capital models… and why angels should care€¦ · • move hq to us, asia or europe, keep devops...

Capital Models…and why angels should care

Ron Weissman Band of Angels October 2015

The story!

The Capital Model

Agenda

1. Why Capital Models?2. Understanding Risk3. New Sources of Capital4. Issues & Best Practices5. Capital and Outcomes6. Lessons for Angels

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What is a Capital Model?• Each sector has its own capital model• How much funding will a company need

• To get to the next round?• To get to breakeven?• To get to scale?• To lead the market?• To exit?

• What are the likely sources of funding at each stage?• What are the key capital risks at each stage?• What are the exit returns for this sector? How do they

compare with capital needed to exit?

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What beyond equity, does our capital really buy?

Metrics Milestones

The Capital Model must integrate with the overall business plan.

Business Plan Milestones• Seed: MVP? Connect with angels?• Angel: Proof of early customer interest, strong technical

and business founders? Attract VC interest?• Series A: Business model assumptions work, key exec

hires, growing customer metrics?• Series B: Repeatable sales model, reduced CAC,

broadened management team?• Series C: Can company scale?• Series D: Is company an emerging market leader?• Series E: Can company dominate global markets, its

ecosystem and attract exit partners?

CAPITAL MODELS

Physical Consumer Product: Kickstarter Lean Internet Startup Enterprise Software

SaaS Semiconductor Medical Device

Biotech7

Company Capital Strategies

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Incubator $25K - $100K

Angels $0.25M - $2M

Series A VC $2M-$5M

Series B VC $5M - $15M

Series C, Corp. VC $10M - $25M

Later Stage VC or PE $$25M - $150M

Joint Development Partner

Venture Debt

IPO

M&A

PE

Agenda


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RISK: The Ultimate Question

Can we make money on this investment?

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Analyzing Investor Risk• Technology Risk

• Does it work? Can it work and scale in real life use?• Management Risk

• Is this team right for THIS deal?• Market Risk

• Will customers buy it?• Competitive Risk

• Can this company dominate its markets?• Exit risk

• Multiple buyers? Private Equity exit? Chance of an IPO?• Capital Risk

• Will they need so much capital that follow-on VCs will wipe us out? Will there be sources of capital when they need it?

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A Startup’s Capital Model is a Critical Angel Investor Risk Factor

SeedInstitutional Angel

Series ASeries BSeries CSeries CSeries D

Incr

easi

ng A

ngel

Ris

k

Friends & Family

• Follow-on Financing Risk• Pay to Play Risk• Misaligned Investor Risk• Liquidation Preference Risk• Early Investor Cramdown Risk• Down-round Risk

One Angel Capital Strategy

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Incubator $25K - $100K

Angels $0.25M - $2M

Series A VC $2M-$5M

Series B VC $5M - $15M

Series C, Corp. VC $10M - $25M

Later Stage VC or PE $$25M - $150M

Joint Development Partner

Venture Debt

IPO

M&A

PE

Potential VC Buyout

Agenda

1. Understanding Risks2. Why Capital Models?3. New Sources of Capital4. Issues & Best Practices5. Capital and Outcomes6. Lessons for Angels

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Crowd Funding Incubators, Angels, Seed Funds

Early Stage VCs (Series A, B) Corporate VCs Venture Debt Providers (Post Series A)

Motivation Pre-buy product (Kickstarter) $$ (Equity CF)

Strong value creation: 10X - 30x return Supernormal returns: 5x -10+; role in building “the next big thing”

Access to next gen. innovation; strong returns are nice, too

Above market yield, low risk

They want Access to products Equity in next big thing

Reasonable valuation OR discounted & capped convertible note OR VC buyout

Valuation consistent with target returns; control over process and outcomes; Your Soul

Participate behind lead investor; Access to market, team & IP partnership

Senior debt; Interest + warrants + loan fee

They Fear They often don’t know VC cram down Down rounds Competitors Illiquidity; getting handed the keys

Value Add Limited Mentoring, VC Introductions or Incubation

Future $, Network, Keiretsu, Exec Recruiting, Brand

Customer & Market Access, Credibility $$, when it works well, it can be less dilutive than VC

Investor Role Passive Investor / mentor Lead investor Syndicate investor Venture debt lead

Investor Security

None Ability to price this round; capped convertible

Liquidation Preference, anti-dilution, Investor Rights

Liquidation Preference Senior claim on IP & assets; covenants, warrants

Round Metrics, Milestones, Issues

•Initial product run •MVP •US limits follow-on

participation < 1 year •Expensive Fees •Hard to raise $$ from VCs

•Anchor executive •6-12 months runway •Initial sales •Product milestones •Completion of proofs of concept •Evidence of traction •Less dilutive & controlling than

VCs

•Strong Team / CEO •12-18 months cash •Tracking business plan metrics &

milestones, e.g., CAC, MRR, churn, cash •Customers, OEMs, eyeballs, subscribers, JDA

partners, etc.

•Product milestones •Evidence of interesting market •Supported by internal product group •Tech expert help for product groups •Can limit deals with their competitors

•Is company meeting revenue, EBITDA and cash flow covenants?

