Week 3: It gets serious: You’re about to see a Term Sheet

Week 3: It gets serious: You’re about to see a Term Sheet

“Mistakes in the Process … Due Diligence … Valuation … Negotiation … The 3P Framework … The Entrepreneur’s View … The VC’s Perspective”
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Summaries

  • Week 3: It gets serious: You're about to see a Term Sheet > Mistakes in the Process > Mistakes in the Process
  • Week 3: It gets serious: You're about to see a Term Sheet > Due Diligence > Due Diligence
  • Week 3: It gets serious: You're about to see a Term Sheet > Experts 3.1 > Experts 3.1: What is a fair valuation for your company
  • Week 3: It gets serious: You're about to see a Term Sheet > Negotiation > Negotiation Tips
  • Week 3: It gets serious: You're about to see a Term Sheet > The 3P Framework > The 3P Framework

Week 3: It gets serious: You’re about to see a Term Sheet > Mistakes in the Process > Mistakes in the Process

  • You already contacted the VC and we might have made the company presentation or we are about to make the company presentation and now we want to get closer to the deal.
  • Again, we’d like to quote Guy Kawasaki who has given you some tips of he calls it the ten mistakes entrepreneurs do when approaching a VC. You won’t get further if you do one of those things.
  • The first thing is if you believe that patents make your product defensible.
  • If some big company is coming up and says “Ok that’s really interesting” they can copy you and you do not have any chance to fight against them.
  • So that’s the first thing you should never say to a VC. The second thing is, don’t say something like “Our projections are conservative”.
  • The next thing is “We have a proven management team”.
  • Well why do you really have to be proven as a management team? I mean that might be the case but it’s better to talk about the management team and tell that it suits really well or is the best team for this opportunity than saying “Oh we are proven”.
  • How does this research firm know? Nobody knows and so I mean you should quote research and so on but don’t be too sure about the results.
  • 2020 is far away and nobody knows what’s really the market in 2020.
  • The next thing, don’t try to tell the VC Oracle or another great company is too big, too dumb, too slow to be a threat.
  • Next thing “Big-name companies going to sign our purchase order next week”.
  • If you say that, the VC will definitely tell you “Ok we’re gonna wait a week” or “We’re gonna wait two weeks” and if you don’t show traction you’re out of process because this is about trust and if they can’t trust you even in the first meeting, you will be out.
  • It’s a really close group of people and if they found out nobody saw the business plan or you always told all of them “Hurry hurry hurry” it lacks trust again and they might put you out of the process.
  • Maybe you can sign something before the VC money comes in but in general you have to be ready as a team and the team has to be perfect before the specific idea.
  • What happens is that VC’s get the same idea and tail by two or three different companies.
  • I mean how could you know what’s happening on the globe? Maybe there’s someone in China who is doing the same thing or in South America or in Europe or in the US. How could you know that? So just don’t say “No one can do what we are doing”.
  • Just avoid to say all these things and especially avoid to say “All we have to do is get one percent of the market” because this one percent is really hard to get.
  • If you come up with the 1% argumentation it shows that you too much believe in the top down thing and this is what VC’s normally don’t like and this is what experienced entrepreneurs normally don’t do.

Week 3: It gets serious: You’re about to see a Term Sheet > Due Diligence > Due Diligence

  • Now you made it: The VC is really interested, he sent you a letter of intent and he’s saying “We’d like to do a due diligence”.
  • It’s in general a good sign, however the VC now is dedicating a lot of work to you and you have to be very close in looking at what he does that the due diligence is going to be really positive for you.
  • That’s especially astonishing for engineer natural scientists when they come up to the VC and the VC says “Oh yes sounds great let’s do it” and you wonder “He’s not asking about how it really works”.
  • Well the reason for that is he doesn’t understand how it really works.
  • He has people to understand that and these guys do the technical due diligence.
  • If they are not able and they might go on the wrong track that’s bad. One example I just experienced was a patent due diligence we had. It was one of my companies and the patent attorneys who had to do the patent due diligence basically didn’t really understand the technology.
  • By the way, really good VC’s have great people to do all the parts of the due diligence.
  • If your technologies are really new groundbreaking if your financial model is new, that also might be difficult for those people.
  • In general he makes up his own excel and tries to understand your numbers and makes up his own calculations, evaluations and so on.
  • Is it consistent the number of customers you like to get and the number of personnel in marketing you have? Is it really consistent or is there a big gap between that? This is why the VC tries to understand, not only understand your model, your excel, normally he tries to build his own excel in order to get to the same results.
  • You want to be really close to those guys in order to understand what they’re doing and they don’t get something wrong which brings the VC on the wrong track.
  • I mean the VC has to understand that you are in the right timing, you’re in the right place and so on.
  • So these are the six areas of the due diligence and again: Be close to those six areas and not only that, also be prepared.
  • Be prepared to have all the papers ready for the due diligence process especially the contracts you made between you and the co-founders and previous investors.
  • Honestly, they will always look into those contracts and they might want to change those contracts so you also have to prepare previous investors to that and if you have really crucial or astonishing contracts between you and co-founders, because some get a lot more shares and some less, they will ask for “Why is that the case?” and so on.
  • The contracts between you and your customers and suppliers.
  • VC’s hate surprises in these process so be prepared with all the papers, trying to build a data room for that and the VC can go into that data room, it’s not necessarily a physical space, but he goes into that and he tries to understand whether there a no surprises, whether it’s really good to do an investment.
  • So don’t hide anything, try to be prepared, have a data room ready and be very very close to that due diligence process.

