Early-stage Fund Raising (including social-impact fund raising) bob.bridge@swanimpact.org, cell (512) 658-2240 Founder and Executive Director, Southwest Angel Network 30 years experience in early stage technology start-ups Raised $60M from investors

Agenda Stages of Fund Raising What Motivates Angels and VCs How Investors Evaluate Deals Types of Investment Instruments

Not all companies do all these things. Stages of Fund Raising Amounts raised $0 $x0,000 $x00,000 $xx,000,000 $xx0,000,000 Exits Bootstrap Friends and Family Angels Venture Capital IPO Crowd Funding Strategic Investors M&A Kickstarter Private Equity Grants Time Not all companies do all these things.

What Motivates Angels and VCs

How Angels work Wealthy individuals looking for an energizing activity Enjoy helping young companies Angels are either part of a network or invest on their own Networks work one of two ways: Individuals write personal checks (aka, a network) The angels create a funding pool which makes investments (aka, a fund) Angels plan to make a return on their investment

What (ideally) happens with investments? Then, maybe five companies will provide a return, and one of those will be a big win. Assume 10 equal sized investments $ $

How Big an Angel Portfolio? 5 10 25 100 Minimum of 10 20 is better

Some Texas Angel Networks Southwest Angel Network

How VCs Work They are professional, full-time investors Early-stage VCs raise a ~$350M fund from largely institutional investors They make 1st investment in 20-40 companies over the first 2-3 years of fund’s existence They plan to continues to invest in these companies in later rounds Then wait ~7 years for an exit/payout 1 in 10 deals make a fund successful

How Investors Evaluate Deals The bottom line: Can they make a return on the investment?

The most important consideration! At a high-level …. Gain confidence in the management team. The most important consideration! Gain confidence that the company will become profitable and provide a return to investors For social-impact investors - Gain confidence that the company will have significant social impact

Team Validation –Job #1 CEO’s emotional maturity Transparent, open, trustworthy, humble, coachable, always learning Ability to enable team collaboration and open communication CEO’s startup experience Prior mistakes are good CEO’s domain knowledge of the company’s market Appropriate titles? How does the C-level team work together?

Social Impact Validation – The most basic test Does the company’s primary business mission clearly speak of impact? Does the company’s home page clearly communicate that impact mission? That said – “Impact is in the eye of the Investor”

Social Impact Validation - Efficacy What evidence is there that the company will effectively deliver significant impact? What a nice idea  High confidence that significant impact will occur vs.

Demonstrating Efficacy Pre launch Post launch Write a Theory of Change Cite evidence complied by other sources Publish pre-release test results Compare pre-use and post-use outcomes Compare outcomes relative to competitive impact solutions Compare outcomes relative to a control group

How Significant an Impact? How much impact is the company creating per individual? Useful, Helpful, Relieving, Life Changing How many people will the company directly impact? Tens, Hundreds, Thousands, Millions, Everyone How long does the impact last? Days, Weeks, Months, Years, Lifetime How long before the impact takes effect? Days, Weeks, Months, Years

Learn More on Impact Measuring Impact Download the Angel 203 Webinar material at https://swanimpact.org/angel-investing-education/

Market Validation Can they demonstrate that they solve a problem for a payer who strongly feels that pain, and who has a budget to pay for a solution? Are there enough of those payers to generate enough revenue (big market)? Is there thorough validation of the market opportunity? Early revenue from payers is strong validation

Go-to-market validation Does the company know how it will get to ~$30M in sales and an M&A? How do they connect with potential customers? What is the cost of acquiring one incremental customer? What type of marketing and sales organization and partners do they need? And are they in place?

Product/Technology Validation How ready is the product for full release? Modern and viable architecture that matches market need? Is the technology scalable? Are developers tightly coupled to market validation? If hardware, is the supply chain in place?

Competitive Advantage Validation How significant is their competitive advantage? What keeps them successful five or ten years from now (enabling M&A)? Critical mass of customers? Sales channel lock? Supply chain lock? IP?

