Description
Angels and Venture Capital firms are in the business of generating a high rate of return on their investment, not in creating or building businesses.
AN ENTREPRENEUR’S
GUIDE TO SECURING
VENTURE FINANCE
Raising Angel & Venture
Capital Finance
Dr. Tom McKaskill
ii
Raising Angel & Venture Capital Finance
Angels and Venture Capital frms are in the
business of generating a high rate of return on
their investment, not in creating or building
businesses.
To be successful, the investor needs to achieve
an exit of their investment within three to fve
years and that means planning the exit strategy
from day one.
The strategic trade sale is the preferred
investment exit method.
The business plan sets out the operational
detail of how the frm will create the necessary
conditions for achieving the exit for the
investor.
If you can’t create the necessary platform for
an Initial Public Offering, you are going to have
to sell your business.
The author hereby gives permission for any recipient of this publicaton to
reproduce, store in a retrieval system, transmit in any form or distribute by any
means for personal use of any recipient. This publicaton may not be sold or
resold for any fee, price or charge without the permission of the copyright owner.
iii
Raising Angel & Venture Capital Finance
Testmonials
‘Many entrepreneurs have achieved great success by partnering with
Angel investors but they need to have the right business venture and the
right approach to external investment to atract investors. This book provides
the essental guide for anyone contemplatng seeking Angel investment.’
– John Mactaggart, Chairman Australian Associaton of Angel Investors
‘Through his experiences as a successful startup entrepreneur, business school
professor, advisor and author, Dr. McKaskill provides some great insights and a
comprehensive game plan for companies seeking Angel and VC funding. Raising
Angel & Venture Capital Finance is a great read for founders and entrepreneurs—
whether they’re raising outside capital or just trying to understand the fundraising
process—and just made our jobs as investors a lot easier.’
– Joe Platnick, Partner iGlobe Treasury Management Ltd. and Director
Pasadena Angels
‘Tom is one of those unique individuals who has lived both a life of a successful
entrepreneur and spent tme understanding what makes them successful. This
book is a synthesis of decades of this experience and is a must read for anyone
who wishes to understand how to raise capital from the venture capital managers
and angel investor.’
– Richard Palmer, Investment Director, New Zealand Venture Investment
Fund Limited
‘An entrepreneur only gets a few chances to pitch a venture capital group.
This book will prepare you and signifcantly enhance your opportunity to receive
funding.’
– Patrick Thean, President, Leadline Group, Inc., Charlote, NC
iv
Raising Angel & Venture Capital Finance
‘Early-stage investng is all about fnding and nurturing a nugget of value with
the goal of presentng the improved value for acquisiton by a company in whose
hands that value can contnue to grow and reward. Investors need entrepreneurs
who want to build and sell such companies. While they ofen share the same
goal, investors and entrepreneurs frequently struggle to understand each others’
perspectve. These are the myriad deals that don’t fail, they never happen because
of a basic failure to communicate.
With his usual clarity, Tom explains the investor’s thinking to an entrepreneur
and ofers a practcal guide to preparing for and pursuing such investors.’
– Jordan Green, Angel Investor and Deputy Chairman, Australian
Associaton of Angel Investors Limited
‘Venture Capital is a highly specialised form of both business fnance and
partnership that relatvely few people understand. Dr. McKaskill has provided
a very useful introducton to the topic for aspiring entrepreneurs searching for
the best ways to accelerate their business growth.’
– Doron Ben-Meir, Executve Director & CEO, Prescient Venture Capital,
Melbourne, Australia
‘To stand out from the crowd, you must get into the mind of the venture
capitalist, and understand their motvatons and pressures. Raising Angel &
Venture Capital Finance is a practcal step-by-step guide that explains the pros
and cons of raising and working with private equity and venture capital funds.
This is partcularly relevant in today’s market where both Debt and Equity are
more difcult to obtain Tom McKaskill’s frst-hand experience in raising venture
capital is a valuable resource for any entrepreneur or business owner.’
– Ian Knight, Partner, KPMG’s Corporate Finance Group, Australia
Testmonials
v
Raising Angel & Venture Capital Finance
‘Tom has a wealth of entrepreneurial experience and he really understands
how entrepreneurs do business. Every entrepreneur wants to know how to raise
venture capital and Tom’s book is a “must read” for those that do. Tom’s book
sets out exactly what is involved. It is essental reading for any entrepreneur.’
– Noel Lindsay, Professor of Entrepreneurship and Commercialisaton
and Director of the Entrepreneurship, Commercialisaton and Innovaton
Centre (ECIC), Faculty of Engineering, Computer and Mathematcal Sciences,
The University of Adelaide
‘In additon to describing the current state of Angel and VC fnancing, this book
provides entrepreneurs (and investors) with a very practcal guide for designing
businesses for growth. This book should be read by any serious entrepreneur who
is even in the earliest stages of their new venture, such that they can lay down a
solid foundaton to enable later investment as needed. Later stage entrepreneurs
can of course beneft greatly from this book and the many references it provides.’
– Martn J. Bliemel, Lecturer, Australian School of Business, Strategy and
Entrepreneurship, UNSW, Sydney, Australia
‘Dr. McKaskill’s book is a great resource for entrepreneurs and investors.
Especially part B of the book with investor ready indices and self-assessment
guidance is very useful.’
– Peter Haubrich, President, Okanagan Research & Innovaton Centre ORIC,
Canada
‘Simple, straightorward and practcal advice that speaks directly to the
entrepreneur.’
– Michael Schaper, former Professor of Entrepreneurship and former Small
Business Commmissioner for the ACT, Australia
Testmonials
vi
Raising Angel & Venture Capital Finance
Testmonials
‘People in the business of building value have many competng priorites
for their tme. Raising external investment is ofen one of these priorites, yet
even the jargon can take on a life of it’s own. Dr McKaskill puts the focus back
on the important. The book contains approaches that puts founders, investors
and advisors on the same map writen in a common language. Building solid
alignment is a core theme, so reading or re-reading this book is a great next step.’
– Mat Yallop, Repertoire Management, New Zealand
‘At the Australian Graduate School of Entrepreneurship we pride
ourselves on the applicaton of theory for practce sake. Our graduates are
entrepreneurial, innovatve and proactve, and enhance our reputaton as the
leader in entrepreneurship educaton in the southern hemisphere. Against this
backdrop, we proudly integrate Tom’s e-books within our acclaimed Master
of Entrepreneurship and Innovaton program. The way in which Tom provides
insights and applicatons in a logical, realistc and real-world way beneft not only
entrepreneurship scholars, but anyone with an interest in high-growth ventures.
Since entrepreneurs manage opportunites in a resource-scarce environment,
raising angel and venture capital is most appropriately addressed by Dr McKaskill,
an absolutely must read as a guide to securing venture fnance.’
– Dr Alex Maritz, Director: Master of Entrepreneurship and Innovaton,
Australian Graduate School of Entrepreneurship, Swinburne University of
Technology, Victoria, Australia
‘Angel and VC funds who invest together with entrepreneurs are entering into
a joint venture partnership involving not only money, but expertse, networks and
ultmately commercial success. Dr McKaskill succinctly describes the challenges
and risks required to achieve a positve outcome for all partes in a balanced and
straight forward manner.’
– Greg Siters, General Manager, Sparkbox Investments Limited, New Zealand
vii
Raising Angel & Venture Capital Finance
Dr. Tom McKaskill
G
lobal serial entrepreneur, consultant, educator and
author, Dr. McKaskill has established a reputaton for
providing insights into how entrepreneurs start, develop and
harvest their ventures. Acknowledged as the world’s leading
authority on exit strategies for high growth enterprises, Dr.
McKaskill provides both real world experience with a professional
educator’s talent for explaining complex management problems
that confront entrepreneurs. His talent for teaching executves
and his pragmatc approach to management educaton has
gained him a reputaton as a popular speaker at conferences,
workshops and seminars. His approaches to building sustainable, proftable
ventures and to selling businesses at a signifcant premium, has gained him
considerable respect within the entrepreneurial community.
Upon completng his doctorate at London Business School, Dr. McKaskill
worked as a management consultant, later co-founding Pioneer Computer
Systems in Northampton, UK. Afer being its President for 13 years, it was sold
to Ross Systems Inc. During his tenure at Pioneer, the company grew from 3 to
160 people with ofces in England, New Zealand and USA, raised venture capital,
undertook two acquisitons and acquired over 2,000 customers. Following the
sale of Pioneer to Ross Systems, Dr. McKaskill stayed with Ross for three years
and then lef to form another company, Distncton Sofware Inc. In 1997 Atlanta
based Distncton raised $US 2 million in venture capital and afer fve years,
with a staf of 30, a subsidiary in New Zealand and distributors in fve countries,
was sold to Peoplesof Inc. In 1994 Dr. McKaskill started a consultng business in
Kansas which was successfully sold in the following year.
Afer a year as visitng Professor of Internatonal Business at Georgia State
University, Dr. McKaskill was appointed Professor of Entrepreneurship at the
Australian Graduate School of Entrepreneurship (AGSE) in June 2001. Professor
McKaskill was the Academic Director of the Master of Entrepreneurship and
Innovaton program at AGSE for the following 5 years. In 2006 Dr. McKaskill was
viii
Raising Angel & Venture Capital Finance
appointed to the Richard Prat Chair in Entrepreneurship at AGSE. Dr. McKaskill
retred from Swinburne University in February 2008.
Dr. McKaskill is the author of eight books for entrepreneurs covering such topics
as new venture growth, raising venture capital, selling a business, acquisitons
strategy and angel investng. He conducts workshops and seminars on these topics
for entrepreneurs around the world. He has conducted workshops and seminars
for educatonal insttutons, associatons, private frms and public corporatons,
including KPMG, St George Bank, AMP, AICD and PWC. Dr. McKaskill is a successful
columnist and writer for popular business magazines and entrepreneur portals.
To assist Angel and Venture Capital investors create strategic exits for their
investee frms, Dr. McKaskill conducts seminars, workshops and individual strategy
sessions for the investor and their investee management teams.
Dr. McKaskill completed three e-books for worldwide, royalty free distributon.
He has also produced over 150 YouTube videos to assist entrepreneurs develop
and exit their ventures.
Dr. McKaskill is a member of the Apollo 13 Angel Group located on the Gold
Coast and a member of the Australian Associaton of Angel Investors.
Dr. Tom McKaskill
ix
The Ultimate Deal 1
Selling your business
This book is aimed at those businesses which need to maximise their proft and
growth opportunites in a sale to a fnancial buyer to leverage the best sales
price. It sets out a breakthrough process which includes reducing risk, improving
sustainable profts and building growth potental in the business to maximise
the sales price. This world frst process can increase the value of the business
between two and ten tmes the conventonal sales value of a frm.
The Ultimate Deal 2 Get an unbelievable price
This book uncovers the secret of how to leverage strategic value in the business
to create a large revenue opportunity for a strategic buyer. Dr. McKaskill’s is the
world’s leading authority on selling a business to a strategic buyer and sets out
a comprehensive and systematc process for selling a business to a large cor-
poraton. Sales values of 40 tmes EBIT and/or many tmes revenue are highly
probable using his Strategic Sale Strategy for a business with underlying strategic
assets or capabilites.
Angel Investing
Wealth creation through investments in
entrepreneurial ventures
Designed to help high net worth individuals become successful Angel Investors.
Angel investng involves actve mentoring and coaching of an early stage man-
agement team towards sustainable proftability or additonal funding, probably
from a venture capital frm. This book sets out a comprehensive and rigorous
process that will help the Angel generate deal fow, evaluate investment propos-
als and manage the investment and subsequent harvest. The book also provides
a useful guide to managing operatonal risks in the venture.
Get A Life!
An inside view of the life of an
entrepreneur - from around the world
This book is a collecton of stories from entrepreneurs around the world where
they describe their work and their lives. They explain what it is like to be an
entrepreneur, how they got started, the successes and failures of their ventures
and the highs and lows of their personal and business lives. The stories are rich
in content and provide deep insights into how entrepreneurs think. If you are
an entrepreneur this will resonate with your inner being. If you are not, this will
provide you with a great understanding of entrepreneurs.
Order Books from www.tommckaskill.com
x
How to raise venture capital
The purpose of this book is to educate the entrepreneur on how Venture Capital
frms work, what they seek in an investment and how they manage that invest-
ment through to an exit transacton. It helps the entrepreneur judge whether
they have a venture suitable for VC investment and whether they wish to be part
of such an actvity. It lays out a comprehensive process that the entrepreneur
can follow which will assist them in raising VC funding.
Winning Ventures 14 principals of high growth businesses
Explains the major contributors to high growth success. Includes a comprehen-
sive Growth Check list for each principle as well as a robust Growth Potental In-
dex to help the reader judge the growth potental of their venture. Based on es-
tablished theories of growth, venture capital selecton criteria and the author’s
personal experience, this is a must for entrepreneurs.
Masterclass for Entrepreneurs
Creative solutions for resilience, growth
and proftability
This book is a collecton of published artcles by Dr. Tom McKaskill. This volume
expands on 30 of those artcles to provide a wide-ranging guide for entrepre-
neurs on how they can mange their businesses more efectvely.
Fast Forward
Acquisition strategies for entrepreneurs
In this book, Dr. McKaskill sets out a systematc and pragmatc process for ident-
fying, evaluatng, valuing and integratng fnancial and strategic acquisitons. He
draws extensively on his own experiences as a CPA, entrepreneur and academic,
as well as his experience with acquiring and selling his own businesses. He brings
a systematc and comprehensive approach to growing business through acquisi-
tons.
Finding the Money
Order Books from www.tommckaskill.com
xi
Order e-books from www.tommckaskill.com
This book is aimed at those entrepreneurs who have high growth potental
ventures and seek to raise fnance to assist them to develop their business.
To secure the fnance, the entrepreneur will have to demonstrate that their
business is capable of achieving a premium on exit, usually through a stra-
tegic sale. The book provides a checklist for the entrepreneur to assist in
developing a strategy to raise fnance.
Raising Angel & Venture Capital Finance
An entrepreneur’s guide to securing
venture fnance
Designed to help high net worth individuals become successful Angel In-
vestors. Angel investng involves actve mentoring and coaching of an early
stage management team towards sustainable proftability or additonal
funding, probably from a venture capital frm. This book sets out a compre-
hensive and rigorous process which will help the Angel generate deal fow,
evaluate investment proposals and manage the investment and subsequent
harvest. The book also provides a useful guide to managing operatonal risks
in the venture.
An Introduction to Angel Investing
A guide to investing in early stage entrepreneurial ventures
Investors in early stage ventures need to focus on strategic exits if they are
to achieve a high return on their investments. This book explains the charac-
teristcs of strategic value, how the investor should negotate the investment
and then how they should manage the process to a strategic trade sale. The
book includes a very detailed discussion on the problems of high growth ven-
tures, the unrealistc expectatons associated with IPOs and the advantages
of investng in strategic value ventures.
Invest to Exit
A pragmatic strategy for Angel and Venture Capital investors
xii
Raising Angel & Venture Capital Finance
Published by:
Breakthrough Publications
RBN B2173298N
Level 1, 75A Chapel St.,
Windsor, Melbourne, Vic 3181
www.tommckaskill.com
Copyright © Tom McKaskill 2009
All rights reserved. This publicaton may be reproduced, stored in a retrieval system or transmited in any form by
any means for personal use without the permission of the copyright owner. This publicaton may not be sold or resold
for any fee, price or charge without the permission of the copyright owner.
Every efort has been made to ensure that this book is free from error or omissions. However, the Publisher, the
Author, the Editor or their respectve employees or agents, shall not accept responsibility for injury, loss or damage
occasioned to any person actng or refraining from acton as a result of material in this book whether or not such injury,
loss or damage is in any way due to any negligent act or omission, breach of duty or default on the part of the Publisher,
the Author, the Editor, or their respectve employees or agents.
National Library of Australia Cataloguing-in-Publication data:
McKaskill, Tom.
Raising Angel & Venture Capital Finance - An entrepreneur’s guide to securing venture fnance
ISBN: 978-0-9806458-4-2 (on-line), 978-0-9806458-5-9 (CD-ROM)
1. Venture Capital. 2. Investment analysis. 3. Entrepreneurship. 4. Business enterprises -
Finance.
I. Title.
658.15224
Cover design: T. McKaskill
Page design and production: T. McKaskill
xiii
Raising Angel & Venture Capital Finance
Preface .................................................................................................................. XV
Acknowledgements ........................................................................................... XViii
Part A: Angel and Venture Capital Investment
1. A wealth creaton partnership ......................................................................... 2
2. Sources of Private Equity ................................................................................. 8
3. Angel Investor fnance ................................................................................... 30
4. Strategic vs. Financial ventures ..................................................................... 43
5. A compelling investment opportunity ........................................................... 53
6. Exit strategies ................................................................................................ 75
7. Preparing for the investment ........................................................................ 86
8. Investor presentaton techniques ................................................................. 95
9. Valuaton ..................................................................................................... 110
10. Finalising the investment ............................................................................ 127
11. Conclusion ................................................................................................... 138
Part B: Investor Ready Indices
Introducton to Part B ......................................................................................... 141
A. Awareness and Alignment ............................................................................. 145
- Awareness and Alignment Index ............................................................... 158
Table of Contents
xiv
Raising Angel & Venture Capital Finance
B. Venture Potental ........................................................................................... 159
- Venture Potental Index ............................................................................. 179
C. Operatons Development ............................................................................... 180
- Venture Potental Index ............................................................................. 207
D. Strategy .......................................................................................................... 209
- Strategy Index ........................................................................................... 220
xv
Raising Angel & Venture Capital Finance
Preface
F
ew entrepreneurs succeed in raising Angel or Venture Capital
f i nance. Many bus i nes s owner s don’ t bot her t o appl y
knowing that they won’t be successful. Others simply don’t need it and have
an operaton capable of generatng the free cash fow they need to grow their
business. Only a very few are able to meet the requirements of the Angel or
Venture Capital (VC) fund and succeed in getng an injecton of funds.
However, this type of funding is not a recipe for success. Around 50% of Angel
investments are in ventures which fail. More than 20% of VC investments are
writen of and at least a further 20% fail to achieve their target returns. On the
other hand, Angels and VC funds do succeed in picking winners and spectacular
returns have been achieved in a limited number of deals.
Over the period 1978 to 1999, I was fortunate to have raised venture capital
twice. The frst tme involved a sofware frm in the UK which I started in 1978
with two partners. By 1984, we recognised we needed to acquire one of our
sofware suppliers to be able to control the directon of sofware development
we were dependent on. We spent more than 12 months walking the streets of
London looking for venture capital to fnance the acquisiton.
Eventually we were successful in raising US$1.5 million for 20% of our equity
from a corporate venture fund. A few years into the new structure, the business
was in trouble. Our investor was acquired and our investment did not ft in with
the investment objectves of the new owners. We were successful in buying back
most of the shares of the VC fund for about US$30,000. A few years later, with
160 employees, 16 distributors and more than 4,500 customers, we sold out to
a US-listed sofware company for US$9.6 million. Had the VC fund stayed in, it
would have made a positve return on its money, although not the ROI it would
have liked.
Afer working for the acquiring corporaton in the US for three years, I formed
a new frm, building supply chain optmisaton sofware. We started with 12
people from the former frm which meant that we had a proven development
team and proven management. Afer spending two years building the frst
modules of the new suite of products, a small company called Red Pepper sold
xvi
Raising Angel & Venture Capital Finance
optmised scheduling sofware was purchased by Peoplesof for something like
23 tmes revenue. Recognising that we were in a boom market we set out to
raise venture capital.
This tme I was wiser, with some prior success and a proven team. However, I
stll spent nine months going from VC fund to VC fund trying to raise US$2 million.
I discovered that the VC funds all specialised in industry, investment stage, size
of deal and locaton. However, rather than miss out on the next Microsof, they
would stll see you – just in case. Finally, we raised US$2 million from a corporate
venture capital fund for 20% of the equity.
Two years later, we had used up most of the money and had achieved litle.
The market proved much more difcult than we expected. The early indicatons of
a boom market were not realised and several frms in the sector were in trouble.
SAP, the world’s largest applicaton sofware provider, then announced a full suite
of products in our sector, quickly followed by similar announcements by their
major compettors. Most of these products were ‘in development’.
Soon our prospects had essentially disappeared. We were faced with
dramatcally reducing the size of the business or selling out. We decided to sell
out. Within a few weeks we had eight frms interested in buying and a week later
received an ofer from Peoplesof at six tmes revenue. The VC fund came out in
front with a reasonable return.
When I returned to Australia in 2001, I was appointed Professor of
Entrepreneurship at the Australian Graduate School of Entrepreneurship. Over
the next few years I had tme to refect back over 20 years’ experience as an
entrepreneur over four diferent ventures. I also had the opportunity of working
with many start-up ventures and with several venture capital frms. Certainly, in
the past 30 years, the venture capital market has matured. There are now many
Venture Capital Funds or General Partners in the US, UK and Australia with many
investments to their credit. We all now have a much beter idea of what it takes for
a new venture to be successful, although we stll don’t have the secret to success.
More recently I have become actve in an Angel Group and have been involved
in educatng Angels on selectng and exitng investments. One thing which is now
very clear to me is that the objectves of the Angel and VC fund are rarely the same
as the entrepreneur seeking venture capital. It is only when the entrepreneur
xvii
Raising Angel & Venture Capital Finance
understands that he or she has to tailor the venture to meet the requirements of
the investor, and not the other way around, that the partes have a real chance
of succeeding.
The objectve of this book is to show the entrepreneur how they can create
a business which matches the investment objectves of the Angel or VC fund. In
doing so, there is a high probability of raising fnance. Venture capital is not for
everyone no mater how proftable the venture might be. Angels and VC funds
are not in the business of solving an entrepreneur’s need for funding albeit that
may be the outcome. They are simply there to achieve a high rate of return for
themselves, their investors or limited investment partners. The entrepreneur
who understands this and builds a proposal to meet their objectves, should be
much more successful in gaining Angel or Venture Capital fnance.
Tom McKaskill
xviii
Raising Angel & Venture Capital Finance
Acknowledgements
A very large number of people have contributed to my knowledge of this topic.
Hundreds of entrepreneurs who have been through my classes and workshops,
Angels who have atended my training sessions and discussed their investee
frms with me and VC executves I have worked with on exit strategies for their
investee frms. Each conversaton, queston and problem has helped me refne
my knowledge of Angel and VC fnance.
My life partner, Katalin Johnson, has been with me every step of the way,
partcipated in the seminars, workshops and most of the conversatons. She has
assisted me greatly by asking the hard questons, reviewing the material and
making her own contributon to the content.
Tom McKaskill
Australia
August 2009
[email protected]
www.tommckaskill.com
1
Raising Angel & Venture Capital Finance
PART A
Angel and Venture Capital
Investment
2
Raising Angel & Venture Capital Finance
1
E
very entrepreneur I know expects to build a winning business. Whether
it is the business they have right now or the next one they have in their
plans, they hope, one day, to get it right. They are optmists. Fortunately for
all of us, they are prepared to risk their savings and their tme to have a go
because without their drive, creatvity and perseverance, many of today’s large
corporatons would not be in existence.
One could also say the same about Angel and Venture Capital funding.
Without their funding and actve involvement, many of the successful companies
of today would have foundered. This partnership between entrepreneurs and
private equity capital has created signifcant wealth for both partes and, along
the way, many jobs, new innovatve products and a major source of export
earnings. However, it is a very small part of overall private enterprise capital
and the chances of a successful outcome are only fair.
Because of all the public relatons and hype around venture capital, we are
lef with the impression that it is a major contributor to business growth and
job creaton but the truth is that it is relatvely insignifcant in overall terms.
Only about 1 in 10,000 private frms will have independent private equity at any
point it tme and only about 1 in 20 frms seeking external private equity will be
successful in receiving it. So why is it seen to be an important factor in business
development?
A Wealth Creation
Partnership
3
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
The answer is found in the role that private equity plays in early stage, high
growth ventures. To appreciate that role, we must frst understand what it is
and how it works.
There are various forms of independent private equity. Angels typically
provide fnance for very immature ventures. Formal Venture Capital funds
tend to undertake deals in the business expansion to late stage of venture
development. The large Private Equity funds invest in mature businesses which
are undertaking a reorganizaton through a management buyout or are aiming
for a public listng. Even the terminology is somewhat confusing. In some markets
the term venture capital refers to any independent private equity investment,
especially from investment funds, while in others the term refers to diferent
types of investment. In more established markets, such as the USA, Venture
Capital refers to seed, early stage and some expansion capital, while Private
Equity normally refers to late stage, mezzanine, buy out and management buy
out or leveraged larger scale investments.
Collectvely the term Private Equity (PE) can be used to cover all forms of
independent investments. In this book, the term Venture Capital (VC) will
be used to refer to the form of private equity most ofen raised by emerging
enterprises, that is, those seeking funds from business Angels or Venture Capital
Funds to develop their business concept or to support the inital growth phase.
The common feature of VC investments is that they provide business fnance
in relatvely high risk situatons where other forms of fnance, such as bank loans
or lines of credit are not available. Because there is a high risk, high reward
element in these deals, there are both signifcant failures as well as spectacular
successes. It is mostly the long term successes which give the VC sector its
reputaton.
Private equity flls a gap in the market of business fnance, however, it is
very focused and, therefore, the vast majority of businesses do not satsfy
the investment criteria. Private equity investors are seeking opportunites for
returns well above what an average public equity investment would achieve.
They accept that the investment will be ted up for some tme and the venture
they are investng in is of a somewhat risky nature. They look for investments
4
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
which have the potental for very high rewards. These ventures will always have
a high growth potental component. That, in itself, means these ventures are
unusual as only a very small percentage of businesses ever succeed in reaching
a few million dollars in revenue.
To generate a high return, lets say in excess of 20% per annum, the venture
has to have the possibility of generatng high revenue growth or creatng
signifcant strategic value. This potental exists in only a very small percentage of
early stage businesses. The vast majority of high growth potental ventures are
unable to inherently generate enough cash to fuel their business development
plans, thus creatng the opportunity for private equity investors to partcipate.
Without private equity, most of these ventures would fail or never realize their
potental.
This is the genesis of the entrepreneur/private equity partnership. These
two partes come together to create something which neither could do by
themselves. In doing so, they have the opportunity of creatng a business
venture which can generate signifcant rewards for both. This is the place where
the entrepreneur accepts that a small part of a larger pie is beter than no pie at
all or a much smaller pie which is not getng bigger. It is also a place where the
partes have to work together to be successful. As we will see in later chapters,
that is not without it challenges as these ventures tend to push the envelope and
risks, disruptons, delays and surprises are the norm rather than the excepton.
The Private Equity market is much misunderstood by the average
entrepreneur. They have litle understanding of the structure of the
private equity market and tend to see it as one size fts all - ‘Venture
Capital’ without appreciatng the diferent forms of private equity. Most
start-up entrepreneurs see Venture Capital as the soluton to all their
problems. Venture Capital it seems is simply there for the taking – if only they
can have those few minutes to pitch their groundbreaking idea. The limitatons
of lack of experience, a yet to be completed product in a yet to be proven
market seem to be small hurdles whichthe venture capital frm can surely solve
for them. However, few really understand how these funds work and very few
understand the impact that taking the money will have on themselves, their
businesses or their future.
Most entrepreneurs seek VC to solve a funding problem. They seem to think
5
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
that the purpose of VC is to solve their problems, whatever they might be, and that
access to money is the key to success. Almost as if throwing money at their great
idea will solve any basic faws in the idea. In high growth frms there are usually
lots of constraints to growing the business and lots of places where additonal
funds could be usefully directed. This might be to complete a research project,
launch a new product into the market, build out an executve team, expand the
capacity of the business or its market presence and so on. In their quest for Angel
or VC fnance, the entrepreneur ofen thinks that by solving their own problems
they will automatcally provide a good investment for the VC investor.
However, few have ever thought of the specifc needs of the Investor and what
they want out of the investment or what limitatons, constraints and motvatons
they work under. While they understand that the return sought by Investors is
higher than say a bank, they have litle appreciaton of the risks that Investors take
and how they manage those risks or what this means in terms of how they judge
applicants or negotate the investment agreement. Successful entrepreneurs who
have taken a business to an IPO or made substantal personal wealth through
an Angel or VC backed venture ofen only experience the good tmes and are
more than willing to recommend this form of equity fnance. However, a porton
of Angel and VC backed ventures fail or end in disappointment for both the
entrepreneur and the Investor. Investors antcipate some level of failure and
manage their investee frms accordingly as they have learnt over tme to take a
hands-on approach to their investments.
Entrepreneurs who have raised Angel or VC funds have ofen been confronted
with a whole range of issues which they have not experienced before, or were
not expectng. Ofen to the surprise of the founder, the Investor insists on a
formal Board, a say in the strategy, a veto over certain operatng decisions and
regular fnancial and operatonal reports. In additon, the investment agreement
or shareholders agreement may contain clauses which mean that, in certain
circumstances, the entrepreneur can be dismissed and their business sold from
under them.
This all sounds very painful for the entrepreneur – so why bother? What is
missing in this scenario is an educated entrepreneur who understands how Angel
or VC fnance works and how to optmise the use of such funding so that the
entrepreneur can achieve his or her objectves alongside those of the Investor.
Angels and VC frms play a very important role in the structure of venture
6
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
funding – but it has a limited role and is really only appropriate for certain types
of situatons and certain types of endeavours. But for those which can meet the
requirements of the Investor and understand how to leverage the relatonship,
it can provide a platorm for wealth creaton unparalleled by any other form of
fnance. Many successful entrepreneurs have launched lifelong careers in high
growth enterprises through their frst Angel or VC backed venture.
Perhaps the least understood aspect of Angel and VC fnance is the need
for an exit event for the investor. There are basically two types of Angel and
VC backed ventures; fnancial and strategic. The fnancial venture will strive for
high growth in revenue and proft and will exhaust the supply of cash to drive
growth. On the other hand, a venture which creates strategic value will use
whatever cash is available to build an asset or capability which will be atractve
to a large corporaton. Both these ventures eat cash and rarely throw of spare
cash to pay dividends to the investors. In fact, Investors assume this will be the
case and understand that they will only see a return of their original investment
and a proft on the actvity when the business is able to achieve an ‘exit’ event.
In the case of a fnancial venture that would be an Inital Public Ofering (IPO),
achieved by only a very small percentage of investee frms, or a fnancial trade
sale. Strategic ventures generate a return to the investors by being acquired
by a large corporaton in a trade sale. VC investments are ofen called ‘patent
capital’ simply because they have to wait for the venture to achieve one of these
exit outcomes.
The need for an exit event is fundamental to an Angel or VC investment. It
is the only practcal manner in which the investor will achieve a return of their
investment and a proft from the transacton. Given the critcal nature of the
exit, it is the most important characteristc of the decision to invest and the
highest priority aspect of the business development strategy. It also means
that an entrepreneur who seeks equity fnance needs to accept that his or her
venture will be directed towards an exit as a conditon of the investment. With
the excepton of the rarely achieved IPO, this means the business will be sold in
a trade sale within a few years of the investment.
Almost without excepton, a trade sale will see the end of the business as an
independent entty and, almost certainly, the senior management team will exit
7
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
at the same tme. While this may seem like the end of the grand adventure, it
really is the start of a new one. The cashed up entrepreneur achieves a reward for
their creatvity, energy and innovaton and has the chance to do it again, retre,
become an Angel investor or become actve in philanthropy. Not a bad outcome
for their contributon. One journey fnishes and another starts, but they do need
to accept that by taking the funds, the likely outcome will be that this baby will
grow up and go its own way.
With a greater appreciation for how Angel and VC finance works, the
entrepreneur can decide if they want to take this path to wealth creaton. It is
not without its challenges but it a path worth exploring if the underlying venture
has the potental.
The purpose of this book is to help the entrepreneur decide if this is the right
path for them. It seeks to educate the entrepreneur on how Angel and VC fnance
works, what the Investor seeks in an investment and how they manage that
investment through to an exit transacton. It will help the entrepreneur to judge
whether they have a venture suitable for investment and whether they wish to
be part of such an actvity. It also lays out a comprehensive process which the
entrepreneur can follow that will assist them in raising Angel and VC funding.
8
Raising Angel & Venture Capital Finance
Private Equity comes in various forms and generally depends on the stage
of development of the investee frm. Knowing the extent to which the business
has matured is ofen an indicaton of the risks the business faces and the type
of support it needs to get to the next stage.
The Australian Bureau of Statstcs’ 2001 Special Artcle – Venture Capital
Survey uses a multple stage classifcaton to describe business maturity. The
defnitons describe stages at which Angel or Venture Capital fnance is invested.
• Seed: product is in development. Usually in business less than 18
months.
• Early: product in pilot producton. Usually in business less than 30
months.
• Expansion: product in market. Signifcant revenue growth.
• Turnaround: current products stagnant. Financing provided to a
company at a tme of operatonal or fnancial difculty.
• Late: new product or product improvement. Contnue revenue growth.
• Buy out: [leveraged buy out (LBO), management buy out (MBO) or
management buy in (MBI)]: a fund investment strategy involving the
acquisiton of a product or business, from either a public or private
company, utlising a signifcant amount of debt.
Source: ABS, 2001, Special artcle - Venture capital survey
2
Sources of
Private Equity
9
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
A similar classifcaton is provided by the Britsh Venture Capital Associaton.
In their case investments in private companies are classifed by the stage at
which the funding is needed. Stage defnitons are:
Seed Financing provided to research, assess and develop an inital concept before
Stage a business has reached a start-up phase.
Start-Up Financing for product development and inital marketng. Companies may be
Stage in the process of being set up or may have been in business for a short tme,
but have not sold their products commercially and are yet to generate a proft.
Expansion Financing for growth and expansion of the company which is breaking even or
Stage trading proftably. Capital may be used to fnance increased producton
capacity, market or product development, and/or to provide additonal working
capital.
Replacement Purchase of shares from another investor or to reduce gearing via the
Capital refnancing of debt.
Buy out The acquisiton of a signifcant porton, majority control or 100% of businesses
which normally entails a change of ownership. Funds are ofen used for
expansion, consolidatons, turn-arounds, and spinouts of divisions or subsidiaries.
Source: htp://www.evca.com Accessed 29/12/04
There are only a limited number of Venture Capital funds focused on fnancing
seed or start-up stages, although this is ofen the stage where Business Angels
play a major role.
An emerging company which has constructed an experienced management
team, a robust compettve positon and strong gross margins usually has litle
need for Angel or VC investment. Early stage ventures with strong proft and
high growth potental may be able to skip Angel fnancing and go direct to
formal venture capital. The Angel plays the middle role: funding the business
that has yet to stand on its own feet and not yet mature enough or with enough
potental to atract venture capital. Angels typically invest in seed, start-up or
early stage businesses.
Angels ofen play the fnancing role between ‘family, friends and fools’, ofen
referred to as ‘close money’ and formal venture capital. Coping with what has
come before and what comes afer their involvement in the venture is a challenge
for the Angel. On the one hand, Angels need to develop the business given the
10
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
constraints inherited from earlier investors and then they need to prepare the
business for the next round of investment, usually from formal venture capital.
Even though the majority of their investee frms will not require venture capital,
this will not always be apparent in the early stages of the Angel’s involvement
with the investee frm.
Business Angel fnance, the role of the Angel and the manner in which Angels
work will be covered in greater detail in the next chapter.
Family, Friends and Fools
Most new frms start with whatever funds the new enterprise team can
scrape up between them. This may be advances on credit cards, savings and
bank loans (generally secured on property). This is the entrepreneur’s money
and if they lose it, they have only themselves to worry about. Most ventures start
this way and may never require further shareholder investment. The profts are
normally re-invested to fund additonal working capital as the business expands,
however, funds for expansion are ofen limited as the founding team usually
exhaust their personal savings. To keep the enterprise going and to fund the
next stage of development, founders normally turn to their family and friends.
However, everything has a price and even money from those who are
close comes with its own problems. While they may not have the same ROI
requirements as an Angel or be subject to the regulatons and tmescales of the
VC, investment from family and friends (close money) has its own issues. Fools
are said to be investors who throw their money in on the of chance that it might
make a return, but generally don’t risk very much and have low expectatons of
getng the money back.
New ventures are not without their risks. Australian research indicates that
up to 70% of new start-ups will fail within fve years. Further, few will ever grow
beyond six people and very few will achieve signifcant size. The chance of losing
the money from relatves and friends is reasonably high.
One of the consideratons which new venture entrepreneurs face is the
impact on their relatonships with family and friends of the venture failing.
11
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
What happens when the venture fails and close relatves have invested life
savings into the business, having been sold on the dream of owning part of the
next Microsof? Few non-business people really appreciate the risks of a start-
up. Everything appears atractve up-front when it all looks so easy and they are
sold on the idea of their young relatve growing a monster company. But when
it fails and they accept that their relatve simply didn’t have the experience to
make it work, will they really be happy to write of the investment, or will this
be a lifelong problem between them?
The same could be said of close friends. Being work colleagues, school friends
or social friends hardly qualifes people to undertake the stress and rigor of
going into business together. What happens when their talent and experience
proves not to be the level required, they don’t really want to put in the tme or
they want to have the fnal say on all decisions? Then there is the dysfunctonal
team which may cause the failure of the venture or may need to be broken up
by forcing some of the team to quit. If they have money invested in the venture
and stll own equity, how are the remaining shareholders going to buy them out
or deal with their ongoing equity interest?
Many start-ups involve couples, business colleagues, school friends and
relatves. Not all of them will appreciate the tme and efort which must be
put into the venture to get it to a reasonably proftable, sustainable state.
There are many stories of partners working long hours, taking low salaries and
undertaking actvites they are not trained for just to survive. Not everyone
going into the venture is capable or willing to put in the efort and tme it takes
to get something up and running.
Close money may or may not come with other constraints. If a founding
investor is working in the business, they may well feel an equal partner and
want to be actvely involved in the decision-making on a day-to-day basis.
While this can work in very small frms, it becomes very problematc as the frm
grows. As more staf join and the frm becomes more complex, some formal
organisatonal structure is required. At this point, the queston of who is boss
and who makes the decisions becomes a real issue of debate and ofen confict.
With independent people, this can be more easily resolved; however, when
the other person is a spouse, cousin or best friend, the issue is not so readily
resolved.
12
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
At the same tme, family investors who don’t work in the business may feel
a need to interfere if they see something they disagree with, even without
understanding the situaton or the business requirements. So the wife of the
cousin who sees diferentals in remuneraton or diferent workloads may feel
compelled to voice critcism to the aunts and uncles. Now the managers are
spending tme defending their actons to people outside the frm who may have
no idea of the pressures they are under.
Then there is always the issue of a family member, friend or fool who decides
that they would like their investment capital back before the other shareholders
are ready to exit the business.
An issue common to many new ventures owned by married couples are the
problems which arise when they start a family or go through a divorce. Where
other owner/managers are involved in the business and one needs to take tme
out for family reasons, this can create tension and assertons of unfairness and
inequality. Where a divorce occurs, it may be impossible to contnue a close
working relatonship. The issue of ownership and involvement can become a
very messy problem, ofen resultng in the failure or sale of the frm.
A major consideraton for the entrepreneur is what happens to the original
team as the frm grows. Will they be capable of playing their part in the
management team of a frm which grows to 30, 100 or 500 people? If they don’t
have the experience, personality or capability to handle the tasks, how will the
problem be resolved?
Investors are ofen confronted with these complex personnel situatons.
As an external and perhaps a more objectve investor, the Investor needs to
tread carefully around these relatonships. Clearly, if they don’t see that a
constructve business environment exists, or one that can be readily resolved
through discussion and a realignment of roles, responsibilites, remuneraton
and objectve decision-making processes, they are beter of rejectng the
investment. If the Investor thinks the team is not capable of delivering the
growth and proft required, they will simply walk away from the investment
opportunity. If there is a problem between founders and early investors and the
Investor feels that this will limit the process of building the business, then they
are beter of not investng.
13
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
At the same tme, the Investor needs to acknowledge that the venture
probably would never have survived had it not been for the investment, tme
and commitment of those people who were willing to come in at the start. This
is an interestng problem for the Investor to deal with.
Before proceeding to invest, the Investor must be satsfed on the following
issues:
Will the family, friends and fools interfere in the negotiation for the
investment, the management of the company or the decision on the
exit strategy?
Do the family and friends who helped start and grow the company
form part of a management team? Does the investor have confdence
in them and is he willing to trust them to grow the business to achieve
its potential?
Current management and shareholders should be aware that these issues
will need to be addressed as part of the investment agreement. The Investor
may require that some of these problems be resolved as part of the decision
to invest. This may involve a restructuring of the business, new job descriptons
and a more formal organisaton structure. The Investor might also be willing to
buy out some of the early shareholders in order to simplify the shareholdings.
Venture Capital Funds
Venture Capital is the most formalised form of private equity investment.
Unlike most Angel investments where the Angel takes a personal role in deal
due diligence and management, Venture Capital provides a channel whereby
high net-worth investors can partcipate in higher risk ventures without having
to personally undertake the burden of venture evaluaton and management.
The VC fund itself provides the expertse in sourcing, evaluatng, investng,
managing and harvestng the venture investments.
Whereas most Angels invest in their own right, VC investment is through
a fund. The common structure of a Private Equity Fund or Venture Capital
14
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Fund is the Limited Partnership. This structure is commonplace in both the
USA and UK markets and has been introduced in Australia. The beneft of
this structure is that the fund itself is not a legal entty for tax purposes
for the investor. There is a pass through treatment of any gains for tax
purposes. Thus any gains and losses pass directly to the investor and are
taxed in their hands. The investor also has the beneft of limited liability at
the level of the fund itself. No liability from the investee frms can pass back
to the investor. A comprehensive descripton of the Limited Partnership
Agreement can be found on the Britsh Venture Capital Associaton website
(see www.bvca.co.uk/).
Funds are normally closed-end in structure, meaning that the investor has
very limited or no ability to withdraw their investment during the fund’s life.
Funds are typically established for a 10-year life, but may be extended in some
circumstances. The investor (also known as a Limited Partner) commits to make
available funds as needed for the underlying venture investments. Investments
are then normally made by the Investment Manager (otherwise called a General
Partner) generally over the frst one to fve years of the fund life. As investments
are harvested, proceeds are returned to the Limited Partners and not re-
invested into new opportunites. Since the tming of exits cannot be known in
advance, Limited Partners must be prepared to wait for some tme before they
start to see any return on their funds.
In his book, ‘Early Exits: Exit Strategies for Entrepreneurs and Angel Investors
(But Maybe Not Venture Capitalists)’ Basil Peters notes the following:
Most VC funds are designed for a lifetime of 10 years. But in
practice, the actual lifetime of technology (IT) VC funds averages
closer to 13-14 years.
