?

a) friends, fools and family

b) angel investors

b) angel investors

c) venture capitalists

d) the ASX

d) the stock exchange

Trick Question?

Sell something to Customers!

Startup Tip #1:

A friendly venture capitalist is not the solution to all your problems

Ramen Profitability“Ramen profitable means a startup makes just enough to pay the founders' living expenses” – Paul Graham, YCombinator

Startup Tip #2: Ramen Profitability

Role of Startup CEO• One job and one job only – “to keep the company funded”

Startup Tip #3:

STARTUP CEOs

YOU HAVEONE JOB ANDONE JOB ONLY

Running out of cash is a disasterDO NOT RUN OUT OF CASH

Startup Tip #4:If you need to raise money..

Inflection PointBreak-even

Ramen Profitability

Time (months)

Cas

h flo

w ($

k)

$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$

Valu

atio

n ($

m)

Valuation of Company (RHS)

Ideally raise enough to plug this hole

Peak of TechCrunch Hype

Valley of Death

Horizon of Hope

Slope of Enlightenment

Plateau of Productivity

At minimum enough cash to reach demonstrable valuation milestone

Raise enough to cross the valley of death

DO NOT RUN OUT OF CASH

CASH IS KING!!!!

Running out of cash is a disasterNOT RUN OUT OF CASH

COMPANIES RARELY SURVIVE DOWNROUNDS

STARTUP TIP 4: Remember Hofstadter’s Law

“A task always takes longer than you expect, even when you take into account Hofstadter’s Law”

Startup Tip 5:

Hofstadter’s Law

“A task always takes longer than you expect, even

when you take into account

Hofstadter’s Law”

Startup Tip #6:It is easier to ask for more

money than less money

Startup Tip #7:Think from an investor’s

perspective

Venture investing obeys power law

Actual

Company Rank

Inve

stm

ent R

etur

n (m

ultip

le)

Perceived

10x

5x

1x

Venture Investing Tip #1:To a first approximation, a VC portfolio will only make money if your best company investment ends up being worth more than your whole fund.

This is why that $100m fund isn’t

interested in giving you

“only $500k”

• Even if you hit it out of the park and generated 10x return, that’s only a $5m return on a $100m fund.

• That’s 5% return.• Even worse, for a VC that’s 5% over the 7 year fund life

VCs can’t recycle money from old investments into new- they need to return the cash to their LPs.

• They are better off putting their money into a Dollarmite account.

• To make sense, they have to (over time) invest $10 million.. so they have a chance of returning $100 million.

This is why that $100m fund isn’t interested in giving you “only $500k”.

Startup Tip #8: Ask for..

But be damn sure to generate ROI on each dollar

Venture Tip #3:Double down on

winners

Venture Tip #4:THE CARDINAL RULE OF INVESTING ISDO NOT RUN OUT OF DRY POWDER

Venture Tip #5:Venture investing is LAST IN, FIRST OUT

Otherwise known as the “golden rule”

He who has the gold, rules.

Venture Tip #6:VCs cut their losers

quickly

Most VC investments last longer than the average

marriage

There is no active market for an

investor to sell their shares in private

companies.

Bad VCs will “actively manage”

their losers.

YouVC

Most startup founders lose control of their business the second they take the moneyStartup Tip #9

Do not raise money from venture capitalists

Startup Tip #10:If you do raise from venture

capitalists, make sure they have operating

experience.

Startup Tip #11:Most startup founders lose control of their business the second they take the money

How do startups lose control?

Competitive positionThey do not

get in a competitive

position.

Board ControlVCs use

information asymmetry

to get the deal they want

Startups do not understand the

deal documentation

Board Composition

In a startup, the board has one primary role:

TO HIRE AND FIRE THE CEO

• Hires and fires the CEO• Sets broad policies and objectives• Sounding board for CEO• Approves budgets• Ensuring the availability of adequate financial resources• Accounting to the stakeholders for the organization's performance• Setting the salaries and compensation of management

• Resolutions by simple majority in vote or circular resolution signed by all directors

Yes, boards do other things..

https://en.wikipedia.org/wiki/Project_stakeholder

While the board’s job is not to run the company, it has effective control

.. it can fire the CEO who can appoint a new management team

Startup Tip #11:

If you lose control of the board, you lose control of the company.

XBoards should be an odd number, so you can make decisions

The best number for a small startup is 3

After that 5

• In a meeting of shareholders, an ordinary shareholder resolution is passed by simple majority (> 50% of votes).

• One share, one vote.

• So after a $2m financing at a $6m pre-money (25%), the founders would still determine the entire board.

VC Equity Everyone else

How directors are normally determined

How board control is immediately lost

Board of 5VCs choose 2Everyone else choose 2Independent 1

VCs have veto rights overIndependent, must beunaffiliated with company.

What’s the difference between a shopping trolley and Non-Executive Director?

You fill both with food & grog, but a shopping trolley has a mind of its own.

Refer to Startup Tip #5: The Golden Rule

Allocation of Returns on Exit

In a trade sale or wind up

Fully participating Preferred Liquidation Preference

The VC gets 2.5x their money

Then they share pro-rata inwhat’s left!

Let’s think this through:• Let’s say you are raising $2 million on a $6

million pre-money (25%).• If your company gets acquired, the VC gets $5

million off the top, then they share (they take 25% of whatever is left).