Week 3: It gets serious: You’re about to see a Term Sheet > Experts 3.1 > Experts 3.1: What is a fair valuation for your company

  • So we don’t set a valuation, we let the market set the valuation.
  • Yes, you can raise money at a twenty million dollar valuation right after the black.
  • Well the question is what is the definition of a fair valuation? In valuation there are many ways to look at it.
  • One is, you have your own belief system of how disruptive you think your company is and therefore you should ask for a very high valuation.
  • If you can prove with a good business model, with the right people behind it that you have something truly disruptive, you will get away with a high valuation.
  • At the same time at this moment particularly in Silicon Valley and in other places as well, we all have heard about the unicorns and the valuations of companies are fairly fairly high.
  • The question is, is it justified or is it a little bit of a hype right now? I don’t want to call it a bubble but valuations are a little bit on the high side to say it very carefully.
  • I would say plenty of startup companies, early-stage startup companies in segments where it’s very crowded, will probably will disappear and only the good ones will survive and they probably will ask for a nice valuation in their next rounds.
  • It becomes increasingly scientific as a company matures and there is a better view point into its unit economics and its margin characteristics but there’s not, the earlier the company is the more speculation and the more art comes into that.
  • So being clear that services revenue might get between one and two times your annual revenue in terms of market valuation for your company, whereas recurring software revenue might get between four and eight times valuation.

Week 3: It gets serious: You’re about to see a Term Sheet > Negotiation > Negotiation Tips

  • We will make you understand what the term sheet is about in the following parts, now you have to negotiate the deal.
  • We helped you to understand the papers, now we have to understand people a little bit you’re dealing with.
  • In most cases you have a businesses angel on board and he can help you doing the negotiations.
  • Because he had already done several negotiations on term sheets and for the entrepreneur it’s often the first time, sometimes second, third time.
  • Just an example for some reactions we can give you is, the first is, the bully: So the other side, the VC he yells and screams at you and says “Are you crazy? That valuation never don’t do it”.
  • If you’re able to outbully the bully do that or just be patient, chillout, wait until he comes down and then you might be able to talk to him.
  • The second is the wimp: He tries to, like you, negotiate both sides of the deal.
  • Valuation for him and valuation for yourself which is basically the same valuation.
  • He’ll put contractual details in the deal which might make the valuation a real real sour thing for you.
  • So if you even get a good deal, the other terms might make it a bad deal.
  • So if you have that kind of person on the other side, I mean you start with a valuation, you say: “My company is worth 10 million pre money” and he says “Well we habe to think about it” and so on.
  • So cover all your points together and again, try to get a commitment by and from him.
  • It’s about people at the very end and if you understand the person on the other side, it really helps your deal.
  • If you really have to negotiate that, you have to understand the term sheet, you have to understand the terms in the term sheet and so this is why we’re talking about that in the future.

Week 3: It gets serious: You’re about to see a Term Sheet > The 3P Framework > The 3P Framework

  • Welcome to the introduction to Venture Capital the 3P framework.
  • If you want to gain venture capital you have to get three things in order and this is the 3P framework.
  • That’s our 3P framework: Papers process and people.
  • So what is the papers again? It starts with the pitch deck which you need if you approach a venture capitalist, if you can do your company presentation, you need a little pitch deck and you also need the business plan.
  • If you go further into that process also the due diligence material.
  • So those are the most important papers you have to have in order if you want to raise venture capital.
  • What is process? First of all we had this four-stage process, so you started contacting the VC, it is a rough analysis and there’s a detailed analysis and the negotiations.
  • So that’s the first process but even before, are you ready for a VC? And not you personally but also your company.
  • So basically the question who’s driving your process.
  • This is the 3P framework and the 3P framework summarizes what you have to do if you want to raise venture capital.

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