Limited Partners typically give a wide degree of discreton to the General
Partner to invest on their behalf as they cannot know before the fund starts
to operate the types of investments which may present themselves. The fund
15
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
agreement typically specifes the minimum and maximum investments the
fund can make in any one venture. The Limited Partners are commited to the
investments made by the General Partner and there is generally no ability for
the Limited Partner to withdraw from any investment made by the General
Partner. Typically, General Partners or Fund Managers issue a Prospectus or
Informaton Memorandum to investors to raise their investment capital.
The typical Private Equity Fund terms are:
Minimum investor commitment Ofen $5 million or greater.
Manager’s commitment General Partners typically invest their own money in the
fund. Ofen this will be around 1% of the total fund and is
sometmes a prerequisite of the Limited Partners.
Partnership term The fund life is normally 7-10 years with the
possibility of limited extensions to facilitate exits.
Distributons may be made as investments are sold.
Investment/commitment period On average, Private Equity Funds invest commited
capital over a 3-5 year period.
Management fees Normally the management fee is set between 1.5% and
2% of commited capital.
Incentve/performance fees Typically 20% of the total returns and is usually only paid
once the Limited Partners achieve a predetermined hurdle
rate. This is known as the ‘carried interest’.
Preferred return or hurdle rate The carried interest may not be paid out untl total returns
exceed some agreed threshold. Currently (2004) this is
around 8%.
Source: htp://www.evca.com Accessed 27/10/03
A comprehensive glossary of phrases commonly used within the Australian
Venture Capital Industry can be found on the AVCAL website.
Source: htp://www.avcal.com.au
16
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
In Australia, The venture capital sector is relatvely small but is growing. As at
30 June 2005, the industry had the following characteristcs:
• Number of venture capital managers 140
• Number of venture capital vehicles 210
• Number of investee companies 912
• Venture capital under management A$11.2 billion
• Venture capital invested for the year
ended 30 June 2005 A$0.839 billion
Source: ABS 5678.0 Venture Capital 2004-5
By the tme of the 2007/8 ABS survey, the number of actve Venture Capital
and later stage Private Equity managers hasdincreased to 183 managing 286
ventures.
Source: ABS 5678.0 Venture Capital and Later Stage Private Equity, Australia, 2007-8
In the USA comparable data is difcult to fnd. However, the Natonal Venture
Capital Associaton (NVCA) represents 460 venture capital and private equity
frms (see www.nvca.org). In 2004, VC frms invested US$21.2 billion. Of this
65% went into early or expansion stage companies and 33% went into later
stage companies. One directory lists more than 1,400 VC frms in the USA (see
www.vfnance.com).
In the UK, there are several VC directories, one of which is published by the
Britsh Venture Capital Associaton (BVCA). The BVCA has more than 170 full
members and 150 associate members (see www.bvca.com.uk). Worldwide
investment by UK PE frms was £9.7 billion. The number of companies fnanced
was 1,301. Another VC directory for the UK is available from VCR Directory Online
which lists more than 3,000 investors across Europe (see www.vcrdirectory.net).
General Partners have the responsibility of sourcing, evaluatng and
negotatng investments in private frms. This can be a lengthy and tme-
consuming task. Due to the immature nature of many of the frms being
examined and the uncertaintes associated with their products and business
models, combined in many cases with the lack of proper systems or audited
17
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
accountng records, considerable expertse is needed to undertake the
task efectvely. Since such experience is in limited supply, Venture Capital
Funds have difculty recruitng senior managers, although the work may be
outsourced in some areas to external advisors. The ability of the VC Funds to
invest is constrained by the number and experience of their managers. At the
same tme, frms receiving investments (investees) are looking to their General
Partners for advice, contacts and help securing customers, grants and staf.
When investee frms get into trouble, such as not achieving targets, making
losses or losing key staf, General Partners need to devote considerable tme
to their current investments and have litle tme to source and evaluate new
investments. General Partners will also be actvely involved in setng strategy,
planning and executng the exit. Around 70% of the General Partner’s tme is
taken up working with their investee frms; hence the capacity of the Venture
Capital Fund is limited. Venture Capital Funds therefore typically make few
investments: only a few in any year. They ofen have limited tme to carefully
evaluate new investments and ofen spend only a few minutes on an executve
summary establishing whether the proposal is worth further investgaton.
Even when a propositon looks atractve, extensive tme will be spent with
the new venture team evaluatng them as well as the merits of the business.
Considerable due diligence will be undertaken before any investment is made.
Ofen 20-30 or more proposals will be investgated for every single ofer made.
The 2004 Australian Bureau of Statstcs (ABS) survey reported similar ratos.
‘The selecton of investee companies (into which venture capital is invested)
was an intensive process. The total of 137 venture capital managers reviewed
10,530 potental new investments during 2003/04 and conducted further
analysis on 1,067 of those, with 181 being sponsored for venture capital. These
managers spent a total of 179,000 hours with the investee companies (190,000
in 2002/03), advising and assistng in the development of the enterprises.’
Source: ABS 5678.0 Venture Capital, Australia Accessed 26/11/2004
18
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
In the 2007/8 ABS survey, fund managers spent on average 3.9 days a month
on each investee company.
Due to the complexity of the business proposals, VC frms will ofen limit
themselves to specifc industry sectors where they have both the expertse to
evaluate the deal as well as the experience and networks to add value to the
investment. In the US and UK markets some funds have a single industry focus;
however, in Australia most funds have a more general focus.
VC frms will also ofen limit themselves to certain development stages,
such as start-up, expansion or buy out, where they can add real value. VC frms
which spread themselves across too many sectors or too many stages will ofen
be viewed less favorably by investors as they will see higher risks in such a
spread. At the same tme, larger funds prefer only to invest larger amounts as
they can only support a limited number of investments. A typical fund invests
in approximately 10-12 investee companies with individual investments of
between 5-15% of the individual fund’s total investment capital. The increasing
cost of proposal analysis and subsequent due diligence is itself an inhibitng
factor. If only one in ten proposals investgated are being invested in, the
average cost of investgaton of an investee frm is quite high. Therefore small
investments are simply not economical.
The drif towards larger funds and the lack of early stage expertse within
the VC community has led to an increasing shif of investments towards later
stage investments. For example in 2003, 55% of venture capital investments
in Australia went into various types of buy outs of existng businesses – the
vital seed, start-up and early expansion phases accounted for only 16% of
investments.
Source: htp://www.smh.com.au/artcles/2004/04/11/1081621834935.html?oneclick=true
Accessed 31/12/04
In the ABS 2007/8 survey the percentage in later stage private equity fell to
36% of total funds invested.
19
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
The 2005 ABS Venture Capital report shows the following breakdown of
investments by stage:
Stage of development Number Value $ million
Seed 145 65
Early 313 665
Expansion 265 1,183
Turnaround 34 118
Late 65 267
LBO/MBO/MBI 90 1,234
Total 912 3,532
For the 2004/5 year, 49% of investments went into ventures which were 2-4
years old and 26% into those which were 5-10 years old.
USA data from the MoneyTree™ Survey for 2004 shows the following
breakdown:
Stage of development Number Value $ billion
Startup/Seed 178 0.391
Early Stage 850 3.883
Expansion 1,217 9.653
Later Stage 700 7.578
Undisclosed/Other – –
Grand Total 2,945 21.506
Source: PricewaterhouseCoopers/Thomson Venture Economics/Natonal Venture Capital
Associaton, MoneyTree™ Survey, Total U.S. Investments by Year Q1 1995 – Q3 2005 htp://www.
nvca.org
2004 data for the UK from the BVCA showed the following:
20
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Stage of development Number Value GBP million
Seed/Early Stage 264 188
Expansion 522 789
MBO 237 3,778
MBI 30 320
Grand Total 1,053 5,075
Of the total funds raised by UK VC frms in 2004 (£3.3 billion), 90% was
expected to be invested in the MBO/MBI stages, 6% in expansion and 2% in
early stage.
Source: htp://www.bvca.co.uk
Many of the more successful and longer established VC frms receive so many
business proposals that they restrict their tme to recommended proposals
from individuals or professional frms which have already reviewed the business
plans, so they can beter use their tme. It also means that to access the beter
VC frms, an entrepreneur needs to frst work with an Angel or professional frm
which has access to the General Partners.
The legal structure of the fund, the manner of remuneraton for General
Partners and the process in which Limited Partners achieve a return of
their inital investment plus their desired ROI, means that investments
need to be harvested within a relatvely short period of tme. Most VC
frms target a period of between 3-5 years for harvestng. However,
if you take out the last year for the exit executon, this leaves only
2-4 years to create the pre-conditons for a successful exit.
If investments go over the fve-year mark they are at risk of running up against
the fund term. This means the General Partner has to apply to the Limited
Partners for an extension or they need to force an exit event. To achieve a 25%
compound return, they need the value of the investment to double almost
21
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
every three years. An investment that has been in play for six years needs the
capitalised value to have reached 3.8 tmes the inital investment. If the VC fund
only held 20% equity in the investment, a $2 million investment in a $10 million
capitalised frm has to achieve an exit valuaton of nearly $38 million to provide
the VC frm with a 25% ROI over the six years. Since few frms consistently
achieve this type of growth, the pressure is on the VC frm to choose the right
investments and then to actvely manage them to get the desired growth rate.
Any slippage from the agreed targets will create considerable pressure on
the VC to intervene to sell the business or to replace the management team
to get the frm back on track. Few entrepreneurs seeking VC investment really
appreciate the impact on the frm of a 25% cumulatve growth in value and how
difcult it is to reach.
Usually the VC fund is a minority investor which normally would give them
litle power or authority to force a sale of the investee frm. However, the
investment agreement would typically provide the VC fund with the power to
intervene to ensure they are able to exit under certain circumstances. Typical
provisions would include the following:
Votng trust: Entrepreneurs hand over shares if they don’t perform. The VC
has the ability to take control, notwithstanding it is initally in a minority
positon.
Unlocking provision: A shareholder receives an ofer they don’t wish to
accept but the VC does – the shareholder must buy the VC out.
Put provision: The VC may have the right to sell the business to the ‘highest
bidder’ if an exit is not achieved by a given date.
Registraton and public ofering provision: The VC may require an IPO afer
a given date. If this is not possible, the frm will be sold.
Piggyback opton: The VC can sell their shares anytme the business sells
shares either in a public ofering or in a trade sale.
Come along: The VC can force the business to sell shares if the VC receives
an acceptable ofer for its shares.
22
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Drag along: The VC can force all shareholders to sell their shares if the VC
receives an acceptable ofer for its shares.
Tag along: If a shareholder receives a favourable ofer for its shares, other
shareholders have an opton to notfy the purchaser that they too wish to
sell their shares.
For additonal details see: D Gladstone and L Gladstone, 2002, Venture capital handbook
– An entrepreneurs guide to raising venture capital, Prentce Hall, pp 180-208 and B Ferris,
Nothing ventured, nothing gained: thrills and spills in venture capital, Allen & Unwin
Many people incorrectly think that VC General Partners are business experts
who are knowledgeable about growing a business. In truth, most of them
have a banking and fnance background, with limited management experience
outside the banking and fnance sector and litle hands-on experience in most
of the markets in which they have investments. In many cases, the investment
manager actng for the VC frm will be in their late 30s or 40s, have not worked
in any sector other than fnancial services and have never undertaken any
entrepreneurial actvity. Their ability to help with specifc experience in the
development of a long-term strategy or with market development is limited.
Some of the beter funds have expanded their investment team with managers
with operatonal experience, but these are certainly in the minority.
The more experienced General Partners will have learnt through a series of
investments, will have developed good networks across a range of industries and
will have partcipated in several exits as well as several write-ofs. However, this
experience can make them more cautous in their assessment of opportunites.
For the most part, VC General Partners are fnancial administrators. They
are good at fnancial analysis, working the ratos, accountng for the money and
making sure the legal requirements are satsfed. But they can only remain in
the VC business if they can raise a new fund, since funds have a limited life.
Raising a new fund means delivering healthy returns to their Limited Partner
investors. That means getng both the investment and the exits at the right
price. Without the exit returns, they don’t achieve their bonuses and they don’t
have the opportunity to raise a new fund.
Mature VC frms which have been actvely involved in funding emerging
companies for a number of years have discovered just how hard it is to cope
23
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
with innovatons, emerging markets and untried teams. Those VC frms
typically have recruited senior staf who have technical (and ofen business)
qualifcatons as well as a number of years of senior operatonal experience
if not direct entrepreneurial success. In mature markets such as the USA, top
VC frms will not employ an investment manager who does not have senior
operatonal experience. While they have discovered that fnancial administraton
can be outsourced, operatonal experience is a real asset when it comes to
understanding how a value propositon will achieve tracton in the marketplace
and understanding whether or not the management team has the atributes to
build a good business.
Occasionally a VC frm will be able to sell to another VC frm which might be
interested in taking the business to the next level of development. An early stage
VC frm may sell their positon to another VC frm interested in an expansion
investment. This may also involve a further round of investment in the investee
frm. VC frms atempt to maximise the value of their return through the most
favorable exit vehicle. IPOs generally achieve the best returns with buybacks
usually the lowest positve return. As an indicaton of the frequency of each
type of exit, consider the following data sets.
In Australia, from March 2000 to September 2002 there were a total of 209
exits, of which 117 or 55.6% were at a proft, 10 broke even, and 79 or 37.8%
were at a loss.
Source: htp://www.asto.com.au/news03/techbotoms.htm Accessed 27/12/04
In 1999/2000, 24 companies were sold, 12 companies went public, four
companies were bought back and 19 investments were liquidated. The value
of exits during the year 1999/2000 was A$536 million. The average trade sale
was A$3.7 million, while the value of all IPOs was A$346 million.
Source: Venture Capital in Australia (Research Note 28 2000-01)
htp://www.aph.gov.au/library/pubs/rn/2000-01/01RN28.htm Accessed 31/12/04
24
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Not all exits can be achieved quickly, as this data from 1995-2001 shows.
Exit path Full exit Partal exit %
IPO 22 16 29.3
Private (undisclosed) 10 1 8.4
Acquisiton 25 (cash) 5 (shares) 23.0
Secondary Sale 9 1 7.7
Buyback 9 8 13.1
Write-of 24 0 18.5
Total 99 31 100
Source: G Cumming and G Fleming, 2002, ‘A law and fnance analysis of venture capital exits in
emerging markets’ Working paper series in fnance 02-03, Australian Natonal University
The ABS 2005 and 2007/8 Venture Capital Reports show the following exit
statstcs:
Exit path Value A$ million 2005 2007/8
Trade Sale 291 456
IPO 246 376
Buyback 35 11
Write-ofs 49 45
Lef the Industry 215 162
Total 836 1,050
Ratos for the USA are comparable. Data from Q3 2005 from the NVCA showed
that there were 19 IPO exits compared to 76 trade sales (25%).
Source: htp://www.nvca.org/pdf/2005Q3IPOreleasefnal.pdf Accessed 5/12/05
25
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Data from the NVCA in the USA for 2004 show investment losses occurred in
61 of the 181 exits (34%); however, 20 of the 181 (11%) exits resulted in the
VC frm achieving more than 10 tmes their investment.
Source: htp://www.ventureeconomics.com/vec/news_ve/2005VEpress/VEpress05_04_05.pdf
Accessed 11/12/05
Exit data from the UK for 2004 shows that, by value, 28% was from trade
sales, 20% were sales to another private equity frm, 13% were write-ofs and
10% was from IPOs.
Unlike VC funds, Angels are not restricted by the closed fund limitaton, thus
they can stay with their investments longer if the occasion warrants. They can
also be more selectve with their investments. The General Partner of a VC fund
is under pressure to allocate the money during the early phase of the fund and
so a high volume of possible deals needs to be sourced for evaluaton. Angels
can invest without an expectaton of a positve return, perhaps to ‘give back’ or
to fund or assist a young entrepreneur. The VC frm can really only be involved
if it can see a healthy return for their Limited Partners.
Angels typically invest in one in three proposals which they evaluate where
VC funds only invest in one in one hundred. Perhaps, because of the higher
cost of investng and the higher return expected, the VC frm has a much more
difcult task in fnding appropriate investments.
Private Equity Funds
Another form of private equity is the Private Equity (PE) Fund, a term
normally reserved for funds which invest in late stage ventures. Where Venture
Capital Funds typically take a minority investment in a frm and actvely manage
through the original management team, the Private Equity Fund typically takes
100% or a majority stake in an investment. PE frms typically aim to acquire
frms where direct interventon can overcome prior problems or constraints
and provide a short-term turnaround situaton or performance uplif which will
yield an atractve return. PE frms look for inefciencies to exploit. Common
approaches are:
26
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
• Improve the proftability. Access to more experienced management,
networks and technical knowledge may provide the basis for a relatvely
easy improvement in proftability.
• Buy at a favorable price when the market is low and wait untl the
market improves when valuaton multples are higher.
• Break the business up and sell of the assets or business units. Some
businesses are undervalued where one part of the business is more risky
or where the market does not understand the business economics. More
focused businesses will ofen sell at a higher multple.
• Leveraged buy out. The PE frm uses debt to fnance a major part of the
buy out. When the value improves, the returns to the equity porton are
magnifed due to the high debt component.
• Management buy-out.
• Management buy-in.
• Make bolt-on acquisitons to generate economies of scale or gain access
to new products or markets.
PE could be used to remove the burden of existng debt which might allow
the business to reinvest and grow. Existng management may be retained with
incentves or may be allowed a minor equity positon as an incentve.
PE investment may be used to provide existng management with the
opportunity to buy out the existng owners, re-engineer the business and then
positon it for an IPO. The PE frm would use the IPO as their exit strategy leaving
the management team in control post IPO.
PE funds have become actve in ‘sell down’ transactons in recent years. This
occurs where the PE fund buys shares from a founder representng only part
of the ownership, although most ofen the majority. In this way, the founder
has the opportunity to cash out part of their investment in the enterprise. The
PE frm will then work with the founder to actvely progress the business to a
higher exit valuaton which could be achieved either through an IPO or a trade
sale. In undertaking the development strategy, the PE frm may arrange for
additonal debt fnancing, replace some of the management team, restructure
the Board of Directors, assist with acquisitons and development of new strategic
partnerships and so on.
27
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
This strategy has the advantage of allowing tme for the business to be
properly prepared for an exit with the actve co-operaton of the founder and
the management team. The founder may also achieve a secondary harvest at
a higher valuaton. An Angel might seek out a PE fund as an exit strategy if the
business could be substantally developed with signifcant capital injecton, a
new management team or as part of a roll-up strategy.
Corporate Venture Capital
An Investor may co-invest with a corporaton or seek follow-on funding
from a corporaton as part of an exit strategy. Many corporatons have Venture
Capital Funds specially for the purpose of investng in early stage ventures. The
manner in which these corporate funds are managed and the terms under which
funds are invested closely mirror traditonal Venture Capital Funds. Ventures
successful in acquiring a corporate investor can ofen gain additonal benefts
beyond those which can be ofered by the traditonal Venture Capital Fund.
Corporatons have a variety of reasons for investng in early stage ventures
although the most common are:
• access to specialised knowledge, intellectual property or equipment
• exposure to emerging technologies
• investment in potental acquisitons
• understanding of new or emerging markets
• access to entrepreneurial talent
• preventng compettors from acquiring a technological breakthrough.
For the new venture, a corporate investor could provide the following
benefts:
• access to industry expertse, networks, equipment and/or research and
development facilites
• access to a key customer or to an established distributon channel
• access to complimentary technologies.
28
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Typically, Corporate Venture Funds invest in their core or closely related
technologies.
According to a joint study by Venture Economics and the Natonal Venture
Capital Associaton in United States, in 1994 only 2% of venture capital
investments were corporate venture capital, but in 2000, corporate venture
capital accounted for 17%, nearly US$20 billion. In four years, from 1996 through
the end of 1999, the number of companies investng in outside ideas increased
elevenfold, from 30 to 330. During the same period, corporate venture capital
spending rose from US$100 million to US$17 billion annually.
Source: htp://www.1000ventures.com/business_guide/corporate_vinvestng_external.html
Accessed 3/01/04
In 2003, US$1.1 billion was invested in the USA in growth orientated
companies by corporate venturing groups, representng 6% of all VC investment.
The amount invested by corporate venture capitalists has tracked similarly to
the trends of the overall VC industry. The 2003 fgures were close to the actvity
seen in the last pre-bubble year, 1997, when corporate venturing groups
invested US$957 million, also representng 6% of total VC invested in that year.
Source: htp://www.nvca.org/nvca02_04_04.html Accessed 3/01/04
There is limited informaton available about Corporate Venture Capital Funds
in Australasia.
Overseas and local corporatons may undertake venture investments through
a local fund, via a traditonal Venture Capital Fund or through a local subsidiary.
The major problem which most corporate businesses have with VC investments
is access to experienced VC executves. Since the VC investment model is one of
actve interventon as well as portolio investng, this type of investng is foreign
to most corporatons. Many will invest in an established VC fund in order to
access the investment evaluaton experience and venture investment skills.
An early stage venture which can clearly show how their innovatons relate
to the business of a large corporaton should include that corporaton in their
list of potental investors. However, corporatons not familiar with investng in
early stage ventures can be a mixed blessing. Because they are not familiar with
29
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
the norms of such investments, the frm may fnd itself wastng considerable
tme trying to convince the corporaton of the value of an external investment,
although benefts may come from a more favorable valuaton, access to
corporate resources and an early exit opportunity.
The entrepreneur should be wary of the motvaton of the corporate investor.
Their involvement is mostly driven by their own strategic objectves and their
support may be highly infuenced by wantng the investee frm to develop
in a partcular directon. They may inhibit, consciously or unconsciously, the
directon of the business and limit the exit opportunites.
30
Raising Angel & Venture Capital Finance
A
ngel investors, ofen simply referred to as Business Angels or ‘Angels’,
are high net-worth, non-insttutonal, private equity investors who have
the desire and sufciently high net worth to enable them to invest part of their
assets in high-risk, high-return entrepreneurial ventures in return for a share of
votng, income and, ultmately, capital gain.
Angel investment is normally the frst round of external independent
investment. Angels normally invest in early stage ventures where the founding
team has exhausted their personal savings and sources of funding from family
and friends. These ventures are not sufciently developed to stand on their
own, or sufciently atractve to gain venture capital funding. These ventures
exist in a halfway state, ofen between possible failure and take-of. Typically
the management team lacks experience in a growth venture and the business
needs not only the additonal funding, but also mentoring to take it to the next
stage of development.
Investng in early stage private companies has many drawbacks, which is why
this form of investment is typically undertaken by individuals who can aford to
lose the money and/or are willing to wait some years before they see a return
on their money.
3
Angel Investor
Finance
31
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
To put this into context, private early stage ventures have the following
atributes:
• The shares are not freely traded and no established market exists for
them. An investor is forced to wait for a liquidity event such as a trade
sale or a public listng.
• Novel business concepts and inventons are ofen associated with
emerging and untried markets. The risks in the venture are likely to
be higher and some aspects of the business subject to high levels of
uncertainty.
• Products may be new and/or under development and stll subject to
technical and market risks.
• The knowledge of the product and its design may be highly dependent
on a small number of key staf, who may not necessarily have proven
business experience.
• The small size of new ventures and their lack of presence in the market
mean they may be highly susceptble to changes in market conditons.
Timing may be critcal to survival. Small delays in product release or in
achieving revenue milestones may be sufcient to cause failure of the
enterprise.
• There is limited access to further fnance if the business encounters
delays or undertakes operatons which require additonal funds.
• Early stage ventures typically have litle collateral to pledge for loans.
• Early stage ventures ofen have a high cash burn rate as they have yet to
reach a critcal mass where they are self-funding.
• Funding for acquisitons or expansion can be limited.
• Valuatons are problematc – if not speculatve. Shares are not readily
traded and so no public market value exists for the frm. Ofen there
is litle historical performance and future revenues and profts are
uncertain.
• Minority shareholders have litle power unless it is through an
investment agreement. Even if they disagree with management actons,
they have litle power and can’t sell their shares easily.
32
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
Angel investments are both risky and problematc. Since most new venture
entrepreneurs lack the business experience to antcipate many of the problems
they will encounter as the enterprise grows, the investment risk is generally
seen as considerably higher than a public corporaton.
Private equity investment is ofen referred to as ‘investng in securites
through a negotated process’. Unlike purchasing shares in a public company,
the investor in a private enterprise negotates the terms and conditons under
which the investment will be made. A defning characteristc of Angel investng
is that it is a ‘transformatonal, value-added, actve investment strategy’, in
which the investor expects to have a hands-on approach to their investments,
not possible in public company investments.
Entrepreneurs ofen seek out Angel investors to help them develop their
business. Apart from the funding they bring, an Angel would be expected to
contribute in one or more of the following ways:
• industry experience
• experience in start-up or business building
• networks
• experience in raising venture capital
• access to VC frms
• access to strategic partners.
There are diferent types of Angels. An Angel with direct experience in the
frm’s industry and with entrepreneurial experience can help with business
development, recruitment, sales, strategy, contacts and so on. Their expertse
and experience can be an invaluable help in developing the business. Ofen
cashed-up entrepreneurs with start-up experience will invest back into new
ventures. They can bring the experience of a successful venture through its
growth stages. However, they may not have experience in the industry in which
the frm operates. Wealthy and/or retred corporate executves ofen make
investments in new ventures within their industry. They can assist with customer
introductons, recruitment and risk assessment. However, many Angels are
simply wealthy individuals with a desire to invest in the private sector and their
only real contributon is fnance.
33
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
The new venture entrepreneur may fnd Angel investment very useful as a
bridge to VC fnance. The Angel can provide much needed fnance as well as
assist in developing the business further to prove the business model.
One Canadian study showed that 57% of frms with Angel fnancing
subsequently obtained VC funding.
Source: htp://www.smartlink.net.au/library/riding/1 Accessed 31/12/04
However, Scot A. Shane in his book ‘Fools Gold?: the truth behind angel
investng in America’ disputes this as a general relatonship and indicates that
the probability of follow on VC is signifcantly lower.
So what does the typical Angel look like? There have been a number of studies
of Angels across several countries; however, because Angels typically stay out
of the public eye and are ofen retcent to speak of their investng experience,
data has been difcult to collect and therefore the samples have been relatvely
small. Even so, the fndings are relatvely consistent across several studies.
The Center for Venture Research at the University of New Hampshire
has created a profle of the ‘typical (USA) Angel investor’. The predominant
characteristcs are:
• Angels tend to invest close to their home base, usually no further than a
half-day’s drive.
• Individual Angels rarely invest more than a few hundred thousand
dollars in total.
• Angel investors tend to be older, wealthier and beter educated than the
average citzen, yet a large number are not millionaires.
• Angels antcipate an average annual return of 26% on their investments.
• Angels expect that up to one third of their investments will fail, resultng
in signifcant capital losses.
• Angel investors reject seven out of every 10 deals that cross their desks.
• Deals are rejected for a variety of reasons, including poor growth
potental, overpriced equity and inexperienced management team.
Source: htp://wsbe.unh.edu/cvr/cap_locator.cfm Accessed 21/01/06
34
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
In their book Angel Capital, Benjamin and Margulis describe the typical USA
Angel as follows:
• 46-65 years of age, male
• postgraduate degree, ofen technical
Example
‘The private nature of Angel funding means that much informaton about
actvity in Australia is anecdotal.
It appears that most investors are worth upwards of A$10 million, ofen have
an entrepreneurial background and take stakes of between A$250,000 and
A$4 million. Equity investment generally concerns small or medium sized
enterprises (SMEs).
Some Angels also provide loan fnance, independently or as part of packages
from lending insttutons.
Some government and industry studies suggest that the size of the local Angel
market is 35% to 50% of VC investng, signifcantly lower than that of Canada,
the US and UK where Angel investng is greater than the total of formal venture
capital funding.
Investment criteria appear to be similar to those of VC funds (e.g. rate of return,
cash fow, capital growth and tme to exit). Most Angels, in contrast to VC fund
managers, appear to be averse to publicity – one reason may be wariness about
approaches by entrepreneurs – and limited requirements for public disclosure
of investments means that informaton about the sector is problematc. They
appear to be biased towards early stage and start-up enterprises rather than
funding expansion capital or management buyouts.’
Source: htp://www.caslon.com.au/ecapitalguide3.htm Accessed 25/10/03
An overview of the Australian Angel investment environment is provided
below:
35
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
• previous management experience, started up, operates or has sold a
successful business
• invests between US$25,000 and US$1 million per transacton
• prefers partcipaton with other fnancially sophistcated individuals
• strong preference for transactons which match with technical expertse
• 23% prefer to invest close to home
• maintains an actve professional relatonship with portolio investments
• invests in one or two transactons per year
• diversifcaton and tax shelter income are not the most important
objectves
• term for holding investment is eight years
• looks for rates of return from 22% to 50%: minimum portolio return
20%
• learns of investment opportunites primarily from friends and trusted
associates; however, majority would like to look at more investment
opportunites than present informal referral system permits
• income is US$100,000 per year minimum
• self-made millionaire.
By contrast, a study by Professor Kevin Hindle and Robert Wenban of
Australian Angels found that: there were two dominant groups – those with
university educaton and those without, they were slightly younger than their
American equivalents, invested less per transacton and were mostly ‘general
managers’ or ‘people managers’ by background, although most had been
involved in several start-up ventures. They typically invested 10-14% of their
net worth in new ventures, although one quarter invested over 25% of their net
worth. They were investng in about one third of proposals considered.
Source: Kevin Hindle and Robert Wenban, 1999, Australia’s informal venture
capitalist: an exploratory profle, Venture Capital, p199, Vol. 1. No. 2
Motvaton for investng varies slightly among the countries for which survey
data is available. Benjamin and Margulis, in their book Angel Capital, provide
the following reasons:
36
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
• improve self-image, self-esteem and recogniton, ‘you never know how
much you know untl a small company turns to you’
• alleviate concerns – help others
• obligaton to give back, the ‘joy of giving’
• get ‘frst crack’ at next high-rise stock prior to IPO
• habit, addicted to high-risk ‘rush’
• fun and excitng
• ROI 30% minimum
• desire to take charge of the stock selecton process more directly.
It may be that their sample has more hi-tech Silicon Valley entrepreneurs
and thus is not representatve of Angels in other countries.
Data from Scotland shows similar reasons for becoming a Business Angel.
Reason Main Main Other Other
reason reason reasons reasons
number % number %
To give something back 11 7.9 49 35
For capital growth 64 45.7 46 32.9
For income 12 8.6 28 20
To create a full-tme job for myself 8 5.7 13 9.3
For tax advantages 2 1.4 36 25.7
To give myself a part-tme interest 18 12.9 55 39.3
Enjoyment and satsfacton 13 9.3 77 55.0
Other 4 2.9 4 2.9
Unidentfed 8 5.75 – –
Total 140 100 – –
Source: Stuart Paul, Geof Whitam and Jim B Johnston, 2003, The operaton of
informal venture capital market in Scotland, Venture Capital, October, Vol. 5. No. 4
37
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
In contrast, Australian Angels appear to have a greater focus on the
investment returns.
The amount of net worth invested in private equity by Angels varies
considerably and appears to be somewhat based on the total worth of the
individual as well as their prior background. Estmates vary from 5-50% of net
worth with the average difering across countries. For example, one German
study reported the average to be 20%.
Amounts invested by Angels tend to vary from country to country. Individual
investments tend to be somewhat larger than where Angels act in a group to
co-invest. The majority of Angel investments are co-investment situatons.
Co-investments by Business Angels:
Co-investor Investments in Investments in
technology-based non-technology
frms based frms
No. % No. %
None 5 10.6 24 29.6
Other Business Angels in 9 19.1 20 24.7
the same syndicate
Other Business Angels who 11 23.4 16 19.8
invested independently
Venture capital funds 6 12.8 7 8.6
Banks 1 2.1 8 9.9
Public sector 0 – 3 3.7
Multple (Two or more of the above) 15 31.9 3 3.7
Total 47 100 81 100
Source: Colin Mason and Richard T Harrison, 2004, Does investng in
technology-based frms involve higher risk? An exploratory study of the performance of
technology and non-technology investments by business angels, Venture Capital, October 2004,
Vol. 6. No. 4
38
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
In a Scotsh study, 38% of Angels had an SME background while 60% had no
SME experience. Similar studies have been undertaken in Australia, Germany
and Singapore. While the distributon of responses is not identcal for each
country, the results are not markedly diferent.
Rates of investment compared to deals screened seem to be comparable
across several western countries. A German study reported an investment
rate of one or two out of every nine investgated. Investments take generally
between 20 to 90 days from inital contact and involve, generally three to six
negotaton sessions.
Research in the USA suggests that Angels invest in about 10 tmes the number
of companies as the VC frms but the total amount of investment by dollar value
is somewhat similar. The most recent estmate (2002) is 400,000 actve Angels
in the USA investng US$30-40 billion in 50,000 early stage ventures.
‘Through 2001, the 220 members of Tech Coast Angels (Los Angeles, Orange
and San Diego Countes) made approximately 800 investments in 52 companies
totalling US$40 million in 81 rounds of investments. The average investment is
just over US$40,000 and 95% of the individual investments have been in the
range of US$20,000 to US$100,000. Fify per cent of the investment rounds
totalled US$500,000 or less.’
Source: William H Payne and Mathew J Macarty, 2002, The anatomy of an
angel investng network: Tech Coast Angels, Venture Capital, Vol. 4, No. 4
Returns on investment and exit paths tend to vary from country to country,
possibly depending on the state of the economy at the tme of the research,
the availability of a robust secondary public listng market and the type and
availability of potental deals.
A USA study published in 2002 showed that a quarter of the Angel investments
were achieving beter than a 50% rate of return and generally exitng the
investment through a trade sale.
Source: Jefrey Sohl, 2003, The private equity market in the USA:
lessons from volatlity, Venture Capital, Vol. 5 Issue 1, p 29.
39
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
Investment Investments in Investments in
returns IRR technology-based frms non-technology based frms
No. % No. %
Loss 17 36.2 34 42.0
Break-even (0-9) 11 23.4 17 21.0
20-49 6 12.8 13 16.0
50-99 7 14.9 10 12.3
100 and over 6 12.8 7 8.6
Total 47 100 81 100
Source: Colin Mason and Richard T Harrison, 2004, Does investng in technology-based
frms involve higher risk? An exploratory study of the performance of technology and
non-technology investments by business angels, Venture Capital, October 2004, Vol. 6. No. 4
Angel investor exits by the Tech Coast Angels, 1997-2001
Actvity Number
Investments 52
Operatng independently 32
Exits 20
• Out of business (–1X) • 10
• Partal return of capital ( 0 to – 9X) • 5
• Sale to private companies (exit pending) • 3
• IPO (2X – 3X) • 1
• Sale to public company (+120X) • 1
Source: William H Payne and Mathew J Macarty, 2002, The anatomy of an
angel investng network: Tech Coast Angels, Venture Capital, Vol. 4. No. 4
‘This paper provides the frst atempt to analyse the returns to informal
venture capital investment using data on 128 exited investments from a survey
of 127 Business Angel investors in the UK. The paper fnds that the distributon
40
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
of returns is highly skewed, with 34% of exits at a total loss, 13% at a partal loss
or break-even, but with 23% showing an IRR of 50% or above. Trade sales are
the main way in which Business Angels harvest their investments. The median
tme to exit for successful investments was four years. Large investments, large
deal sizes involving multple co-investors, and management buyouts (MBOs)
were most likely to be high-performing investments.’
Source: Colin M Mason and Richard T Harrison, 2002, Is it worth it? The rates of return
from informal venture capital investments, Journal of Business Venturing, Vol. 17. No. 3.
Exit routes for technology and non-technology investments
Exit route Investments in Investments in
technology-based non-technology
based frms
No. % No. %
Flotaton 6 14.3 3 3.9
Trade Sale 12 28.6 19 24.7
Sale of shares to existng shareholders 3 7.1 16 20.8
Sale of shares to third party 6 14.3 6 7.8
Writen of/shares have no value 15 35.7 32 41.6
Asset break-up 0 – 1 1.3
Total 42 100 77 100
Source: Colin Mason and Richard T Harrison, 2004, Does investng in technology-based
frms involve higher risk? An exploratory study of the performance of technology and
non-technology investments by business angels, Venture Capital, October 2004, Vol. 6. No. 4
‘On the average, 60 - 65% of these investments break even
or represent a partal or total loss. So a substantal porton, 6 out of
10, even afer metculous due diligence, result in no fnancial return
or in returns below that of a bank deposit account. Approximately
20% of these investments, based on our research, provide a two
to fve tmes multple on the investment. About 8-9% provide between 5 and
41
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
10 tmes the investment, and about 7 tmes out of 100, about 6.9%, we see a
return of 10 tmes or more the investment made.’
Source: htp://www.icrnet.com/faq/home.html#q17 Accessed 22/01/06
Angel Capital Educaton Foundaton reported that, for the 539 Angels
surveyed across 86 Angel Groups they reviewed in 2007, the average return on
the 1,130 exits of that year was 27%. (www.angelcapitaleducaton.org)
When they do invest, Angels will stpulate similar conditons to their
investments as VCs. Typically they will require:
• a positon on the Board of Directors
• remuneraton for their tme spent on the business
• veto power over the issue of new shares
• adjustment of the number of shares issued to the investor if milestones
are missed and/or a lower valuaton is set in a subsequent round of
investment
• veto power over further long-term debt
• approval rights over executve remuneraton
• approval rights over issue of optons
• the right to put the business up for sale if certain milestones are not
achieved
• the right to replace the CEO if certain milestones are not achieved.
Angels are normally actve ‘hands-on’ investors. They expect and ofen enjoy
being directly involved in the management of the venture. In fact, this is ofen
one of their prime reasons for investng. They typically spend tme with each of
their investments on a regular basis.
A study of Angel investors in Germany showed that Angels typically spent 6.2
days per month on their investments, averaging 1.34 days per month on each
investment, with the most tme being spent on their most recent investees.
More actve investments might involve a day per week.
Source: Malte Bretel, 2003, Business Angels in Germany:
a research note, Venture Capital, July 2003, Vol. 5. No. 3
42
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
Angel investors play a very important role in developing early stage ventures.
It is their combinaton of funding and mentoring that makes their contributon
so advantageous to a fedgling business. Certainly, without Angel help, many
early stage businesses would founder. Even though many fail, at least half grow
into more substantal businesses providing essental job and wealth creaton.
There are many sites ofering informaton on Angel fnance in the USA and
several directories of Angels and Angel Networks. One site ofers access to more
than 20,000 Angels (see www.vfnance.com). The Angel Capital Associaton has
an extensive list of Angel Networks.
For some background to Angel investng in the United States of America see
Note on Angel Investng – Prepared by Michael Horvath and Fred Wainwright,
Center for Private Equity and Entrepreneurship, Tuck School of Business at
Dartmouth University 01/05.
Source: htp://www.empea.net/peindustry/research.aspx Accessed 11/12/05
The UK Natonal Business Angels Network (NBAN) estmates that there are
currently 18,000 Business Angels in the UK investng roughly £500 million into
3,500 businesses every year. Informaton on Angels and Angel Networks within
the UK can be found through the Britsh Business Angels Associaton (BBAA)
which is the Natonal Trade Associaton for the UK’s Business Angel Network.
Source: htp://www.bbaa.org.uk/portal/content/view/12/50/ Accessed 11/12/05
In Australia, Angel Networks are listed on the website of the Australian Venture
Capital Associaton (see www.avcal.com.au). Australia has an associaton of
Angel groups called the Australian Associaton of Angel Investors (www.aaai.
com.au) where you can fnd details of Angel Groups.
A recent report on Australian Angels enttled “Study of Business Angel Market
in Australia’ by Professor Michael Vitale, Belinda Everingham and Richard
Butler (November 2006) is available at:
http://www.ausicom.com/filelib/PDF/ResearchLibrary/Business_Angel_
Report.pdf
43
Raising Angel & Venture Capital Finance
T
here are basically two types of ventures which atract Angel or VC
investment. These ventures create a return to the investor through their
exit event. Financial ventures create value on exit via a fnancial trade sale or an
IPO by assigning a value to the future proft generatng power of the entty being
sold. Alternatvely, a strategic venture creates exit value, not on the basis of what
proft it could inherently generate, but on the basis of what future proft could
be generated by the buyer exploitng the underlying assets or capabilites of the
entty being acquired. These are fundamentally diferent types of businesses
and the Angel or VC investor has to ensure that the business development
process and the exit preparaton align with the appropriate exit.
In order to assess the potental exit value of any entty, we must frst
understand how the business creates value for its buyer (fnancial or strategic
sale) or its future public shareholders (IPO). Those businesses which deliver
inherent proftability must create value for its future owners through enhanced
proftability and future proft growth. By contrast, strategic value businesses
create value by enabling a large corporaton, the strategic buyer, to exploit a
signifcant revenue opportunity enabled through the combinaton of the two
companies. The strategic seller builds value by developing strategic assets and
capabilites which a large company will exploit.
4
Strategic v.s Financial
Ventures
44
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
In the case of a strategic sale, it may not mater whether the selling business
is making a proft, has revenue or is growing. This is in direct contrast to a
fnancial exit which is entrely based on revenue and proft growth which the
business itself must deliver to its new owners.
Because these outcomes are very diferent, the manner in which the Angel
and VC investors will evaluate the investment and then should plan the exit
for their investee business depends greatly on which type of exit is most
appropriate.
I have grouped fnancial trade sale and IPO under the fnancial exit as they
both have the same basic value creatng process, they both need to generate
a future stream of positve earnings to create a successful exit event. The IPO
exit is an extreme situaton of a fnancial venture where the projected revenue
levels and the projected market capitalizaton is very high. While the IPO exit
requires a more sophistcated organizaton to be successful, the fact is that
both the fnancial sale and the IPO require a proven, high growth potental
business concept to generate a successful exit value.
Smaller frms and frms with limited growth potental which create value
through projected net earnings need to be directed towards a fnancial trade
sale as they will not be able to meet the rather high threshold of revenue
and potental growth requirements needed for a successful IPO. Given that
only a very small percentage of frms are able to achieve IPO status, the vast
majority of frms need to be prepared for a fnancial sale. For the purposes of
this discussion, I am going to refer to all fnancial exits as a ‘fnancial sale’ with
the understanding that some exceptonal frms will be able to achieve an IPO.
Also, for the purposes of this discussion, I am going to assume that all fnancial
exits will be to an individual or corporaton, that is a ‘fnancial buyer’, and that
the buyer is setng the purchase price based on the antcipated future stream
of earnings from the acquired frm alone. That is, the buyer is not assigning
any synergy or beneft to the acquisiton based on what is happening, or could
happen, in the rest of the buyer’s organizaton.
The fnancial sale is very diferent from a strategic sale where value is
created through the combinaton of the buyer and seller businesses. We
have all heard of businesses which were sold for many tmes revenue and
45
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
staggering multples of proft. These situatons are all cases where the business
being acquired had something which the large corporaton needed to counter
a major threat or to chase afer a major new revenue opportunity. Most of
these acquired businesses had unique intellectual property, deep expertse or
well established brands or rights (e.g. to exploit forests, minerals, fshing etc).