$5m exit (or less) $10m exit $40m exit

VC Proceeds

Everyone else


$6.25m

$3.75m

$15m

$25m

If only that was the end of it• The Series B investor will want at least the same

deal (SEE: THE GOLDEN RULE)• Let’s say they invest $10m on a $30m pre-money

Series A Everyone elseSeries B


Series A

Series B

Everyone else $25m

$5m

$16.875m

$10.625m

$32.5m

$39.375m

$18.125m

$42.5m

I have seen companies with

hundreds of millions of liquidation preference.

Would you like to be a unicorn?

No sweat.

I will give you $100 million at a $1,000,000,000

valuation


VC Proceeds

Everyone else


With a 2x participating

preferred liquidation preference

Fenwick & West publish a free quarterly report of what currently is “market”

Running out of cash is a disasterNOT RUN OUT OF CASH

Remember I talked about down rounds?

Antidilution

If you issue shares for cheaper, the VC

converts as if they bought at that price

THIS IS BRUTAL• Let’s say you are raising $2 million on a $6

million pre-money (25%).• Let’s say you then have a down round of $1m

at a $3m pre-money (25%)• The original VC still has 25% VC Equity Everyone else

$7.5m exit (or less) $10m exit $20m exit

Series A

Series B

Everyone else

$5m$2.5m

$1.25m

$5.625m$3.125m

6.25m

$8.125m

$5.625m

Greater Fool Theory

Dilution

Dilution

Aaron’s done a phenomenal job of building a world class company, but would have owned significantly more at IPO if he hadn’t taken so many rounds.

Reality is, unprofitable wealth transfer transfer to venture capitalists

you lose your control, voting and veto

thresholds

Ratchets

If you issue shares for cheaper, the VC

converts as if they bought at that price

RatchetsSeries F ratchet converts at IPO to common at minimum($20, 90% of IPO Price)

Furthermore there was a second, time-based ratchet, that if the IPO didn’t occur before July 7 2015, then the Series F gained $3 in value per share every 360 days, paid quarterly.

IPO Price was $14, so Series F converted at $12.60 – 11.1% premium to Texas Pacific Group & co.

Ironically, Box’s share price opened at $20.20.

RatchetsDec 2013, Box raised $150,000,000 at $20 a share in Series F redeemable convertible preference shares.

RatchetsSeries F ratchet converts at IPO to common at minimum($20, 90% of IPO Price)

Furthermore there was a second, time-based ratchet, that if the IPO didn’t occur before July 7 2015, then the Series F gained $3 in value per share every 360 days, paid quarterly.

IPO Price was $14, so Series F converted at $12.60 – 11.1% premium to Texas Pacific Group & co.

Ironically, Box’s share price opened at $20.20.

Mark to MarketFollowing the greater fool theory, public markets participants started getting tapped for late stage rounds.

This has created a perverse situation where private companies now have floating prices

RatchetsSquare IPO price range $11-13

Priced at $9, under the range

Ratchet for Series E at $18.56 -> Giving Series E investors 2.06x shares

Ironically.. Square IPO pops opens at $11.05, peaks at $14.78

Fidelity makes out like a bandit!!!

Perversely, it’s in the interests of late stage ratchet investors to mark

down their investments once set

Who is the fool now?

IT SEEMS WE FORGOT THE GOLDEN RULE!!!

Why does every silicon valley startup want to be a unicorn?

Silicon valley companies love stock based compensation

In 2014, LinkedIn paid employees 14% of revenue in stock ($319 million) In 2015, LinkedIn paid employees 17% of revenue in stock ($510 million)(96% of operating income)

2014-5, Twitter has paid 39% of revenue in stock.

However employee stock options are most often issues with a strike price equal to fair market value ..

i.e. at time=0, the options are worthless.

The company needs to rise in value to gain value.

They’ll make you an offer

you can’t refuse.

Which is easy with a

fantasyvaluation.

Not so good in public marketsUnlike the fantasy land of unicorns, the stock price doesn’t always go up.

LNKD60%

Employee stock wiped out.

There are 174 unicorns valued collectively at $585 billion

Average # of tech IPOs per year2012 - 2014

36

# of tech IPOs in 1H 2015

23

7# of tech IPOs in 2H 2015

0# of tech IPOs in 1Q 2016

1# of tech IPOs in 2Q 2016

Venture Capitalists are constipated

No exit.

Unicorns are going extinct

The unicorn is dead, long live the cockroach

Management Controls & VetosVetos over:

Business plansDeviation from plan

Share issuancesIPO

Winding upAsset sales

CommitteesHiring/Firing CEO

Employee Option PlanAcquisitions

Management Controls & VetosVetos over:

Spending over $100,000 (individually & in aggregate)Borrowing over $50,000

Hiring & Firing of CFO, CTO, COO, VP Sales, VP Marketing

Any transfer of sharesAny mortgage or security over $50,000

Any leases over $50,000Any remuneration of any executive over $100,000

Variation of any superannuation, incentive, share or bonus schemes

Any payments or transfer of assetsAny agreements signed ….

I know of a well known startup whose investors refused to approve any

travel budget greater than $0 so she could not fundraise

NO SOUP FOR YOU!!!

VENTURE CAPITALIST WINS!

Refer to Startup Tip #5: The Golden Rule

Luckily she paid out of her own pocket and found an investor that

helped do a reset.

Most startup founders lose control of their business the second they take the moneyDo not raise

money from venture capitalists

Sell something to Customers!

If you do raise from venture

capitalists, make sure they have operating

experience.

Competitive positionGet in a

competitive position

Board ControlRead and

understand every line of

your deal documentation

STARTUP CEOs

YOU HAVEONE JOB ANDONE JOB ONLY

DO NOT RUN OUT OF CASH!!!