This week I spoke at the Digital Shoreditch Festival in London. I made a presentation on “How to get through a VC transaction?” which was aimed at companies which have had angel funding and now wish to proceed to a larger VC institutional funding - a natural progression for many. My presentation (which I am happy to email to anyone who wishes) focussed on the differences an Angel backed company will encounter when they go to VCs for funding as opposed to angel investors.
I was happy to chat with several interesting CEOs of start-ups afterwards including David Kosky of WorkLife and Alexei Poliakov of Locomizer.
First of all timing: you don’t want to go to VCs for funding until you have enough commercial traction to command a valuation that limits dilution. More importantly in the first instance, you need to be at a stage to command any interest from the VC at all. So an angel backed company needs to ascertain their Valuation Inflection Points (VIPs) and monitor progress on them over time to then know when they are ready for VCs. Typical VIPs are commercial product readiness, first commercial revenue, users over a certain number, cash flow positive and (best of all) bottom line positive.
A company needs to know the differences in the process you went through with Angels and the one you now face with VCs. Major differences will be seen around:
- Valuation - different approach by VCs as opposed to angels
- VCs will take a keen focus on valuation unlike Angels who are more “price takers” in the market. Angels often price deal along the lines of ...”Well if I put in £100k - for this stage of a company - I want 10-15%” and will often take or leave a term sheet set by the company with minor alterations. This is a valid way to view valuation from an angel doing many small deals for the portfolio effect with no time to negotiate each in detail. VCs will write their own term sheet.
- VCs will work backwards from an exit price calculated for some time in the future, include any more rounds at a potential uplift (for dilution effect) and then work back to a price for the current round – a more involved pricing process.
- They will square this off with valuation on current metrics – Price to revenue, price to EBITDA, (even price to users if you are Whatsapp! and make not yet a penny)
- Deal structuring – also different – more complex
- VCs will introduce terms such as Liquidation prefs linked to preferred shares - which means they have the right to have X times their initial investment returned before common shareholders (the management and original angels). They will also look to “double dip“ and have a participating preferred share which then subsequently shares “as if” converted to common. See this article on Liquidation prefs even in unicorns!
- Other terms VCs like - anti-dilution protection, drag and tag rights, veto control rights, ratchets on valuation (for explanation on any of these terms in plain English – please contact us)
“You set the price - I’ll set the terms”
With the advent of many smaller VC funds – there is now more capital for series A so you may be able to get VC attention earlier than a couple of years back; however, just because a VC is small (actually most likely because) they will still hammer on these terms, unless you have something compelling that is being chased by the investment market.
I'll will write more about the following in my next blog:
- Preparation for a VC round
- Strategy of a VC round – play hard to get or not….
- Closing the round – perseverance and deal fatigue
White Lake through our Virtual CFO London service offer growth companies a subscription service to cover strategic and control financial issues plus capital raising all in one from a team of ex-VCs.
In my years of experience as an ex-VC, a founding team can become distracted by the often time-consuming fundraising process and not spend enough time developing their core product and gaining traction with potential clients.
Our goal with this service is to cover the range of emerging startups that need more than a simple accountant, but have not scaled to the degree to be able to integrate a full-time CFO and pay monthly brokerage fees for fundraising.
By John Rowland, Managing Partner