The assets or capabilites being acquired were considered by the buyer to be
too expensive to copy, build or develop, or would take the buyer too long to
assemble or to create internally. The delay in acquiring the asset or capability
may also expose the acquiring corporaton to an unacceptable level of risk.
In a strategic acquisiton, a small business can ofen provide the means by
which a large corporaton can quickly generate many tmes the purchase price
by leveraging its own assets and capabilites alongside those being acquired.
Such acquisitons are bought, not on the basis of the profts of the acquired
business, but on the value which can be generated within the combined entty.
Few acquisitons, however, ft this profle. I will use the terms ‘strategic sale’ and
‘strategic buyer’ to describe a situaton where a business is sold on the basis of
its strategic value to the acquirer.
Businesses which are typically sold to a strategic buyer are those in
biotechnology, informaton technology, research and development, designer
fashions, mineral exploraton, agricultural science, computer hardware and
telecommunicatons. Also companies in consumer packaged goods with strong
brands or with manufactured products which have global market potental can
ofen secure signifcant premiums on sale. Acquisitons which can deliver very
signifcant synergies in operatng costs through integraton would also ft into
this category.
Probably about 95% of all private businesses which are sold are acquired
by a fnancial buyer. In some, there will be synergies in the acquisiton but
these will be minimal and not sufcient to override the need for the acquired
business to show its inherent proftability. Most companies don’t have the type
of assets or capabilites to leverage large scale opportunites for an acquirer.
Instead, they build profts through their own inherent compettve advantages
for a local customer base.
46
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
A fnancial buyer seeking an acquisiton will ofen have many choices of
similar businesses, although sometmes geographically separate. The buyer
may be buying a business to own and manage or a corporaton undertaking a
consolidaton strategy by acquiring many businesses of a similar type. What the
fnancial buyer is acquiring is a proft stream and so the basis of the purchase is
simply how much proft the frm makes now and is likely to make in the future.
Purchase value is calculated almost purely on the inherent proftability of the
acquisiton with litle regard to the combinaton synergies in the acquisiton.
The seller to a fnancial buyer must put efort into increasing proft and proft
potental.
Businesses which would normally be sold to a fnancial buyer are professional
services frms, marketng frms, management consultancies, distributon
companies, trucking companies, most retail businesses, wholesalers, import/
export companies, agricultural enterprises, printers, professional practces,
builders, constructon companies and so on. Non complex manufacturing also
atracts a high proporton of fnancial buyers. Basically any business which does
the same as many other businesses will fall into this group.
Businesses acquired to be operated as a stand alone business will be purchased
on the basis of their inherent proftability as there are no synergistc benefts
in the deal for the acquirer. Therefore, a business bought by an individual who
wants to invest retrement or redundancy funds to buy a business to manage
will be a fnancial sale. Similarly, a business purchased by a private equity fund
which intends to increase its proftability through new management, increasing
its debt level and refocusing the business will also be a fnancial sale.
Businesses acquired by corporatons can be expected to have both fnancial
and strategic contributons. Many acquisitons are undertaken for roll-up,
consolidaton or expansion purposes. These businesses typically are purchased
to add revenue and proft generaton through their own inherent operatons
although the acquirer may gain some synergistc benefts from operatng at
a larger scale or some benefts through reducing duplicate functons, but the
prime consideraton is generatng operatng proft from the business purchased.
The purchase price would be driven by the current and potental proft of the
acquired business itself. While the additonal synergies may make it more
atractve, the seller would need to prepare the business for a fnancial buyer.
47
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Acquired businesses which are expected to contribute signifcant synergistc
benefts to the acquiring corporaton may contribute litle inherent proft. They
are acquired because of the benefts which the acquiring corporaton expects
to achieve through the combinaton of the businesses. In most cases, these
acquired businesses bring some asset or capability to the acquirer which the
corporaton is able to leverage through their own operatons thereby generatng
signifcant future revenue and profts for the acquirer. A seller who was able to
make such a contributon would seek out a strategic buyer.
Some frms will be able to do both. That is, they will have good proft
capabilites and also be able to provide strategic benefts to the acquirer. But
one will be more signifcant than the other. To the extent that strategic value
benefts are greater than inherent proftability benefts, the seller would be
much beter of seeking a strategic buyer. Financial sales are always going to be
limited by the proft generatng capability of the seller. A strategic sale, however,
is only limited by the size of the opportunity generated within the acquiring
corporaton. Thus, a very large corporaton that can signifcantly leverage the
strategic contributon of a small acquisiton may be prepared to pay many tmes
its fnancial sale value to ensure it receives the benefts of the acquisiton rather
than allow it to be acquired by one of its compettors.
I have extensively examined the process of a fnancial trade sale and have
documented a methodology in my book, The Ultmate Deal 1, which can be
used by business owners to signifcantly improve their sale value.
My book, The Ultmate Deal 2, examines strategies which owners of businesses
with strategic value will use to sell their businesses to a strategic buyer. Angels
and VC investors who wish to examine the strategic sale preparaton process in
greater detail should also read my e-book ‘Invest to Exit’.
48
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Financial v.s Strategic Buyer Strategies
Attribute
Strategic Buyer
Financial Buyer
Source of value
to the buyer
Proftability, risk
minimizaton, growth
potental.
Threat eliminaton and/
or revenue potental in
the combinaton of the
two businesses.
Value created by Increasing profts,
reducing risk, future
growth and proven
growth potental, roll-
up or consolidaton
opportunites.
Underlying assets and
capabilites which the
buyer will leverage to
eliminate a threat or
exploit a large revenue
opportunity.
Additonal value
created by
Increasing current
profts, increasing
growth rate,
developing additonal
substantated growth
potental.
Reducing integraton
tme, increasing rate of
scalability and speed
of exploitaton, adding
additonal strategic
assets and capabilites
for the buyer to exploit.
Individual, investment
trust, private equity
frm, corporaton
undertaking a roll-up or
consolidaton strategy.
Large corporaton which
can exploit the strategic
assets and/or capabilites
in a large customer base.
Buyer
Financial or Strategic Sale – Which One?
I ofen confront entrepreneurs with existng investments with a stark choice
– what is the best strategy to prepare your business for a sale – build up the
profts or develop underlying assets and capabilites for a strategic sale. You
might well ask ‘Why can’t you do both?”.
49
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Attribute
Strategic Buyer
Financial Buyer
Impact of
increased
proftability
Major impact on value. May be irrelevant. Profts
are only needed to
ensure survival prior to a
sale.
Size Any size.
Large acquisitons
may have difculty
creatng sufcient new
incremental revenue.
Existng growth Signifcant impact on
value.
Size must be sufcient
to allow a critcal mass
platorm for opportunity
exploitaton. Growth
itself may not be
important.
Growth
potental
Signifcant impact on
value.
May have no impact on
the buyer’s opportunity.
Underlying
assets and
capabilites
Must deliver
compettve advantage
within the seller’s
business as a stand
alone entty.
Must deliver a
sufciently large and
robust base for exploitng
a strategic opportunity
in the combinaton of
businesses.
Inherent risks Must be eliminated
wherever possible.
Must be eliminated
wherever possible.
Succession
planning
New buyer must
be able to run the
business if the senior
management leave.
Key manager and key
employees needed to
exploit the opportunity
must be retained.
50
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Attribute
Strategic Buyer
Financial Buyer
Advisors Business broker,
professional services
frm, business advisor
Large professional
services frm, investment
banker.
Preparaton tme
18 months to 2 years Normally 2 years or more.
Level of
integraton
Most ofen contnues as
a sole business or might
be loosely integrated
bolt on acquisiton.
May contribute
administratve
synergies in a
consolidaton.
Varies. Ofen fully
absorbed. Sometmes
integrated into only one
part of the business.
Could be lef as a stand
alone entty passing
products, IP or processes
to group.
I am sure that some companies can do both, but when they look at the
processes involved and the priorites which will determine where to use their
surplus cash, you ofen see a clear choice – they don’t have the resources to
do both so they need to decide which strategy is going to give the highest exit
price.
There is sometmes the possibility that a single venture can throw of more
than one exit. This can happen where the frm has developed IP across multple
markets or solves quite diferent problems. It may be worth separatng the
diferent IP into distnct ventures and preparing each for an exit.
Another possibility is that a single venture may have quite diferent actvites
each of which could be directed towards their own sale, perhaps with some being
fnancial sales and others being strategic sales. This can happen, for example,
where IP is the basis of a sales transacton of a product but is then followed by
maintenance or service sales. The IP may appeal to a global corporaton but
they may have no interest in the local services business. In such a case, it may
51
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
be worthwhile splitng the business and selling the diferent parts to diferent
buyers.
Companies which are sold as a fnancial sale are those which provide the
buyer with a platorm which enables the buyer to generate a stream of future
earnings through the use of the resources contained within the acquired
business. While these might be augmented by the buyer through the inserton
of beter processes, more capable management and beter funding, essentally
it is the same underlying business which is generatng the proft stream. Thus
any acquisiton valuaton will be based on the net present value of those future
earnings. Most businesses fall into this category. Financial buyers typically buy
retail, wholesale, light manufacturing, transport, property and services based
businesses.
You increase the value of such businesses by reducing the inherent risks for
the buyer, improving the visibility and reliability of future earnings forecasts,
improving on-going proftability, building growth into the business and fnding
ways to create growth potental for the buyer.
By contrast, those businesses which appeal to strategic buyers have some
underlying assets or capabilites which a large corporaton can exploit through
the buyer’s own organizaton. Small companies will ofen develop products or
services which can be sold by the acquirer through their very large distributon
channels. In the right circumstances, a buyer might be able to scale the revenue
by 50 to 100 tmes that of the seller just by having the right access to global
customers. The key to a strategic sale is to fnd a large corporaton which can
exploit the underlying asset or capability of the seller to generate very large
revenues. In these situatons the size, revenue, number of customers or
employees or level of profts of the seller may be entrely irrelevant. It is the
size of the revenue opportunity of the buyer which is the key to strategic value.
A business which has the right type of assets or capabilites which can
generate strategic value may be much beter of putng additonal efort into
developing those assets and capabilites to provide greater or earlier revenue
generatng power for the intended buyer. A higher exit price will be achieved if
the buyer can scale or replicate the asset or capability faster and can integrate
the seller’s business quicker. The only size consideraton for the seller is to be
52
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
big enough to provide the launch platorm for the buyer to fully and quickly
exploit the strategic value.
Entrepreneurs need to be sensitve to these two types of ventures as it
directly impacts the evaluaton of the venture for Angel and VC investment and
directly impacts on the manner in which the business would be developed for
an exit.
53
Raising Angel & Venture Capital Finance
B
usiness advisors ofen talk about a compelling business concept and
encourage entrepreneurs to create a venture which has high growth
potental. They then assist the entrepreneur to build a business plan around the
compelling business concept so that the entrepreneur can seek out investors
to help them realize the business potental. However, what they have missed
in all this work is that the Angel and VC investor is not that interested in the
business, the product, market or what customers think of the product or service
being developed or sold. What they really want to hear about is a ‘compelling
investment opportunity’. They want to be convinced that their investment funds
will be used to create a successful exit event so that they achieve a great return
on their investment. Their interest starts and ends with how the entrepreneur
is going to make them money not produce the world’s best widget.
The investor will approach the investment opportunity with a set of
assumptons as to how the business will be developed and how the exit will
be achieved. Almost without excepton, those assumptons will include the
following:
• The business is almost certainly going to be sold within 3-7 years.
Outside a boom market, very few frms make it to an IPO.
5
A Compelling
Investment Opportunity
54
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
• The entrepreneur and most of the equity holding management team are
unlikely to stay with the business once it is sold to a corporate buyer.
• The investor, in most cases, will not be involved in the day-to-day
operaton of the business but will play a mentoring and strategic role.
• The investor can be expected to provide specifc help in an aspect of the
business where they have deep personal experience.
• A primary actvity of the investor will be to ensure the business
implements formal operatonal management systems and good
governance processes.
• The investor will most likely hold at least one Board seat.
• The valuaton of the business at the tme of the inital investment has to
take into account the risks associated with the investment and therefore
is likely to be much lower than the entrepreneur thinks the business is
worth.
One of the evaluaton issues facing the investor is whether the business will
have a fnancial or strategic exit. Clearly, the fnancial venture must be able to
prove out an entre business model and be able to convincingly demonstrate a
capability to produce signifcant growth in revenue and proft. This is in contrast
to a strategic venture which must simply show that it is an ideal acquisiton for
a large corporaton. While there are a number of atributes which both these
ventures must demonstrate, the hurdle for the fnancial business is signifcantly
higher.
For a fnancial investment to have a serious chance of being successful,
resultng in an IPO or fnancial trade sale, it needs to show that it can demonstrate
the potental to achieve the revenue and proft levels to provide a good return
on the investment. In order to do so it is almost certainly going to have to satsfy
some basic high growth potental criteria. These include the following;
• Clearly identfable and reachable customer with a compelling need.
• An emerging and growing market with signifcant global potental which
is fragmented and where demand exceeds supply.
• A business model with sufcient barriers to entry to protect the business
over the frst few years.
55
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
• A growth strategy which can achieve the levels of revenue and proft
within 3-7 years to easily sustain the ROI needed by the Investor.
• A proven product or service which has clear customer acceptance.
• A management team which can demonstrate they have the skills and
experience to execute the growth strategy over the next several years in
conjuncton with assistance from the Investor.
• A set of shareholders and a management team willing to sell the
business within 3-7 years and walk away if necessary.
• A robust exit strategy with a high probability of executon within 3-7
years.
• A well-defned plan for the use of the investment funds which is directly
linked to clear and measurable targets which in turn support the exit
strategy.
• A robust business strategy and cash fow which can cope with things
going wrong and can stll, in the worst case, return the inital investment
to the investor.
• A team willing to negotate a realistc valuaton.
For a strategic investment to be successful it must be able to show a highly
probable exit through a strategic trade sale. In the assessment of a strategic
venture, the business needs to demonstrate the potental to achieve the strategic
sale. This means the business should display the following characteristcs;
• Clearly identfable and reachable customer with a compelling need.
• An emerging and growing market with signifcant global potental which
is fragmented and where demand exceeds supply or an established
market which would rapidly absorb the frm’s product or service.
• A product or service with sufcient barriers to entry to protect the
business over the frst few years.
• A level of scalability or replicaton in the product or service which can
generate signifcant new revenue for the strategic buyer in the frst few
years afer the trade sale.
• A proven product or service which has clear customer acceptance.
56
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
• A management team which can demonstrate that they have the skills
and experience to execute the strategic trade sale over the next several
years in conjuncton with assistance from the Investor.
• A well-defned plan for the use of the investment funds, which is directly
linked to clear and measurable targets which in turn support the exit
strategy.
• A robust business strategy and cash fow which can cope with things
going wrong and can stll, in the worst case, return the inital investment
to the investor.
• A set of shareholders and a management team willing to sell the
business within 3-7 years and walk away if necessary.
• A team willing to negotate a realistc valuaton.
You might argue that it is near impossible to fnd an early stage venture that
meets either of these sets of criteria. Your proposal to the investor should be
able to demonstrate that you can satsfy one of these business models. You
need to convince them that you and your management team can take them to
a successful exit.
Angels and VC investors generally invest where they can see that the venture
can be developed over a few years to the point where it can be sold to a corporate
buyer or taken to an IPO. Your task as the entrepreneur seeking investment
funds is to convince the investor that, with their funds and assistance, you can
develop the business to achieve the desired exit.
Your investment proposal will need to show that you understand what the
investor wants in an investment opportunity and that you have a business
venture which will satsfy their objectves. In setng out your business venture
you will need to examine a number of areas of the business to show that you
can meet their investment criteria.
The market analysis
There are many marketng texts that you can read which talk about market
segmentaton, customer buying paterns, pricing models and so on. Most likely
the Investor will have read those and so understands the jargon. The key to
57
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
an investable business is more about the executon of a business plan over a
limited period of tme to achieve the exit conditons. This might be a stated level
of revenue and proft, rather than developing a sophistcated marketng plan for
market dominaton. Alternatvely, it might be in preparing a product or service
for a strategic buyer’s market. If the life of the venture is to be 3-7 years before
an exit, then very specifc targets need to be achieved.
Whether it is the target market of the venture or the target market of the
strategic buyer, it can be expected to have the same fundamental atributes.
The target market defniton needs to be very simple, robust, obvious and easily
proven. The ideal model is characterized by the following:
• Well-defned, identfable and easily reachable customers who have a
high compelling need to buy, a willingness and ability to pay the price
and are in sufcient numbers that the revenue targets can be readily
achieved.
• A segmented market where it is possible to signifcantly diferentate the
product or service from compettors and where that diferentaton is
difcult to copy or neutralise.
A fnancial venture would also need to be able to demonstrate the following:
• A total market which is growing, has global potental and would be
atractve in the long-term to a major corporaton.
• A fragmented market which enables growth by acquisiton.
The customer
The beter business to be in is where the business has a list of all possible
customers for the product or service. Alternatvely, the customer can be readily
reached through an established, or readily built, distributon channel. The
investment proposal should be explaining:
• the profle of the ideal customer
• how contact will be established
• what their buying patern is
• how they have the purchasing power to readily meet the sales price.
58
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
You see businesses all the tme which reach out to the general public in the
hope that they will buy. A retail store, a restaurant and the internet marketng
frm are all hoping they can atract customers. But they have litle infuence over
the buying cycle. On the other hand, customers which can be clearly identfed,
named and are able to be approached with a value propositon are much easier
to sell to. This is not to say that other models are not successful, however, they
generally carry a greater risk.
The compelling need to buy
Few people understand just how hard it is to build a value propositon which
compels a customer to buy. Most products are chosen on a whim, can be readily
deferred or have many alternatves and substtutes.
Example
Distncton Sofware Inc. a business established in 1994 in Atlanta,
USA, by Dr. Tom McKaskill developed a sales forecastng and inventory
planning system for high volume, low cost consumer packaged goods.
Using prospect data the sofware could show a 15-30% reducton
in safety stock over a three month period providing an investment
payback of 3-6 months on the sofware cost. Even though many
corporatons expressed interest, few made the investment. Why?
Afer fve years it became apparent that only corporatons that
had deep-seated inventory problems were willing to make the
organisatonal and system changes to implement the sofware. For the
others, their proftability was high enough that the changes required
to implement the sofware were simply ‘too hard’. For the sofware to
work efectvely the customer needed to change job responsibilites,
reportng lines and data ownership. The ‘compelling need to buy’ only
existed in a few corporatons. For the others, it was a desirable, but
not necessary, thing to do.
59
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
Think about these questons:
What problem is the venture solving?
Is it satisfying a need or a desire?
What degree of compliance (penalty or cost) results from not buying?
What happens if the customer does not buy?
Are there alternatives to the frm’s product or service?
Who is required to solve the problem? What happens to them if they
don’t?
Market characteristics
Historically, most investors have preferred their investee companies to
operate in medium-sized global markets as this will ultmately atract the
corporate acquirer or will be the basis on which to launch an IPO. Investors
now are much more atuned to the need for an exit event and so for them, it is
not whether the market is small or huge, it is simply whether the target market
over the next 3-7 years can provide the frm with the capability to achieve the
valuaton required for the investor to exit. In the end, it all comes down to
valuaton on exit and ease of exit. The target market may be directly addressable
by the investee frm or could be the target market of a strategic buyer.
For a fnancial venture, a larger fragmented market where new products
and services can fnd a reasonable size niche market are preferred by investors
as this is easier to achieve than global dominaton or a share in a commodity
market. The frm has to demonstrate in its investment request that it can secure
the level of revenue and profts required to achieve the valuaton target. Even in
a very large market, a lack of customer demand for the specifc ofering of the
frm won’t make the target numbers.
60
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
For a strategic venture, it is whether the potental strategic buyer has an
existng market which can be readily addressed or a potental market which
they can exploit.
Basically the entrepreneur must establish, with a reasonable degree of
certainty, that the revenue, cash fow and proft targets of either the frm itself
or the intended buyer can be achieved. This requires a very good understanding
of the marketplace, an understanding of the needs of the customers and some
level of proof that customers will buy in the quanttes forecast. This might
be based on existng sales, prospect surveys or expert advice plus experience
within the executve team.
However, in order to show a probable exit path, the requirements of the exit
strategy need also to be shown. An IPO requires the company to confdently
build to, say, a $100 million valuaton within three years afer listng. Smaller
companies are not excluded from an IPO, in fact many companies smaller
than $100 million are successfully listed; however, they tend to miss out on
atractng insttutonal investors and in many cases do not atract broker
coverage, accordingly, they present a greater risk to maintain or increase values.
Furthermore, as the management team and the Investor usually have at least
part of their shareholding escrowed for a period of tme, the exit value may
ultmately be at prices below the inital listng price. For an IPO exit the frm
needs to confdently show that it can achieve the revenue, cash fow and proft
targets needed to support the share price over a 3-5 year period afer listng.
With an IPO exit, hopefully funding through the IPO and subsequent rounds of
public capital raising will fund growth. The business needs to have a very strong
product/market positon to fuel growth.
For a fnancial trade sale exit, the requirements for revenue and profts are
very diferent. The frm need only show that it can reach the level of revenue
and profts needed to close the trade sale deal. In the case of a strategic trade
sale, revenue and proft targets could be zero or limited, that is, the deal is
based on some other aspect of the business which needs to be achieved, such
as a product development stage. At other tmes, the acquiring corporaton may
want to see a limited number of customers actvely using the product as a proof
of design, marketng and operatonal use.
61
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
In many cases, corporatons enter into a strategic trade sale with an emerging
frm to acquire a product which has considerable global potental. In proposing
a trade sale exit strategy, the frm needs to convince the investor of the ultmate
size of the market which would atract the proposed buyers, whether they be
a fnancial or strategic buyer. Thus market size and compettve positoning
become important, not for the short term, but to secure the ultmate acquirer.
You should explain the structure of the industry and show an analysis of the
market dynamics to demonstrate the business or product potental.
Which companies are growing and why?
Which frms are declining and why?
Is this an emerging market where demand exceeds supply and thus
even poor businesses will survive?
Given the product positioning, which market is the frm attacking and
what retaliation, if any, can the frm expect from the current players?
Is this a market which will attract new entrants and, if so, how will the
frm defend its business from the new competition?
Competitive analysis
Angels and VC investors prefer their investee companies to sell products
or services which are diferentated from their compettors. They like to see
diferentaton based on some level of innovaton in product, process or business
concept. The innovaton itself needs to be difcult to match over the period of
tme needed to achieve the exit target.
If an IPO is planned, the product needs to be sufciently diferent to be able
to sustain a long-term compettve advantage. This is the only positon which
will allow the frm to achieve the revenue, cash fow and proft levels needed to
sustain the share price in the public market.
62
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
In a fnancial trade sale, the frm has to be able to demonstrate revenue
growth into the medium term. Compettve advantage is going to be a key
aspect of the business case to the buyer.
For a strategic trade sale, compettve positon is not as important as being
the right product for an acquisiton. However, if you look beyond the acquisiton,
you have to deal with the compettve positon of the acquiring corporaton and
the subsequent merged operatons. This means the investment proposal needs
to show how the acquiring corporaton would use the frm’s products to secure
signifcant revenue. Although, this may be in combinaton with the acquirer’s
other products or by selling the frm’s products into their own customer base.
The compettve analysis needs to show very clearly why the frm’s products
are preferred in some market segments and to demonstrate reasonable proof
of that asserton.
Barriers to entry
Whatever the exit, the future generaton of revenue and proft will require the
frm to establish that its products or services which drive revenue generaton
and have a level of compettve advantage which itself has a signifcant degree
of sustainability. This implies a reasonably high level of barriers to entry.
There are two fundamental questons which the entrepreneur needs to
answer:
Why would customers buy our products or services?
What is to stop a competitor from taking the business away from us?
The frst queston should be supported in the proposal by the product value
propositon, a market analysis, a compettor analysis and the compelling need
to buy. ‘Why you?’ is also an issue of credibility. The frm or the strategic buyer
needs to be able to convince the target customer that they can trust it to deliver
and support the product. In the case of the investee frm, establishing the
product or service in the market may be achieved through the experience of
the team, from existng customer testmonials or through customer trials.
63
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
The second queston is simply about protectng the business from erosion
from existng or new compettors. What is to stop a much beter funded,
larger, more aggressive compettor from duplicatng what the frm has done
and ofering greater incentves for their prospects to buy from them? This gets
down to: how is the frm or the strategic buyer going to protect its business?
Protectng the business is achieved by erectng barriers to entry. What can
the frm or the strategic buyer put in place to protect its compettve advantage,
distributon channel, ongoing customer revenue and source of supply.
Barriers to entry have one, or several, of the following atributes:
• high start-up costs
• expensive to acquire
• takes a long tme to acquire
• protected by patent, trademark or copyright
• restricted under licence, rights or agreements
• requires specialised knowledge which itself is in limited supply
• highly innovatve and not capable of reverse engineering
• protected by ongoing customer revenue through high switching costs or
contracts
• ownership of or contracted distributon channel
• restricted or contracted source of supply.
Strong barriers to entry usually create the basis for a sustainable compettve
advantage. This is also the foundaton of any longer term growth strategy for a
public listng. A strategic buyer will need to be convinced that these conditons
can be established by it subsequent to the acquisiton.
The management team
The literature in the venture capital area is dominated by the quest for the
‘A team’. This is the super team. The ‘A team’ has done it all before and has
the skills, capabilites and diversity to cope with anything under any conditons.
Regretably they rarely exist and Angel and VC frms have to put up with business
plan presentatons from ordinary mortals.
64
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
However, that is not to say that their objectve is wrong. It is simply that
executves who have done it before have probably learnt from their successes
and failures. They are well connected in the industry and are knowledgeable of
other experienced executves and can easily recruit additonal team members.
For the Angel or VC investor, it is all about reducing risk. If they can invest in a
well-rounded team with experience, they have a greater chance of achieving
their minimum targets.
The ‘A team’ also brings with them the following:
• a knowledge of Angel and VC investment requirements
• willingness to negotate a realistc valuaton
• experience with an exit
• not as emotonally atached to the ‘product’
• networks within the industry and with potental alliance partners.
For the Investor, members of an experienced management team are easier
to deal with and have a good understanding of the funding process.
Although the venture capital market has been operatng in Australia and
New Zealand for more than 20 years on a formal basis, there are stll very
few experienced management teams which have gone through a formal
private equity investment and exit cycle more than once, unlike the US and
European markets which have foatng management teams which move from
one investment with an Angel or VC frm through to an exit and on to another
investment.
Many of the deals brought to the Angel or VC frm for funding simply lack
an experienced set of executves. There can be no queston the entrepreneur
brings the idea, the passion, the vision and the energy, but other team members
usually make it work.
When the investor looks over the business plan, they are working on the
actvites which need to be executed to deliver the critcal targets. This might
be sales, marketng, product development, quality control and so on. For
each of these actvites, they want to know who on the team will deliver this
operatonally.
65
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
The real test to be applied here is operatonal. Given where the business is
today, can the team execute, with reasonable confdence, the actvites needed
to get them to the exit conditons within the 3-7 year period? In some cases the
investor will be making a judgement as to their own impact on the ability of the
frm to achieve such results. So the fundamental queston which the investor
has about the management team is: ‘Can the team and I together achieve the
targets needed to exit?’
For most exits, this will be a trade sale and the management team may not
be needed beyond that. Not all proposals need the 20-year veteran or the
executves recently cashed out from their IPO. In fact, this may be the wrong
team for a clearly defned trade sale exit.
The business propositon also needs to show who is going to deliver on each
of the major actvites needed to reach the exit conditons. Any weakness in the
team will need to be addressed by the investor. The management team can be
supplemented with experience from a Board of Directors, a Board of Advisors
and external consultants. Where the management team is not complete, the
Investor will want to see an acknowledgement that the existng management
recognise this defciency and accept that new talent will need to be recruited to
deliver on the business targets. Some of the founding shareholders may have to
step aside. This is a critcal tme for entrepreneurs as they need to put together
a team which has a high probability of meetng the targets.
Operations
Day-to-day monitoring of the business is an essental characteristc of a well-
run frm. The frm has to know where it is, what it needs to do and have the
systems, policies and procedures in place to monitor and correct defciencies.
The reason why Angels ofen become involved in early stage ventures is
because it is this experience they can bring to the venture. From their past
experience with start-up and high growth revenue ventures, they have learned
the importance of being well informed and taking remedial acton early.
Operatonal systems include all the budgetng, fnancial and operatonal
reportng systems, performance setng and monitoring processes, and systems
and reward schemes which encourage the right behaviour. High growth
66
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
businesses are fnely tuned because they consume cash in building capacity.
They have litle room for mistakes and therefore early warning systems and
quick response systems are very important.
At the same tme, the business must manage its contractual risks. Well
writen contracts with customers and suppliers, well-designed contracts of
employment, well documented intellectual property ownership and assignment
are all components of good management of risks.
Product development
It is unlikely that an investor will ever know as much about the product as
the entrepreneur and his team. Even if they have a technical background, this
can be out-of-date quickly and they are rarely in a positon to adequately judge
the quality of the product development systems or the reasonableness of the
tmescales. This is therefore a high exposure area for the investor. To overcome
this limitaton, the entrepreneur will need to show adherence to budgets
and targeted tmescales, or show how the available products are capable of
producing the results required. The entrepreneur must accept that keeping
development costs under control and meetng development tmescales is
critcal to ensuring the investors ongoing fnancial support.
Later Stage Investments
More mature frms with established management, proven products and
demonstrable revenue streams, ofen seek funds for market expansion, flling
out product portolios, acquisitons or working capital. Such frms ofer a very
diferent risk profle to the private equity investor compared to a start-up or
early stage venture. However, such investments are not without their risks.
Firms ofen seek external private equity fnance because they don’t have the
tangible assets needed by traditonal banking lenders. Thus the ‘assets’ which
underwrite the funding are ofen ‘sof’, such as patents, brands, copyrights or
simply a good business model. As such, they are harder to value and ofen hard
67
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
to liquidate. Even so, they may be good revenue generatng assets and can
provide some level of comfort to the investor.
The investor is stll concerned with an exit. He will need to balance two
opposing concerns, the upside potental of the business and the risks of failure.
The upside opportunity will be presented in terms of building market share,
establishing overseas ofces and penetratng existng markets with additonal
products. However, the risk will be in the executon. Does the team have the
skills and experience to deliver the target numbers? Will the market support
their growth?
With more mature enterprises, the investor has a much greater body
of evidence to examine how well the company performs strategically and
operatonally. The investor will stll need to conduct extensive due diligence to
uncover any weaknesses or risks. Established products and relatonships can be
examined to determine market potental and service excellence.
Many entrepreneurs seek fnance at this level to provide a boost to their
business so they can reach a size and proftability where they can convert equity
to debt or take the company to an IPO. This recapitalisaton enables them to
gain larger critcal mass while at the same tme gaining back the equity passed
to the investor as part of the fnancing deal. The entrepreneur is betng they
can generate the level of security needed to fund debt within a relatvely short
period of tme (3-7 years) to take out the investor.
Entrepreneurs are ofen reluctant to part with equity, seeing this as loss
of control and/or loss of upside potental. However, a deal which allows the
entrepreneur to redeem the investor’s shares at some agreed formula can be a
very atractve method of building up the business with an opportunity to buy
back the external equity. Expansion fnance which is used to build up tangible
assets, decrease revenue and proft volatlity or increase the portolio of revenue
sources, can provide a platorm for negotatng debt to repay an investor.
Entrepreneurs interested in short-term equity investment with redeemable
optons need to have a clear focus on the security requirements for debt
fnance. These factors then need to be built frmly into the business plan with
the agreement of the investor. Even partal redempton, swapping some equity
68
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
for debt, during the investment period, may be an atractve opton for both
partes.
However, the entrepreneur stll needs to accept that there is a potental pitall
in bringing in an investor. An investee frm which fails to meet agreed targets
or fails to generate sufcient free cash to fund debt obligatons is stll subject
to interventon by the investor. The investment agreement would normally
allow the investor to take acton if the investment is in trouble. No business
is entrely free of risk, even if this is external to the frm and even to their
marketplace. The entrepreneur seeking later stage fnancing cannot guarantee
they can recapitalise or take the business to an IPO. Failure to provide a liquidity
opportunity for the investor will result in interventon by the investor to ensure
that there is an exit opportunity while the business stll has real worth. This will
ofen result in the frm being sold in a trade sale.
In more mature businesses, the investor is likely to play a very diferent
role than that undertaken in early stage ventures. Where early stage ventures
typically need advice and directon in moving the business to proft, growth
and sustainability, later stage businesses ofen only need help at the Board
level. Their needs are more likely to be advice on strategy and creatng the right
foundaton for an IPO or major trade sale. Good governance, good reportng
systems and a structure which reduces internal risks need to be developed.
Investors in larger ventures ofen assist with global expansion, help establish
strategic relatonships and assist with VC rounds.
The Investment Proposal
Any request for Angel or VC fnance should have a comprehensive business
plan. It is not that the investor could not understand the business from a
discussion or presentaton, it is just that it is more efcient in the long run
for the entrepreneur to have it all documented in advance. The investor can
then reject it with a quick glance at the executve summary, review it prior to a
meetng, use it to open discussions with other co-investors and use it to drive
the due diligence process if they wish to proceed.
69
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
The general view is that, if the entrepreneur cannot put together a good
business plan explaining every aspect of their business, they probably don’t
understand the business well enough to grow it to the point the investor
desires. Part of the entry test for investment is that the entrepreneur have the
necessary literacy, numeracy and communicaton skills to run the business. The
business plan is one of the tests they need to pass.
The major beneft to the investor of the business plan is to provide an
opportunity for the management team to demonstrate they can build a model
of the business which an outsider can understand. The model needs to be
holistc. It has to explain every aspect of the business in sufcient detail to show
that they understand how all the parts have to work together over tme.
The investor is being asked to invest considerable funds in a business which
they are trying to understand. It is unlikely that they will ever understand the
business as well as the entrepreneur and the management team. Since the
investment is only for a short period, say 3-7 years, they need to see a strong
possibility of a trade sale or an IPO during that tme. What the entrepreneur
needs to demonstrate in the investment proposal, in non-technical terms, is
that he or she can achieve those objectves.
Most business plans are simply projectons of the past. It is simply Excel
madness. It is almost as if, by putng the data into Excel and projectng it
forward for three years, it will happen. Of course it may. But that would be
more hope than strategy. Forecasts need to be based on a set of realistc and
defensible assumptons. For many entrepreneurs, the business plan is an
expression of what they would like to happen. They work backwards from what
they would like to happen to establish the growth rate that will get them there.
Alternatvely, they use a set of assumptons which seem reasonable and build
their business plan on those assumptons. This is ofen presented as the classic
‘percentage of the market’ plan: ‘The market is huge and we only need 2% of
the market to be a $100 million business.’
However, most ofen this is not supported by any validaton that the customers
will buy the frm’s products or that they will buy in the volumes asserted. The
business plan needed by an Angel or VC frm has a very specifc purpose. It is to
70
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
convince the investor that the frm can deliver the objectves they have for the
use of their money. Put simply, that means:
• a 25% plus ROI
• known expansion opportunites
• an exit via an IPO or trade sale in 3-7 years
• identfed potental trade buyers
• limited support required
• relatvely low risk.
Many entrepreneurs think the purpose of Angel or VC fnance is to help them
grow their business, or they think that the investment is simply another form
of fnance that will help them overcome some constraint within their business.
What they fail to appreciate is that Angel and VC fnance is specifcally designed
with certain objectves in mind which can only be achieved by developing the
business so that the investor can achieve a good return on their investment
usually through an exit event in a relatvely short period. The purpose of the
business plan is to prove that those objectves can be met.
The business plan the entrepreneur needs to produce should have the
following three components:
Where is the venture now and what is the growth opportunity?
What is the exit strategy?
How are they going to achieve it?
The business plan should also include details of the management team
and their capacity to deal with the business development strategy along with
the how the funds sought are going to be utlised in support of the business
objectves.
Where is the venture now?
The entrepreneur should have a well-artculated business opportunity which
needs Angel or VC fnance in order for it to be achieved. So the frst part of the
71
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
proposal for Angel or VC fnance should be about the business opportunity and
the extent to which it has been validated.
It is almost always going to be the case that the entrepreneur will think only
in terms of building a fnancial business. They will seek to generate signifcant
revenue and proft to justfy the Investment. It is highly unlikely that they will
have thought of an IPO or a Strategic Trade Sale exit or be able to show how this
could be achieved. Their inclinaton will almost always be to prove a traditonal
business model concept. What they need to do is to switch focus and show how
the exit will be achieved.
The proposal should demonstrate the strength of the growth potental of the
underlying product or service as this will be critcal for an IPO or trade sale exit.
The entrepreneur should be explaining the following :
• What is the business concept?
• What is the size of the target market and how will the frm secure its
share?
• Who is the customer?
• What is the beneft to the customer and where is the compelling need?
• What price and why?
• How is the product or service distributed to the customer?
• What is the compettve advantage?
• How is sustainability of the business achieved?
If the business is already operatonal, the existng business should be able
to demonstrate the operatonal aspects of the business model. This should
validate the product/market informaton, the fnancial aspects of the business
and the management team’s capabilites. If there is a strategic exit opportunity,
this informaton may deal with how the strategic buyer would execute on some
of these elements.
In summary, the investor needs to be convinced that this is a good business
with a good idea or strategy, is well run and has a good chance of achieving the
fnancial or strategic exit required.
72
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
What is the exit strategy?
Most Angels and VC frms have similar objectves for their investments. While
they enjoy the involvement with emerging companies, they want their money
back with a 25% plus ROI within 3-7 years. Therefore, the investment proposal
should clearly set out how much Angel or VC fnance will be needed and how
the investor will achieve that objectve.
The investor needs to know which exit strategy is being proposed and why.
Potental multple exit opportunites are even beter as they bring fexibility
and reduced reliance on equity market cycles. The vast majority of frms simply
cannot meet the atributes of an IPO. For others, the IPO strategy cannot be
met with their existng business model and it will take a number of acquisitons
to create the right IPO vehicle. Only very few will have the right mix of products,
markets and potental to undertake an IPO and also meet revenue and proft
targets for several years beyond. Since an IPO generally achieves a much higher
ROI than a fnancial trade sale, the IPO strategy should be followed. However,
a trade sale alternatve should be artculated in the proposal for periods where
the market is unreceptve for an IPO.
For the trade sale exit, the entrepreneur should be setng out a comprehensive
road map for how the sale will be achieved. This should include identfcaton
of specifc potental buyers, the tactcs which will be employed to develop
relatonships with each and an estmate of the likely sales price.
How are you going to get there?
The business plan is simply about executon. The business is at point A (now)
and it needs to get to point B (the exit), what are you proposing to do to get
there? You need to set out exactly how you are going to put the strategy in place
over the 3-7 year tmescale.
Some Angels prefer to keep it simple. Knowing that the management team
is somewhat green and need help to develop the business, they need to ask:
Exactly what are you going to do with my money?
73
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
Say you are a $1 million revenue business. To get to the exit point, you may
need to grow the business to $4 million. Alternatvely, you may need to complete
product development or establish trial customers to prove the product. How
are they going to do it? It is not simply an extrapolaton of the numbers. You
need produce operatonal plans for every part of the business.
• A detailed marketng plan
– Size, growth, customer profle, competton
– Promoton, advertsing, PR plans
– Proof of efectveness
• A sales plan
– Closure rates, remuneraton plan
– Recurring business revenue and targeted prospects
– Sales targets and recruitment and training plan
• An R&D plan
– Product development and release milestones
– Quality assurance, recruitment and training plan
– Equipment plan
And so on.
There is nothing wrong with an entrepreneur admitng they need help to
develop such a detailed plan, but the investor is likely to delay making any
substantal commitment untl a proper business plan is in place, even if they
help develop it. Only by getng down to this level of detail will you understand
just how much fnance and efort you need, but also, just how likely the business
is to succeed.
74
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
Before commitng to the investment, the investor will need to review every
part of the plan and see exactly what each manager will be doing to contribute
to the overall plan. The business plan should also set out an organisatonal
plan (including recruitment and training) and plans for ofce accommodaton,
manufacturing and warehousing space, infrastructure and fnance. A set of
projected fnancial statements should be available.
An investor will ask; ‘Show me exactly how these revenue numbers are going
to be made?’ They may want to see a breakdown of forward revenue projectons
for both recurring revenue and new business. The recurring revenue should
be supported by actual contracts with customers. The new business should be
supported by a prospect generaton and sales closure plan that targets specifc
customers or specifc channels and so on.
The more you can show you really understand how to make the targets
and you have the people, systems and processes in place to do so, the more
convincing your plan will be.
At the same tme, the growth plans may call for new management positons
to be flled, in which case an executve recruitment plan should be included in
the plan.
Which business plan layout
There are many examples of conventonal business plan structures in
textbooks and on the internet. Those ofered by VC frms are good guidelines
for the content. However, it is the way it is put together that is important.
Remember that the business plan should be about how you are going to meet
the investor’s objectves, not how you are going to meet yours.
For an insight into how a typical VC business plan might be structured, review
the descripton provided on the Britsh Venture Capital Associaton website in
the document A Guide to Private Equity (see htp://www.bAngela.co.uk/).
75
Raising Angel & Venture Capital Finance
6
There are two major paths to a successful exit of the frm. One is to sell the
frm. This might be to another business (trade sale), usually a corporaton in a
similar or related feld or to another Angel or VC Fund (secondary buy out), or to
a wealthy individual. The second path is to list the frm on the stock exchange,
an inital public ofering (IPO).
Initial Public Offering
The requirements for listng a frm are quite onerous and expensive. Unless
the listng results in a share price which can maintain a positon at least as
good as the sector index, the listng will not achieve an exit the shareholders
antcipated (assuming the shareholders hold shares in the listed company). Just
having liquidity of the shares via a market listng does not in itself guarantee
the value achieved by the shareholders will be greater than an outright sale to
a corporaton.
Some private companies undertake an IPO, or a back-door listng (acquire
an existng but dormant publicly listed corporaton), with the intenton of using
it to raise funds or to sell shares. Typically, back-door listngs are done with
smaller companies. However, unless the size of the shareholding in public hands
is signifcant, generally thought to be above $100 million, there is insufcient
liquidity to create a market to sell shares.
Exit Strategies
76
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
The table below shows the types of characteristcs which best suit an Inital
Public Ofering (excluding speculatve ventures such as biotechnology and
resource ventures).
Atribute Requirements for long-term atractve public listng
Revenue $20 million plus ($100 million plus the most successful).
Net proft Proftable for three years with minimum of $2 million in the year prior to
listng. Projected profts growing over next few years.
Scope Natonal or internatonal markets.
Portolio Range of products with some in diferent markets.
Potental Major natonal leadership or global markets.