•Senior claim on IP and other lender rights may complicate new financing

•Operational skills are rare

Sources of Early Stage Capital

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Angel/Seed FinancingIncubators, Angels & Seed Funds

Motivation Personal value creation: 10X - 30x return

They want Term sheet at reasonable valuation OR discounted & capped convertible note

They fear Missed milestones leading to down rounds/hostile VCs & VC cram down

Value Add Mentoring & VC & ecosystem Introductions, less dilution

Investor Role Investor & mentor

Investor Security Ability to price this round; capped convertible

Round Metrics, Milestones

•Anchor executive •6-12 months runway •Initial sales •Product milestones •Completion of proofs of concept •Evidence of traction

Crowd Funding• Product based (Kickstarter) vs. Equity based Crowd Funding

• US: Equity-based Jobs Act

• Who: Small “Retail” investors

• How Much: $1M funding cap

• Limits: $ caps for investors based on income tiers

• Via: Intermediaries: Crowd funding Portals, Broker/Dealers

Benefits• Ready access to capital• Democratizes angel investing• Much broader investor pool• Potentially faster time to $

Risks• Costly (expensive broker fees)• Reputation• Hard to raise 2nd tranche w/in 1 year• Fraud & Litigation• Is ‘retail’ a realistic model for angels?

Incubator Explosion

• 1000+ US incubators and accelerators• Hugely important in early stage maturation• Every major city in the world• Every major university• Growing number of company sponsors • Plug & Play, Techstars, YCombinator, 500Startups,

Excelerate Labs, Dreamit ….

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Corporate Venture Capital (CVC)

1100+

19%

$2.2B

300+

Deployed Q1 ‘15

% of Q1 ‘15 VC Deals

Silicon Valley CVC Teams

Total US CVC Teams

Source: CB Insights

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Agenda


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Capital Planning & ForecastingC

ash

($M

)

0

3

6

9

12

QuarterAngel/Seed Series A

Metrics Visibility

Metrics Visibility

Series BBootstrap /Incubator

High Valuation: a two-edged sword

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POSITIVE

• Less dilution to investors

• Evidence of progress• Everyone feels great!

NEGATIVE

• If not based on fundamentals…

• … next round may be a down round

• Angels get crushed• May reduce M&A

field

Who Should Fundraise?Person Rationale Reactions

CEO, CFO, CXO A key responsibility CEO fundraising is essential

Board, Corp Counsel A key responsibility Trusted participants

Existing Investor Introductions part of value-add …especially if investing in follow-on round

Neutral 3rd Party Friendly introduction Neither positive nor negative

Major I-Banker Part of value add role Helpful to neutral

Passive Investor Helpful… but … failure to co-invest (except for old funds) is a negative

Hybrid VC/Broker Invests Series A, Places follow-on rounds

New Jersey Boiler-room scam, poor use of raised capital

Paid IntermediaryCEO too busy or company is

out of areaCredible when intermediary invests

Placement Agent CEO too busy or inexperienced

“You’re being paid. Why should I believe anything you say?”

Cre

dibi

lity

Avoiding Legal Risk

• Problem: Insider-led follow-on rounds

• Fiduciary responsibility of Directors

• We’re all conflicted

• Solution: Independent Committee of the Board, Fairness Opinion

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• Natural adversaries? Partners? Both?

• The more capital raised, the greater the dilution (and down round) or pay-to-play risk

• There’s no such thing as a prior round protection

• VCs love building companies on OPM

• Build syndication networks–VCs support angels where there's a long-term relationship and mutual respect

• Arrange early VC buyout25

“Money is the root of all evil.” –The Bible

“LACK of money is the root of all evil.”–Mark Twain

The Growth Capital Barbell Problem

$50K - $2M SEED, EARLY STAGE

Economic Development Funds,

Incubators, Seed Funds, Angel, Series A

Capital

$20M+LATE STAGE

Last Man StandingExpansion Capital Global VCs, P/E

Funding Gap

??

X-Border Strategies for Startups in Regions with Little Growth $$

• Move HQ to US, Asia or Europe, keep DevOps at home

• Target multinational VCs

• Encourage local angels & VCs to do larger deals via syndication

• Leverage multinational customers

• Merge or buy US company to build a US base and attract US capital

• Leverage ex-pat community in Silicon Valley …. or help build one

France tech has found that every US job creates multiple jobs “at home”

Agenda


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Study of $500M in US & UK Angel Deals

Source: ACA, Returns to Angel Investors in Groups, 2007, Robet Wiltbank, revised 2014)

< 1X 10X - 30X+

Length of Investment < 3 years 5 years +

Domain Expertise Low High

Diligence < 20 hours 20 hours +

Post-deal Monitoring Low High

• Active monitoring = 3x return of passive investors

• $50M+ exits unusual

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Average Return = 2.6x (Returns to Angel Investors in Groups, 2007, Robet Wiltbank, 2014)

Top 10% of exits returned 75% of all cash

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US Venture Backed M&A, Q1 2015

Only 15% of M&A exits likely

returned capital or made money for investors in

Q1 2015

Source: National Venture Capital Association, 201532

More Capital ≠ Higher Returns to Angels(Source: Robert Wiltbank, 2014)

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Angel Funded Exit Values, 1996-2006Source: Robert Wiltbank, 2014

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Agenda


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Your angel capital model may be different from your investee company’s model

✓What is in the best interest of an investee company may not be in your best interest. Deal with conflicts of interest responsibly

✓Cultivate VC partnership to protect your angel equity

✓An early exit reduces risk of later dilution or cram down

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Lessons1. Don’t confuse YOUR capital model with the investee's capital model2. Understand the company’s capital and returns model before

investing3. Capital efficient deals are an angel’s best friend4. Scale your investment to likely outcomes 5. The more capital, the greater the risk of YOUR dilution6. To avoid early cram down: reserve $3 for every $1 invested7. Series B or C VC buyouts are your friend8. Partner with VCs to avoid VC cram down9. Actively monitor and mentor your investments. Monitoring is all

about metrics and milestones. How else will you know if you should reinvest?

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capital models… and why angels should care€¦ · • move hq to us, asia or europe, keep devops...

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