Financial Validation Reasonable bottom-up details driving the financial model? Credible, customer-driven revenue plan? Yes: “number of customers willing to pay how much to solve a problem” No: “we will get 10% of big market”

Types of Investment Investments ?

3 Ways Investors Can Make a Return Revenue-based Payments M&A – Merger and Acquisition IPO – Initial Public Offering of stock

Type of Investment by Stage Bootstrap Pre-Seed/Seed A > B > C ……. IPO or M&A Founders Common stock Typically few additional shares Shares become liquid Employees Common stock option grants. Option pool may increase over time. Can exercise options & have liquid stock Equity Investors - Often angels & convertible debt, SAFE, KISS Typically VCs & preferred stock Preferred converts to common Non-equity Investors Angels & revenue-based funding

Revenue-based Funding Investors invest in company Company repays investors by sharing a percentage of revenue Benefits to company Company does not give up equity [non-dilutive] No M&A pressure from investors [no exit required] Repayment amounts scale with revenue [no fixed monthly payment]

Revenue-based Structure Amount raised 25% to 33% of annualized revenue Repayment rate 4% to 8% of gross revenue Total repaid 1.5x to 2x the amount raised Typical repayment period 3 to 5 years Examples: Monthly revenue $20k $100k Annualized revenue $240k $1.2M Amount raised $80K $400k Amount repaid $160k $800k

Key Equity Concept - Valuation Pre-money company valuation ($2M) plus Investment amount ($1M) equals Post-money company valuation ($3M) Result: Investors own 1/3 of the company

Equity Return Considerations What percent ownership will investors own at an exit? Is the current pre-money valuation or cap reasonable? What future rounds of investments are anticipated? With this current investment can the company achieve a business result that significantly increases valuation before the next investment? How likely an exit? What are acquisition examples?

Convertible Debt Does not require a pre-funding valuation to be defined The loan automatically buys series A preferred stock when A is issued, at better terms than the series A investors receive Loan is basically unrecoverable if the company fails

Convertible Debt – Key Terms Valuation cap Protects the percent ownership position for investors at conversion time The most important term for investors Discount rate The discount from the Series A preferred price Typically a 20% discount Interest rate Earned interest used to buy stock at Series A conversion Typically 3% to 8% annually Conversion trigger Typically = series A of a certain size

What is a Typical Convertible Debt Valuation Cap? Depends on every aspect of business plan Team, traction, technology, market size, IP, sales challenges, competition, etc. That said, annualized revenue rate (ARR) is a strong determinate … at least in Texas! Likely valuation caps Pre-revenue ARR < $100k ARR < $500k ARR > $1M $1.5 to $3M $2.5M to $4M $3M TO $6M $5M to $10M

Comparing Early-stage Options – there are variations for each type Structure Number of versions Equity mechanism Has a discount Has valuation cap Earns interest Has Maturity Date Convertible Note (traditional) No standard Conversion  Keep It Simple Securities: KISS 2 varies SAFE - Simple Agreement for Future Equity 4 Warrant to buy X Increasingly Investor friendly More detail and nuance at: https://www.supportscaleup.com/convertible-loan-note-kiss-safe-choose/

Preferred Stock Successive rounds: Series A/B/C…. Typically a VC-led round The marketplace (investors) sets the price/share Don’t bother with net-present-value calculations If investor wants 25% ownership for a $1M investment, the pre-money valuation is forced to $3M

Preferred Stock Preferred stock holders have rights that common stock does not have. Most notably, upon acquisition investors have the option to get 1 to 2 times their investment back before common gets anything If a company raise $3M and get acquired for $2M than common stockholders may get nothing The preferences are why investors pay more per share than stock option strike prices CEO

Raising Funds is a Real Slog Iterative / non-linear process 1 step forward, followed by 2 steps sideways or backward Emotional roller coaster Raising money can be a full-time job for CEO 6-12 months per round

Further steps Download this presentation at https://swanimpact.org/companies-education/ Sign up for our network’s email list at https://swanimpact.org