Management Majority with public corporaton experience and some with experience in
larger corporatons.
Board Signifcant industry and public corporaton experience.
CEO Able to deal with market analysts, insttutons and shareholders.
R&D Products in various stages of development to ensure contnued market
leadership.
Cash Sufcient funds to meet forecast plans without further capital raisings.
Funds use Funds raised to be used for market development, innovaton, overseas
expansion, acquisitons, working capital, repayment of debt.
Advantage Clear compettve advantage based on strong intellectual property and/or
proven innovatve business model.
Public awareness Products and their benefts are easily understood by the public.
Support Listed shares are large enough in value and number in insttutonal and
public ownership to encourage market analysts to track the stock. Generally
this means a market capitalisaton of at least $100 million.
Since few companies in private ownership can meet these requirements, an
exit strategy aimed at an IPO is not a viable opton for most privately held frms.
That is not to say the smaller companies cannot exit through an IPO, but the
above provides the best foundatons for success.
77
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
Generally it will take a minimum of $500,000 in legal and accountng expenses
for even the smallest and simplest IPO. According to KPMG Corporate Finance’s
2004 Australian Capital Markets survey, the average cost of raisings up to $10
million was 10.1%, falling to 4.7% for raisings greater than $500 million. If only
a small amount is to be raised, this cost is very high for the funds received. At
the same tme, an IPO usually involves signifcant work for the top executves.
This has ofen been thought to be 50% of the CEO and CFO’s tme over the
six months prior to the IPO. This is a very signifcant burden on the frm and
requires the rest of the management team to bear the burden of day-to-day
management during this tme. A USA listng would be more expensive in annual
expenses due to the greater disclosure requirements.
The overall consensus of private equity advisors is that only four factors are
considered key to a successful IPO. The frst factor is the venture should have a
strong compettve advantage and sufcient growth potental to achieve a $100
million capitalisaton value within about fve years of listng. Neither the current
level of revenue or proft is considered signifcant compared to antcipated
revenue and proft. This factor also goes a long way to explaining why low
growth frms which have low margins either don’t make it to the exchange or
have to be signifcantly larger before they can.
The next major factor is the depth and experience of the management team
and the industry experience of the Board of Directors. Again this is not surprising
when you consider that the shareholders are backing a group of individuals to
take them to the size necessary to support the $100 million capitalisaton. A
new management team or one which has signifcant technical depth but litle
management depth is not going to be received well.
Knowledge of the IPO process itself by the management team is a major
factor. This demonstrates just how important the roadshow to the brokers
and the presentatons to insttutonal investors are. Achieving signifcant share
purchase commitments up-front is almost a necessary conditon for a foat.
Knowledge of retail and insttutonal investor risk and return requirements and
being able to convincingly show growth potental is an imperatve. Investors are
typically risk-averse and will quickly zero in on potental risks in the venture.
The management team must be able to convincingly demonstrate knowledge
of their business, their industry and how to mitgate possible risks.
78
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
Finally the frm must have the best possible advisors. The best advisors and
investment bankers are expected to have the best due diligence processes,
require the highest standards of preparaton but also carry the highest level of
credibility to the market. They are also very selectve in who they represent.
Too many entrepreneurs see an IPO as a means of solving their own business
problems rather than seeing it as a means where retail and insttutonal
investors achieve a return on their investment. Without gaining the support of
a signifcant number of retail investors and/or support from some insttutonal
investors, the frm is likely to push themselves onto the market by satsfying the
minimum listng conditons and then fnd that just being publicly listed does
not solve their inherent problems. As we have seen many tmes – the market
penalises those which don’t perform. In many cases, these frms would have
been beter to wait untl they had more robust growth potental before listng.
It may not be possible for the major shareholders to exit at the tme of the
IPO or even within some years. Markets are very wary of public issues where the
key managers sell of their shares completely. In a situaton where the results
are not achieved subsequent to a sale of shares, the inside shareholders could
also face legal charges of insider trading.
A frm which wants to undertake an IPO exit needs to build the IPO profle
above. So, to the extent that it cannot meet the requirements within the existng
business, the additonal atributes need to be developed or acquired. With 3-7
years to execute the IPO strategy and especially with Angel and VC fnancing,
a frm may be able to achieve the necessary characteristcs given the right
startng point. Many companies which atract funding have already identfed
strategic acquisiton opportunites to bring economies of scale and growth to
the company.
In some sectors, building a company via acquisitons is a possible strategy.
Certainly in the years 2002 and 2003, frms in the biotechnology sector in
Australia needed to undertake consolidaton to gain additonal resilience,
product portolio spread and critcal mass. Too many biotechnology frms were
undercapitalised, had very narrow product ranges and too litle revenue spread
from licensing to longer-term producton products.
79
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
Ofen in emerging markets there will be several frms with complementary
products, ofen selling to the same customers or working with the same alliance
partners. These could be brought together to provide a platorm for an IPO
vehicle. However, there needs to be an obvious and demonstratable synergy
between the products and the frms. Just lumping a number of frms together
to reach the revenue and proft targets is unlikely to convince the insttutonal
investors they are investng in a sound platorm of future growth.
At the same tme that the underlying product portolio is being built, the
frm needs to construct a management team capable of running a growing
public corporaton. Public corporaton experience, experience with larger
corporatons, deep experience in the industry and a good track record, are all
essental characteristcs for the IPO management team.
The IPO strategy needs to show, in considerable detail, how the IPO prospect
profle will be achieved. Underpinning the plan should be documented
representatons from respected accountants, lawyers, bankers and brokers who
are willing to work with the frm on building the IPO strategy.
Trade Sale
Most Angels and VC Investors exit or harvest their investment through a sale
to another frm. This is called a trade sale.
Where possible, the Investor will seek a strategic trade sale to order to meet
or exceed their return on investment (ROI) needs. A strategic sale occurs when
the value placed on the business exceeds its fair market value (FMV). The FMV
is most ofen determined by looking at the current business as an investment by
an independent investor looking for a return on their money. The current proft
is taken as indicatve of the ongoing proftability of the frm and ROI. Since few
owner/managers operate the business to maximise profts, this will normally
undervalue the business.
A conventonal sale based on an EBIT multple would certainly be atractve
to an Investor if a strategic sale was not possible. In that situaton, atenton
needs to be given to increasing operatng proft, decreasing risk and establishing
a growth potental in order to secure the best price.
80
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
However, normally a strategic sale can be expected to achieve a sale price
considerably above a conventonal sale price. The key to a strategic sale is to
fnd a corporate buyer which has a need for the assets and/or capabilites of the
frm. This strategic ft can come from any number of possible areas:
• customer base
• distributon channel
• brands
• patents, trademarks, licences
• key employees
• access to specialised knowledge and so on.
Strategic buyers most ofen come from within the industry in which the frm
is operatng. They can be suppliers, customers, alliance partners, joint venture
partners or compettors. Sometmes the sale will be to a corporaton not in
the sector. They may want to acquire a presence in a market/geography as a
foothold or may wish to diversify.
The Proactve Sale Strategy developed by the author defnes a process which
can be used for fnancial and strategic trade sales. This methodology has fve
major components:
• alignment of interests
• due diligence and good governance
• creatng value for the buyer
• selectng buyers
• building relatonships with potental buyers.
(a) Alignment of interests
In order to be prepared for a trade sale, especially when there is tme
pressure to set up and consummate a deal, the various stakeholders need to
agree on the possible outcome. There is litle point in progressing a deal if the
Directors cannot agree on what they want, or the shareholders cannot agree on
a reasonable price. A negotator cannot go into a meetng to secure a deal if the
interests of the major stakeholders are unclear. Experienced Investors usually
have the Board focused on exit strategies from the frst Board meetng.
81
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
The major stakeholders who are critcal to executng a deal are:
• members of the Board of Directors
• management
• Investor along with other shareholders
• key employees.
The Investor needs to ensure that all stakeholders are focused in regard
to the two extreme situatons: a forced sale due to decline in the viability of
the business or a planned sale over a longer term. Once the CEO has a list of
requirements, opinions, conditons and issues which need to be considered,
he/she can start to bring all elements together to arrive at a strategy which
could be followed in these two extreme situatons.
(b) Due diligence and governance
Nothing kills a deal quicker than an uncertain or immeasurable risk. Many
people think the valuaton on sale is due simply to revenue and proft. What
happens in practce is the buyer conducts an extensive due diligence into every
aspect of the frm’s operatons in order to uncover actual or potental problems,
risk and liabilites. Since each of these requires tme and funds to resolve, the
ofered price is likely to fall as the review goes forward. At some point the risk,
tme and cost to fx the problems become so great that a deal is not possible.
The task of the Board from a directonal perspectve together with the CEO
from an operatonal perspectve is to establish the frm and its operatons to
minimise risks to the buyer. This includes putng into efect such things as:
• Standardised and documented contracts with customers and
suppliers.
• Industry standard terms of employment, benefts and enttlements.
• Full ownership and tracking of intellectual property.
• Full compliance with industry, health, safety and environmental
regulatons.
• Comprehensive reportng, budgetng and planning systems.
• Policies, procedures and processes covering critcal aspects of the
operatons.
• Industry knowledgeable accountants and lawyers.
82
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
The key to passing a business to a buyer is to put yourself in the buyer’s
shoes and think through the integraton and operatons of the business afer
the acquisiton. The task of the CEO and management team is to ensure that
the business can operate efectvely afer the acquisiton without imposing an
undue burden on the buyer.
Included in the planning for a sale should be a consideraton of the roles of the
key employees. In most acquisitons some roles will change, some staf will be
made redundant and some key employees are needed to ensure a transiton of
knowledge. How can you ensure that this process happens without disrupton?
This means determining retenton terms for some, redundancy packages for
others and incentves for all staf to make the transiton happen as smoothly as
possible.
(c) Creatng value for the buyer
In a fnancial exit, the frm needs to create value through the generaton
of future net earnings. Preparaton for sale would focus on improving internal
processes, reducing expenses, increasing revenue and margins, adding revenue
growth and then seeking out opportunites for potental growth.
Strategic acquisitons occur because a corporaton has a need for some asset
or capability which the frm has. Generally this is something which the frm
already leverages to create its own compettve positon. As part of the Strategic
Sale Strategy, the Entrepreneur needs to think carefully through the operatons
of the business and isolate those things it has and those things it does which
could be used by a large corporaton to resolve a threat or generate signifcant
new revenue.
Assets or capabilites which create strategic value should be based on one, or
several, of the following characteristcs:
• difcult or tme-consuming to copy
• protected by patents, trademarks or copyright
• only available through licensing or registraton which is limited in
supply
• unknown due to confdentality or trade secrets
83
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
• requires specialist knowledge to acquire or utlise
(d) Selectng buyers
Financial buyers are ofen corporatons undertaking a roll-up or consolidaton
strategy. They are looking for well managed frms in their sector which can add
revenue and proft to group earnings.
A strategic buyer is a corporaton which is prepared to pay a premium over fair
market value because the business solves a critcal problem for them or ofers
them a good opportunity for additonal revenue and proft. The best strategic
buyers are ones which can exploit an opportunity by ofering a unique product
on a much larger scale than the frm is able to with its limited resources. The
Investor should look for corporatons which can overcome whatever constraint
is holding back the business.
Buyers normally come from within the industry, so start by listng companies
in the same industry as the investee frm. You then need to select those
companies which have the capacity and experience to do the deal. Corporatons
with experience at acquisitons and which have ample size and funding are
much easier to deal with. The ideal buyer will typically be at least 8 tmes the
size of the seller.
(e) Building relatonship with potental buyers
Trade sales are mostly made between partes which already have some
knowledge of each other. This could be informally through networking functons,
between prior colleagues or could be a formal trading relatonship such as a
partner or distributor. Other relatonships can exist through Boards of Directors
or Boards of Advisors or equity partcipaton. The key to a trade sale for an
Angel or VC funded company, as with any other company, is to be prepared.
Any early stage venture is going to experience some turbulence and not
everything will go according to plan. In terms of exit preparaton think of the
situatons you may experience.
84
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
1. You need to sell
Not everything is going to go according to plan. Sometmes market conditons
change and the business is no longer capable of reaching the targets initally
set or may no longer be viable. Rather than let the frm become insolvent or
bankrupt, the exit plan should be established early so that there is litle delay
in executng a trade sale. This way the maximum beneft can stll be extracted
from the failing business.
Ofen tme is against you. If the management team has not put an exit
strategy in place, they will have litle tme to prepare or to initate discussions
with potental buyers. If they have not set up the relatonships in advance,
especially with overseas buyers, it probably is not going to happen the way
you would like. Without planning, the ability to atract a buyer who will pay a
premium value for the company is signifcantly constrained.
By setng up relatonships in advance and by knowing why the corporaton
would want to buy the frm and who to deal with inside the potental buyer,
management can execute the acquisiton discussion quickly. As long as the frm
has several potental buyers, compettve tension in the deal can stll result in a
very atractve sale price.
2. The frm is approached with an offer to buy
Many Angel and VC funded frms are targets for acquisitve corporatons.
However, when the ofer comes management may be unprepared. They are
ofen unsure of an appropriate price. If management is unprepared and needs
to go through extensive due diligence, this not only takes considerable tme, but
it uncovers risks to the buyer. Instead of closing a good deal the frm will end up
with a disrupted business, staf who are stressed due to uncertainty and a price
the shareholders would normally not have accepted. Management may also
have talked themselves into the deal. Management will have taken their eyes
of the ball and will have much to do to recover.
How much beter would the situaton be if the frm had already lined up
several possible buyers? They can now announce that they are prepared to sell
and take on all ofers. Management will have prepared the due diligence fles
and can execute the deal quickly with litle disrupton. The staf understand the
85
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
process and have incentves to ensure the best deal is done. The exit strategy
should be canvassed with staf from an early stage so they understand the
objectves of the Investor as a shareholder in the company.
3. The Investor and management decide to sell
Experienced Investors and good management should already know of the
best potental buyers and through business operatons should already be in
a positon to actually know those partes. If management have prepared the
company for sale over many years, they are best placed to drive the exit process
rather than have it drive them. The Investor and management simply need to
decide on the tming.
It is a highly desirable characteristc of Angel or VC funding that the Investor
exits the investment within a relatvely short period. Few Investors like to have
their funds ted up for more than fve years in a venture. If the prospectve
investee frm artculates a viable and well-artculated strategy for a trade sale
going into the funding negotatons, it will greatly improve their case and the
Investor’s confdence for achieving the Investor’s exit objectves.
With the trade sale exit strategy outlined here, you can be reasonably assured
that you will gain the best price you can and know the corporaton doing the
buying will make more money out of it in the future. If the Investor has a very
good idea of the trade sale exit opportunity, he can spend the tme assistng
management to develop the business and build a strong case for the buyer. This
focus makes it easier for the Investor and the entrepreneur to work together
since they have clearly defned common objectves.
This process is well proven. If you think of the frms you have seen sold at
large premiums, you will always fnd they created signifcant value for the buyer.
86
Raising Angel & Venture Capital Finance
7
R
aising VC funds is a process that will involve several partes. The smart
entrepreneur wants the best investor, however, the best ones don’t go
looking for investment, they atract them from known and trusted business
colleagues. To fnd the right Angel or VC investor, the entrepreneur needs to build
up a network of knowledgeable contacts within the investment community. The
process may well start with a local professional advisor and then extend through
more experienced advisors to the ultmate Angel or VC investors.
Professional advisors help to educate the entrepreneur, prepare him or her for
the evaluaton and the negotaton and ensure that the ultmate deal is fair for
both partes. In the end, there is no substtute for quality – both in the professional
advice and in the Investor that the entrepreneur ultmately works with.
Only a small number of entrepreneurs will ever raise Angel and Venture
Capital fnance once and even fewer do it several tmes. Therefore
very few have built up knowledge of the venture capital investment process.
Working with professional advisors who partcipate in these transactons on a
regular basis can provide the entrepreneur with insight into how best to prepare
for discussions with the Investor. Not only can this save tme but it should lead
to a beter deal for the entrepreneur. The professional services frm should be
able to provide introductons to beter investors, ensure that the deal is fair and
Preparing for the
Investment
87
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
reasonable and set the right expectatons up front so that all partes understand
how best to work together for mutual gain.
Accessing the right Angel or VC frm is also an important part of the investment
process. Not all Angels or VC frms have the same capabilites, networks and
capacity to work efectvely with the entrepreneur. Finding the right one can be
critcal to the ultmate success of the venture.
The professional accounting and advisory frm
The type of advice and help which a professional accountng frm can provide
includes assistance in the following areas:
Valuation
The services frm can assist the entrepreneur to prepare a valuaton of the
business either prior to the investment or at the antcipated exit. If the frm
has prepared a valuaton of the current business and projected valuaton of
the business at the proposed exit point, this will contribute considerably to
the equity share discussion with the Investor. The advisory frm can assist in
the preparaton of the valuaton or review the fnancial projectons for the
entrepreneur, check the completeness and accuracy of the informaton and
review the underlying assumptons and values.
Checking the business plan
The business plan is the foundaton document which will be used by the
investor to evaluate the investment. It is important that the business plan be
prepared thoroughly, be properly explained and contain the informaton needed
by the Investor to undertake due diligence on the opportunity. The advisory frm
can review the business plan and show where additonal informaton is needed.
Reviewing fnancials
Current fnancials need to be prepared according to generally accepted
accountng principles and presented in a conventonal format which allows easy
analysis. The accountant can ensure that the statements are prepared correctly
and the accompanying data fully supports a detailed investgaton.
88
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Advice on use of debt and equity structures
The business may be able to support some level of debt as well as an equity
investment. Using debt should reduce the equity share which the frm would
give to the Investor. The advisors may also be able to show where cash may be
beter managed in working capital, accounts receivable and accounts payable
to reduce fnancing needs as well as provide independent advice on debt fees
and terms.
Helping with introductions and referrals
Well-established advisory frms partcipate regularly in transactons involving
Angels and VC funds. This would include investments, acquisitons, trade sales
and IPOs. They are, therefore, in a good positon to know local Angels and VC
funds on a personal basis and certainly by reputaton. The advisory frm can
assist with preparing informaton on the frm for an investment proposal and
assist with Angel and VC introductons. An accountng frm can help short list
the Investors to approach and can help with introductons or referrals. Since
many Angels and VC funds only deal with referred proposals, this can make
a big diference in accessing quality Investors. It can also assist in getng an
opportunity to the top of the pile as advisory frms act as a pre-reader of
opportunites and provide a deal fow which expects a tmely response from
the beter investors.
Reviewing term sheets
While term sheets are typically set out in a conventonal format, the
Entrepreneur may wish the advisory frm to review the term sheet before it is
sent back to the Investor.
Assisting in negotiations
The Entrepreneur who is represented by a well-established and respected
advisory frm is likely to be beter prepared for the negotaton. At the same
tme, the Entrepreneur should expect that the Investor will be equally
represented by their own advisory frm who would be familiar with private
equity transactons. The terms and conditons of the investment should be
reviewed by a knowledgeable party so that the Entrepreneur knows that the
terms of the investment are reasonable and standard. This should result in more
89
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
productve discussions and is likely to be beter for the ongoing relatonship
between the partes. Investors prefer to deal with entrepreneurs who are
represented by a professional frm as they know that the entrepreneur will not
need to be educated about the investment terms and conditons, the required
rate of return, management controls and exit requirements of the Investor.
Due diligence
Due diligence will be carried out by the Investor as part of the inital
evaluaton of the investment opportunity. This is mostly a product/market
evaluaton to see if the business environment can support the projectons of
the frm. Afer the term sheet is issued, the Investor will carry out an extensive
review to further assure he has a thorough understanding of the business and
the management and has uncovered any data discrepancies and investment
risks. The professional advisory frm can help the Entrepreneur prepare for a
due diligence investgaton by identfying any problems, risks and defciencies
which need to be addressed.
Advice on pensions, options schemes and remuneration
The professional advisory frm can review these before an investment is
made to ensure the current remuneraton and benefts are fair and reasonable
and provide the most positve basis for the planned exit.
Tax advice
The frm can expect to change signifcantly over the period of the investment
and beyond the exit. Their current tax planning may not be suitable for such
changes. The accountant can review the current business processes for
compliance, tax collecton and reportng.
Exit strategy assistance
A well-artculated and probable exit strategy needs to be prepared as part
of the business plan. If this has not already been prepared by the entrepreneur,
the advisors can help to defne acquisiton value, identfy potental buyers and/
or show how the frm can best positon itself for an IPO or a trade sale exit.
90
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Commercial review of agreements
The accountng frm can review legal agreements to ensure they are
commercially acceptable. This review should also be done in conjuncton with
the frm’s legal representatves.
The professional legal frm
The type of advice and assistance which a professional legal frm can provide
includes the following:
Review share purchase agreement
The share purchase agreement would normally be prepared by the Investor’s
lawyers. This is a complex legal document which few entrepreneurs will have
ever seen and certainly few would understand at any depth. The professional
legal frm can review the document, explain the terms and conditons to the
entrepreneur and work with the Investor’s legal representatve to fnalise the
agreement.
Prepare warranties and indemnities
The frm would normally be expected to provide warrantes, representatons
and indemnites to the investor. The professional legal frm can prepare
the warrantes and representatons and indemnites documents for the
Entrepreneur.
Review new employment agreements
The Investor should expect the key executves to enter into employment
agreements and will expect to have signifcant control over their remuneraton.
Those agreements would normally contain restraint of trade and/or non-
compete clauses. The professional legal frm can review these agreements.
Prepare disclosure letter
The frm should be prepared to disclose any issues which may afect the
decision of the Investor. It should also identfy any potental risks of the business.
The professional legal frm can prepare the these disclosures and advise the
Entrepreneur how to deal with theses in the negotaton.
91
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Review corporate documents
As part of the preparaton for investment, the professional legal frm will
review the corporate documents which authorize the frm to undertake business
to ensure that it meets the requirements of the Investor. This review would
normally extend to board minutes, shareholder agreements, opton schemes
and any material contracts the frm has entered into.
The Entrepreneur should plan for 5-10% of the money invested to be spent
in professional services fees, notng that smaller deals are likely to have a larger
percentage of advisor’s fees.
Not all professional services frms have the necessary experience to
undertake this type of work efectvely. An Entrepreneur seeking their frst
investment should not assume that their current professional services provider
has the expertse to properly advise him in this area. Before startng to incur
costs for this service, the Entrepreneur should undertake some due diligence
and investgate the extent to which the frm has a track record of success
advising Entrepreneurs seeking investment from Angels or VCs. Asking for
references would not be unreasonable and they also should be asked for a
list of transactons which the frm has partcipated in and some details of the
work performed for the clients involved. The Entrepreneur should also ensure
that the expertse is stll with the frm and ask to be allocated an advisor with
personal experience in these types of transactons.
Selecting an Angel or Venture Capital Fund
Angels and VC frms vary greatly in their
capabilites and the extent to which they desire or are
able to intervene directly. Some frms prefer a hands-of approach and thus seek
a management team able to execute the business plan without interventon.
Other VC funds prefer to assist with the selecton of some of the management
team, stay close to the acton and actvely partcipate in setng up deals,
promotng the frm and establishing networks.
Most experienced Angels and VC frms are reasonably good at declaring the
type of investments they are seeking. They will normally provide an indicaton
of the stage they prefer and the level of investment which they typically
92
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
make. These atributes will allow the entrepreneur to prune down the list of
Angels and VC funds to those which are actve in their target area. Next the
entrepreneur can exclude those Investors who target specifc industry sectors
that are inappropriate. This should leave a smaller list which the entrepreneur
can investgate more thoroughly.
The entrepreneur needs to assess what type of assistance (if any) is needed
from the Investor. Possible issues might be:
• recruitng senior executves;
• recruitng Directors for the Board;
• accessing industry advisors;
• helping with staf recruitment;
• providing accountng, tax and fnance assistance;
• providing legal advice especially in contracts and IP;
• helping with banking relatonships;
• providing assistance with closing large customer or distributor deals;
• access to possible acquirers;
• experience with an IPO process; and
• expertse with overseas markets.
The entrepreneur needs to identfy how important various characteristcs of
the Investor are. For example:
• How experienced is the Angel or the VC team? How many frms have
they invested in and what is their performance?
• What experience do they have with similar ventures at their stage?
• What experience do they have in their industry?
• What has been their success with prior entrepreneurs? Have they
been able to work with them or have they been replaced?
• Have they been able to secure follow on investment?
• What has been their success at trade sales and IPOs?
With larger funds, the day-to-day management of the investee will typically be
handled by either an Associate Director or Director of the VC fund. This person
or the Angel will most likely sit on the Board of Directors and be involved in the
development of strategy. It may be of some importance to the Entrepreneur just
how much experience the Angel or the VC fund representatve has. A person
93
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
with limited business experience may be more of a liability than an asset to the
business.
Part of your investgaton should be to investgate the Angel or VC fund to see
if you would want them as a partner in your business. Aspects that you should
look into include:
Reputaton
The beter Angels and VC funds are well known to the professional services
community. Ask for advice from your advisor, lawyer, accountant and banker. Most
Angels and VC funds will work with sets of lawyers and accountants on each deal
they conclude. The larger professional services frms do the majority of the deals.
Compatbility
You will be working with the Angel or the VC fund and its nominees on your
Board for some years. You need to be comfortable with the people you are dealing
with and the way in which they prefer to do business.
Investee references
Take the tme to talk to the CEOs of the investment portolio frms. You might
also like to talk to those entrepreneurs who have worked with the Investor and
have exited. What type of support did they provide to the frms? How did they
react to changes in plans, disappointments and missed targets? How did they
work with the frm on strategic issues, exit plans, subsequent fund raising rounds,
closing deals, providing access to networks etc? Would they recommend them
to you?
Generally speaking it is not wise to approach too many Angels or VC funds at
the same tme. The industry is quite small and most executves in the industry
know each other, ofen work together in consortum funding deals and partcipate
in industry functons. The Entrepreneur who shops around will be identfed
relatvely quickly and probably be dismissed or avoided as the Angels and VC funds
may not believe they will get enough tme and atenton from the entrepreneur
to undertake their own inital investgaton.
94
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Some Angels and VC funds will only deal with referrals and not look at
unsolicited business plans. The VC Fund research data shows that most business
plans are only read as far as their executve summary (about 16 seconds on
average). Thus having a professional services frm make the introducton provides
the Angel and VC funds with some level of comfort that the basics have all been
covered. The professional services frm will also provide advice on which Angel
or VC fund is best suited for the investment sought.
Many frms with Angel investors will go on to raise Venture Capital fnance.
The inital due diligence undertaken by the Angel investor and his partcipaton
in the business can ofen provide the level of comfort that the VC fund is looking
for. Ofen angel investors have had prior experience co-investng with a selected
VC funds and thus the introductons carry greater weight.
The inital approach to a Angel or VC fund should be with an executve
summary. This way the Investor can have a brief review of the investment
opportunity without the complicaton of having to deal with a detailed business
plan. If the summary is of interest, it may request a meetng before going into
the business plan detail. It will use this meetng to assess the entrepreneurial
team as well as the proposed venture.
You may be concerned about confdentality. Normally this would not be an
issue with an established and reputable Angel or VC fund. However, you might
like to take some steps to provide yourself with a higher level of comfort. This
would include seeking advice from a professional services frm which works
actvely in the area of private equity fnance. Check to see that the Angel or VC
fund has no confict of interest with its other investments, provide confdental
data only during later discussions, initally just provide the executve summary
and consider using a confdentality agreement.
95
Raising Angel & Venture Capital Finance
8
T
here are as many diferent forms of investor pitches as there are investors.
If you are looking for a silver bullet, there isn’t one! For every investor
who prefers a two minute presentaton, there will be as many who want 20
minutes. For every Angel who wants you to tell them how much money you
are seeking up front, there will be just as many who would rather have that
informaton at the end when they know what you want to do with the money.
However, don’t be despondent. Over 50% of the presentatons I hear are
seriously lacking and almost all of them have some vital bit of informaton
missing. Rarely have I heard a great pitch. If you can avoid the obvious mistakes,
you will be in the minority and if you can provide the essental informaton,
you will be well received. There is nothing wrong with generatng questons at
the end of a presentaton, but what you don’t want is your audience to be lef
wondering why they wasted their tme because they don’t understand what
you do or what you want from them.
Building a story about your business and being able to present it to diferent
audiences is an essental requirement for any entrepreneur. If you are looking for
investment, recruitng a key executve, selling to that frst customer, borrowing
money from a bank or trying to convince a supplier to give you extended
credit, you need to be able to give a succinct and compelling explanaton of
your business. They can’t be expected to wade through all the details of your
Investor Presentation
Techniques
96
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
business to discover if it makes sense. Unless you can provide a short sharp
‘pitch’ on your business, you are going to miss out on some great opportunites.
The short version of your investor presentaton is ofen referred to as an
‘elevator pitch’ and is part of the language of venture capital. It derives from
an exercise that MBA students were required to do as part of their training in
entrepreneurship. You are told you have entered an elevator and next to you
is a venture capital executve who will get of the elevator in two minutes. You
have two minutes to present a compelling argument as to why he should meet
with you so that you can explain your venture in more detail. People who work
exhibiton stands know the drill very well although they rarely get 2 minutes. If
they are lucky they might get 20 seconds.
There is a lot to be learned from building a 2 minute pitch on your venture
and trying it out on people who know nothing about your business. The frst
thing you learn is that 2 minutes goes by real fast. You have to use words
sparingly and stck to the most important points. The next thing you fnd is that
your audience does not understand your business at all. They fail to grasp what
a great business idea you have, how great the product or service is and how
important it is that they invest in it. Basically – they don’t’ get it!! Of course
it does not take a rocket scientst to discover that this is not their fault. You
have simply failed to structure the explanaton in such a way that they could
understand it. So go back to the drawing board and start again.
Many people make the mistake of being too technical and providing too
much detail, forgetng that the aim of the pitch is to convince the non believer
about how fnancially atractve and robust the business venture is. Generally,
the greatest mistake is to fail to provide a clear explanaton of the essence of the
business; what problem are you solving, how you are solving it and for whom,
how big is the opportunity, what is your competton and why you think you can
be successful.
For an investor to be seriously interested, they need to see a customer with
a compelling need, a product or service that has unique, hard to copy atributes
which fulfll that need and enough potental customers to make it a reasonable
size business. You have to convince them that you have the team that can
execute on the opportunity. Lastly, it has to provide a good return on their
97
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
investment through a public listng or by selling the business within a relatvely
short period of tme, say, 3 – 5 years. You need to be able to deliver that message
in two minutes. A longer presentaton allows you more tme to present greater
detail but the core message is the same.
At one investment pitch session for angel investors which I atended, eight
seed and early stage ventures were given 20 minutes to present their investment
opportunity. The presentatons varied from poor to very good and from boring
to passionate. However, most of them failed to clearly defne the problem they
were solving and why their soluton was beter than the competton. Some
forgot to provide statstcs on market size, what porton they could capture
within a reasonable period of tme and how they were going to do that. Not
one of them had a clear explanaton of the exit strategy, perhaps the most
fundamental aspect of any angel investment.
I suspect that with further probing, all of these ventures could have been
made to look atractve. Angel and VC investors are not typically passive
investors who put their money in and wait for the cheques to come; they
are actve investors who typically assist the venture to develop. They do not
expect the business model to be ideal at the inital investment stage, but they
do expect to be given enough informaton to decide whether to spend more
tme in the investgaton of the opportunity. Most of these ventures wasted
their presentaton tme at this forum as they were poorly prepared, had failed
to test out their presentatons with non expert audiences and lacked practce.
Following each presentaton, the angel investors were given an opportunity to
ask questons and the teams were able to see where they had failed to present
essental informaton. Fortunately for them, they also received some very good
advice on areas where their business strategies could be improved.
Whether you have 20 seconds, two minutes or an hour to present your
business opportunity, you do need to prepare and practce the presentaton
otherwise you are wastng invaluable opportunites. As a potental recruit, a
prospectve customer or investor, I want to be convinced by both your passion
and your argument. If you can’t explain succinctly what you do and why I should
be a part of your grand venture, why should I waste my tme working with you?
98
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
What Investors Want to Know
Put yourself in the investor’s shoes. Why are they there and what do they
need to know to have an actve interest in talking to you further? Remember,
they hear lots of presentatons, don’t really care about the product or service
and are really interested in the risks and rewards for their investment. Keep in
mind that without a highly probable exit event, they don’t get their money back
and don’t achieve a return on their investment, so don’t forget about the exit.
While there is no ‘one size fts all’ presentaton, the basics should include the
following:
Introductions
Who are you, what is your positon in the business and what is the name
of the business.
What does the frm do?
You should be able to state what your business does in a few sentences.
“We provide security safety fences for high rise building developments”
“ We develop skin care products designed for tropical climates”
What problem or need are you addressing?
You would be surprised at how ofen I ask ‘What problem are you solving?’
at the end of a product presentaton. I hear all about the features and
functons, how it beats the competton and that customers love it, but
half the tme I am not told what problem or need it addresses. The key
here is to explain why customers need the product. What pain are you
addressing? What need are you satsfying? Why can’t the customers defer,
delay or avoid buying it? What evidence do you have that your soluton is
efectve and that customers will buy it at the price you propose?
Who is the customer?
I want to know exactly who the customer is and why they need it. How
99
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
do you put yourself in front of your target customer with a compelling
propositon?
What is your competitive advantage?
A strong compettve advantage means that you solve the problem beter
than anyone else and that customers with that need or problem prefer
your soluton. You also need to demonstrate that you can protect your
advantage over tme through some registered IP (patent, brand, copyright,
license, trademark etc) or a level of deep expertse which is difcult to
copy, mitgate, develop or acquire.
How big is the market?
This is where evidence is required about the number of potental buyers,
the manner of distributon and the conversion rate of prospects to sales.
“In our initial pre-release testing we had a take-up rate of 9 in 10 trades-
man. With 600,000 tradesman in our target region, we can expect
sales of $2 million within 2 years of the initial marketing campaign.
Replacement sales are anticipated to be at a rate of 20% per annum.”
What is your distribution strategy?
How are you going to distribute the product and put your product or service
in front of your target customer? There are a variety of strategies which can
be used; direct sales, internet, retail, wholesale and manufacturing license.
Which ones will you be using and why do you think they will be efectve in
meetng your revenue and proft targets?
What is your exit strategy?
Unless you have an exceptonal high growth venture which could achieve
an IPO, your business will need to be sold in a trade sale to achieve an exit.
What is your target exit date? Which companies have you identfed who
would be interested? Why would they buy your business and what is the
estmated sale price?
100
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
What do you need to do to achieve the exit?
What are the milestones you need to achieve and tasks you need to
complete to succeed in a trade sale or IPO event? This might include product
development, proof of concept, revenue targets, strategic relatonships
and so on. If the exit is a trade sale, you should have selected the potental
buyers, have a plan to approach them and understand why they would
want to acquire your frm.
Who is going to do the work?
Who is on the management team? What are their qualifcatons and
experience and which positons need to be flled for you to deliver on your
strategy? Why do you think this team is capable of achieving the milestones
and exit outcome? It is OK to have an incomplete management team but
you should show how you plan to fll those vacant positons.
How much investment do you need?
How much funding do you need, when do you need it and what is the
money going to be used for?
What are you offering the investor?
While this will certainly be negotated, if you can, you should give some
idea of the level of equity partcipaton and the likely return to the investor.
Be prepared! You may expect to have 20 minutes to present and then be told
you have only 5 minutes. You may antcipate doing a formal presentaton to be
told that they only want a short descripton of the investment proposal.
The Elevator Pitch
Sometmes you only have a minute or so to get the message across. In
those situatons you need to focus on the essentals and ensure your audience
understands what you do and why they should come and talk to you afer your
presentaton.
101
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Here are two examples from ventures which I have been involved with. Each
of these presentatons could be done is less than one minute.
Investor Pitch for Pioneer Computer Group (1990)
My name is Dr. Tom McKaskill and I am the President of Pioneer Com-
puter Group, a software development business located in Northamp-
ton, UK, with offces in London, San Diego and Auckland. The business
develops, markets, implements and supports integrated enterprise
wide resource planning (ERP) applications for both discrete and pro-
cess manufacturers and a set of software development tools (4GL).
The business currently employs 160 staff and has revenue of $15 mil-
lion.
PCG has over 200 customers for its ERP systems and over 2,000
customers for its 4GL products spread across 16 countries supported
by its own staff and over 20 distributors. PCG has partly completed the
world’s frst 4GL, relational database ERP system for process manu-
facturing which has received signifcant interest from early customers,
distributors and our major strategic partner, Digital Equipment Corpo-
ration. The process manufacturing ERP market is anticipated to be the
next big growth market in the software applications space. PCG have
just signed an agreement to install the system in 16 factories of a large
UK based manufacturer, the largest manufacturing software contract
signed this year in Europe.
PCG is seeking $2 million to complete the development of the process
manufacturing suite, set up trial sites in the USA and seek a strategic
US buyer for the business. We estimate sales of the new product to
exceed $100 million in the frst two years of release in the USA giving
a potential trade sale exit value of around $50 million within 2 years.
This explanaton would be improved if I had identfed the potental buyers
and the reason why they would be willing to pay a premium to buy the business,
but you can see how much informaton can be delivered in a brief statement.
102
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Investor Pitch for Distinction Software (1997)
My name is Tom McKaskill and I am President of Distinction Software,
a software development company which provides an integrated suite
of software modules for supply chain optimization for medium sized
process manufacturing companies who manufacture high volume, low
priced consumer packaged goods.
Our product suite optimizes the relationship between retail demand,
warehouse inventory, logistics, manufacturing capacity and raw mate-
rial inventory. The package uses a sample of client data and shows a
payback time on the cost of the software of less than 6 months.
The product suite is one of only a limited number of fully completed
and implemented supply chain optimization products worldwide.
The market for such products is growing rapidly and there is keen
interest from large application software providers to enter this market.
These products are highly specialized, take years to develop and are
expensive to complete.
Our exit strategy is to sell the business to a global software corpora-
tion providing them with an immediate revenue opportunity within their
existing customer base as well as a strong competitive advantage for
future sales. We estimate an exit price of around $60 million.
We are seeking $2 million to complete multi-lingual translation, multi-
country trial implementations and documentation and training material
required for a global release.
This descripton was my frst atempt. Note that I do not menton revenue,
staf numbers or projectons. With any presentaton, you should improve each
tme you do it. It is important to be able to explain your business in one minute
or in a descripton which is no longer than one page.
103
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Powerpoint Presentation Guidelines
There are lots of ways of doing a presentaton and therefore there is not one
format which is perfect but the basic rules of presentaton stll apply.
Do’s of Presenting
• Outline why you are there
• Tell them what you are going to tell them, tell them and then tell
them what you told them
• Have a logical fow, be confdent, positve, focused and professional
• Use photos, diagrams and videos to demonstrate your product
• Show you know what you are talking about
• Be honest (identfy problems, risks, outstanding work)
• Tailor your presentaton to the target audience (why are they there)
• Be realistc and reference your data sources
• Limit the number of points to a slide
• Use at least an 18pt font. Major bullet points should be at least 24pt
Don’ts of Presenting
• Don’t make ambiguous, vague or unsubstantated statements
• Don’t use technical or industry jargon
• Keep the sizzle down - stck to the meat
• Keep the slides simple and to the point
• Don’t be casual, uninterested or otherwise engaged - show you are
keenly interested in the decision
• Don’t read and don’t present fnancials to 3 decimal places.
Powerpoint is a very powerful tool but can be over-used. The slides are there
to allow you to convey informaton - remember that your audience can read so
you don’t need to read them out. The order of slides allows you to control the
fow and pace of the presentaton. You are telling a story, make it interestng but
stck to the central theme.
104
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Your audience should be able to read everything on the slide within a few
seconds. Don’t put so much informaton on the slide that it distracts them from
listening to your explanaton.
Use fonts you can read from a distance. Avoid TLCs and technical jargon if
you are presentng to a non-technical audience.
105
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Ensure the colours you use are easy to read. Put contrastng colours together
so the text can be read easily.
Avoid using backgrounds which have lots of diferent colours or shades. It is
very difcult to get contrastng colours when you have complex backgrounds.
106
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
You are presentng to a professional audience so avoid the gimmicks. Don’t
use fun graphics, noises or fancy animatons.
Your audience wants to read what is on the slide.
107
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Why Are You There?
Be very clear in your own mind what you want to achieve from your
presentaton and ensure you come back to that at the end. Listen carefully to
the questons and make sure you answer them rather than simply repeat what
was in your presentaton.
Learn from every presentation:
• What went right, what went wrong?
• What questons came up later - can this informaton be incorporated
in the presentaton?
• Find out where the weak points were.
• Where were you not convincing?
• In the story, strategy, concept - what did you miss?
• Who or what do we need to do to be successful?
Your presentaton is only the frst step, you need to have a plan to follow
up on the meetng. Ask for business cards of those who would like a further
discussion. You can also ask if you can send them additonal informaton.
Presentation Checklist
Afer you have put your presentaton together, check it against the following
list. Depending on the type of business and the type of exit, not all of these
items will be relevant and some will need more detail than others.
Almost without excepton, you will have made some assumptons about
your audience, especially their knowledge of your industry and technology. You
need to deskill your presentaton for a general audience. The best way to do
this is to give the presentaton to people from outside your sector. Try it on
friends, siblings, your spouse/partner/mother and your co-workers. If there
is something they don’t understand or have difculty following, you need to
change your presentaton. At the end of the presentaton, you might ask them
questons about your business and investment opportunity and see if they
understood it. These days it is not essental to wear a business suit and te but
neat and professional is important.
108
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
• Introduce yourself and your other presenters
• Who are you and what do you do?
• What problem or need do you satsfy?
• Is the customer clearly identfed?
• Are you showing why the customer should buy from you?
• Are you identfying your principal compettors?
• Are you identfying your sustainable compettve advantage?
• Are you showing who the management team is?
• Do you have fnancial projectons with worst, likely and best case?
• Are you identfying the risks in the deal?
• What problems are unresolved or needed additonal work?
• Do you have a well defned exit strategy?
• Have you identfed what needs to be done to deliver on the exit
event?
• Have you said why you are there and make the investment request?
• Is the investment opportunity well defned and convincing?
• Are your Powerpoints clear and easy to read?
Depending on whether you are a fnancial or a strategic exit, your explanaton
of what is important can be very diferent. With a strategic trade sale, the key is
to identfy the strategic buyers and explain why they would want to undertake
the acquisiton. In a fnancial sale or an IPO, you need to show that you can
create a high growth venture.
The last tme I raised venture capital I did over 30 presentatons to venture
capital frms in 5 cites up and down the eastern seaboard of the USA. Each
tme I learnt a litle more about what they were interested in and refned the
presentaton. What I also found was that even the best opportunity had to ft
into their investment criteria, investment portolio, sector preferences and
level of investment. You may need to do a number of presentatons to diferent
audiences before you fnd a match.
Some organisatons will have a preferred presentaton outline which they
would like you to follow. Ask them if they have a specifc format which they
prefer. Ofen they will want an executve summary either in advance or on the
day. This needs to cover the major points of the investment proposal and should
include contact details for those who wish to explore your proposal further.
109
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Some organizatons like to have a writen business plan available for those who
wish to examine the proposal further.
With formal Powerpoint presentatons, many organisatons like to hand out
a copy of the slides to the audience so they can make notes during and afer the
presentaton. Remember to invite the audience to ask questons and ofer your
business card for follow-up discussions.
Most investors try to put themselves into the shoes of the target customer
and ask the queston “Why would I buy this product and from this frm?” They
try to do this as early into the presentaton as possible so they can understand
the business. This means that it is really important to deal with this issue as
early into the presentaton as possible. Showing the product, demonstratng it
or showing a short video or photo of it in use can be quite efectve.
I have sat through many presentatons where I didn’t understand what the
product was or what problem it solved untl well into the presentaton. The
problem for the presenter was that most of the audience were not listening to
the content because they were stll focused on working out what the business
did. You should not be spending more than a minute or so on describing your
product or service. Once the audience understands what you do, move on to
the core of the presentaton which is about what you need to do to develop
the business, the investment required and the return which the investors
will receive by partcipatng in the venture. If you are at the idea stage or stll
developing your business concept, simply state that in your presentaton, but
ensure that your host understands that prior to the presentaton and has the
opportunity of setng the right expectaton for those who will be atending.
If you are not sure what level of detail is required in the presentaton or are
unfamiliar with some of the terms used by investors, ask your host. You can also
learn a lot about Angel and Venture Capital funding from artcles, websites and
books. The more familiar you are with the requirements, the beter prepared
you will be to deliver your presentaton and answer the questons.
110
Raising Angel & Venture Capital Finance
9
O
nce the investor has evaluated the investment proposal, the discussion
will usually move to the queston of valuaton. Entrepreneurs have
always seen the inital valuaton as the most important part of the investment
process – as this can impact greatly on what they walk away with on exit. At the
same tme Investors see entry valuaton as the key to the investment return –
if they get too litle equity they may not get a reasonable return on the exit if
the venture is not overly successful. Thus valuaton discussions can be stressful
on both partes and ofen somewhat emotonal. Finding a path through this
discussion is critcal if both partes are to proceed with the investment and stll
retain a positve working relatonship.
Traditonally Investors and entrepreneurs have used the existng revenue
and proft or near term revenue and proft as the basis of a valuaton discussion.
While the exit is always a consideraton, few use this to arrive at a current
valuaton. Typically, exit planning is deferred untl the investor has made the
investment and had some experience with the venture when the investor has
a beter idea of the market and the venture capabilites. But in fact, this is the
critcal event and should play a much greater part in the investment decision
and the valuaton discussion.
Valuation
111
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Valuation
Valuaton of an existng business before VC and Angel funding and valuaton of
a business following funding has to be the most controversial topic in the venture
capital literature. It is the greatest source of confict between entrepreneurs
and Investors, is plagued by emoton, misunderstanding, entrenched positon
taking and ignorance. It has ofen been said that 40% of deals fail to secure
funding due to a failure to agree a valuaton. What is regretable is that it is
highly possible that many of these ventures could have made both the Investor
and the entrepreneur considerable wealth.
Valuaton is the process of estmatng the monetary amount the frm is worth
based on its future expected returns. Valuaton is a functon of risk and return
and considers:
• the expected return from an investment in the frm
• the expected returns from investments in other comparable frms
• the risks associated with the expected return
• any other relevant characteristcs of the frm or the industry/
geography in which it operates.
A more conventonal defniton of market value is: the price that would be
negotated between a knowledgeable and willing but not anxious buyer and a
knowledgeable and willing but not anxious seller actng at arm’s length within
a reasonable tme frame.
While this is probably not true of Angels, entrepreneurs ofen refer to venture
capitalists as greedy, one-sided, ‘vulture capitalists’. On the other hand, venture
capitalists and Angels complain of entrepreneurs being unrealistc, unwilling to
negotate a fair value and ignorant of the balance between risk and return.
Valuation models
In the absence of an independent ofer to buy the frm, the valuaton of a
private frm is a highly judgemental process. Valuaton models are each designed
with diferent purposes in mind. Like the problem of identfying cost, (historical
cost, replacement cost, market price, incremental cost, infaton adjusted cost,
depreciated cost) it depends what you want to use it for.
112
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
The major valuaton models are:
• Earnings-based
- Capitalisaton of future maintainable earnings
- Discounted future cash fows (DCF).
• Asset-based
- Going concern value
- Realisaton value
• Industry-specifc based
- Market value
- Rules of thumb.
In emerging businesses seeking venture fnance, only the earnings based
valuaton models are relevant. Traditonal earnings based valuaton methods
have been established to value existng business where historical data can be
used to show revenue and proft trends and where established products have
a market presence. However, most emerging ventures which seek funding are
of limited life, have litle history and a somewhat speculatve future. Thus while
traditonal methods of valuaton don’t really apply, the entrepreneur should be
familiar with their use as valuaton discussions may involve them. In order to
start any sort of meaningful discussion, the conventonal approach to valuaton
for an investment has been to write a forward projectng business plan and
then to try to use this as the basis for discussion.
Most Investors will estmate a future (exit) valuaton based on a four to six
tmes earnings before interest and tax (EBIT) multple of the projected proft
at the tme of harvest of the investment and then work backwards using an
internal rate of return (IRR) to refect the risk in the venture to arrive at a
post funding valuaton. Early stage ventures may atract a 55% IRR with more
advanced ventures atractng 20% to 40% depending on the expected risk.
However, even this valuaton is highly speculatve as more funding rounds
may occur, each setng a new valuaton at the tme of funding. To arrive at
the equity percentage for the Investor, the investment required is deducted
from the post-funding valuaton and then the ‘pre-money’ valuaton is arrived
at. The Investor’s equity percentage can then be calculated from the rato of
investment to post-money valuaton.
113
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Strategic trade sales require a diferent approach as the valuaton is based
on the expected earnings of the buyer in the frst few years following the sale.
However, a valuaton can be applied to this stream of earnings to arrive at an
exit value.
Capitalisation of future maintainable earnings
Capitalisaton of future maintainable earnings methodologies include:
• Price earnings rato (PER)
• Pre-tax earnings multples such as earnings before interest, tax,
depreciaton and amortsaton (EBITDA), earnings before interest, tax
and amortsaton (EBITA) and earnings before interest and tax (EBIT).
Earnings-based valuatons are used as a proxy for the Discounted Cash Flow
(DCF) methodology.
The PER can be applied in two ways:
• Total value of the frm: PE multple x net proft afer tax (NPAT)
• Value per share: PE multple x earnings per share (EPS)
The PER is applied to an estmate of earnings afer tax. The value derived
using a PER is a valuaton of the ordinary shareholders’ interest. This is described
as an equity value.
Valuatons based on EBITDA, EBITA or EBIT multples calculate the Enterprise
Value of the frm before factoring in the way it is funded. The Enterprise Value is
typically adjusted for the following items to calculate an Equity Value:
• Interest-bearing debt
• Surplus assets
• Contngent liabilites
• Future capital expenditure
114
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
To further explain the diference between Enterprise Value and Equity Value
consider the following example of somebody’s house:
Item $ Value
Market Value 500,000 Enterprise value
Bank Debt 400,000
100,000 Equity value
Some sectors have well established valuaton norms. These can vary with the
economic cycles refectng likely growth or depression trends. Multples applied
to mature industries with litle likelihood of growth are generally lower than
multples applied to growth sectors. Firms which have experienced higher than
average historical growth will usually command a higher multple on the basis
that future growth is also expected to contnue at higher than average rates i.e.
history is ofen used as a predicton of the future.
The assumpton underlying the PER method is that the frm has stable or
predictable earnings, that these will contnue on a linear path for some years,
the business will not change from its current business model and there is an
appropriate debt/equity mix.
It is useful to set valuaton expectatons prior to going into a valuaton
negotaton. If the sector is currently valuing listed corporatons at 10 tmes EBIT
and the frm is seeking something higher, they have unrealistc expectatons. If
on the other hand they are seeking fve tmes EBIT, you probably have a basis
for negotaton.
The earnings used in a valuaton need not be the actual historical earnings.
Earnings should be adjusted for abnormal, extraordinary and non-recurring
items to determine a normal level of earnings. If the entrepreneur can show
highly probable growth with achievable revenue and proft targets, future
earnings might be used to calculate a market valuaton. However, it is important
to avoid double countng growth by using future earnings and applying a ‘growth
multple’.
115
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Discounted cash fow (DCF)
A DCF has two elements:
• forecast of future cash fows of the frm for a number of years into
the future
• discountng the forecast cash fows back to a net present value (NPV)
using a discount rate which refects the riskiness of those cash fows.
• The preparaton of a DCF can be challenging as it can be difcult to:
• accurately forecast cash fows for a number of years into the future
• select an appropriate discount rate.
The discount rate should represent the risks associated with generatng the
expected earnings of the frm. In many cases entrepreneurs and Investors will
simply use the Investor’s investment hurdle rate.
This method is somewhat more problematc. It is based on discountng
future free cash fow to a present value. The free cash fow, or uncommited
cash surplus, represents the cash available to pay of the inital investment plus
provide a return on that investment.
Most high growth businesses invest heavily in growth capacity. This might be
R&D, sales force, promoton, channel expansion and so on. Few entrepreneurial
ventures have spare cash.
The DCF discount rate in an Angel valuaton is likely to be 35-40% and a VC
fund 25% -35%.
When deciding on a valuaton for a strategic exit, a value is arrived at for the
exit price and then discounted to a NPV.
Fundraising alternatives
It is useful to put Angel and VC investment into context.
Let’s say the entrepreneur wanted to borrow $1 million. His choices are a frst
or second mortgage on his personal home, a loan secured on business property,
a loan secured on inventory, or a loan secured against debtors.
116
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Secured loans can normally be recovered by the lender as a market exists for
the pledged asset. The lower the likelihood of recovery, the higher the interest
rate and the lower the percentage advanced on the value.
Borrowing against the entrepreneur’s home would possibly result in a
professional valuaton, which may be lower than the entrepreneur would
willingly agree and a loan of probably not more than 80% of the valuaton.
A bank is likely to seek higher rates of interest on a second mortgage to
compensate them for the additonal risk of the second mortgage. If scheduled
repayments can’t be met, the bank has the right to sell the home and recover
their debt plus accumulated interest and costs.
Securing a loan on business property may be a litle more expensive as
business propertes generally experience more fuctuatons in value. A premium
above a second mortgage on a house is likely.
Taking a loan on inventory is of much higher risk as the inventory may sufer
from obsolescence or damage. Usually the recovery can only be made at an
aucton which itself ofen returns much lower values than in the normal course
of business. So an advance of not more than 50% of book value may be made
but with an interest rate higher than the above mentoned rates. A similar
treatment may be applied to debtors except that it may be limited to 50% of
approved debtors, perhaps only those aged 30 days or under.
Now let’s consider the typical early stage entrepreneurial business, which
will display some or all of the following atributes:
• uncertain cash fows
• few tangible assets
• some specialised equipment which typically becomes technically
obsolete
• few debtors
• litle inventory
• new and sometmes unproven products or services
• ofen an immature management team
• an emerging market which is yet to be stabilised
117
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
• no established market for shares, especially a minority holding
• uncertain tming of revenue and proftability.
So, unlike a secured investor such as a bank, the Investor has an illiquid
market in which to sell the shares, is dealing with high levels of uncertainty in
the business and the market and the management team has no security for the
investment.
If a risk free rate in Government Bonds is yielding, say, 6% over a long term,
what return should an Angel or VC investment under these riskier conditons
return over a portolio of such investments? The typical Angel or VC investor will
invest across a range of ventures expectng to return, on average, approximately
5% above long-term share market returns. However, within this portolio some
investments can be expected to be writen of, some may break even, some
may make a reasonable return and one may make a sizable return. In order
to achieve a 15-20% average pre-tax return, the Investor needs to set a pre
tax hurdle rate of at least 25-30%. Investors with a technology, biotechnology
or early stage investment focus tend to seek higher returns (potentally in the
order of 35-40%) due to higher failure rates. Only a small percentage of the exits
will exceed 7 to 10 tmes their investment, thus the Investor may set a relatvely
high hurdle rate knowing that those investments which fail or have poor returns
will pull down the average.
Most entrepreneurs will accept this logic. So where is the problem? The
problem is in the ofen extreme views of the likely outcome. Entrepreneurs
by their very nature are optmistc. Investors, while not being pessimistc, are
cautous and have been conditoned by failed ventures, all of which started out
looking very positve. In truth, it is the pursuit of the target value which ofen
causes the venture to fail. If the Investor has to achieve a high value to exit their
investment with a good return, the pressure is on the entrepreneur to push the
growth rate. It is ofen this pressure which creates the conditons for insolvency
and failure.
At the same tme, the gold medal for an Angel or VC investment is an IPO, not
withstanding that the most common exit mechanism is a trade sale. This means
ever growing revenue and proft targets. However, the successive yearly targets
are inherently risky. The growth rate puts huge pressure on the organisaton
and the cash needed to fuel the investment in inventory, debtors, recruitment,
118
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
training, accommodaton, research and development, development of
distributon channels, customer support and so on. Much of the investment is
in growth preparaton rather than in servicing the current customers.
Let’s consider an example:
The business is achieving $5 million in sales with 20 staf. It is currently
making 5% net proft afer tax ($250,000). The business is valued at six tmes
net proft afer tax, therefore the pre-investment valuaton is $1.5 million. The
frm raises $1.5 million for 50% share giving it a post-investment valuaton of $3
million. The Investor expects to achieve an ROI of 25% with a planned exit in
four years. Assume that revenue grows at 40% per annum and the revenue per
head remains constant.
Year Revenue NPAT Employees Valuaton Investor share
’000 ’000 $ million $ million
1(a) 5,000 250 20 1.50 0.00
1(b) 5,000 250 20 3.00 1.50
2 7,000 350 28 2.10 1.05
3 9,800 490 39 2.94 1.47
4 13,720 686 55 4.12 2.06
5 19,208 960 77 5.76 2.88
Notes:
• (a) Pre-investment valuaton
• (b) Post-investment valuaton which includes $1.5 million of surplus cash
• The Investor’s additonal capital of $1.5 million is used on capital expenditure to increase
business capacity.
• Years 2-5 assume $nil surplus cash and $nil debt
• Assumes 5% net proft afer tax in all years
• The Return on Investment is 17% which does not achieve the 25% target expected by the
Investor.
Imagine all the things which can go wrong over that fve-year period: the
market may change with new compettors, the market size may be considerably
less than estmated, new technology may make the product obsolete, the frm
119
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
may be unable to recruit quality staf at the rate needed and so on.
While size is not the only determinant of a company’s ability to undertake
an IPO, in the above example the growth rate would most likely be insufcient
to create an IPO opportunity and therefore the Investor would need to pursue
a trade sale as an exit mechanism. For the same frm to gain the level of sales
and proftability to achieve an IPO, they would have to grow at a signifcantly
higher rate.
The business risks associated with high growth rates are signifcant and
require a massive change in organisaton structure, processes, systems and
formalised controls.
The executves who are capable of running a 20-person frm are probably
unsuited to a 200-person frm. Very few entrepreneurs have the skills to make
this transiton.
The Investor who pushes an investee frm to an IPO may create the seeds
of their own failure. Regardless of the product/market opportunity, very few
management teams are capable of managing a high level of growth. Growing
frms tend to require signifcant levels of working capital and investment into
the business. Consequently, cash reserves are generally stretched and even
a small mistake can result in rapid diluton of cash reserves sending the frm
to the brink of insolvency. As Investors require an exit, in these circumstances
some Investors may panic, replace management and probably push the frm
into a fre sale to recover as much of their investment as possible.
The inital valuaton may create the platorm for future failure. The higher the
inital valuaton, the greater the pressure to grow and the higher the likelihood
of failure.
To protect the investment from some of the risks mentoned above, the
Investor is likely to push the inital valuaton down so that they have a greater
chance of gaining a fnal exit which will return the ROI needed. They also build
in conditons which allow them to replace management if the team fails to
achieve the milestones needed to keep them on track to reach the target exit
valuaton.
120
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
A lower valuaton has the beneft of taking some of the pressure of the
entrepreneur. Reaching a target ROI for the Angel or VC investment is more
likely, the intermediate milestones are likely to be more easily reached and
there is not undue pressure on growth. The downside is that the entrepreneur
will give up more equity at the lower valuaton.
Which valuation should you use?
Too many entrepreneurs produce fve year forecasts based on assumptons
which are, at best, educated guesses as to the state of the economy, the
reacton of compettors and the behaviour of prospects. They then use complex
formulae to work out a Net Proft Afer Tax (NPAT) over fve years. From this
proft forecast they calculate a valuaton to four decimal places using an assumed
discount rate. At the very best, it is one person’s view of the future, but it fails to
recognise that any other view might be equally valid.
In truth, no-one can accurately predict the future. The entrepreneur is
generally going to be optmistc and the Investor somewhat pessimistc.
Somehow they have to come to an agreement on a valuaton or the negotaton
simply never goes anywhere.
Entrepreneurs should be highly averse to high valuatons. While they look
good at the start of the venture, they place unrealistc expectatons on the
business to perform. Even the slightest slippage can lose the entrepreneur his
business. Investors are not known to take shortalls kindly. The problem is that
they have their own investment to protect. Far beter for both partes to agree
a lower/negotated valuaton where the Investor can readily make his hurdle
rate and the entrepreneur has a beter chance of staying in control and making
a reasonable return on his efort.
Negotiated valuation
One method of arriving at a valuaton is to consider what the valuaton of
the business may be at a future exit date and discountng this value back into
today’s dollars. This method also has more relevant applicaton to strategic
sales. The future exit valuaton of the frm is highly speculatve and is a metric
of real interest to both partes. If it was known with some certainty, the current
valuaton could be more readily determined by using a discounted cash fow
121
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
methodology. The discount rate could be adjusted for higher levels of uncertainty
but it would stll be a place to start.
So, for example, a frm with an exit valuaton of $10 million in three years
with a discount rate of 40% would be worth $3.64 million now. A $1 million
investment would thus gain the Investor 27.5% shareholding.
Possible alternatve valuaton scenarios to the above are:
• The Investor wanted some higher comfort factor. A higher rate of
discount may be used, say 50%, which would result in a lower Net
Present Value (NPV) of $3 million giving the Investor 33% equity.
• The Investor wanted some higher comfort factor. A lower exit
valuaton may be used, say $8 million, which would provide a NPV of
$2.9 million, giving the Investor a share of 34.5%.
• The entrepreneur is more optmistc than the Investor and believes
that an exit valuaton of $20 million is likely. This would give a NPV of
$7.3 million and the Investor share of this would be 13.7%.
The real problem lies in the balance of risk and reward. If in fact a low exit
value was achieved, both partes lose but the Investor is likely to be the one
with the highest cash investment loss. The entrepreneur and his team will have
put tme and sweat in but probably much less cash.
At the same tme, if a high value is achieved, both partes would seek the
upside. The entrepreneur would most likely claim that he deserves the most
credit because it is his vision, business model and leadership that are probably
the key to success, not the cash from the Investor. The Investor would most
likely argue that the business could not have achieved the high valuaton
without the cash injecton from the Investor. The Investor of course wants the
lower valuaton in case things go wrong and so the upside is much higher. The
entrepreneur wants a higher valuaton to limit the equity of the Investor if the
venture proves very successful.
A soluton for both partes lies in negotatng a valuaton formula which both
partes can live with. This could be a stated value at somewhere between the
Investor valuaton and the entrepreneur’s valuaton, or it could be a startng
value but with equity adjusted up or down for diferent levels of success.
122
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
So, for example, the partes could agree a strike point which would
determine inital shareholding. This could then be adjusted for higher or lower
exit valuatons. For example, the partes could take the two opposing valuatons
and use these as a basis for calculatng the shareholding at exit.
Negotiated valuation – Example 1
• Investment is $3 million for an inital 33% equity share.
• Exit afer three years.
• The Investor estmates a $25 million exit.
• The entrepreneur estmates $50 million.
In this example the partes have agreed on the following:
• Investor’s equity share will remain at 33% for all exit valuatons below
their expected valuaton of $25 million.
• The Investor’s ROI on exit valuatons between $25 million and $50
million are held at 40% thus giving the Investor certainty of returns.
• Where the entrepreneur’s estmate of $50 million is achieved, he
retains a greater proporton of the equity (i.e. the Investor’s share is
reduced to 16.4%), but the return the Investor earns is signifcantly
greater than at lower valuatons.
• Consequently in this example both the entrepreneur and the Investor
share in the upside of higher valuatons.
123
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Exit valuaton Investor porton ROI to Investor Strike Investor’s equity
$ million $ million % per year valuaton share %
5 1.64 Negatve 33.0
10 3.33 4 33.0
15 5.00 19 33.0
25 8.25 40 Investor exit estmate 33.0
30 8.20 40 27.3
40 8.20 40 20.5
50 8.20 40 Entrepreneur’s 16.4
exit estmate
80 13.10 63 16.4
100 16.40 76 16.4
Negotiated valuation – Example 2
Alternatvely, a much more aggressive model would see the valuatons
move in the Angel’s favour with lower exit valuatons and more security on the
downside for the Angel. This acknowledges the need for the Angel to achieve
their desired ROI. At higher exit valuatons, the pendulum swings the other way,
increasing the reward to the entrepreneur for outstanding performance.
In this example:
• Angel investment $3 million.
• Exit afer three years.
• The Angel estmates a $25 million exit.
• The entrepreneur estmates $50 million.
In the example set out below, the partes have agreed the following:
• Angel’s equity share increases at low valuatons thus providing more
security on the downside.
• The entrepreneur retains a greater share of equity at higher
valuatons while stll allowing the Angel to earn a signifcant rate of
return.
124
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Exit valuaton Investor porton ROI to Investor Strike Investor’s equity
$ million $ million % per year valuaton share %
5 5.0 Negatve 100.0
10 8.2 19 82.0
15 8.2 40 55.0
25 8.2 40 Investor exit estmate 33.0
30 8.2 40 27.3
40 8.2 40 20.5
50 8.2 40 Entrepreneur’s 16.4
exit estmate
80 9.3 46 11.6
100 10.0 50 10.0
Negotiated valuation – Example 3
For a smaller deal the model might look like this:
Investment $3 million and an Exit afer three years.
Exit valuaton investor porton ROI to Investor Strike Investor’s equity
$ million $ million % valuaton share %
1 1.0 Negatve 100
3 3.0 Negatve 100
8 8.0 38.7 100
10 8.2 40.0 Strike valuaton 82
15 9.0 44.0 60
20 10.0 49.0 50
30 12.0 59.0 40
50 15.0 71.0 30
100 17.0 78.0 17
125
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
This type of formula can be used over successive rounds of Angel or VC
funding. Each round would put in place the formula for determining the share
of the fnal exit valuaton to the new investor.
The entrepreneur who is unwilling or unable to accept a lower/negotated
valuaton, should consider seriously a ratchet where the entrepreneur earns
additonal equity for achieving certain pre-agreed milestones/targets. These
targets could be qualitatve or quanttatve in nature.
Investors want to ensure that, at the very least, they don’t lose any money
on the deal. An investor is much more sensitve to a loss than to a signifcant
gain. There is considerable pressure on the Investor to push down the valuaton.
However, a lower valuaton means the entrepreneur makes much less when
they exit the business and therefore the Investor needs to fnd a valuaton fgure
which strongly motvates the entrepreneur.
Angels and VC investors can use a variety of techniques to achieve this
balance. One simple technique is to set the return to the Investor at a specifed
rate of return. Any excess over this amount from the exit proceeds goes to
the entrepreneurial team. Another technique is to establish the investment as
preference shares with an accumulatng dividend. Since preference shares are
paid before ordinary shares, the Investor will recover some or all of their money
before other shareholders share in the proceeds. An Investor may also have
some ordinary shares to give him a percentage of the higher exit valuatons.
Some Investors use optons to provide additonal incentves to the
entrepreneur and senior management to allow them to accumulate additonal
equity in the business. The optons may be set against certain milestones or
performance targets which represent higher potental exit proceeds. The
entrepreneur gains a greater percentage of the proceeds as the optons kick in
at higher exit valuatons.
An ant-diluton clause in favor of the Investor in an investment agreement
has the efect of protectng some or all of their investment in the event that
the valuaton falls with a subsequent funding round. This clause adjusts the
shares of the Investor so that their original investment retains its monetary
value under the new valuaton. In this situaton, it is the original founders who
126
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
sufer the negatve adjustment. However, this type of adjustment is typically
not readjusted with a subsequent higher valuaton.
127
Raising Angel & Venture Capital Finance
10
M
ost formal Angel and VC evaluatons follow
a similar staged process. This approach
is commonly used by an experienced Investor with many investments and by
Angel syndicates, Angel Groups and VC frms. Individual Angels ofen go by their
gut feel or a ‘seat of the pants’ judgement, however, fewer mistakes are likely
to be made with a more systematc and comprehensive process. Also, if other
Angels are investng at the same tme, the individual Angel doing the evaluaton
would be beter able to later justfy and defend an investment recommendaton
if a more formal process was followed. Given the high level of Angel syndicate
investments over the past several years, the process set out here will apply to
an Angel co-investment situaton.
The purpose of the staged process is to eliminate, at the earliest possible
tme, those investments which fail to meet the criteria established by the
Investor. Each successive stage involves higher levels of expenditure on tme and
professional services and investgaton expense. Only very few frms progress to
the later stages.
The overall duraton of the process will vary according to the complexity
of the proposal and the ease with which the detailed investgatons can be
completed. Larger Angel syndicates and VC frms can be expected to have more
formal processes and perhaps more sign-of stages. It is unlikely that funding
Finalising the
Investment
128
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
would be provided in less than three months with the average taking closer to
six months.
(a) Initial contact
The beter and more established Investors prefer to receive their inital contact
through a referral. However, whether it comes with a recommendaton from
another Angel, professional services frm, personal contact or simply through
the mail, the inital review of the proposal will be a quick read of the executve
summary to see if the size of funds required, the stage of investment, the
industry and the geographical locaton are of interest. If interested, the Investor
will ask the Entrepreneur and one or two members of the senior management
team to come to a brief meetng where the proposal will be discussed.
(b) First formal meeting
The purpose of the frst meetng is for the Investor to evaluate the Entrepreneur
and the management team. The Investor should set the expectaton that the
management team should come prepared to answer detailed questons about
all aspects of their business. They may be asked to do a formal presentaton on
the business opportunity for 10-30 minutes.
(c) Exchange of information
If the inital meetng goes well and both partes are interested in going forward,
the Investor would normally request a business plan (if the management team
has not already provided one) as well as contact details of other executves in
the frm, names of referees, key customers, suppliers and distributors. The frm
may be unwilling to provide confdental informaton at this stage but should
provide sufcient informaton for the Investor to decide if they wish to expend
more tme and expense on evaluatng the investment.
(d) Informal due diligence
The Investor would normally conduct a limited investgaton into the market,
the frm and the business propositon. This will ofen involve contacts with
industry executves they already know or with other Angels or VCs actve in the
sector. The Investor might also visit the ofces of the frm and interview the
key executves and key employees. The market analysis would normally include
129
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
an investgaton of compettors and some validaton of the customer benefts
associated with the products or services ofered by the frm.
(e) Term sheet negotiated
The Investor would then brief the frm on the evaluaton of the proposal
and the terms under which an investment would be undertaken. During this
discussion the Investor and frm agree a valuaton or valuaton formula, discuss
costs and fees and decide on the equity to be taken by the Investor.
(f) Investor quality review
Before proceeding to issue a term sheet, the Angel syndicate or VC frm
may wish to have the proposal presented to them with a justfcaton of the
investment to be made. This is an internal check to ensure that due process and
adequate product/market opportunity evaluaton has been carried out. The
presentaton would normally include a limited fnancial model of the business
over the likely term of the investment. Additonal analysis may be required
following the discussion and before individual Angels or the VC Fund issue the
term sheet. Larger deals may require more extensive and expert investgaton.
In these situatons the Investor may outsource part of the work to professional
services frms and specialist market analysis consultancies.
(g) Term sheet issued
Once the inital due diligence has satsfed the Investor that the investment
should move forward to a detailed investgaton, the Investor would issue a
formal ofer in the form of a heads of agreement called a term sheet. This sets
out the terms and conditons under which an investment will be made if the
proposal satsfes a more detailed and formal due diligence investgaton. The
term sheet is not binding on either party at this point. However, the Investor
may expect the frm to deal exclusively with them during the detailed due
diligence period.
(h) Investment approval
Once the term sheet has been issued and accepted by the frm, a more
extensive fnancial modelling exercise may be undertaken to help other Angels
or other VC Fund partners understand the risks and opportunites in the deal.
This analysis would look at the likely investment returns under diferent risk
130
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
conditons. Exit strategies will be formulated under diferent performance
assumptons. Once this additonal work has been undertaken, the proposal will
again be reviewed, perhaps by a larger number of Angels or the full investment
commitee of the VC Fund. Larger Angel syndicates and VC Funds will have a
formal authorisaton process for the detailed investgaton. This protects the
syndicate and VC frm from an over enthusiastc Angel or investment manager
and allows a wider range of expertse and experience to review the proposal
before the syndicate incurs the expense of a detailed due diligence investgaton.
(i) Formal due diligence
Upon signing the terms sheet, the Investor and their professional advisors
will examine the company’s corporate structure, assets, intellectual property,
fnancial statements, material contracts, employment agreements and any
actual or threatened litgaton. Technical specialists may be hired to review R&D
results and plans, specialist equipment or foreign market plans.
(j) Formal approval
Once the detailed due diligence has been completed the proposal is reviewed
again to ensure that risks have been adequately assessed. If the Angel syndicate
or VC frm is stll comfortable with the investment and the ability for the lead
Angel or investment manager to manage it, formal approval will be given to go
forward with the investment.
(k) Legal documentation
Upon completon of due diligence, partes typically prepare and sign the
following formal legal documentaton:
Subscripton agreement: which sets out the number and price of shares,
funding tranches and dates of subscriptons, detailed warrantes
concerning the company, rights ataching to shares and conditons
precedent to funding. Subscripton agreements may also cover future
subscriptons by the Investor, the founders, other shareholders or key
staf and ratchet mechanisms to re-allocate shares in the event of over
or under performance by the business.
Shareholders agreement: which sets out the ongoing relatonship between
the shareholders and the company as agreed in the term sheet.
131
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
Intellectual property acknowledgment deeds: is an acknowledgment by
other partes that they have no rights to any intellectual property which
they develop and assigns all such creatons to the company.
Executve service agreements: will bind ‘key’ employees to the company
for a period (usually two or three years), and will set out the employees’
terms of service, remuneraton and bonus enttlements.
Source: htp://www.oznetlaw.net/facts.asp?acton=content&categoryid=226 Accessed 31/12/04
Once the fnal documents are signed, the Investor will issue the frst tranche
payment to the frm. Follow on payments will be made under the terms of the
agreement, but may be subject to performance achievements.
Normally the investee would be expected to reimburse the Investor for all
the expenses associated with making the investment if the investment is made.
If an investment is not made, only where the frm has misrepresented material
facts or withdraws afer the due diligence costs have been incurred will the
Investor expect to recover their investgaton costs.
Where an investment is made, the frm would normally reimburse the
Investor for the external expenses incurred in the due diligence process. This
would include professional fees and external consultant’s costs and will occur
with or without a transacton proceeding. Even on a small investment these can
be expected to be $50,000 to $70,000. For a larger deal, it could easily exceed
$250,000. Some funds charge an advice fee if they have helped to structure
part of the deal with external partes. If the venture is relatvely small and the
product/market issues are straightorward, it may be sufcient for the Investor
to undertake a limited due diligence and use a regional or local professional
services frm thus cutng down on the costs.
The Investor is normally appointed as an external Director to the frm and
the company would normally be expected to pay a Director’s fee, in most cases
it would be around $15,000 to $25,000. Larger companies will incur higher
Directors’ costs.
Some Angels and VC frms charge an annual management fee which might
vary but ofen can be around 1% of the amount invested.
132
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
Term Sheet and Deal Structure
The term sheet sets out the terms and conditons of the investment in the
frm. Term sheets can vary in length and complexity but would normally contain,
at least, the following clauses:
• The number and price of the shares in the company to be purchased.
These are normally set up as preferred shares with cumulatve
dividends (where declared). The preferred shares would normally be
paid out in full prior to any payment to ordinary shareholders in the
event of the liquidaton or sale of the frm. This secton would also
state what other shares are issued as well as the capitalised value of
the business. The value of the business is then used to calculate the
percentage of the shareholding that would be owned by the Investor
subsequent to their investment. The preferred shares are normally
converted to common shares on liquidaton or exit. However, in the
event of failure, the preferred shares are enttled to frst call on the
liquidaton proceeds. The Investor would normally be enttled to at
least one seat on the Board of Directors and would have certain veto
powers or power of approval over:
– the capital expenditure budget
– the annual operatng budget
– any debt or asset lien over a specifed value
– appointment of CEO, CFO and senior executves
– remuneraton and employment conditons of senior
management
– any issue of additonal shares
– a change in the number of Directors
– any dividend
– any major change in structure, assets, merger, acquisiton or
disposal
133
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
– the use of the invested funds.
• The Investor may require their percentage of the total capital of the
frm not be reduced in a subsequent share ofer at a price lower than
the one they came in on (ant-diluton rights).
• The Investor will be enttled to ‘piggyback’ the registraton of their
shares with other shares being registered for sale.
• If at least 75% of the shareholders accept an ofer to sell the company
the balance of the shareholders agree to the same conditons of sale
(‘drag along rights’). This may be extended to enable an Investor to
‘drag along’ the other shareholders where the Investor accepts an
ofer to sell shares afer an agreed period of tme.
• The Investor has the right to purchase shares in any new issue of
shares in the same percentage as their holding.
• If a founder has an ofer to sell his/her shares, the Investor has the
right to partcipate by selling the same percentage of their shares
(‘tag along rights’).
• The Investor can require their shares be purchased plus accumulated
and unpaid dividends afer a specifed date in specifed stages
(redempton rights).
• The ofer to invest will be conditonal on adequate due diligence and
the producton of various documents.
• The ofer is confdental and will only be open for acceptance for a
specifed period of tme.
• Each party will be responsible for its own professional fees.
The term sheet is an ofer to invest. Untl accepted, any terms and conditons
can be negotated, although many of the terms and conditons are standard
and are unlikely to be varied since they protect the Investor in the event of the
business failing to meet their objectves.
In most circumstances term sheets are not legally binding, but provide
guidelines on maters to be documented in subscripton and shareholders
agreements.
134
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
An example of a term sheet is provided by the Britsh Venture Capital
Associaton under the ttle Example of a Term Sheet for a Series A Round (see
www.bvca.co.uk). While these are local UK legal documents, the terms are
very similar to those which would be present in most other legal jurisdictons.
Another example is given at:
htp://www.angelblog.net/The_One_Page_Term_Sheet.html
In most cases the term sheet is issued prior to the completon of due
diligence. As such the Investor will usually reserve the right to amend the terms
of the term sheet should anything of concern be found during the due diligence
process.
Due Diligence
Once the Investor has issued a term sheet and this has been formally accepted,
the Investor will proceed to a full analysis of the investment opportunity. At
this point commercial analysts, lawyers and accountants actng on behalf of
the Investor will undertake a due diligence investgaton. The Investor will incur
considerable costs in this investgaton and will want to ensure that the frm
is actng in good faith during this period. To protect himself, the Investor will
normally request the frm execute an exclusivity agreement where the frm
agrees not to seek investment from any other party during the due diligence
period. A penalty may be agreed for a breach of this conditon.
One objectve of the due diligence process is to investgate the frm to see
if the business itself has any major problems which have not been identfed in
the informaton already provided to the Investor. The due diligence process will
undertake a validaton of all aspects of the existng business as presented in the
business plan. This would include most of the following:
• background checks on the key executves and key employees
• review of all fnancial informaton and additonal investgatons where
necessary to validate key numbers
• inspecton of all key contracts
• interviews with major customers, suppliers and distributors
135
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
• verifcaton of costs, expense levels and purchase commitments.
This process will check the integrity and honesty of the frm as well as provide
a view on how well the business is managed and on the adequacy and accuracy
of the informaton which is being used in the business. It will also uncover how
well the key executves understand their own business and the ease with which
they are able to access and provide additonal details necessary to the analysis.
A key part of the due diligence process is for the Investor to identfy anything
which would incur additonal costs, create delays or expose the business or
the Investor to actual or potental liabilites not identfed in the informaton
provided to the Investor. Items which frequently create problems include:
• non-standard customer contracts
• non-standard supplier agreements
• harsh lease conditons
• loose IP agreements
• overly generous reward and remuneraton systems
• generous health or vacatons benefts
• shareholders’ rights, legal structures, joint ventures, opton schemes
and
ant-diluton arrangements
• poor reportng systems
• out-of-date equipment
• poor quality products or services
• personal use of company funds or resources
• pre-existng obligatons, rights, commitments or restrictons
• non-standard rights of existng debt holders.
A business which is efectvely and efciently run, has good customer,
distributor and supplier relatonships and has good internal reportng systems
which monitor performance, ensure adherence to compliance regulatons and
protect the business from mistakes, should have few problems in satsfying the
Investor.
Afer the frm has satsfed the Investor with regard to its current operatons,
the Investor will examine the business projectons and other planned targets
and milestones which underpin the business plan. This is the area which exposes
136
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
the Investor to the greatest risks. This investgaton will review the following:
• the identfcaton of the prospectve customers and the quality of the
benefts the customers gain from the product or service
• the size and growth rate of the prospectve market
• the size, strength and strategies of current and potental compettors
• the quality of the intellectual property underpinning the business
plan
• the quality of the sales, marketng and distributon strategies
proposed
• the likely ability of the management team to be able to execute the
business plan
• availability of executve and specialised staf needed to grow the
business
• the quality of the exit strategy proposed
• the likely cash fow over the expected investment period.
To the extent that uncovered risks reduce the probability of achieving
the desired outcome or delay the tme to execute, the value of the potental
investment declines. In some cases problems can be overcome by installing
additonal controls, renegotatng agreements and putng in place alternatve
strategies. However, these may result in additonal costs or delays in executng
the business plan. To the extent that problems cannot be easily resolved or the
entrepreneur is reluctant to make changes, the investment will incur greater
risks. At some point the Investor will decide that the risks are too great and will
decide not to make the investment.
If the investgaton results in an agreement to proceed with the investment,
the frm will most likely incur the costs of the due diligence plus the legal fees
associated with the preparaton of the investment agreement. Fortunately,
emerging businesses are ofen quite small and the amount of investgaton
needed to understand their current operatons is also small. Due diligence costs
should be reasonable relatve to the size of the investment.
Part B of this book sets out an ideal operatons checklist against which the
current business can be measured. Start-ups and early stage frms are unlikely
to have sophistcated control and reportng systems in place, but these can be
introduced over tme as the business develops. The checklist can form a guide
137
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
to the development of the governance and operatons management within the
frm as it prepares for its next stage of growth. Firms which antcipate accessing
venture capital or expect to undertake an IPO will need to score highly across all
elements of the operatons Index.
138
Raising Angel & Venture Capital Finance
11
F
or the entrepreneur to dramatcally increase the probability of
successfully raising Angel or Venture Capital fnance he needs to create a
business proposal with these characteristcs:
• a well-artculated and highly probable exit strategy within three to
fve years;
• a detailed plan to achieve the exit conditons;
• an experienced executve team that can deliver on the plan;
• a product/market opportunity that has sufcient compettve
advantage that it has a high probability of reaching the exit
conditons; and
• an inital valuaton and a likely exit valuaton that will provide the VC
fund with a 25%+ plus ROI.
The entrepreneur needs to accept at the outset that there is a high probability
that the exit will be by way of a trade sale, in which some of the executve team
may be made redundant. Even if an IPO strategy is planned, a trade sale should
also be considered as part of exit planning.
The successful entrepreneur creates a business opportunity which meets
the objectves of the Angel or the VC fund, not the personal ambitons of the
executve team. Private equity investors are not solely in the business of building
frms or the commercialisaton of inventons. Whilst this may be a by product of
Conclusion
139
Raising Angel & Venture Capital Finance
Chapter 11: Conclusion
their investment, their principal focus is simply to invest their own funds or the
funds of their private investors and administer that investment to an exit to gain
a high rate of return to the investors. In the case of the executves of a VC fund,
their personal remuneraton is ted to that of their investors and their future
ted to the total return on the fund, thus their motvaton is the return on the
investment, not being nice to the entrepreneur or keeping the business going.
The entrepreneur who creates a business opportunity which meets these
needs has a high probability of raising fnance.
140
Part B: Indices
Raising Angel & Venture Capital Finance
PART B
Investor Ready Indices
141
Raising Angel & Venture Capital Finance
A
ngels and VC investors typically invest in start-
up or early stage ventures where the business is
somewhat unsophistcated, management ofen inexperienced, products
are in development or in their early release stage and internal systems are
poorly developed. In these circumstances it is unrealistc to expect that the
business will be as ‘investment ready’ as it would be for an expansion stage
or late stage venture capital investment. Therefore, instead of measuring the
business proposal against an established business, the Investor will look at the
management team and the underlying assets and capabilites of the business
and try to measure whether it has the potental to emerge into a proftable,
sustainable, growth business or a strategic value business which could provide
the Investor with the exit they desire.
Antcipated development of the business should provide the potental
of taking the frm to an ‘investor-ready’ state if further capital injectons are
required. At the same tme, the Investor should be preparing the business for a
trade sale, since this is the most likely exit path. An IPO is unlikely, but possible;
the Investor should keep this in mind as they investgate the business and help
it grow and develop.
Part B sets out pre-investment selecton criterion of the prospectve investee
frm. The frst evaluates the alignment of the investee shareholders and
Introduction
Part
B
142
Part B: Indices
Raising Angel & Venture Capital Finance
management and then there are three major development charts; the frst
assists the Investor to evaluate the venture potental and the second provides a
means of guiding the development of the internal governance and management
processes and systems which will be needed for an efectve exit. Using these
Indices, the Entrepreneur can judge the atractveness of the venture for outside
fnance. Finally, the Strategy Index guides the entrepreneur on the process of
raising fnance.
The Awareness and Alignment Index (AAI) has been designed to capture the
attudes and preparedness of the entrepreneur, shareholders and management
team of the business to a possible injecton of external capital. Using the AAI,
the Entrepreneur can work through the issues which will confront the Investor
as he assesses whether the management and shareholders are ready for an
injecton of external equity fnance. The Entrepreneur can use the AAI to
prepare the venture for investment.
Once the Investor is convinced that the frm understands the nature of an
external equity investment and the impact it will have on the current managers
and shareholders, the Investor will then use the Venture Potental Index (VPI) to
measure the quality of the investment proposal. The VPI provides a systematc
method of measuring the quality of the business concept in terms of its ability
to support development of the business to a point where a proftable exit can
be achieved. An investor ready business is generally regarded as one in which an
Angel or Venture Capital (VC) fund would be keen to invest. The list of atributes
has been refned in consultaton with a number of successful entrepreneurs who
have raised venture capital, a number of private equity professional advisors as
well as a number of venture capital general partners.
The Entrepreneur who is keen to develop their business using external
private equity can use the VPI to measure their ‘investor ready’ state. Where
they see defciencies, they can, where possible, adjust their business concept,
change products, markets and organisatonal structure and so on, to create a
beter candidate for investment. However, a venture which scores low on the
VPI and which cannot be readily changed, will be an unlikely candidate for
external private equity fnance.
The Entrepreneur should also be sensitve to the fact that the VPI keeps in
143
Part B: Indices
Raising Angel & Venture Capital Finance
mind the potental for a trade sale exit and assesses whether the venture has
the potental for either a fnancial or strategic exit.
The next Index is the Operatons Development Index which (ODI) should
be used as a checklist in evaluatng the quality of operatons management in
the venture. Its primary purpose is to provide a guide for the development of
governance and operatons management once the investment has been made
and to indicate to the Investor how much work needs to be done to prepare
the venture for an exit. A business which scores more highly on the ODI will
be a venture which is easier for the Investor to work with and will be beter
positoned for an early exit. Certainly those frms which achieve a higher score
on the ODI will be more efectvely and efciently managed and so allocatng
resources to improve their situaton according to the ODI would beneft day-to-
day operatons.
Raising Angel or VC fnance is a process which needs to be managed over
tme. There are a series of actons which need to be taken both within and
outside the frm to secure the investment. The fnal Index, Strategy, provides a
process whereby the frm can assess its progress towards closing an investment
proposal.
Each atribute of the Indices helps to defne the state of readiness of the
frm either for investment or exit. It is unlikely that any frm would have an ideal
positon on every item; however, the scoring will indicate where improvements
can be made or problems addressed. The AAI will show the Investor where
the frm is currently in their preparaton for external investment and should be
used by the entrepreneur to stmulate discussion and acton within their frm
to ensure the frm is beter prepared for inital discussions with an external
investor.
The VPI can be used to undertake an inital evaluaton of the likelihood of
being able to secure investment and then later to guide development of the
business to an investor ready or exit objectve. The ODI will help identfy just how
well developed internal processes of governance and operatons management
monitoring systems are and guide development work on their implementaton
and improvement. In many cases, specialist assistance will be required to
implement changes needed to reach higher Index scores.
144
Part B: Indices
Raising Angel & Venture Capital Finance
The purpose of the Indices is to help the Entrepreneur evaluate their own
chances of securing investment and to manage the process of securing the
investment. The frst three Indices mirror what an Angel or VC investor will
evaluate in assessing the venture for investment. It is thus a comprehensive and
systematc way of investgatng a proposed investment and should help isolate
any serious defciencies in the proposed business. Each queston or atribute
will provide an insight into the business and the work which will be needed to
make it investor ready.
Angel and VC investng is a process not an event. Historically, many Angels and
VC Investors thought that they could rely on their gut feel or on their evaluaton
of the entrepreneur and a quick walk around the frm’s ofces to judge the
quality of the investment proposal. While these factors are important, the
investng process has become much more formal and sophistcated, especially
through the development of formal Angel syndicate investng. Angels and VC
investors now appreciate that a systematc and comprehensive review is more
likely to catch fatal faws and problems.
In many cases, the efectvely managed frm will score highly on an atribute.
In other areas, where no atenton has been given to preparing the business for
an external investment, litle will have been done. By scoring these atributes,
you will fnd out the status of the business and identfy what needs to be done
to prepare it for external investment. Alternatvely, you may fnd out something
which will cause you to abandon seeking external investment.
The Indices are constructed with an ‘atainment’ or ‘achievement’ scale of
1-5. To complete an Index, you should circle the descripton which is closest to
the current positon.
Nothing Litle Reasonable Signifcant Fully N.A.
done progress progress progress atained
1 2 3 4 5
N.A. = Not applicable
Once you have identfed where the frm is on the atribute, you will be able
to see from the later descriptons the actons which you might need to take to
turn this venture into one which will atract Angel or VC investment.
145
Raising Angel & Venture Capital Finance
Awareness and
Alignment
A
A
ngel and VC investment is benefcial for
many businesses, but it is not for everyone. In
fact, it may directly contradict some shareholder’s plans for the business. At
the same tme, the venture may be inappropriate for an external investment.
What is clear is that the shareholders and senior management team should
understand the domain and objectves of the Investor and seriously consider
whether they are willing to meet the conditons and obligatons inherent in
that type of investment. The business which is able to show the potental for a
successful exit sought by an Investor would stand a good chance of gaining Angel
or VC investment, but the conditons which come along with the investment
may stll be unacceptable to the business. Thus some educaton in this area is
certainly benefcial for anyone considering this type of investment.
Once the nature of an Angel or VC investment is understood, there stll needs
to be a clear understanding on the part of the shareholders and management as
to the objectves to be achieved through the investment. Those objectves need
to be aligned closely with those of the Investor.
146
Part B: Indices
Raising Angel & Venture Capital Finance
A1. Majority shareholders agree on an external equity
fnancing strategy
The obvious implicatons of an external investment are:
• A diluton in existng shareholders’ equity.
• Some constraints on executve decision-making, especially with regard
to the issue of shares, extensions of debt and executve remuneraton.
• Management will be expected to agree to various performance targets.
Failure to achieve those may result in a loss of votng rights, terminaton
of management contracts and the business being sold.
• Internal systems will become more formal and a higher emphasis will be
placed on record keeping, governance and compliance.
• A formal Board of Directors will be required (if it does not exist already)
and the Investor will almost certainly want at least one positon on that
Board.
• An exit strategy for the Investor will most likely have to be achieved
within 3-7 years. This may be in the form of a buyback, trade sale or IPO.
• Additonal rounds of capital injecton may be required from Angels or a
VC.
The majority shareholders need to seriously consider the implicatons on
their own ownership positons and, where appropriate, their roles as managers
and directors. The majority shareholders need to agree on the need for the
external investment for there to be an efectve plan to proceed to raise the
investment.
Self-assessment
1. Discussions have not been undertaken with or between the major
shareholders.
2. Majority shareholders have talked about taking on an external
investment but have not taken the discussions seriously or established
any consensus about tming.
3. The shareholders have agreed on raising external capital but as yet have
not decided on a strategy.
147
Part B: Indices
Raising Angel & Venture Capital Finance
4. The majority shareholders have agreed how they will approach the
project of raising external capital and have formulated a strategy but
have not taken professional advice on whether the strategy has a
reasonable chance of success.
5. The majority shareholders have refned a strategy in conjuncton with a
professional advisor.
A2. Managers and owners agree on use of funds
Any approach to an external investor should be able to show how the use of
the investment funds will directly contribute to the development and growth of
the business and to achieving the objectves of the Investor. Too ofen applicants
seeking Angel and VC investment are focused on solving business problems,
refnancing an ailing business, buying out a shareholder or trying to build a cash
bufer, rather than directng their atenton to providing the external investor
with an outstanding opportunity. Even where there is an obvious investment
opportunity, there may be disagreement among the managers and owners over
how the growth and proft objectves are to be achieved.
Angel and VC investors are rarely experts in a specifc business, especially
when a business works with complex technologies or is based on specialist
knowledge. Thus the investor is reliant, to a large extent, on the managers of
the business to come up with a resilient plan to achieve the growth objectves
needed to satsfy the investment objectves. Unless the management have taken
the tme and efort to develop such a plan, disagreement is likely to occur in the
management team as the investor digs into their intended strategy. Nothing is
likely to kill of a deal faster than an investor being exposed to a lack of agreed
strategy or a team which clearly is not in synch.
The management team needs to be able to show the Investor a robust
business plan which incorporates the use of the investment funds and shows
the expected growth of the business and how the objectves of the Investor can
be achieved. This needs to be endorsed by the majority shareholders and by the
current Board of Directors. To ensure the plan is consistent with the requirements
of the Investor, it should be presented in a way that the Investor can evaluate
it and build an investment proposal for discussion with any co-investors. It
would be helpful to the Investor if the business plan had been reviewed by
148
Part B: Indices
Raising Angel & Venture Capital Finance
professional advisors who work frequently with Angel and VC investors. This
would be helpful to the Investor as the professional advisor’s recommendatons
for layout, style and detail and any changes they advise on the use of the funds
could be agreed with management and majority shareholders and incorporated
into the business plan before it is sent of to the Investor for evaluaton.
Self-assessment
1. Senior management and majority shareholders have not discussed how
any investment would be used.
2. Discussions have been held by senior management but there is no
consensus on how or where the funds will be used.
3. Managers and majority shareholders are agreed on the priorites for the
use of investment funds but have yet to integrate this into a proposed
investment business plan.
4. A detailed investment business plan has been created which shows how
an external investment would be utlised and has identfed the results
which would accrue to that investment; however, professional advice
has not been sought as to whether this would meet the needs of the
Investor.
5. Professional advice has been sought on the use of the funds and
adjustments have been made to the investment business plan to
incorporate that advice.
A3. Entrepreneur and key managers are committed to
the venture
Without the entrepreneur and the key management team the venture is
unlikely to be successful. The Investor needs to see a commitment on the part
of the key individuals to ensure they will put their best eforts into the venture.
The Investor is not a full-tme member of the management team and so is reliant
on the entrepreneur and the management team to take the business forward.
The business has to be operated on a daily basis by those most commited to
it, even if the task becomes onerous or stressful. The Investor wants to see that
these individuals have something at risk if the venture fails and much to gain it
if is successful. The Investor needs to have some assurance that members of the
149
Part B: Indices
Raising Angel & Venture Capital Finance
team won’t bail out when things go wrong or when they need to step up their
commitment to see the venture through hard tmes.
A conditon of many external investments is to have senior management
share in the risks as well as the rewards. This may be through an equity stake,
employee optons, generous bonuses on successful completon of milestones
and/or a bonus on a successful exit. A business which does not refect this
balance of risk and reward for key individuals will need to implement ownership
and bonus structures which provide the Investor with an assurance that the key
individuals are commited to making the venture successful.
Self-assessment
1. The frm has not considered this issue. Some key individuals do not have
equity or optons and bonus systems are not in place to motvate long-
term commitment.
2. Most senior management have equity but, for some, their allocaton is
not at a sufcient level to ensure long-term commitment. Small bonuses
are possible on achieving individual objectves.
3. Each of the senior management team has adequate incentves in the
form of equity and/or optons to be commited to the venture. Other key
employees have bonuses for personal achievement.
4. Senior management and key employees have equity and/or optons
sufcient to motvate them to stay commited to the venture. In
additon to personal bonuses, there are corporate-wide bonuses for
major milestones. The system of rewards has not been reviewed by
a professional advisor to ensure it would be sufcient to support an
external investment.
5. The allocaton of equity and optons and the system of bonuses have
been reviewed by a professional advisor and adjusted to assure an
Investor that it provides a good basis for key executve and key employee
commitment to an external investment.
150
Part B: Indices
Raising Angel & Venture Capital Finance
A4. Key shareholders are familiar with exit conditions
External investors are faced with a lack of liquidity when it comes to
recovering their investment in a private business. Generally few investors wish
to hold a minority positon in a private company as they have litle control
over the events of the business and generally are unable to recover their
money when they need it, especially if the business gets into trouble. Thus the
investor imposes on the frm a series of conditons which will efectvely force
the business to undertake a liquidity event within a reasonable period of the
investment, say 3-7 years, in order for the Investor to recover their money and
hopefully achieve a reasonable return on their investment.
The exit conditons are mainly as follows:
• If an ofer is received for the business, the Investor may force the
shareholders to accept it.
• If the shareholders wish to sell their shares, they will not be able to do
so without selling those of the Investor.
• The business may need to undertake an IPO within a set period or, failing
that, be put up for sale.
• The existng shareholders may be required to buy back the shares of the
Investor afer a certain period where failure to do so would result in the
sale of the business.
• Failure to achieve agreed performance targets may result in the Investor
taking control over the business. Once this is achieved, the Investor
might decide to sell the business in order to liquidate their investment.
Self-assessment
1. Key shareholders have litle or no knowledge of Angel and VC
investment conditons.
2. Key shareholders are agreed which the frm could be sold if they fail to
meet targets but are unaware of how this would work operatonally.
3. The key shareholders are aware of the diferent conditons which will
be imposed on them in terms of the performance requirements of the
Investor but senior management and majority shareholders have not
151
Part B: Indices
Raising Angel & Venture Capital Finance
discussed how this will work or how they will manage the business to
meet those targets.
4. Senior management and key shareholders have developed an external
investment plan, with events and targets which senior management
believe are achievable, which will meet the management and exit
requirements of the Investor and stll leave them in control during the
investment phase.
5. The frm has engaged a professional advisor to brief them on the
investment conditons of an external Investor and has reviewed the
investment plan to ensure that management has a reasonable chance of
meetng the Investor’s conditons.
A5. Cost and time for raising funds is understood
Few entrepreneurs appreciate the level of tme, efort and costs which they
will incur during the process of raising external investment. Those who have
been through the process estmate that 50% of the CEO’s tme and much of
the CFO’s tme over a period of three to nine months will be consumed with
preparaton, presentatons and negotatons. In additon, the due diligence
actvity can easily consume many months of staf tme. During this process, the
business has to be directed and managed without impactng on revenue and
proft – a very tall order indeed.
Beter preparaton can considerably ease the burden on the executve team
and administraton staf. This may include compilaton and update of due diligence
fles, a periodically updated business plan, regular and comprehensive monthly
management reports, compliance audits and performance reviews based on key
performance indicators and budgets. By working with knowledgeable advisors
during preparaton for an investment, the tme to fnd the right investor will
be cut and the discussions streamlined as the executve team will be beter
prepared for the negotatons.
An Investor will want to spend tme with the senior executves to get to know
them and to develop an understanding of the business. This will take most
senior executves away from the business for signifcant portons of tme. The
business needs to have a plan in place so that the rest of the executve team can
carry on without undue disrupton to the fow of actvity.
152
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Senior management and majority shareholders have not discussed the
tme and resources required to raise external investment.
2. The frm has some idea of the tme and efort required but has yet to
allocate these or consider how the business will operate while senior
management is diverted into that actvity. The cost incurred to raise
funds has not been estmated.
3. Advice has been sought on the process of raising investment and the
amount of tme and efort has been clearly identfed but responsibilites
for actvites and succession plans have not been planned or agreed. The
cost incurred to raise funds has been estmated.
4. Responsibilites for the investment raising actvity have been allocated
but responsibility for managing the ongoing operatons has yet to be
clearly allocated and assigned.
5. A plan has been agreed with senior management and subordinates with
respect to roles and responsibilites for undertaking the investment
actvites as well as the running of the day-to-day operatons. A budget
has been allocated for the costs associated with raising the investment.
A6. Board of Directors accept authority limits of an
external investment
Many immature businesses seeking external investment have litle
experience with formal Boards of Directors and will fnd the process of setng
up a Board and handing over authority for signifcant strategic decisions very
uncomfortable and ofen frustratng. No longer can the executve team meet
whenever they feel like it and make a decision which materially afects the
shape of the business. More developed frms which have consttuted a Board
of Directors may have friends and family on the board and perhaps a trusted
family advisor, such as a local lawyer or accountant. With the introducton of the
external investor, the role of the board will change markedly and the existng
executve directors will have to justfy their actons, defer major decisions to
the Board and allow the Investor to have the fnal say on a number of strategic
actvites. This can be very confrontng to the entrepreneur who is used to
having the Board rubber stamp his or her actons.
153
Part B: Indices
Raising Angel & Venture Capital Finance
The investment agreement will specify that a number of actvites can only
be taken with the approval of the external director. This would almost certainly
include issuing new shares, declaraton of a dividend, changes in senior
management remuneraton, changes in levels of debt and approval of capital
expenditure. The following descriptors refer to the Board of Directors prior to
an investment.
Self-assessment
1. The Board of Directors have litle understanding of the authority limits
imposed under an Angel or VC investment.
2. The Board of Directors understand that there will be some constraints
on decisions they make but are unfamiliar with the type and extent of
such limits.
3. The Board of Directors has reviewed a list of the limits on authority
which will be placed on them by an Investor but have yet to translate
these into operatonal or strategic impact.
4. The Board of Directors understands and accept the limits on their
authority imposed on them by an Investor but have yet to translate this
into operatonal details and procedures.
5. The Board of Directors have reviewed the authority limits imposed by an
external investment with a professional advisor and has implemented
various limits on the authority of management and established
procedures for how issues relatng to those items will be handled in
Board meetngs.
A7. Post-investment management roles and
responsibilities accepted
Experienced Investors place great emphasis on having the right management
team in place. This refects the wisdom of having an experienced team with
the right mixture of qualifcatons, skills, networks and industry experience but
also the lessons learned over the years by Angels and VC Investors that few
plans are implemented as expected. The experienced entrepreneurial team
adapts to changing circumstances and copes well with unforeseen events. The
current management team will be thoroughly scrutnized and gaps exposed.
154
Part B: Indices
Raising Angel & Venture Capital Finance
The Investor may well suggest (and impose) management changes either
through a new alignment of roles and responsibilites or the introducton of
new executves.
Clearly it is in everyone’s interest to have a successful venture. The business
which sees an investment as an opportunity to introduce new talent into the
business will be well received by the Investor. Finding experienced executves
who have experienced growth to the level the venture needs to achieve can
make all the diference in the success of the venture. At the same tme, the
entrepreneur will need to acknowledge that some of his current team may be
inappropriate for the new growth plan. Regretably that means that some of
the current executves may lose their jobs or be relegated to more junior roles.
Understanding that such changes may occur and being willing to work through
them to fnd the best overall soluton, will be critcal in securing an investment.
Self-assessment
1. Senior management and majority shareholders are not aware that any
changes could or would be made to their senior management team or
their responsibilites.
2. Senior management have reviewed their management experience and
functonal expertse and experience and have determined that they have
some gaps but are yet to develop a plan to address them.
3. Specifc skill gaps have been identfed in the management team. Senior
management and majority shareholders have acknowledged that the
Investor may require changes in responsibilites, a new organisatonal
structure or some new senior executves. However, this has not been
accepted by senior management and they have not accepted that it
might be a conditon of the investment.
4. Senior management and the majority shareholders have acknowledged
and agreed that they lack a number of skills, the organisaton structure
may need to be changed, an Investor may require some new executve
talent and their current roles and responsibilites are most likely to
change.
155
Part B: Indices
Raising Angel & Venture Capital Finance
5. A professional advisor has reviewed the management team, organisaton
structure and responsibilites and proposed changes in structure and
roles. The advisor has also helped the frm to develop a proposal for
flling gaps in the management team which has been included in the
investment plan. The current management acknowledge that an Investor
may have a diferent view and the new structure and roles will need to
be negotated and agreed with the Investor.
A8. Angel and VC valuation models are understood and
accepted
Many deals are never concluded or, in fact, never proceed to substantal
business negotatons because the majority owners have quite unrealistc
views about what the business is worth. It is important that the frm seeking
external investment have some understanding of valuaton methodology.
While it is always possible for valuaton formulae to be used which are based
on performance or on an exit value, it is unlikely that this will be agreed in the
early stages of the discussion.
It is important that each party accept the valuaton norms of the Angel or VC
investment sector prevailing at the tme they are seeking investment. This way
valuaton does not get in the way of the negotatons proceeding. Variatons to
the norm can then be negotated based on how future risks may be translated
into equity share. The process set out here provides a basis for negotatng value
but it starts with an understanding of conventonal valuaton techniques. From
that point, the entrepreneur or Investor can argue for a variaton which perhaps
beter refects the risk tolerance of each party.
Few entrepreneurs have current knowledge of what is happening in the Angel
and VC investment sector and this is where access to knowledgeable advisors
can be a great help. The advisor can provide the entrepreneur with informaton
on current transactons and also work with the frm to develop a valuaton
which could be used in the investment discussions. An Investor will recognise
that the entrepreneur has sought professional advice and will be expectng that
the valuaton proposed will be close to the fnal negotated value.
156
Part B: Indices
Raising Angel & Venture Capital Finance
In the case of a potental strategic trade sale, the entrepreneur or the Investor
may have some view on the value to the potental buyer and this may be used
as a basis for a valuaton discussion.
Self-assessment
1. The frm has no appreciaton or knowledge of how an Angel or VC
Investor will establish valuaton and equity arrangements.
2. The frm understands conventonal valuaton formulae and antcipates
that this will be used by the Investor as a basis for negotaton but has
no real understanding of how the fnal valuaton and equity share will be
determined.
3. The frm has some familiarity with valuaton techniques used by the
Angel and VC investment sector and some knowledge of how equity
will be structured following an investment but does not have a good
understanding of how this might be applied in their venture.
4. The frm has built a valuaton model based on conventonal Angel and
VC valuaton methods and has determined what they believe will be
a reasonable basis for valuaton and equity share but has not had this
validated by a professional advisor.
5. The frm has engaged a professional advisor to assist in the development
of a valuaton and equity share model which would be acceptable as a
basis for negotaton with an Investor.
A9. Level of fnance required is realistic
What can go wrong will go wrong. Perhaps not – but this is the view which
most Investors take when evaluatng the level of investment required to provide
a frm basis for development of the venture. Under-funding during the critcal
growth stages can place the business in a desperate situaton where product
development is not quite fnished, cash fows are not yet positve or market
development has not reached a critcal turning point. Typically, the only opton
frms have at this point is to seek a further injecton of cash. Unfortunately this
can ofen only be achieved at a valuaton lower than the one established when
the inital Angel or VC investment was made. Investors will negotate hard to
avoid this situaton.
157
Part B: Indices
Raising Angel & Venture Capital Finance
A realistc view of the funds needed can only be achieved through a thorough
simulaton exercise of the venture. Various scenarios need to be created across
a range of possible outcomes which include worse case, most likely and best
case situatons. In this way, the sensitvity of the venture to the level of funding
needed and the estmated return to an Investor can be ascertained. With this
knowledge, the frm can beter negotate the investment. It may be possible
for the investment to be taken in tranches to refect funding needs and for
the equity positon to be adjusted accordingly. The Investor can then set aside
the maximum likely investment funds but recognises that not all of it may be
needed.
Self-assessment
1. Senior management has not undertaken any rigorous analysis of the
fnancing requirements of the business.
2. The funding requirements of the current business are well known
and understood but this has not been reviewed in light of the ROI
requirements of an external investor.
3. The frm has considered the ROI requirements of an Investor and has
considered the impact this might have on the business strategy and but
has yet to translate this into the business plan.
4. The ROI requirements have been worked into the business strategy
and into the operatonal business plan, establishing the level of funding
which would be required from an Investor, but this has not been
reviewed by a professional advisor.
5. A professional advisor has reviewed the funding requirements,
requested a sensitvity analysis on the strategy and assisted the frm to
establish the level of funding they believe an Investor would be expected
to provide in order that the investor’s desired ROI has a reasonable
chance of being achieved.
158
Part B: Indices
Raising Angel & Venture Capital Finance
Awareness and Alignment Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
A1 Majority shareholders agree on an external fnancing strategy
A2 Managers and owners agree on use of funds
A3 Entrepreneur and key managers are commited to the
venture
A4 Key shareholders are familiar with exit conditons
A5 Cost and tme for raising funds is understood
A6 Board of Directors accept authority limits of an external
investment
A7 Post-investment management roles and responsibilites
accepted
A8 Angel and VC valuaton models are understood and accepted
A9 Level of fnance required is realistc
159
Raising Angel & Venture Capital Finance
B
Venture Potential
T
he essence of any Angel or Venture Capital investment
evaluaton is the quality of the management
team (as discussed in Awareness and Alignment) and the quality and viability of
the business concept itself. That is, how and where is the money made and how
does the investor get a return on their investment? The Investor is looking for
a set of atributes which, in a holistc manner, provide a strong and compelling
business case for an investment. Each atribute should lead to a high probability
of a successful outcome. Any atribute which has a weak situaton leaves a gap
in the plan and can lead to failure or erosion of the business by an internal or
external weakness or threat.
We need to diferentate in our evaluaton of a potental investment between
those ventures which are being prepared for a fnancial exit, a fnancial trade
sale or an IPO, from those which are destned for a strategic exit. In a fnancial
exit, the robustness of the business concept and its ability to generate growth
in revenue and profts are critcal. In a strategic exit, what we are seeking
are strategic value assets or capabilites and a management team to take the
venture to a strategic trade sale. In a strategic sale the buyer will be providing
the horsepower to take the product or service to market, capabilites to drive
revenue and proft growth may be of litle consequence in the proposed venture.
160
Part B: Indices
Raising Angel & Venture Capital Finance
The atributes listed in this Index are those which have been found to have
a signifcant impact on the success of fnancial ventures. While they apply to
all fnancial businesses, later stage businesses may already have moved past
the point where they can substantally change their market positon, however,
these should have proven revenue and proft to show a viable business concept.
Many of the product/market atributes are also critcal for strategic ventures.
An Investor in unlikely to fnd a venture which scores highly on all atributes,
but since they are constantly seeking investment opportunites, each possible
deal must compete with other investment opportunites which the Investor has
reviewed. The Investor is looking for those ventures which have the greatest
potental and the highest probability of success. It is almost certainly the
case that assistance from an Investor would improve the business, afer all,
this is what the Investor is looking for – an investment where they can add
value through their knowledge and fnance. The Investor may be able to fnd
additonal executve talent to fll out the team, connect the frm with strategic
customers or alliance partners or secure a strategic supplier.
In evaluatng the venture potental, it may be that the Investor, with superior
knowledge of a partcular market, may see greater potental than has been
evidenced by the entrepreneur. For example, the Investor may know a strategic
partner relatonship which can be readily secured or a potental acquirer for the
business. While such insights cannot be guaranteed, the Entrepreneur should
seek out an Investor who has experience in their sector so that synergistc
benefts can be tapped.
B1. Business and economic conditons support the venture
Ventures which are most likely to succeed are driven by signifcant change,
whether this is in technology, legislaton, consumer values or the economy.
New technology ofen solves problems which were previously not able to be
addressed or signifcantly enhances productvity or reduces cost in solving
existng problems. Obvious demographic trends create new needs in housing,
aged care, infrastructure, travel services and so on. New legislaton ofen creates
new opportunites in compliance training and auditng.
161
Part B: Indices
Raising Angel & Venture Capital Finance
Investors look for the problem the business is solving. The more obvious
the problem and the greater the imbalance between demand and supply, the
more urgent the need is and the higher is the likelihood that the business will
be successful. Businesses need to solve a problem or meet a need and the
entrepreneur should be able to show the source of that need and the size of it.
This should be able to be validated with independent data.
Self-assessment
1. Evaluaton has not yet been undertaken.
2. There are changes which appear to support the venture but evaluaton
has not been undertaken. The proposal is based on personal opinion.
3. There are clear indicatons of changes which support the venture in
external independent informaton. Validaton has not been undertaken
of the strength or likely duraton of the need or to what extent the need
is currently being satsfed.
4. Business and economic conditons which support the venture are well
documented and supported by externally validated data. Informal
research shows that the business need is unsatsfed and a strong
demand for a soluton exists.
5. Business and economic conditons strongly support the venture either
through legislatve changes, strong demographic changes, major shifs
in consumer values, major changes in technology or major economic
shifs. The proposal is strongly underpinned with validaton data, expert
opinion of customer needs and the lack of a currently available soluton.
162
Part B: Indices
Raising Angel & Venture Capital Finance
B2. Well artculated, focused vision of the purpose of the
venture
More successful ventures have focus. They clearly know the problem they
are solving and have a very good descripton of their customer. They are able
to artculate why they exist, ofen in very simple terms. The purpose of creatng
a short, focused vision of the venture is to ensure that all parts of the business
are heading in the same directon and are supportng the various parts and
not undermining it. Decision-making should become easier, actons are more
targeted and results can be measured in terms of where the business should
be heading.
Few external investors have the specialist knowledge to evaluate the technical
merit of a range of diverse business ventures. However, they can appreciate a
clear non-technical statement of what the business does and the need or problem
it is addressing. Nothing is more of-putng to an investor as the entrepreneur
who has a product that solves everything, which will be available everywhere
and should be bought by everyone. Nor do they appreciate the venture team
which can’t decide which of the many problems they are going to address frst
or which market they are targetng. A clear, focused vision statement which has
been carefully crafed, matches the compettve advantages of the venture and
is agreed to by the venture team, is an essental part of the investment request.
In the context of a strategic venture, the vision of the venture may simply be
to prepare the business for sale. However, the venture needs to see its vision in
terms of the way in which the buyer would see the vision of the acquired frm.
Thus a clearly artculated vision of product/market positoning is stll important.
Self-assessment
1. The venture does not have a vision statement.
2. The vision of the venture is stated in broad terms, lacks focus and may
be overly technical or lengthy.
3. The vision is brief but is overly technical, too long or fails to clearly state
who the customer is or the problem being addressed. The vision may
be stated in terms of a product for sale rather than a problem being
addressed.
163
Part B: Indices
Raising Angel & Venture Capital Finance
4. The vision clearly states the target customer, the problem being solved
and is well focused and brief but is overly technical. The vision may be
focused on a single product rather than a range of problems which may
be addressed within a complimentary set of products or services which
could be developed and delivered over tme.
5. The venture has a well-artculated vision of the business concept
including the problem being addressed and the solutons which are and
will be ofered. The vision is brief and to the point and is stated in terms
that an educated non-industry investor can clearly understand.
B3. Innovatve product, process or business concept
A business which does the same as every other business in the sector will
ultmately be forced to compete on price. If the product or service is the same as
others in the market, then without a compettve cost advantage over the major
expenses in the business, the venture has litle chance of growth and certainly
is not going to reach the levels of revenue and profts which the Investor is
seeking. Cost advantages rarely drive signifcant exit values. What the Investor
will be seeking are products or services which are diferentated sufciently so
they can command a premium price in a niche market.
The Investor looks for an edge. What is it that this business has or does which
will provide it with a compettve advantage? This almost certainly is driven
by an innovaton in product, process and/or business concept. The size or
impact of the innovaton is a metric which conveys informaton about the likely
compettve advantage. A substantal innovaton which signifcantly changes
the cost structure of an industry, greatly improves customer value or opens up
solutons to formerly unsolved problems, provides the underpinning for high
rates of growth.
Obviously, the more unique the innovaton and the more the customers
value the impact, the more it adds to the potental compettve advantage of
the venture. Innovaton which does not add to customer value may in fact
detract from the worth of the venture. If the innovaton adds costs to the
product but fails to add additonal customer value, the venture is unlikely to
164
Part B: Indices
Raising Angel & Venture Capital Finance
succeed. Innovatons which add costs but at the same tme signifcantly improve
customer value can create a solid foundaton for a business.
Self-assessment
1. The product or service is the same as many others in the market.
2. The product ofered has only minor diferences to the competton.
3. The product has clear diferentaton from others in the marketplace but
the diferences are not sufcient to necessarily capture customers from
compettve oferings.
4. The product has major diferences from compettve oferings and
customers will value those diferences. Products have a strong
compettve advantage.
5. The product has breakthrough advantages which clearly separate it from
compettors. Customers highly value the advantages and this will create
a leadership positon. Products are the only ofering in a new emerging
market or are the only products able to solve the target problem.
B4. Clear and compelling customer need
Clearly the most desirable positon for any frm to be in is for their product
to be needed desperately by a set of customers. This does not mean something
they desire or would like to have, or even something they want to have. This
refers to something they must have and, beter stll, must have now! You may
well argue that few products can ever be so compelling but, in fact, many basic
products would ft that need. Each person has a need for food and water, basic
accommodaton and security. Without electricity, water and sewage services,
life in urban areas would be impossible. This is possibly the major reason why
these services are regulated. Food is of course satsfying a basic need although
there are many alternatves. But the compelling need is stll there.
Some conditons do create compelling needs. Virtually all regulatons
have compliance requirements and associated penaltes for non-compliance.
A product or service which stops you from being fned or going to jail has a
high compelling need to buy. Products and services which neutralise or reduce
physical or psychological pain and sufering easily fall into the class of products
165
Part B: Indices
Raising Angel & Venture Capital Finance
which have a compelling need to buy. However, products which have litle
impact if not purchased, have many near substtutes or can be indefnitely
delayed have a low compelling need.
Some products, such as designer labels, well established and trusted brands
and products with high repeat-purchase atributes have a higher score on
compelling need to buy.
Self-assessment
1. The product or service has many compettve and substtute oferings
and is highly discretonary or optonal. Customers regard the purchase as
a nice to have rather than a must have.
2. The product satsfes a clear customer desire but it is neither urgent nor
pressing and can be satsfed by a large number of alternatve solutons
or products. Customers can decide not to buy without being overly
concerned.
3. There is a clear need, but satsfying the need can be deferred as it is
not an urgent need to satsfy. Customers have a strong preference to
purchase and would be concerned if they were not able to. There are
some acceptable near alternatves.
4. The need is obvious and of high value to the customer but may be
temporarily deferred or can be partly satsfed by poor alternatves.
Customers have a strong desire to purchase and would be seriously
concerned by deferring the purchase.
5. There is a compelling need to purchase to avoid high physical or
psychological pain, to avoid severe penaltes or costs or to obtain/
maintain compettve advantage. Deferment is not really an opton, nor
are there any substtute solutons.
166
Part B: Indices
Raising Angel & Venture Capital Finance
B5. Sufcient, willing, funded, identfable and reachable
customers
A great number of businesses target 16-25 year olds, tme poor executves,
free thinkers or people with a desire to feel young at heart. The problem with this
approach is that it is difcult to be proactve, to actually reach out and connect
directly with the target customer. These businesses are highly dependent
on passing trafc for business. It is far beter to have a clearly identfable
target customer who you can directly and proactvely approach. You need to
ofer something for which you know they have already expressed a need. For
example, a product for registered dentsts, members of a gym or subscribers to
a journal are easily approached with an ofer to purchase.
A clearly reachable, identfable customer is one you can get in front of with
your product or service message. Potental customers must be identfed with
a locaton where you can deliver your message. This also needs to be cost
efectve, thus a TV advertsement aimed at registered dentsts does not make a
lot of sense when a trade journal, a dental conference or a direct sales visit to a
registered dental surgery would have a higher conversion rate.
An important atribute of the target market must be that they have the
willingness and the ability to spend on the product or service. Furthermore, the
business needs customers in sufcient numbers in order that the business can
make enough revenue and proft to be a viable entty.
In a strategic sale, it will be the ability of the buyer to reach a customer base
which will be critcal to new revenue generaton but the need to have a clearly
defned customer is stll important for the strategic buyer. The defniton of the
customer profle will ofen provide the key to the identfcaton of the potental
strategic buyers. The customer/market defniton required in a strategic sale
is that of the potental buyer. That is, which large corporatons have a large
customer base of the target customer and have the capability and capacity to
sell the venture’s products or services into their customer base.
167
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Numbers of customers, their defned atributes and locatons and
whether they are willing and able to buy have not been established.
2. Customer defniton is reasonably clear but no atempt has been made
to establish whether they can be approached proactvely, are willing to
purchase or are in sufcient numbers to make the venture atractve.
3. A clear defniton of the customer exists, intenton to purchase has been
established but the size of the market has not been established nor has
a program been developed to proactvely reach them.
4. The size and locaton of a clearly defned existng and/or potental
customer market has been established. The size of the market has been
established and the level of buying intenton has been estmated.
5. A clearly identfable and reachable existng and/or potental customer
market has been defned and validated. There is a clear intenton to
purchase the specifc product of the frm and the size of the market
would support the projected revenue of the venture.
B6. Obvious and meaningful compettve advantage
If you have a product or service in a marketplace which is simply litered with
comparable oferings, you can have very litle hope that your venture is going
to be successful. If everything you do to be diferent can be readily copied with
litle efort, clearly you are in a business which has litle chance of success. Only
by fnding a strong point of diference in an atribute that the target customers
value will your own products or services carve out a segment of the market. The
most desirable positon to be in is to have a product which not only fully meets
the needs of the target customers, but has no compettor or near substtute and
has signifcant barriers to entry.
For a compettve advantage to be meaningful it needs to be validated
by actual or potental customers. The diference must be meaningful and
sufciently important to the target customers that they have a clearly expressed
preference for the product or service you are ofering. Validaton is also needed
to ensure that a close alternatve product is not available. A compettor analysis
is necessary for you to validate your compettve advantage.
168
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. A compettve analysis has not been undertaken.
2. The frm knows of a number of compettors but has not done any
systematc analysis of their positon relatve to the competton.
3. A compettve analysis has been undertaken and shows the frm has
some diferentaton which should appeal to potental customers.
4. The frm has a clear compettve advantage in its target market and
has validated this with potental customers who value the diferental
features.
5. The frm has outstanding diferentaton which is highly valued by
the target market or there are no obvious compettors and there are
signifcant barriers to entry.
B7. Well protected sustainable atributes
While the frm may have established a compettve advantage with its product
or service, this is really only benefcial if it can sustain and/or protect it over the
long term. Sustainability can be achieved from registered intellectual property
(IP) such as is the case of patents or copyrights. Protecton may lie in the fact
that the frm has certain rights which are exclusive or limited such as mining or
forestry rights or a licence to practce. Expert knowledge, if hard to acquire, in
limited supply or requiring extensive experience or training, may provide the
basis for a sustainable advantage.
Protecton can be legal rights which atach to patents or licences. Products
and services can be protected by being difcult, expensive or tme consuming
to copy. A business may protect itself by controlling elements of the market
such as preferred outlets, distributon channels or essental components. Other
frms may be efectvely locked out of a market through customer or supplier
agreements or by controlling the source of an essental resource input. The
ability to defend encroachment is an essental factor in maintaining protecton.
The frm which cannot defend a patent infringement, for example, has litle
protecton against a large well-funded predator.
169
Part B: Indices
Raising Angel & Venture Capital Finance
The value achieved in a strategic sale is directly related to the level of
exploitaton of the venture’s products or services by the buyer. Therefore, the
buyer is keenly interested in the level and sustainability of the compettve
advantage which will be passed to them by the seller.
Self-assessment
1. The venture has not been able to establish any long-term protecton for
its products or services.
2. Products or services have short-term protecton but this can be eroded
by a determined compettor or antcipated new products in the market.
3. Products have some level of long-term protecton but only through an
aggressive product development process, strong customer service and/
or features which appeal to a niche market.
4. The frm has strong intellectual property protecton through patents,
copyright or registraton rights but these may be overcome or eroded
by a determined and well-funded compettor although this would take
some years to be efectve.
5. The frm has very strong intellectual property protecton through
patents, strong branding, high customer loyalty or highly specialised and
difcult to acquire knowledge. Signifcant funding and/or strong alliance
partnerships are present to defend IP which can be expected to deter
copying.
B8. Resources and channels to distribute are in place or able to
be acquired
Great products or services which cannot be placed where customers can see
them, try them or buy them are simply not going to generate revenue in any
volume. A business which has an intenton to grow, especially one wishing to
grow aggressively, has to fnd channels to market which will put its products
in front of the intended target customers in sufcient numbers for growth to
be achieved. There are many possible channels to market and the business
needs to choose those which are most appropriate for the type of product or
service being ofered as well as the type and purchase preferences of the target
customer.
170
Part B: Indices
Raising Angel & Venture Capital Finance
Some products suit direct sales or telemarketng and/or telesales, so capacity
must be built within those channels. Can the business acquire, aford and train
sufcient skilled numbers of staf to handle the intended volume? If the product
suits a high volume distributon channel, can that be acquired or contracted at
a price which is cost efectve? Is the business able to utlise alliance partners
or joint ventures to take the product to market? Many small frms lack the
distributon reach to efectvely scale their business and need to fnd partners
to help them get to market. Is the business able to clearly show how the target
volumes will be achieved through the chosen distributon channels and is it able
to show that those channels are available, willing and afordable?
In the case of a strategic sale, it is the buyer who will provide the channels
to market. The assessment of the venture potental will measure whether the
product or service being developed can be readily rolled into the potental
buyer’s distributon channel. If it can, then the venture can easily satsfy this
atribute.
Self-assessment
1. Distributon channels are not in place.
2. The frm is constrained by limited in-house distributon capabilites, lack
of access to distributon partners and/or powerful distributon channels
which control the interface to customers.
3. The frm has a well-defned distributon strategy but lacks an exclusive
presence, incentves for distributon channels to put above average
efort into the products or a lack of capacity to handle signifcant
volumes.
4. The distributon strategy is well defned, is efectve in reaching the
target customers and can handle the volume of sales antcipated but
lacks robustness to be able to adapt to disruptve events or shifs in
channel commitment.
5. The distributon strategy is able to directly connect with the target
market in an arrangement which provides the frm with excellent and
tmely exposure to the customer. The channels are highly motvated
171
Part B: Indices
Raising Angel & Venture Capital Finance
and incentvised and have the depth and scope to cater for changed
circumstances and can readily support the volumes required to meet
fnancial objectves.
B9. Sales price and cost model provides robust achievable
margins
The business needs to be able to validate both price to customer and expected
costs of goods sold as well as fxed costs at each antcipated level of output. Prices
might be established relatve to compettors, perhaps supported by marketng
survey data. Cost data may also have been established through compettor
informaton or perhaps through a cost build-up model using quotatons for
external costs and cost allocaton for internal costs. For established products,
prices and costs should have already been validated through existng sales.
The business model will need to show that reasonable levels of proft can be
achieved within a short period of tme. Alternatvely, a business which cannot
move into reasonable proft must have a reliable source of contnued subsidies
to allow it to stay in business. The fnancial model should also be tested across
a range of possible business conditons to see if the business concept is robust
under worst, most likely and best case scenarios.
In the case of a strategic venture, the price and cost modelling must be
sufcient to encourage the strategic buyer to go ahead with the deal. If the
buyer can see a signifcant revenue opportunity with good margins and can
readily justfy the acquisiton, this will make it easier for the frm to be sold.
Self-assessment
1. Sales price and costs have not been established.
2. Sales prices are estmated and costs have been partly established but
neither validated.
3. Sufcient informaton on prices and costs has been ascertained to
establish that the products can be sold for a proft. However, a sensitvity
analysis has not been undertaken.
172
Part B: Indices
Raising Angel & Venture Capital Finance
4. Prices and costs have been established and margins have been
determined to be atractve. Volume sales show that proft targets
can be reached, however, sensitvity analysis to cost variaton or price
variaton has not been undertaken.
5. Sensitvity analysis has been undertaken across a range of possible price
and cost scenarios and over worst, most likely and best cases and all
scenarios produce acceptable levels of proft achievement.
B10. Integrated volume operatons (development,
manufacturing, logistcs, support and infrastructure) are
achievable
Many products or service businesses look great when the volumes are small.
This is ofen because the founders take special care over the development and
delivery of the customer soluton and the customer is given additonal assistance
to ensure a satsfactory outcome. However, when the business grows, volume
producton requires a level of planning and control which is not required or
needed when volumes or outputs are small. Logistcs need to be much beter
integrated, quality needs to be controlled throughout the entre value chain
and the business needs to have purchasing, human resources, marketng,
administratve and IT infrastructure to support complex operatons.
Businesses which can handle 10 or 100 transactons need to be massively
redesigned when the volumes reach hundreds and thousands. How will the
business cope if it needs to manage multple locatons? Does the business
have the right people, structure and resources to build a larger, higher volume
business?
Scalability and/or replicaton are critcal to a strategic sale. The venture needs
to be able to demonstrate that, in the hands of the buyer, signifcant volumes
will be able to be produced with stability in quality and reliability in tming.
173
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Assessment of volume operatons has not been undertaken.
2. An operatons plan has been produced but a detailed operatons plan
has not been constructed to see if the plan is achievable.
3. The operatons plan has been established at a low level of detail but
supportng plans for staf recruitment, training and infrastructure have
not been established.
4. A detailed operatons plan has been compiled which fully supports the
growth plans of the venture. Supportng detail shows infrastructure, staf
and resource requirements, however, sensitvity analysis has not been
undertaken in areas where delays, variatons in productvity or shortages
might occur.
5. A detailed, integrated, robust operatonal plan has been prepared which
includes all support operatons. The plan has been reviewed under
various risk conditons and contngency plans have been developed to
mitgate or negate likely risk situatons.
B11. Management team is experienced, complete, commited,
capable and entrepreneurial
Experienced investors know that business plans are very rarely implemented
as writen. Every plan is based on a number of assumptons and those ofen
prove to be unfounded or are invalidated by economic, environmental and
industry changes. The business may not develop in the manner in which it was
originally planned. Experience tells the investor that the best soluton to this
problem is to have a proven management team which has the experience to
cope with the changes that inevitably will occur. They look for an executve team
which has the qualifcatons, experience, mix of skills and industry networks to
implement the original plan but can also react to changing conditons and is stll
likely to achieve reasonable results.
In the case of a venture being prepared for a strategic sale, the management
team, in conjuncton with the Investor, must have the ability to undertake the
sale preparaton process. This may include completng product development,
174
Part B: Indices
Raising Angel & Venture Capital Finance
establishing trial customers, building relatonships with potental buyers and
engaging professional advisors.
In the case of a fnancial venture, it takes more than industry knowledge and
a capable management team to grow a business over tme. Very few markets
are stable over many years, being impacted by new inventons, new entrants
and changing business models. Any business which grows over an extended
period of tme must have an entrepreneurial capability. This is the ability to
see opportunites where others don’t, an ability to construct diferent business
models, a strong sense of tming about market changes, a willingness to have a
go in the face of incomplete or ambiguous market data and the acceptance that
some projects will fail.
Driving a business forward in the face of changing conditons also requires
leadership and good judgement. A strong vision, a sense of partnership
and involvement and a sense of personal achievement and growth are all
characteristcs of a positve work culture. A business grows over tme, not
by doing the same thing all the tme, but by evolving to take advantages of
opportunites in the market place. A business which is open to new ideas,
willing to try new approaches to doing business and encourages people to try
small experiments will proactvely generate avenues for growth.
Whether the intended exit is fnancial or strategic, Investors know that
they work in start-up and early stage ventures where the passion, drive and
energy of the entrepreneur and the management team are critcal to success.
A good product or service, by itself, will not be sufcient to provide the tracton
necessary to drive the business to success. The Investor needs to see indicatons
of what the team members have achieved individually and collectvely; that
they have the ability to take initatve, be proactve and creatve and have the
determinaton to succeed in this venture. The Investor also wants to see that
the executves are commited to the venture. This may occur through their own
personal fnancial investment, tme invested in the venture or the fact that
they have put their personal reputatons behind the business. Where there are
missing skills, the investor wants to see these are acknowledged and a proposal
put forward to recruit the necessary talent.
175
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Assessment of the current management team has not been undertaken
or no team has yet been assembled.
2. The current management team lacks some key skills, experience and
knowledge and plans are not yet in place to recruit to fll the gaps. The
current team has not acknowledged any defciencies which need to be
flled. It is not obvious whether the team will stay with the venture if
the going gets tough. The team has not demonstrated entrepreneurial
actvity.
3. The current management team is highly competent in most of the key
areas and has the skills and experience to take the venture forward. Key
gaps have been identfed but a plan has not been developed to fll the
gaps. Some members of the team have made personal fnancial or tme
commitments. Individuals within the team have shown entrepreneurial
actvity but they have yet to demonstrate this as a team.
4. The management team has the experience, capability and knowledge
to take the venture forward and have plans in progress to recruit some
key individuals as part of the growth planned. Succession plans have not
been developed. The team has made signifcant fnancial, tme and/
or reputaton commitments to the venture. The team demonstrates an
entrepreneurial capability.
5. The management team is experienced, has the necessary range of skills,
experience and entrepreneurial capability to grow the venture and has
an organisatonal plan for both growth and succession. It is clear that the
team is very commited to the venture and will put in the tme and efort
even if the venture proves to be more difcult than expected.
B12. Financial projectons show robust acceptable ROI
The business concept should to be tested across multple scenarios to ensure
that a reasonable fnancial return can be achieved even in the most unlikely
circumstances. When possible funding is added to the fnancial forecasts, the
forecasts should show that the Investor is able to achieve very good results.
Robust fnancial forecasts should declare and test the validity of the basic
assumptons. By changing basic assumptons to diferent possible situatons,
176
Part B: Indices
Raising Angel & Venture Capital Finance
the model can be tested for robustness. Those assumptons which have the
greatest sensitvity can then be addressed with counter measures or additonal
actvites to minimise their impact.
Within the period of the investment where survival and operatonal
performance are critcal, fnancial projectons should include income statements,
balance sheets and cash fows. A breakeven analysis should be shown. These
various fnancial projectons should be created under several possible scenarios
including worst case, best case and most likely case.
Estmates of exit values should be undertaken to show that the business is
able to achieve the rates of return desired by the Investor under all possible
exit scenarios. Remember that in the case of a strategic exit, revenue and proft
growth may not be relevant. What is important is to produce something which
the strategic buyer wants.
Self-assessment
1. Financial projectons have not been prepared.
2. Financial projectons have been prepared but are at a high level of
aggregaton and are based on assumptons which have not been
validated. Detailed cash fows are not available.
3. Detailed fnancial projectons have been prepared which show
acceptable levels of profts (if relevant) and ROI but some assumptons
are questonable and a scenario analysis has not been undertaken.
Detailed cash fows are available.
4. Detailed fnancial projectons have been made which show acceptable
levels of proft and revenue growth (if relevant) and ROI. Underlying
assumptons have been validated and are acceptable. Scenario analysis
has not been undertaken.
5. Detailed fnancial projectons with worst case, most likely case and
best case have been undertaken. Underlying assumptons have
been validated. Projectons have been validated by an independent
professional advisor. Proft and ROI targets are robust and achievable
under all scenarios.
177
Part B: Indices
Raising Angel & Venture Capital Finance
B13. Risk analysis shows resilience to possible delays, shortages,
compettve retaliaton, quality issues, failure to recruit the
right staf, etc.
Most simulatons of fnancial projectons concentrate on changes in revenue
levels but fail to take into account other risks which may be equally damaging
to the venture. The Investor needs to isolate those factors within the business
which can have the most disruptve impact on desired targets. It is only by
undertaking such an analysis that the Investor can uncover the likely risks which
can severely impact target achievement.
Once a risk assessment has been undertaken, those risks can be subjected
to their own mitgaton planning exercise. A business plan which antcipates
potental problems can build contngency plans and take steps to avoid, mitgate
or reduce the impact of possible negatve events. Risk analysis may result in
strategies being developed which change the order of introducton of products,
the tming of selected capital expenditures or planned targets.
Self-assessment
1. Risk assessment has not been undertaken.
2. Some major risks have been identfed but a plan has not been
developed to deal with these when they occur.
3. Major risks have been identfed and plans have been developed to deal
with them when they occur, but mitgaton or avoidance plans have not
been implemented.
4. A risk analysis across the enterprise has been undertaken and plans have
been put in place to counter, mitgate or avoid them.
5. The business strategy has been developed and implemented to take into
account those risks which would have a damaging efect on the business
achieving its objectves.
178
Part B: Indices
Raising Angel & Venture Capital Finance
B14. A robust and well-artculated exit strategy has been defned
Investors need to see a path to liquidity for their investment. Few Angel
or VC investors invest for dividends; most will be investng for capital gains.
However, whether they invest for dividends or capital gains, they stll need to
have a mechanism for releasing their original investment. The normal form of
harvestng is either a sale to another business (trade sale) or a listng on a public
stock exchange (an inital public ofering or IPO). Many investment proposals
use such exit phrases as ‘sell to a corporaton in 3-5 years’ or ‘list on the stock
exchange in fve years’ with no substance behind the statement. They have
neither identfed who the potental buyer might be nor how they would be an
ideal candidate for an IPO.
The business proposal needs to demonstrate to the Investor a well-artculated
exit strategy which is meaningful. A trade sale strategy should have identfed
potental buyers and have convincing arguments as to why the selected
corporatons should buy the business. An IPO strategy should show how similar
businesses, with comparable products, services and growth paterns, were able
to list on the target exchange.
Self-assessment
1. An exit strategy has not been identfed.
2. The exit strategy is very general and lacks detail or validaton.
3. A possible exit strategy has been artculated which looks feasible but
lacks detail and resilience.
4. The exit strategy is very detailed, seems highly probable and includes
estmates of tming, resources required and costs for professional
services.
5. Professional advice has been received to validate the exit strategy and
adjustments have been made as a result. The exit strategy is highly
probable and resilient. Alternatve exits are capable of being executed
depending on market circumstances.
179
Part B: Indices
Raising Angel & Venture Capital Finance
Venture Potental Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
B1 Business and economic conditons support the venture
B2 Well artculated, focused vision of the purpose of the venture
B3 Innovatve product, process or business concept
B4 Clear and compelling customer need
B5 Sufcient, willing, funded, identfable and reachable
customers
B6 Obvious and meaningful compettve advantage
B7 Well protected sustainable atributes
B8 Resources and channels to distribute are in place or are able
to be acquired
B9 Sales price and cost model provides robust achievable mar-
gins
B10 Integrated volume operatons(development, manufacturing,
logistcs, support and infrastructure) are achievable
B11 Management team is experienced, complete, commited,
capable and entrepreneurial
B12 Financial projectons show robust acceptable ROI
B13 Risk analysis shows resilience to possible delays, shortages,
compettve retaliaton, quality issues, failure to recruit the
right staf, etc.
B14
A robust and well artculated exit strategy has been defned
180
Raising Angel & Venture Capital Finance
C
Operations Development
T
he Operatons Development Index (ODI) has been designed so that an
Investor can measure the quality of governance and operatons
management within the investee frm. It can be used to evaluate the potental
investment as well as provide a tool for measuring the progress of development
of internal systems once the investment has been made.
A business can only be run efectvely if it has the measurement and
reportng systems in place to set targets and review performance. The use of
KPIs, budgets and proper reportng systems are critcal. Governance issues deal
with compliance and risk management and can be seen in good relatonships
with customers, suppliers, bankers and so on. Operatonal excellence should
be an objectve of the Angel as this can positvely contribute to the value of the
business at the tme of sale or as preparaton for an IPO.
As part of the inital due diligence of the frm, the ODI can help the Investor
assess potental risks in the investment. When an Angel or VC investor enters into
an investment, they are exposed to the trading risks of the investee company.
They are also exposed to any current or contngent liabilites, current and
potental employee disputes, customer issues and supplier disputes. Once the
investment has been made, these risks will be managed through management
oversight and restrictons on how monies can be used and what loans can be
incurred.
181
Part B: Indices
Raising Angel & Venture Capital Finance
The Investor will also have arrangements in place where they can more
actvely intervene and sometmes take complete control if the business fails
to perform to agreed schedules and targets. However, this is litle comfort to
an Investor who is reliant on the management team to operate the business.
Pre-existng conditons may be underwriten somewhat through warrantes
and representatons and failure of the business to perform may be somewhat
compensated for by a share diluton formula which adjusts the Investor’s
percentage of ownership, but this is litle comfort to the Angel or VC frm which
has invested in a lemon.
The Investor needs to establish the level of risks associated with the
investment before they do the deal, not afer. So an extensive investgaton
will ofen be undertaken to uncover any skeletons which may lie in wait for
the unwary investor. Depending on the size and complexity of the frm, this
process can take many months and be very expensive. While this cost is usually
absorbed by the Investor, it is almost certainly factored into the valuaton or use
of the investment funds. In some cases it may be underwriten or reimbursed
by the investee company.
The Investor will be trying to estmate the costs and tme needed to be
devoted by the Investor, executves within the frm and external advisors to
bring the investee company up to the quality needed for an ongoing stress-free
operaton. As items are uncovered, the Investor will need to estmate the tme
and cost that will be incurred to resolve the issue. Of course, some may not be
that simple, cheap or quick to resolve. Other items may be serious and there
may not be an easy way to estmate the likely damage or cost to resolve. This
is partcularly true with contngent liabilites, intellectual property ownership
doubts and unclear customer obligatons which have not been fulflled.
At some point, the Investor may simply decide that the level of risk is too high
to proceed, or they might decide that it will take too long and be too expensive
to establish the level of exposure in the outstanding issues.
Clearly a frm which appreciates the concerns of the Investor and has closely
managed its operatons, managed its risk exposure and ensured that it has
fully complied with industry regulatons, is a good candidate for Angel or VC
investment.
182
Part B: Indices
Raising Angel & Venture Capital Finance
The ultmate due diligence test which could be used by an Investor is the
following:
Can I leave the investee frm alone to continue managing its opera-
tions without incurring any unreasonable level of risk?
Can I achieve my required ROI in the investment by devoting my effort
to where I can add the most value without being distracted with having
to clean up problems frst?
Not all issues will be resolved by the frm in advance of an Investment, but
the more the frm can do prior to the investment, the easier it is for the Investor
to complete the due diligence investgaton and move to consummate the
investment arrangements. A frm which is prepared for due diligence is a major
advantage for an Investor.
The inital investgaton can provide the Investor with a checklist to be used
afer the investment to drive improvement in the governance and operatons
management of the frm. An Investor keen to see a trade sale or an IPO within
a few years of his investment should be sensitve to the positve impact a clean
bill of health on the ODI will have on the potental exit value of the frm.
In a trade sale situaton where the potental buyer is a corporaton, aspects
of the acquirer’s due diligence will deal with the actual integraton of the two
companies. This will involve reviewing the costs, problems and delays of merging
the acquired business into their own organisaton and will involve such things
as personnel systems, beneft systems, IT infrastructure and so on. The only
way the frm can prepare for this possibility is to ensure that they use industry
standard processes wherever possible.
183
Part B: Indices
Raising Angel & Venture Capital Finance
C1. Monthly fnancial and key performance indicator reportng
exists
The existence of a comprehensive reportng system is important for several
reasons. These are:
• It demonstrates that the frm is well run.
• It shows that the management is efectve.
• It shows atenton to detail.
• It demonstrates that an underlying infrastructure is in place.
• If comprehensive, it should show that problems are identfed early and
addressed.
The fnancial reportng systems should produce balance sheet and income
statements, cash fow projectons, aged debtors and aged creditor reports.
More sophistcated systems go beyond monthly fnancial reportng. Every
business has key performance indicators (KPIs) which demonstrate health
and compettve alertness. Reportng systems should be able to demonstrate
that the company is operatng efciently in all major areas of operatons. For
example, in sales, reportng systems might examine tenders received, tenders
sent, contracts under review, contracts received and revenue to estmates.
In producton, it might refer to actual producton versus planned producton,
overtme hours worked, rework hours, inventory levels and so on.
In a due diligence investgaton, the Investor will be atemptng to estmate
the level of interventon that is to be put in afer the investment. To the extent
that good management systems are in place, this should considerably reduce
the Investor’s concerns.
Self-assessment
1. Internal reportng systems are unsophistcated and incomplete.
2. Monthly fnancial reportng exists but is not comprehensive.
3. Monthly reportng exists but few KPIs are tracked.
4. Monthly reportng systems and KPIs are tracked but have not been
audited for completeness and efectveness.
184
Part B: Indices
Raising Angel & Venture Capital Finance
5. Comprehensive monthly fnancial and KPI reportng exists. Professional
advice has been taken to ensure completeness and efectveness.
C2. A formal business plan has been prepared and is updated
periodically
Most business people would agree that business plans are outdated as soon
as they are printed. However, the discipline of preparing the business plan
captures the holistc nature of the enterprise. This is one of the few tmes where
management have the opportunity of rethinking the vision, goals and strategy
of the frm. It is by pulling it all together that they will gain insights into areas of
weakness and opportunites where the business can be improved.
For the Investor, a good business plan provides insights into the business. For
example:
What is the vision and how is this translated into strategy?
What are the competitive assets and competencies of the frm and
how are these being leveraged into competitive advantage?
Which markets do they compete in and how are they placed?
What are the assumptions behind the numbers and have these been
validated?
What risks are present in the business and how are these being ad-
dressed?
What is the worst case scenario?
Do they understand their underlying cost and revenue structures and
has this been translated into a breakeven analysis and a breakdown
of recurring and new business?
185
Part B: Indices
Raising Angel & Venture Capital Finance
Can they demonstrate clearly where the business comes from and
why?
Do they have clearly articulated marketing and sales plans with identi-
fed targets?
Has business growth been translated into a headcount plan and a
funding plan?
The business plan demonstrates that the management team understand
what it takes to be successful. It should be more than a spreadsheet, it is an
explanaton of why the business is successful and should be backed up with
validaton of assumptons.
The queston that should be asked by the Investor is:
Can this business be run successfully without me having to intervene
to make it work?
It may not be the Investor’s intenton to leave the business the way it is,
afer all, part of the reason for selectng a specifc investment is to leverage the
Investor’s knowledge and contacts. However, he should be trying to estmate
the level of efort he is going to have to put in to improve their operatons
management. If the business can be lef alone to run itself for some period
of tme, the Investor can concentrate on future plans for the business without
having to shore up normal operatons.
The business plan may also indicate where additonal potental lies for the
frm. This helps the Investor to evaluate the opportunity and perhaps see how
the opportunity may be developed with additonal resources or assistance from
the Investor.
Self-assessment
1. A business plan does not exist.
2. There is a business plan but it is out-of-date and/or incomplete.
186
Part B: Indices
Raising Angel & Venture Capital Finance
3. There is a comprehensive business plan but it simply projects past trends
and is not a strategy document.
4. A comprehensive business plan exists and is up-to-date but does not
have the depth or validaton needed to provide a good explanaton of
strategy or how the business might perform in the longer term.
5. A very comprehensive business plan exists which is of professional
quality and fully explains the business strategy, the capabilites and the
likely outcome of the business in the longer term.
C3. A formal budget is prepared and actual performance is
monitored against budget
The preparaton of formal budgets (proft & loss, cash fow and balance
sheet) serves a number of purposes including:
• quantfcaton of formal business plan.
• identfcaton of projected proft and loss and cash fow.
• a basis for fnancial discussions with external partes such as debt and
equity provider.
• a basis for monitoring the actual performance of the business against
the business forecast.
• a basis for performance evaluaton of key staf and departments.
The budget should provide the basis for monitoring actual performance
against budget and should link the formal business plan to the actual
performance of the business.
Budgets should be prepared and monitored on a monthly basis. Budgets
should be prepared on a geographic and department basis in order to properly
assign responsibility and facilitate the management of variances.
Preparaton of a formal budget and analysis of actual performance against
budgeted performance should provide the following benefts to the business:
• assist in identfying under or over performance against budget
• enable tmely actons to be taken where actual performance is
187
Part B: Indices
Raising Angel & Venture Capital Finance
signifcantly diferent to forecast performance
• ensure key fnancial informaton is monitored at various levels
throughout the business
• promote accountability of key individuals and departments.
Evidence of regular budget to actual analysis by the business will provide the
Investor with greater comfort that the business has been actvely monitored
and proactvely managed and that business risks are being assessed on a regular
basis.
Self-assessment
1. A budget is not prepared and analysis of actual results to budgeted
results is not performed
2. There is a budget, but it is out-of-date, or not regularly monitored.
3. There is a summary budget, but it is not detailed enough, does not
link to the business plan, does not ensure accountability of key staf/
departments and is not regularly monitored.
4. A budget exists which partly assists in monitoring actual to forecasts of
the business (including accountability of key staf/departments).
5. A comprehensive budget exists which supports the formal business
plan and is a major tool in the ongoing monitoring and assessment of
business performance including monitoring accountability of key staf/
departments.
C4. Full compliance with regulatory issues (e.g. environmental,
health and safety)
The Investor will be investgatng the health of the business in terms of the
quality of its underlying systems. These will include all the compliance areas.
These will vary from industry to industry but may include:
• tax reportng (income, payroll and sales tax (BAS, VAT, GST, etc))
• company fnancial reportng
• corporate governance (shareholder tracking, board minutes, etc)
188
Part B: Indices
Raising Angel & Venture Capital Finance
• employment law reportng
• mandatory insurance
• health and safety practces and accident reportng
• environmental compliance
• industry-specifc regulatons.
These areas are critcal in a review as they can point to weak management,
lack of concern for potental exposure and the possibility of litgaton and
penaltes. The exposure may not only be for ongoing practce, but may be
retrospectve in more severe cases such as environmental issues.
Self-assessment
1. Compliance is not treated seriously and is inconsistently implemented.
2. The frm is concerned about compliance and has some systems in place
but a comprehensive program does not exist to ensure compliance or to
ensure completeness of coverage.
3. Compliance is treated seriously but is lef up to individual managers and
there is no system in place to ensure that all areas are covered and full
compliance is occurring.
4. A full list of compliance issues exists, responsibilites are defned and
some areas have reportng systems to ensure that compliance is being
adhered to. Professional advice is being sought to undertake an audit in
order to put a comprehensive reportng system in place.
5. Compliance reportng is comprehensive and efectve and is audited by
professional advisors on a periodic basis to ensure completeness and
efectveness. No outstanding or antcipated litgaton exists.
189
Part B: Indices
Raising Angel & Venture Capital Finance
C5. Customer relatonships are managed to minimize litgaton
Litgaton and potental litgaton occur when aspects of the business are
not conducted fairly, transparently and according to accepted standards of
good conduct. It is not sufcient to hope that external and internal relatons
are managed well. The Investor will examine whether the frm has policies,
procedures and systems in place to ensure that they are doing so.
In the case of customers, the frm needs to conduct its business so that
customers clearly understand the obligatons of the frm, customer expectatons
are clearly understood and performance to documented and implied contractual
conditons is monitored. Products and services need to be ft for purpose, of
merchantable quality and sold with clear explanatons of intended use. The
frm should be prepared to assist customers to ensure that efectve intended
use can be readily achieved. Failure to understand the customer’s needs and
intended use exposes the frm to potental complaints, wasted resources and
possible litgaton.
The frm should have in place fair and reasonable contracts or agreements
with customers, efectve complaints handling processes and monitoring
systems to ensure obligatons are met.
Investors will be concerned about potental risks. Poor customer handling
and poor internal processes suggest exposure to potental litgaton, workplace
unrest and/or loss of customer respect and retenton. These seriously damage
the company as a place to work or do business, potentally threatening the
viability of the business. The Investor does not want to inherit problems which
may distract from achieving the objectves in the investment. A frm with
underlying potental litgaton can severely disrupt the frm and will probably
exclude it from a successful trade sale or IPO. The Investor may be beter of to
walk away from the investment than to take the risk.
Self-assessment
1. Special efort is not taken by the company to avoid litgaton in external
customer relatonships. Accounts are not reviewed for current or
potental problems on any systematc basis. An escalaton process does
not exist to deal with unresolved issues.
190
Part B: Indices
Raising Angel & Venture Capital Finance
2. The frm acknowledges that it can do beter. Staf have been advised of
the implicatons of unresolved customer issues. A complaints system is
in place.
3. A formal customer complaints system is in place with proper escalaton
procedures. Formal agreements exist with customers which deal with
outstanding problems.
4. Professional advice has been taken on establishing formal systems
of dispute resoluton, complaints handling and problem escalaton.
Contracts have been reviewed by professional advisors. Relatonship
management training has been given to staf where appropriate.
5. Formal review systems are in place for all agreements with customers.
The frm is proactve in dealing with customers to ensure that
expectatons are set correctly and are monitored on an ongoing basis.
Formal complaint handling systems and dispute resolutons systems are
in place with staf trained and advisors available. Professional advisors
review any serious disputes and provide advice on problem resoluton.
C6. Supplier relatonships are managed to minimize litgaton
Good supplier management is essental for the efcient operatons of a
business. Litgaton and potental litgaton occur when aspects of the business
are not conducted fairly, transparently and according to accepted standards of
good conduct. It is not sufcient to hope that external and internal relatons are
managed well. The Investor will verify that the frm has policies, procedures and
systems in place to ensure that they are doing so.
Some suppliers are more critcal than others where they supply essental
parts, where there are no efectve substtutes or the switching costs of moving
to another supplier is high. Managing supplier relatonships is essental for the
health and ongoing efectve operaton of the business. The frm should have fair
and equitable agreements with suppliers and these should be industry standard
wherever possible. Supplier relatonships should be managed by people in the
company who understand that relatonships are more than simply placing
purchase orders and negotatng the best price.
191
Part B: Indices
Raising Angel & Venture Capital Finance
The frm needs to be able to demonstrate to the investor that goodwill
exists in those relatonships, the business values their suppliers and issues and
complaints are dealt with in a tmely and reasonable manner.
Investors are always concerned about potental risks and disrupton. Poor
supplier relatonship management and poor internal processes to resolve
problems suggest exposure to potental litgaton, workplace unrest and/or
potental loss of key suppliers. Failure to monitor payables and resolve disputes
may also afect credit ratng. No Investor likes to inherit problems which may
distract them from achieving the potental in the investment. An investment in
a frm with underlying potental litgaton can severely disrupt both the frm as
well as the Investor who may have to become involved to resolve the situaton.
Self-assessment
1. Special efort is not taken by the company to avoid litgaton in supplier
relatonships. Accounts are not reviewed for current or potental
problems on any systematc basis. An escalaton process does not exist
to deal with unresolved issues.
2. The frm acknowledges that it can do beter. Staf have been advised of
the implicatons of unresolved issues. A complaints system is in place.
3. A formal complaints system is in place with proper escalaton
procedures. Formal agreements exist with suppliers to deal with
outstanding unmet obligatons and disputes.
4. Professional advice has been taken to establish formal systems of
dispute resoluton, complaints handling and problem escalaton.
Contracts have been reviewed by professional advisors. Relatonship
management training has been given to staf where appropriate.
5. Formal review systems are in place for all agreements with suppliers.
The frm is proactve in dealing with suppliers to ensure that
expectatons are set correctly and monitored on an on-going basis.
Formal complaint handling systems and dispute resoluton systems are
in place with trained staf and advisors available. Professional advisors
review any serious dispute and provide advice on problem resoluton.
192
Part B: Indices
Raising Angel & Venture Capital Finance
C7. Employee relatonships are managed to minimize litgaton
The Investor will want to know that good management practce systems and
fair and reasonable workplace conditons are in place for efectve employee
management. Employees should understand clearly what is expected of them,
be provided with opportunites to provide feedback on their experience and
be given performance appraisals to ensure they understand how they are
meetng expectatons. Processes should be in place to deal with harassment
and discriminaton in the workplace. Only through efectve and systematc
performance monitoring and correctve acton can the frm adequately deal
with dismissals without creatng situatons which might lead to unfair dismissal
claims and possible litgaton.
Every business is dependent on its employee’s goodwill and motvaton. If the
workplace conditons are not fair and reasonable at a minimum and if justce
is not done and seen to be done, this creates a poor working environment. It
is inevitable that the frm will go through a series of changes of management,
systems and directon afer the investment. This is going to take a lot of goodwill
and support from existng staf. An Investor doesn’t wish to start of this process
at a disadvantage. In additon, poor performance management processes expose
the company to claims for unfair dismissal or discriminaton. No Investor wants
to be exposed to potental unquantfable future litgaton costs and damages.
Contngency liabilites are normally the death of a future trade sale or IPO.
Self-assessment
1. Special efort not is taken by the company to avoid litgaton in
employee relatonships. Workplace issues are lef to local supervisors
and local management to resolve. There are no full-tme or dedicated
employees responsible for compliance or to assist in resolving workplace
relatonship issues. A systematc process does not exist to set and
evaluate performance.
2. The frm acknowledges the need to introduce more formal processes.
Job descriptons are in place for most of the employees and an
evaluaton process is used for performance review and setng pay
increases.
193
Part B: Indices
Raising Angel & Venture Capital Finance
3. Performance targets and formal reviews of achievement are in place. A
member of management is responsible for compliance. Management
has been briefed on workplace issues of harassment, discriminaton and
performance review documentaton and dismissal processes. However,
these are not systematcally followed.
4. Formal processes exist for defning job descriptons, setng and
assessing performance targets and dealing with employee workplace
issues. Management has been trained on all aspects of compliance
and workplace performance and dismissal processes. No external
professional advice has been sought to audit the quality of the
processes.
5. Systems and procedures are fully documented and audited to
ensure full compliance with best practce in performance reviews,
dismissal handling and workplace incident handling. The company has
professional internal staf and/or external advisors to assist with any
serious incident.
C8. Credit worthiness with suppliers is excellent
The quality of external relatonships is ofen an indicator of the quality and
integrity of the management team and the culture of the frm. As the business
grows some level of disrupton to the business is likely to occur. During this
period the goodwill of suppliers is going to be necessary so that additonal
problems don’t create crisis events. By reviewing credit payment performance
informaton and interviewing suppliers, the Investor can obtain a measure of
the way in which management has dealt with issues in the past.
Few companies are able to avoid fuctuatons in their cash fow. However,
problems can ofen be mitgated by good relatonships with suppliers. Suppliers
who are normally paid promptly and dealt with fairly are ofen willing to extend
additonal credit for short periods during difcult tmes. This is especially true
if the frm has dealt with them honestly and shown past behaviour of bringing
situatons back to prompt payment.
Those frms which keep their suppliers informed, proactvely tell them about
impending issues and show good management skills in correctng problems
194
Part B: Indices
Raising Angel & Venture Capital Finance
promptly, are much more likely to be given extended credit to cover short-term
situatons. A review of supplier credit performance will help the Investor gain
an independent measure of the quality of management and their culture and
values.
Self-assessment
1. The frm deals with suppliers at arms length and makes no special efort
to value their relatonship. The frm makes no special efort to keep in
regular touch with them or to keep them abreast of business issues.
2. The frm is sensitve to dealing with suppliers and pays when possible on
agreed terms. However, suppliers are only contacted when payments are
already late.
3. The frm has processes for reviewing credit with suppliers and keeps
them informed of any issues where extended payment may be taken.
The frm has a member of management who meets with them on an
informal basis when the occasion arises.
4. The frm actvely informs suppliers of account status and will pay early if
cash permits. Suppliers are kept informed of the level of likely business
which will be placed with them. When payments have been delayed,
senior management will personally contact the supplier to review the
situaton.
5. Professional advice has been sought on credit worthiness best practce
and systems implemented. Senior management keeps suppliers
informed of any payment issues well in advance and before payments
are overdue.
C9. Banking relatonships are excellent
The quality of a frm’s relatonship with their bank is a very good indicator of
the way in which they conduct most of their business. External relatonships
are ofen an indicator of the quality and integrity of the management team and
the culture of the frm. With any signifcant business development, which can
be expected afer an injecton of capital, some level of disrupton to business
is likely to occur. During this period the goodwill of suppliers, customers and
bankers is going to be necessary so that additonal problems don’t create crisis
195
Part B: Indices
Raising Angel & Venture Capital Finance
events. By reviewing formal and informal contact with the bank, the Investor
can determine the manner in which management has dealt with issues in the
past.
Few companies are able to avoid some fuctuaton in their cash fow.
However, problems can ofen be mitgated by good relatonships with suppliers
and by working closely and honestly with the bank. Those frms which keep
their bank informed, proactvely tell them about impending issues and show
good management skills in correctng problems promptly, are much more likely
to be extended a line of credit or a loan from the bank to deal with short-term
fuctuatons. By examining how the frm has dealt with issues in the past, the
Investor can gain an independent measure of the quality of management and
of their culture and values.
Self-assessment
1. The frm deals with its bank at arms length and makes no special efort
to value the relatonship. The bank is simply treated as a facility and the
frm makes no special efort to keep in regular touch with the bank or to
keep it abreast of business issues.
2. The frm is sensitve to dealing with its bank, however, the bank is only
approached when a need arises.
3. The frm has processes for reviewing its patern of business with its bank
and keeps it informed of any issues where cash fow might be seriously
afected. The frm has a relatonship with a named bank ofcer and
meets with them on an informal basis when the occasion arises.
4. Informal arrangements are in place with the bank to review business
performance and banking requirements. The frm also has periodic
formal meetngs with the bank to review their banking arrangements
and banking facilites.
5. The frm has established formal meetngs with the bank on a regular
basis where current and future banking requirements are reviewed.
Senior management of the frm are known to the bank and informal
social relatonships are encouraged by the frm.
196
Part B: Indices
Raising Angel & Venture Capital Finance
C10. Customer interacton, contracts and agreements are
industry standard
A frm incurs problems and costs when obligatons under contracts are
unclear, incomplete, harsh or generous. Risks escalate when procedures
for handling disputes, complaints, claims or clarifcaton are not clear or not
followed. When customers can make claims on the company which cannot
be substantated internally, where the obligatons are not clearly set out and
where the terms of payments are unclear, the frm can be exposed to potental
litgaton, loss of resources or signifcant under payments.
A situaton in which contracts can be customized to suit the customer
becomes an administratve burden. Few frms have the processes in place to
track individual contracts where obligatons and terms vary from one contract
to another and so the likelihood of making a mistake in this situaton is very
high. Problems can be greatly exacerbated if contracts are voluminous or held
at a place away from where actvity is being undertaken.
Investors want to see a smooth administratve operaton. If the contracts are
not standard or vary from contract to contract, costs increase. Risks may occur
if personal undocumented knowledge is required to manage the relatonship.
If the person with that intmate knowledge leaves, so does the ability to handle
issues which arise.
Policies for dealing with customers should be clearly set out and staf trained
in the various actvites which require interacton with customers. Errors are
easily made where inconsistencies in processes are allowed to occur.
Self-assessment
1. Interacton, contracts and agreements with customers are informal and
vary in approach, terms and conditons.
2. Staf are advised on how to deal with customers but this is not formally
supervised or reviewed. Contracts and agreements with customers are
mostly writen but variatons exist and these are not well documented.
Formal sign of of customer contracts is not in place where complex
projects are undertaken.
197
Part B: Indices
Raising Angel & Venture Capital Finance
3. Staf are trained to deal with customer issues. The frm has policies
in place for most customer interacton but these are out-of-date and
compliance is not reviewed formally. Formal contracts and agreements
are used with customers but variatons are common. Variatons are well
documented and agreed by both partes. Formal progress monitoring is
in place and sign of occurs at key stages in projects.
4. Formal policies are in place for interacton with customers and staf
are trained on these. Compliance is monitored and issues dealt
with promptly. Standard contracts and agreements are in place with
customers and progress on long-term projects is monitored. However,
steps have not been taken to ensure that contracts are industry standard
and best practce for monitoring are in place.
5. Professional advice has been taken and recommendatons implemented
to ensure that contracts with customers are industry standard and that
progress monitoring and sign of procedures are in place and being
followed. Periodic audit of customer contracts and progress tracking are
in place. Formal policies for dealing with customers are in force and are
regularly monitored.
C11. Supplier contracts and agreements are industry standard
A frm incurs problems and costs when obligatons under supplier contracts
are unclear, incomplete, harsh, or generous. Risks escalate when procedures
for handling disputes, complaints, claims or clarifcaton are not clear or not
followed. When suppliers can make claims on the company which cannot be
substantated internally, where obligatons or the terms of payments are unclear,
the frm can be exposed to potental litgaton, loss of resources or signifcant
over payment.
A situaton in which contracts can be customized for each supplier becomes
an administratve burden. Few frms have the processes in place to track
individual contracts where obligatons and terms vary from one contract to
another and the likelihood of making a mistake is very high. This situaton is
exacerbated if contracts are voluminous or held at a place away from where
actvity is being undertaken.
198
Part B: Indices
Raising Angel & Venture Capital Finance
Investors are looking for efcient administratve operatons. If the contracts
are not standard or vary from contract to contract, smooth operatons are
not possible. Further risks may occur if personal undocumented knowledge is
required to manage the relatonship. If the person with that intmate knowledge
leaves, so does the ability to handle issues which arise.
Self-assessment
1. Interacton, contracts and agreements with suppliers are informal and
vary in approach, terms and conditons.
2. Staf are advised on how to deal with suppliers but this is not formally
supervised or reviewed. Contracts and agreements with suppliers are
mostly writen but variatons exist and these are not well documented.
Formal sign of of supplier contracts is not undertaken where complex
projects are undertaken.
3. Staf are trained to deal with supplier delays, missing or incomplete
orders, quality issues and relatonship problems. The frm has policies
in place for most supplier interacton situatons but these are out-
of-date and compliance is not reviewed formally. Formal contracts
and agreements are used with suppliers but variatons are common.
Variatons are well documented and agreed by both partes. Formal
progress monitoring is in place and sign of occurs at key stages in
projects.
4. Formal policies are in place for interacton with suppliers and staf
are trained on these. Compliance is monitored and issues dealt with
promptly. Standard contracts and agreements are in place with suppliers
and progress on long-term projects is monitored. However, steps have
not been taken to ensure that contracts are industry standard and best
practces for monitoring are in place.
5. Professional advice has been taken and recommendatons implemented
to ensure that contracts with suppliers are industry standard and that
progress monitoring and sign of procedures are in place and being
followed. Periodic audit of supplier contracts and progress tracking are
in place. Formal policies for dealing with suppliers are in force and are
regularly monitored.
199
Part B: Indices
Raising Angel & Venture Capital Finance
C12. Contracts can be assigned to an acquirer
Companies which are expected to be sold must have the ability to assign
the rights under their contracts, licenses and agreements to the new buyer.
Agreements which do not allow this inhibit the ability of the new owner to
operate the business. Some agreements have clauses which allow assignment
only with the permission of the other party. This agreement should be obtained
prior to going into an acquisiton discussion.
Many agreements do not allow for assignment to a compettor. This is not an
unreasonable conditon if such a change could potentally harm their business.
In this case, the frm needs to have a contngency plan to be able to replace that
part of their business if it is critcal to their operaton. Where such an agreement
might stop the acquisiton from happening, the best acton is to terminate the
agreement and replace it prior to preparing to sell.
Self-assessment
1. The frm is not aware of this requirement and does not know what the
status of its various agreements are in this regard.
2. The frm acknowledges that this would be desirable but has not
reviewed the contracts for compliance.
3. Contracts have been reviewed and those which do not allow assignment
have been identfed and responsibility given to an executve to
renegotate this conditon.
4. Contracts have been renegotated (where possible). The frm does not
see any situaton which would inhibit an acquisiton. Contracts have not
been reviewed by professional advisors.
5. Contracts, licences and agreements have been reviewed by professional
advisors and no critcal impediment remains to assignment of rights.
200
Part B: Indices
Raising Angel & Venture Capital Finance
C13. Intellectual Property is able to be traded and is
appropriately protected
Intellectual property (IP) covers those knowledge assets of the company
which can be sold independent of the people who created that knowledge.
Knowledge in the heads of employees which is not documented cannot be
sold without the employees who have it. Documented knowledge, where
the ownership may be in dispute or where ownership is unclear, cannot be
efectvely traded. Other IP rights which are purchased and are critcal to the
operaton of products or services, need to be able to be sold or assigned to a
new owner. Any contractual impediments to the use of internal or purchased IP
will seriously inhibit a frm’s ability to exploit the IP and may seriously damage
the potental of a sale of the business.
Many acquisitons are targeted at acquiring compettve advantage through
the acquisiton of frms which hold patent rights. Patents which have considerable
revenue generatng potental can atract litgaton over ownership rights if this
has not been carefully managed from the outset of a research and development
project as any employee who has worked on the project could potentally claim
an ownership share. The only way for the frm to protect itself from such a claim
is to have employees assign all rights of any inventons, or those relevant to
their workplace, to the frm. Alternatvely, rights could be assigned to the frm
with acknowledgement of an ownership share, this leaves the frm in a positon
to have full rights to exploit the patent subject to a royalty based on an agreed
formula.
Another aspect of IP is that the frm must ensure the IP was adequately
managed throughout the development process. IP management must ensure
that IP does not infringe any other IP rights, that the IP is appropriately registered
and that rights are kept current. Since many IP rights require registraton in
other countries, the frm needs to have documentaton of the extent of the
registered rights and be able to show how these may be further protected in
any future acquisiton negotaton.
201
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. An IP management program does not exist.
2. The frm acknowledges the importance of IP management but has no
formal system to register or protect it.
3. IP management is considered important and the frm has registered
various IP but the ownership trail is incomplete and may be subject to
dispute by current and/or past employees.
4. Formal IP management processes are in place. Rights are registered in
countries deemed appropriate for the business. Employees are required
to sign over IP rights as a conditon of their employment. IP acquired
externally and used in the business will be able to be traded by a new
owner.
5. The frm has undertaken an audit by a professional advisor and
implemented systems and procedures recommendatons to ensure full
protecton of its IP rights.
C14. Post acquisiton changes in employment are planned for
Detailed consideraton of the organisaton structure following a possible
future acquisiton will indicate which roles will need to change and which roles
will be redundant. Rather than leave this issue for the new owner to resolve,
the frm can negotate potental changes with those employees who are likely
to be afected and put in place agreements which will smooth the transiton.
A future buyer will almost certainly be confronted with the need to
make organisatonal changes. These will involve changes of management,
redundancies, roles and reportng lines. Many of these changes could
potentally efect compensaton packages. Efectng these changes and avoiding
unrest, disrupton and de-motvaton will be challenging. The potental for
litgaton is present where current conditons of employment are at odds with
the new situaton. An employee who feels he or she has been misled or feels
constructvely dismissed through the changes, may feel compelled to seek legal
advice.
202
Part B: Indices
Raising Angel & Venture Capital Finance
Managing expectatons, providing acceptable optons for employees who
are efected and preparing staf for the likely change, is all part of preparing to
sell the business. Some employees may decide to take early retrement or seek
alternatve employment. Others may see the change as benefcial and want to
stay on. Key employees need to be retained and need to be handled carefully
so that there are incentves for them to stay during a transiton period. Others
may need to be given incentves to leave where their roles are being changed
signifcantly or where they are being made redundant.
In antcipaton that the business will be sold in the future as part of the
strategy agreed with the Investor, the frm should put in place employment
conditons which will ease the path to sale and transiton across to a new
owner. For example, current terms and conditons of employment may include
the opton for the business to make the employee redundant on transfer of
ownership and state the level of compensaton to be paid. Alternatvely, a
retenton bonus may be specifed for key employees to encourage them to stay.
Benefts may be able to be changed on sale of the business.
Self-assessment
1. Atempts have not been made by the frm to implement changes in
employment conditons to facilitate the future sale of the business.
Discussions have not been had with employees about post acquisiton
roles.
2. The frm has reviewed its organisaton structure and determined those
positons which are likely to be changed, made redundant or are critcal
to the transiton. Some informal discussion at management level
has occurred. Formal changes have not been made to employment
conditons.
3. The frm has constructed a post acquisiton scenario and identfed
employees who will be afected. Retrement, redundancy and key
employee incentves have been constructed. Employment conditons
have been changed to refect the possible future sale of the business.
4. Key employee conditons have been discussed with key staf and as a
result their conditons of employment have been changed to incorporate
a retenton bonus. A terminaton package has been incorporated into all
203
Part B: Indices
Raising Angel & Venture Capital Finance
employment agreements to cater for redundancies. Bonus, commission,
proft schemes and share purchase arrangements have all been modifed
to lapse on change of ownership. Professional advice has been sought
on the arrangements.
5. Changes and incentves necessary to ensure a smooth changeover to
a new owner have been reviewed by a professional advisor and fully
implemented.
C15. Employment conditons, salaries and benefts are industry
standard
Following any future acquisiton of the investee frm, employees of the
acquired frm will normally be integrated into the employment, health benefts
and bonus systems of the parent company. When this happens, any deviatons
between the two schemes will have to be resolved. This is normally a tme of
considerable change in the acquired frm with employees fearful of their jobs.
The less change that is imposed, the smoother this transiton will be.
Where remuneraton systems are industry standard, few problems tend to
arise. Staf are neither paid too much nor too litle. If the health insurance is
standard and bonuses are in line with industry standards, these can normally
be contnued or transferred. However, if (say) vacaton enttlements are overly
generous, this can create problems where they need to be curtailed or need to
be contnued alongside fellow employees who receive less.
Self-assessment
1. Litle or no efort has been made to ensure employment conditons are
industry standard.
2. The frm has no formal process for setng pay scales or for performance
evaluaton. They believe they are paying reasonable levels to atract and
retain employees.
3. The frm recruits employees at compettve rates but internal procedures
for advancement are not checked with industry norms.
204
Part B: Indices
Raising Angel & Venture Capital Finance
4. The frm is familiar with remuneraton in their industry and tries to
follow industry norms. An external review has not been made of their
practces.
5. The company uses an outside frm of specialists to assist in setng pay
scales and conditons of employment.
C16. Opton schemes and benefts are compliant with stock
exchange regulatons
Many smaller frms ofer incentves to atract and retain key employees.
These include optons, share purchase schemes, bonuses, share allocaton and
so on. Ofen these deals are done privately between the owner and the new
employee. Sometmes advice is not sought on the long-term implicatons of
these schemes on a possible sale of the frm.
Share purchase schemes and opton schemes have atracted atenton by
both the fnancial reportng agencies and tax authorites around the world and
so there normally exists a vast body of regulatons governing these schemes.
While a scheme might be legal and even appropriate for a small unlisted frm,
the same scheme might be non-compliant for a listed company. Since most
acquisitons are by listed companies, this can be a real problem for a future
sale of the frm to a listed corporaton. An employee will not be happy losing
benefts and may well resist any such change if they have a contract in place
which protects their benefts.
Self-assessment
1. Litle or no efort has been made to ensure opton schemes and benefts
are compliant with stock exchange requirements.
2. The frm is familiar with the need to have compliant schemes but has
made no efort to have their own schemes checked for compliance.
3. The frm has sought professional advice to check the degree of
compliance of their schemes and to advise of changes which may be
necessary.
4. The frm is implementng changes to their schemes to bring them into
compliance.
205
Part B: Indices
Raising Angel & Venture Capital Finance
5. Opton and beneft schemes are compliant with stock exchange
requirements.
C17. Due diligence fles are complete and up-to-date
The purpose of due diligence is to check the health of the frm and to identfy
any potental risks. It also checks that the informaton provided by the frm is
complete and accurate. Checks will include:
• supplier and customer contracts
• licences, patents, trademarks and IP management systems
• leases, distributon agreements and hire-purchase agreements
• employment contracts, health insurance and bonus systems
• complaints processing, dismissal processes and warranty systems
• quality control systems
• fnancial reportng systems, aged debtors and aged creditors
• reference checks with customers, suppliers and professional advisors
• background checks on key executves
• R&D, manufacturing and distributon processes
• banking relatonships and loan conditons
• shareholder agreements, opton schemes and share-purchase schemes.
The informaton required for a due diligence investgaton is extensive and
very tme consuming to collect and collate. Ofen there are documents missing
or incomplete. However, it is through this process that the Investor will uncover
internal and external risks which can cause problems with their investment and
may create problems in a later trade sale or IPO. A check of the documents
themselves can ofen be a long and exhaustve process. Every contract, lease
and agreement is sometmes checked to ensure that it does not overly expose
the investor or acquirer. To the extent that professional advice from industry-
knowledgeable legal and accountng frms has been used, this process can be
dramatcally shortened. Sometmes only a sample needs to be reviewed.
206
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. The frm is not conversant with a due diligence process and preparatons
have not been made.
2. The frm is aware of the requirements of a due diligence process but
does not have internal policies to ensure that records are complete and
up-to-date.
3. The frm has a policy of maintaining complete and up-to-date fles but
has not had this process audited or checked compliance with this policy.
4. A professional audit of the accuracy and completeness of records has
been conducted and recommendatons are being implemented.
5. A complete and up-to-date fle has been assembled to enable a full due
diligence audit to be undertaken.
207
Part B: Indices
Raising Angel & Venture Capital Finance
Operatons Development Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
C1 Monthly fnancial and key performance indicator reportng
exists
C2 A formal business plan has been prepared and is updated
periodically
C3
A formal budget is prepared and actual performance is
monitored against budget
C4 Full compliance with regulatory issues (eg. environmental,
health and safety)
C5 Customer relatonships are managed to minimize litgaton
C6
Supplier relatonships are managed to minimize litgaton
C7
Employee relatonships are managed to minimize litgaton
C8 Credit worthiness with suppliers is excellent
C9 Banking relatonships are excellent
C10 Customer interacton, contracts and agreements are industry
standard
C11 Supplier contracts and agreements are industry standard
C12 Contracts can be assigned to an acquirer
C13
Intellectual property is able to be traded and is appropriately
protected
C14 Post acquisiton changes in employment are planned for
208
Part B: Indices
Raising Angel & Venture Capital Finance
Operatons Development Index (Cont.)
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
C15 Employment conditons, salaries and benefts are industry
standard
C16 Opton schemes and benefts are compliant with stock
exchange regulatons
C17
Due diligence fles are complete and up-to-date
209
Raising Angel & Venture Capital Finance
F
i r ms s e e k i n g t o r a i s e An g e l o r Ve n t u r e Ca p i t a l f i n a n c e
o f t e n k n o w v e r y l i t t l e a b o u t t h e n a t u r e o f An g e l o r VC
investment or the role and objectives of Angels and VC funds. Well established Angels and
VC frms with good track records are actively sought by both investors and entrepreneurs
and don’t have the time nor the resources to deal with the many approaches they have,
thus need to screen entrepreneurs seeking fnance and concentrate their efforts where
they can achieve the highest productivity for their time.
Investors often complain about the naivety of the entrepreneurs. Few they encounter really
understand the purpose of Angel or Venture Capital fnance or the criteria which they use
to select investments. They often say that their frst task is to educate the entrepreneur.
This environment provides, in fact, a very fertile ground for the entrepreneur who
approaches the Investor with a well thought out proposal put in terms which they can
appreciate and with the support of a professional advisor they respect. Where they can be
assured they are being offered a chance to look over a proposal which has been reviewed
by a knowledgeable professional advisor, it makes their life easier and more productive.
In fact, some Investors won’t entertain looking at a proposal unless it has come from a
respected angel or professional advisor.
Even when the Investor is approached using the proper channels, the well prepared
entrepreneur must still be able to deliver a written proposal in a form which allows the
Investor to easily evaluate the investment in their terms – that is from the viewpoint of the
D
Strategy
210
Part B: Indices
Raising Angel & Venture Capital Finance
investor not the business builder. The proposal should be backed up with a management
team who can clearly articulate the benefts of the business in terms of growth, ROI, risk
exposure and likely exit and do so in non-technical language.
The entrepreneur should also be well versed in valuation techniques and normal terms
of Angel or VC investment. Discussions with an Investor will be much more meaningful
and productive if the entrepreneur understands how Angels and VC funds work, how they
manage their investments and how they achieve a harvest on their investments. Using a
professional advisor to educate, advise and assist in this process will ensure that neither
the entrepreneur nor the Investor waste their time.
D1. Investment advisors have been appointed
Few entrepreneurs ever have the experience of raising Angel or VC fnance and even less
do it more than once. Thus few ever build up the required knowledge and experience to
effciently work through the requirements. A professional advisor who deals with Angels
and VC funds on a frequent basis not only understands the requirements of the investor
but should have contacts within the investor community to best advise the entrepreneur
on which investors to approach.
The process of securing an investment requires the frm to prepare a wide array of
information, not just on the business concept itself, but extensive information on
the business for the due diligence process. The professional advisor can assist in the
preparation of the investment proposal as well as ensure that the frm is well prepared for
the due diligence activity. A creditable and experienced professional advisor will ensure
that the frm does not waste their executive time pursuing the wrong strategy. Angel and
VC investors have a specifc set of business and legal requirements and the frm needs
to ensure that it can meet these conditions.
Part of the process of selecting a professional advisor should be some form of reference
checking as well as a degree of comfort and ft between the parties. A frm which knows
what it is doing should have little hesitation in providing references to clients which they
have assisted through the same process.
211
Part B: Indices
Raising Angel & Venture Capital Finance
Self assessment
1. Advisors have not been approached or appointed.
2. Advice has been sought as to which advisors the frm should work with but
approaches have not been made.
3. The frm has made an approach to one or more advisors and discussions have
commenced but appointments have not been made.
4. The frm has negotiated terms with one or more advisors, undertaken reference
checking and interviewed one or more clients which the advisor(s) have assisted
but agreements have not been entered into.
5. An investment advisor has been appointed.
D2. An equity investment/debt strategy has been formulated
Angel and VC investment should be part of an overall funding strategy being constructed
for the business. While equity investment has the advantage that it has no repayment risk
associated with it if the business is temporarily unable to fund dividends, it does dilute the
founders equity. On the other hand debt, while not diluting equity holdings, does carry
a risk in the event of non payment of interest and principal. Failure to pay interest when
due or to make the periodic loan repayments can result in the business being put into
receivership and perhaps assets seized and sold. Thus fnding the right balance between
equity dilution and repayment risk is essential for longer term funding of the business.
The frm should be prepared to discuss the fnancing strategy with the Investor and be
able to show how the business will fnance any external debt which it intends to take
on. Generally the Investor will require the frm agree to seek the Investor’s permission
before it commits to any additional external debt.
Self assessment
1. A strategy for the use of debt and/or equity investment has not been formulated.
2. The frm has identifed a need for funding but has not translated this into how much
or what mixture of debt and equity would be appropriate.
3. A plan incorporating a desired level of debt and equity has been constructed but
this has not been tested against the business plan to see if it will adequately cater
for different levels of success in business outcomes.
4. The funding model has been incorporated into a business plan and has been tested
against various scenarios.
212
Part B: Indices
Raising Angel & Venture Capital Finance
5. The funding model has been reviewed by a professional advisor and adjusted
accordingly.
D3. A realistc valuaton formula has been constructed
The valuation of the business prior to an Angel or VC investment (pre-money) is usually
a contentious issue for both founders and investors. The founders clearly want as little
dilution as possible while the investors want the downside protection of a low valuation
going into the deal. Unless both parties can move past the valuation issue, no deal will
be consummated.
Most Investors will argue for a lower valuation based on their experience of past
investments which went sour. Even when everything looks positive at the outset, their
experience shows that forecasts are rarely achieved and activities take much longer than
anticipated, thus their initial valuation needs to refect this. On the other hand, the founders
will want to hold onto as much equity as possible, especially if the venture proves highly
successful. If the initial opening positions are too far apart, it is possible the discussions
will simply be terminated and no investment will be forthcoming. It is in the interest of
the frm to start with a realistic valuation and negotiate from that position. In the end, a
formula based valuation may be the best way to resolve any major differences in valuation.
Self assessment
1. A valuation fgure or valuation calculations has not been undertaken.
2. Crude valuations have been discussed based on market transactions and industry
norms but specifc calculations have not been made.
3. Conventional valuations using a fair market value formula have been undertaken.
Market information of similar transactions has been assembled.
4. Valuations have been reviewed by professional advisors. Market information of
similar transactions has been reviewed with the professional advisor to identify
appropriate norms.
5. A valuation formula has been constructed to refect different possible outcomes at
exit. A preferred valuation or formula has been documented with reference to fair
market valuation and recent industry transactions.
213
Part B: Indices
Raising Angel & Venture Capital Finance
D4. An executve summary and an investment business plan
have been prepared
Most businesses seeking external investment will have prepared a business plan but few
will have constructed the plan with the requirements of the Angel or VC investor in mind.
Most business plans are designed to develop the business rather than to show the Investor
how they can protect their investment and achieve their exit requirements. An investment
business plan needs to be constructed somewhat differently from a normal business plan.
Investors are unlikely to be familiar with the intricacies of the business and its marketplace,
thus the business plan needs to place the business into a context of customers, benefts,
competitors and market dynamics. Within this context, the investment business plan
needs to show how and why the business will be able to achieve the revenue and proft
projections and show how these numbers have been validated.
Investors often deal with hundreds of proposals and so a well articulated executive
summary needs to encapsulate the essence of the business opportunity, the investment
required, the proposed exit strategy and the expected returns to the Investor. Unless the
summary captures their attention, it is highly unlikely the rest of the business plan will
be read.
Self assessment
1. A summary or business plan has not been prepared.
2. Financial projections and annual budgets have been prepared but do not contain
information which would enable the business to be evaluated by an external party.
3. A business plan has been prepared for the normal operations of the business but
does not refect the special needs of an Investor.
4. An investment business plan with an executive summary has been prepared
specifcally for the purpose of raising equity investment but has not been reviewed
by a professional advisor.
5. An investment business plan including an executive summary has been prepared
specifcally for raising equity fnance and has been reviewed by a professional
advisor and adjusted based on their advice.
214
Part B: Indices
Raising Angel & Venture Capital Finance
D5. Appropriate Investors are identfed
While there are many Angel and VC investors, each one has their own preferred investment
objectives which are based on their industry experience, the amount they have to invest,
the time they have available to manage their investments, their existing commitments,
travel preferences and so on. Just because an opportunity looks compelling from an ROI
point of view, does not mean that investors will be focking to review the proposal. They
will know they will often have to get involved with the management of the business
or with the development of its market penetration or the fnal exit. These often require
familiarity with the sector and possible access to alliances, senior executive talent and
possible corporate acquirers.
At the same time, their desire to invest may depend on what other investments they have
and their risk tolerance. A Investor which has substantially allocated their investable funds
may not be in a position to make new investments. A VC fund which is fully allocated
may not be in a position to allocate new funds for some time. Angels and VC funds need
to balance their investments across different risks, thus an Investor may feel over extended
in one sector and not be willing to make further investments in that area. Alternatively,
a different Investor may be seeking investments in the frm’s sector.
Self assessment
1. Investors have not been identifed or approached.
2. Angels and/or Venture Capital frms have been selected based on location and
personal introductions but this has not been done scientifcally or with the advice of
a professional advisor.
3. A number of Investors have been identifed based on their preference for industry
sector, size of investment and geographical preference but reference checking has
not been done and no professional advice has been taken.
4. Professional advice has been sought on the selection of Investors and a small
number identifed for approach but no reference checking has not been undertaken.
5. A select number of Investors have been identifed based on their preference for
industry sector, size of investment, geographical preference and so on. References
have been sought from current and former investees and other professional parties.
215
Part B: Indices
Raising Angel & Venture Capital Finance
D6. Creditable introductons to Investors are achieved
Some Investors have a policy of not reviewing unsolicited proposals. This is partly
based on the fact that they have a good pipeline of referred proposals from professional
advisors, former investees and colleagues but also because they simply don’t have time
to read a proposal which has not been professionally prepared and reviewed before they
see it. Investors prefer not to waste their time with poorly prepared information or with
unrealistic proposals. They expect proposals which they receive to have been referred
to them by knowledgeable persons and that they will not only be complete but also the
applicant will have realistic expectations on valuation.
Investors often complain that they spend too much time educating the entrepreneur about
how Angel or VC investment works. Some of the conditions attached to an investment
are confronting to an entrepreneur, especially when they see there is a chance they may
lose control of their business or their business can be sold from under them. While these
conditions may appear harsh, they refect the reality of dealing with high risk ventures
where liquidity is a serious issue. Rather than having these diffcult discussions, the
Investor would rather deal with proposals which have already taken into account the
manner in which the investment will be constructed and managed. At the same time,
they would rather deal with proposals which have the necessary information in them to
allow them to undertake a proper evaluation.
Self assessment
1. Introductions have not been arranged.
2. The frm has secured a letter of introduction from friends or a suburban accountant
or lawyer. The contacts with the Investor are not personal and are mostly ones of
professional courtesy.
3. Personal introductions have been arranged by friends and acquaintances of
the Investor. These individuals, however, are not familiar with Angel or VC
investments.
4. Introductions have been arranged to the Investor by individuals knowledgeable
about Angel and VC investments but not specifcally about the preferences of the
specifc Investor.
5. Introductions have been arranged by creditable professional advisors and/or other
investors who are actively involved in Angel or VC investment transactions and are
216
Part B: Indices
Raising Angel & Venture Capital Finance
known to the Investor. The introductions have taken into account the investment
preferences of the Investors being approached.
D7. Key messages are practced and refned
Investors evaluate many proposals before they make a single investment, thus they tend
to use their time as effciently as possible. They look for a venture team which can clearly
articulate the essence of both the business and the investment proposal. This is not just
because it helps them in their evaluation but because they know the team will have to do
this task many hundreds of times to customers, suppliers, alliance partners and potential
employees. A venture team which is unable to provide a precise defnition of who they
are and why they are going to be successful probably has not yet come to grips with the
essence of the business and how it needs to be developed to be successful.
The vision of the business needs to be both compelling and succinct. The business
concept should clearly show how and why the business will be successful. The investment
proposition should show how much investment is required, what it is going to be used for,
what exit strategy will be undertaken and what return the investor can expect to receive
on their investment. The investment proposal should be presented in non-technical terms
if appropriate, be able to be adapted to different presentation lengths and show that the
supporting detail will demonstrate validation of the critical business issues.
Self assessment
1. No effort has been made to develop a clear vision and defnition of the business
concept.
2. The frm can discuss their venture knowledgeably but this has not been tuned for an
investment audience.
3. The vision and defnition of the business concept is well understood and has been
developed for an Investor but is too long, overly technical, lacks fow or is not
convincing.
4. The frm has developed a series of presentations for Investors including a short
pitch and a 20-30 minute business plan presentation. This has been tested and
practiced with colleagues and friends.
5. The frm has a well articulated set of informal and formal presentations which have
been reviewed with professional advisors and suit a variety of different technical
and non-technical audiences.
217
Part B: Indices
Raising Angel & Venture Capital Finance
D8. Multple Investors are engaged
A good proposal should be offered to a small number of selected Investors. This is not to
suggest that it is shopped around, but each Investor will have their own portfolio strategy
and the worth of your venture, while attractive, may not suit the investment position or
timing of some of the Investors. You also want to have the opportunity of comparing
what additional value each Investor can bring to your venture. If the money available
is the same across the Investors, their added contribution in terms of networks, access
to experienced staff, ability to open doors to alliance partners and potential customers
should also be evaluated.
You also need to be comfortable with the people you will be dealing with, especially the
Investor or Investor’s representative who will be sitting on your board. You don’t want
to fnd yourself stuck with someone who has a different view of the world or a different
cultural or ethical position. It may be the case that the terms under which the Investors
are willing to invest are different in which case you need to weigh up the different tangible
and intangible benefts. Some may be much more willing to negotiate a formula based
valuation, for example.
Self assessment
1. Investors have not been engaged.
2. The frm has approached a number of Investors but has yet to move to a second
round of discussions.
3. Detailed discussions have been undertaken with several Investors and some level
of interest has been expressed.
4. Discussions with a small number of Investors have progressed to strong
expressions of interest or one Investor has been selected for extensive discussions.
A professional advisor has reviewed the discussions and advised on which Investor
to proceed with.
5. A small number of Investors have expressed strong interest and the frm has
agreed to proceed to develop a Term Sheet with them. A professional advisor has
recommended which Investor should be taken to Term Sheet stage.
218
Part B: Indices
Raising Angel & Venture Capital Finance
D9. Ofers received and negotated
After the various Investment offers have been evaluated and some due diligence
undertaken on each of them, Heads of Agreement will be negotiated. This is something
that must be negotiated as there are many possible components to the investment deal.
You should spend some time prior to the meetings becoming familiar with the normal
terms of an Angel or VC investment and request clarifcation from your professional
advisor if you are not familiar with the implications of the various terms and components.
The verbal offer which you receive is not necessarily the last position of the Investor.
Investors are competing for your business in the same way that you are seeking theirs.
You should be trying to fnd a balance between your interests as founders and shareholders
with theirs as independent investors. If you push your position too hard, however, you
will probably not end up with a deal. But marginal aspects of the deal may still be subject
to movement on their side and you may be willing to offer some concessions on yours.
In the end, however, you still need to make the numbers and the timescales to protect
your investment in the business.
Self assessment
1. Offers have not been received.
2. At least one Investor has expressed strong interest but no discussion of an offer has
eventuated.
3. One or more Investors have expressed strong interest and have discussed the
investment evaluation process with the frm. One or more have indicated that
offers would be forthcoming after some additional due diligence steps have been
undertaken.
4. One or more Investors have indicated the broad terms of an offer. These have not
been responded to and not reviewed with the professional advisor.
5. Verbal offers have been received by the frm and have been reviewed by the
professional advisor. A response has been given to at least one Investor which
indicates that a written Term Sheet would be seriously considered.
219
Part B: Indices
Raising Angel & Venture Capital Finance
D10. Term Sheet received and negotated
The Term Sheet is the formal offer by the Investor. This will be issued only after they
have reached an understanding with you and have done initial due diligence on the frm
and the market opportunity. The Term Sheet means they are ready to put some serious
time into the full due diligence and working with you to make sure each party has a full
understanding of the journey that you will undertake together over the next few years.
However, even a Term Sheet can be negotiated to some extent. Often additional clauses
have been added by the Investors which have not been fully discussed or they have
assumed you are familiar with. These need to be examined, often in conjunction with
a professional advisor and then clarifcation sought. Sometimes minor items within the
Term Sheet can still be negotiated.
Often at this point, you have settled on your preferred Investor and only one Term Sheet
will be dealt with. Providing you have done your reference checking and are comfortable
with the Investor and the deal, there is no reason why you should not proceed at this point.
Make sure all the parties to the agreement on your side are willing to sign off on the deal.
Self assessment
1. Term Sheets have not been received.
2. A Term Sheet has been received but is unacceptable or has not been responded to.
3. Negotiations on the Term Sheet have commenced but there is still some gap
between the parties.
4. Negotiations have concluded on the Term Sheet and verbal agreement reached on
an acceptable arrangement. The frm is waiting on a new terms sheet.
5. A Term Sheet has been received which is acceptable to the frm and has been
recommended by the professional advisor.
220
Part B: Indices
Raising Angel & Venture Capital Finance
Strategy Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
D1 Investment advisors have been appointed
D2 An equity investment/debt strategy has been formulated
D3 A realistc valuaton formula has been formulated
D4 An executve summary and an investment business plan
have been prepared
D5 Appropriate investors are identfed
D6 Creditable introductons to investors are achieved
D7
Key messages are practced and refned
D8 Multple investors are engaged
D9 Ofers received and negotated
D10 Term Sheet received and negotated
doc_682068194.pdf
Angels and Venture Capital firms are in the business of generating a high rate of return on their investment, not in creating or building businesses.
AN ENTREPRENEUR’S
GUIDE TO SECURING
VENTURE FINANCE
Raising Angel & Venture
Capital Finance
Dr. Tom McKaskill
ii
Raising Angel & Venture Capital Finance
Angels and Venture Capital frms are in the
business of generating a high rate of return on
their investment, not in creating or building
businesses.
To be successful, the investor needs to achieve
an exit of their investment within three to fve
years and that means planning the exit strategy
from day one.
The strategic trade sale is the preferred
investment exit method.
The business plan sets out the operational
detail of how the frm will create the necessary
conditions for achieving the exit for the
investor.
If you can’t create the necessary platform for
an Initial Public Offering, you are going to have
to sell your business.
The author hereby gives permission for any recipient of this publicaton to
reproduce, store in a retrieval system, transmit in any form or distribute by any
means for personal use of any recipient. This publicaton may not be sold or
resold for any fee, price or charge without the permission of the copyright owner.
iii
Raising Angel & Venture Capital Finance
Testmonials
‘Many entrepreneurs have achieved great success by partnering with
Angel investors but they need to have the right business venture and the
right approach to external investment to atract investors. This book provides
the essental guide for anyone contemplatng seeking Angel investment.’
– John Mactaggart, Chairman Australian Associaton of Angel Investors
‘Through his experiences as a successful startup entrepreneur, business school
professor, advisor and author, Dr. McKaskill provides some great insights and a
comprehensive game plan for companies seeking Angel and VC funding. Raising
Angel & Venture Capital Finance is a great read for founders and entrepreneurs—
whether they’re raising outside capital or just trying to understand the fundraising
process—and just made our jobs as investors a lot easier.’
– Joe Platnick, Partner iGlobe Treasury Management Ltd. and Director
Pasadena Angels
‘Tom is one of those unique individuals who has lived both a life of a successful
entrepreneur and spent tme understanding what makes them successful. This
book is a synthesis of decades of this experience and is a must read for anyone
who wishes to understand how to raise capital from the venture capital managers
and angel investor.’
– Richard Palmer, Investment Director, New Zealand Venture Investment
Fund Limited
‘An entrepreneur only gets a few chances to pitch a venture capital group.
This book will prepare you and signifcantly enhance your opportunity to receive
funding.’
– Patrick Thean, President, Leadline Group, Inc., Charlote, NC
iv
Raising Angel & Venture Capital Finance
‘Early-stage investng is all about fnding and nurturing a nugget of value with
the goal of presentng the improved value for acquisiton by a company in whose
hands that value can contnue to grow and reward. Investors need entrepreneurs
who want to build and sell such companies. While they ofen share the same
goal, investors and entrepreneurs frequently struggle to understand each others’
perspectve. These are the myriad deals that don’t fail, they never happen because
of a basic failure to communicate.
With his usual clarity, Tom explains the investor’s thinking to an entrepreneur
and ofers a practcal guide to preparing for and pursuing such investors.’
– Jordan Green, Angel Investor and Deputy Chairman, Australian
Associaton of Angel Investors Limited
‘Venture Capital is a highly specialised form of both business fnance and
partnership that relatvely few people understand. Dr. McKaskill has provided
a very useful introducton to the topic for aspiring entrepreneurs searching for
the best ways to accelerate their business growth.’
– Doron Ben-Meir, Executve Director & CEO, Prescient Venture Capital,
Melbourne, Australia
‘To stand out from the crowd, you must get into the mind of the venture
capitalist, and understand their motvatons and pressures. Raising Angel &
Venture Capital Finance is a practcal step-by-step guide that explains the pros
and cons of raising and working with private equity and venture capital funds.
This is partcularly relevant in today’s market where both Debt and Equity are
more difcult to obtain Tom McKaskill’s frst-hand experience in raising venture
capital is a valuable resource for any entrepreneur or business owner.’
– Ian Knight, Partner, KPMG’s Corporate Finance Group, Australia
Testmonials
v
Raising Angel & Venture Capital Finance
‘Tom has a wealth of entrepreneurial experience and he really understands
how entrepreneurs do business. Every entrepreneur wants to know how to raise
venture capital and Tom’s book is a “must read” for those that do. Tom’s book
sets out exactly what is involved. It is essental reading for any entrepreneur.’
– Noel Lindsay, Professor of Entrepreneurship and Commercialisaton
and Director of the Entrepreneurship, Commercialisaton and Innovaton
Centre (ECIC), Faculty of Engineering, Computer and Mathematcal Sciences,
The University of Adelaide
‘In additon to describing the current state of Angel and VC fnancing, this book
provides entrepreneurs (and investors) with a very practcal guide for designing
businesses for growth. This book should be read by any serious entrepreneur who
is even in the earliest stages of their new venture, such that they can lay down a
solid foundaton to enable later investment as needed. Later stage entrepreneurs
can of course beneft greatly from this book and the many references it provides.’
– Martn J. Bliemel, Lecturer, Australian School of Business, Strategy and
Entrepreneurship, UNSW, Sydney, Australia
‘Dr. McKaskill’s book is a great resource for entrepreneurs and investors.
Especially part B of the book with investor ready indices and self-assessment
guidance is very useful.’
– Peter Haubrich, President, Okanagan Research & Innovaton Centre ORIC,
Canada
‘Simple, straightorward and practcal advice that speaks directly to the
entrepreneur.’
– Michael Schaper, former Professor of Entrepreneurship and former Small
Business Commmissioner for the ACT, Australia
Testmonials
vi
Raising Angel & Venture Capital Finance
Testmonials
‘People in the business of building value have many competng priorites
for their tme. Raising external investment is ofen one of these priorites, yet
even the jargon can take on a life of it’s own. Dr McKaskill puts the focus back
on the important. The book contains approaches that puts founders, investors
and advisors on the same map writen in a common language. Building solid
alignment is a core theme, so reading or re-reading this book is a great next step.’
– Mat Yallop, Repertoire Management, New Zealand
‘At the Australian Graduate School of Entrepreneurship we pride
ourselves on the applicaton of theory for practce sake. Our graduates are
entrepreneurial, innovatve and proactve, and enhance our reputaton as the
leader in entrepreneurship educaton in the southern hemisphere. Against this
backdrop, we proudly integrate Tom’s e-books within our acclaimed Master
of Entrepreneurship and Innovaton program. The way in which Tom provides
insights and applicatons in a logical, realistc and real-world way beneft not only
entrepreneurship scholars, but anyone with an interest in high-growth ventures.
Since entrepreneurs manage opportunites in a resource-scarce environment,
raising angel and venture capital is most appropriately addressed by Dr McKaskill,
an absolutely must read as a guide to securing venture fnance.’
– Dr Alex Maritz, Director: Master of Entrepreneurship and Innovaton,
Australian Graduate School of Entrepreneurship, Swinburne University of
Technology, Victoria, Australia
‘Angel and VC funds who invest together with entrepreneurs are entering into
a joint venture partnership involving not only money, but expertse, networks and
ultmately commercial success. Dr McKaskill succinctly describes the challenges
and risks required to achieve a positve outcome for all partes in a balanced and
straight forward manner.’
– Greg Siters, General Manager, Sparkbox Investments Limited, New Zealand
vii
Raising Angel & Venture Capital Finance
Dr. Tom McKaskill
G
lobal serial entrepreneur, consultant, educator and
author, Dr. McKaskill has established a reputaton for
providing insights into how entrepreneurs start, develop and
harvest their ventures. Acknowledged as the world’s leading
authority on exit strategies for high growth enterprises, Dr.
McKaskill provides both real world experience with a professional
educator’s talent for explaining complex management problems
that confront entrepreneurs. His talent for teaching executves
and his pragmatc approach to management educaton has
gained him a reputaton as a popular speaker at conferences,
workshops and seminars. His approaches to building sustainable, proftable
ventures and to selling businesses at a signifcant premium, has gained him
considerable respect within the entrepreneurial community.
Upon completng his doctorate at London Business School, Dr. McKaskill
worked as a management consultant, later co-founding Pioneer Computer
Systems in Northampton, UK. Afer being its President for 13 years, it was sold
to Ross Systems Inc. During his tenure at Pioneer, the company grew from 3 to
160 people with ofces in England, New Zealand and USA, raised venture capital,
undertook two acquisitons and acquired over 2,000 customers. Following the
sale of Pioneer to Ross Systems, Dr. McKaskill stayed with Ross for three years
and then lef to form another company, Distncton Sofware Inc. In 1997 Atlanta
based Distncton raised $US 2 million in venture capital and afer fve years,
with a staf of 30, a subsidiary in New Zealand and distributors in fve countries,
was sold to Peoplesof Inc. In 1994 Dr. McKaskill started a consultng business in
Kansas which was successfully sold in the following year.
Afer a year as visitng Professor of Internatonal Business at Georgia State
University, Dr. McKaskill was appointed Professor of Entrepreneurship at the
Australian Graduate School of Entrepreneurship (AGSE) in June 2001. Professor
McKaskill was the Academic Director of the Master of Entrepreneurship and
Innovaton program at AGSE for the following 5 years. In 2006 Dr. McKaskill was
viii
Raising Angel & Venture Capital Finance
appointed to the Richard Prat Chair in Entrepreneurship at AGSE. Dr. McKaskill
retred from Swinburne University in February 2008.
Dr. McKaskill is the author of eight books for entrepreneurs covering such topics
as new venture growth, raising venture capital, selling a business, acquisitons
strategy and angel investng. He conducts workshops and seminars on these topics
for entrepreneurs around the world. He has conducted workshops and seminars
for educatonal insttutons, associatons, private frms and public corporatons,
including KPMG, St George Bank, AMP, AICD and PWC. Dr. McKaskill is a successful
columnist and writer for popular business magazines and entrepreneur portals.
To assist Angel and Venture Capital investors create strategic exits for their
investee frms, Dr. McKaskill conducts seminars, workshops and individual strategy
sessions for the investor and their investee management teams.
Dr. McKaskill completed three e-books for worldwide, royalty free distributon.
He has also produced over 150 YouTube videos to assist entrepreneurs develop
and exit their ventures.
Dr. McKaskill is a member of the Apollo 13 Angel Group located on the Gold
Coast and a member of the Australian Associaton of Angel Investors.
Dr. Tom McKaskill
ix
The Ultimate Deal 1
Selling your business
This book is aimed at those businesses which need to maximise their proft and
growth opportunites in a sale to a fnancial buyer to leverage the best sales
price. It sets out a breakthrough process which includes reducing risk, improving
sustainable profts and building growth potental in the business to maximise
the sales price. This world frst process can increase the value of the business
between two and ten tmes the conventonal sales value of a frm.
The Ultimate Deal 2 Get an unbelievable price
This book uncovers the secret of how to leverage strategic value in the business
to create a large revenue opportunity for a strategic buyer. Dr. McKaskill’s is the
world’s leading authority on selling a business to a strategic buyer and sets out
a comprehensive and systematc process for selling a business to a large cor-
poraton. Sales values of 40 tmes EBIT and/or many tmes revenue are highly
probable using his Strategic Sale Strategy for a business with underlying strategic
assets or capabilites.
Angel Investing
Wealth creation through investments in
entrepreneurial ventures
Designed to help high net worth individuals become successful Angel Investors.
Angel investng involves actve mentoring and coaching of an early stage man-
agement team towards sustainable proftability or additonal funding, probably
from a venture capital frm. This book sets out a comprehensive and rigorous
process that will help the Angel generate deal fow, evaluate investment propos-
als and manage the investment and subsequent harvest. The book also provides
a useful guide to managing operatonal risks in the venture.
Get A Life!
An inside view of the life of an
entrepreneur - from around the world
This book is a collecton of stories from entrepreneurs around the world where
they describe their work and their lives. They explain what it is like to be an
entrepreneur, how they got started, the successes and failures of their ventures
and the highs and lows of their personal and business lives. The stories are rich
in content and provide deep insights into how entrepreneurs think. If you are
an entrepreneur this will resonate with your inner being. If you are not, this will
provide you with a great understanding of entrepreneurs.
Order Books from www.tommckaskill.com
x
How to raise venture capital
The purpose of this book is to educate the entrepreneur on how Venture Capital
frms work, what they seek in an investment and how they manage that invest-
ment through to an exit transacton. It helps the entrepreneur judge whether
they have a venture suitable for VC investment and whether they wish to be part
of such an actvity. It lays out a comprehensive process that the entrepreneur
can follow which will assist them in raising VC funding.
Winning Ventures 14 principals of high growth businesses
Explains the major contributors to high growth success. Includes a comprehen-
sive Growth Check list for each principle as well as a robust Growth Potental In-
dex to help the reader judge the growth potental of their venture. Based on es-
tablished theories of growth, venture capital selecton criteria and the author’s
personal experience, this is a must for entrepreneurs.
Masterclass for Entrepreneurs
Creative solutions for resilience, growth
and proftability
This book is a collecton of published artcles by Dr. Tom McKaskill. This volume
expands on 30 of those artcles to provide a wide-ranging guide for entrepre-
neurs on how they can mange their businesses more efectvely.
Fast Forward
Acquisition strategies for entrepreneurs
In this book, Dr. McKaskill sets out a systematc and pragmatc process for ident-
fying, evaluatng, valuing and integratng fnancial and strategic acquisitons. He
draws extensively on his own experiences as a CPA, entrepreneur and academic,
as well as his experience with acquiring and selling his own businesses. He brings
a systematc and comprehensive approach to growing business through acquisi-
tons.
Finding the Money
Order Books from www.tommckaskill.com
xi
Order e-books from www.tommckaskill.com
This book is aimed at those entrepreneurs who have high growth potental
ventures and seek to raise fnance to assist them to develop their business.
To secure the fnance, the entrepreneur will have to demonstrate that their
business is capable of achieving a premium on exit, usually through a stra-
tegic sale. The book provides a checklist for the entrepreneur to assist in
developing a strategy to raise fnance.
Raising Angel & Venture Capital Finance
An entrepreneur’s guide to securing
venture fnance
Designed to help high net worth individuals become successful Angel In-
vestors. Angel investng involves actve mentoring and coaching of an early
stage management team towards sustainable proftability or additonal
funding, probably from a venture capital frm. This book sets out a compre-
hensive and rigorous process which will help the Angel generate deal fow,
evaluate investment proposals and manage the investment and subsequent
harvest. The book also provides a useful guide to managing operatonal risks
in the venture.
An Introduction to Angel Investing
A guide to investing in early stage entrepreneurial ventures
Investors in early stage ventures need to focus on strategic exits if they are
to achieve a high return on their investments. This book explains the charac-
teristcs of strategic value, how the investor should negotate the investment
and then how they should manage the process to a strategic trade sale. The
book includes a very detailed discussion on the problems of high growth ven-
tures, the unrealistc expectatons associated with IPOs and the advantages
of investng in strategic value ventures.
Invest to Exit
A pragmatic strategy for Angel and Venture Capital investors
xii
Raising Angel & Venture Capital Finance
Published by:
Breakthrough Publications
RBN B2173298N
Level 1, 75A Chapel St.,
Windsor, Melbourne, Vic 3181
www.tommckaskill.com
Copyright © Tom McKaskill 2009
All rights reserved. This publicaton may be reproduced, stored in a retrieval system or transmited in any form by
any means for personal use without the permission of the copyright owner. This publicaton may not be sold or resold
for any fee, price or charge without the permission of the copyright owner.
Every efort has been made to ensure that this book is free from error or omissions. However, the Publisher, the
Author, the Editor or their respectve employees or agents, shall not accept responsibility for injury, loss or damage
occasioned to any person actng or refraining from acton as a result of material in this book whether or not such injury,
loss or damage is in any way due to any negligent act or omission, breach of duty or default on the part of the Publisher,
the Author, the Editor, or their respectve employees or agents.
National Library of Australia Cataloguing-in-Publication data:
McKaskill, Tom.
Raising Angel & Venture Capital Finance - An entrepreneur’s guide to securing venture fnance
ISBN: 978-0-9806458-4-2 (on-line), 978-0-9806458-5-9 (CD-ROM)
1. Venture Capital. 2. Investment analysis. 3. Entrepreneurship. 4. Business enterprises -
Finance.
I. Title.
658.15224
Cover design: T. McKaskill
Page design and production: T. McKaskill
xiii
Raising Angel & Venture Capital Finance
Preface .................................................................................................................. XV
Acknowledgements ........................................................................................... XViii
Part A: Angel and Venture Capital Investment
1. A wealth creaton partnership ......................................................................... 2
2. Sources of Private Equity ................................................................................. 8
3. Angel Investor fnance ................................................................................... 30
4. Strategic vs. Financial ventures ..................................................................... 43
5. A compelling investment opportunity ........................................................... 53
6. Exit strategies ................................................................................................ 75
7. Preparing for the investment ........................................................................ 86
8. Investor presentaton techniques ................................................................. 95
9. Valuaton ..................................................................................................... 110
10. Finalising the investment ............................................................................ 127
11. Conclusion ................................................................................................... 138
Part B: Investor Ready Indices
Introducton to Part B ......................................................................................... 141
A. Awareness and Alignment ............................................................................. 145
- Awareness and Alignment Index ............................................................... 158
Table of Contents
xiv
Raising Angel & Venture Capital Finance
B. Venture Potental ........................................................................................... 159
- Venture Potental Index ............................................................................. 179
C. Operatons Development ............................................................................... 180
- Venture Potental Index ............................................................................. 207
D. Strategy .......................................................................................................... 209
- Strategy Index ........................................................................................... 220
xv
Raising Angel & Venture Capital Finance
Preface
F
ew entrepreneurs succeed in raising Angel or Venture Capital
f i nance. Many bus i nes s owner s don’ t bot her t o appl y
knowing that they won’t be successful. Others simply don’t need it and have
an operaton capable of generatng the free cash fow they need to grow their
business. Only a very few are able to meet the requirements of the Angel or
Venture Capital (VC) fund and succeed in getng an injecton of funds.
However, this type of funding is not a recipe for success. Around 50% of Angel
investments are in ventures which fail. More than 20% of VC investments are
writen of and at least a further 20% fail to achieve their target returns. On the
other hand, Angels and VC funds do succeed in picking winners and spectacular
returns have been achieved in a limited number of deals.
Over the period 1978 to 1999, I was fortunate to have raised venture capital
twice. The frst tme involved a sofware frm in the UK which I started in 1978
with two partners. By 1984, we recognised we needed to acquire one of our
sofware suppliers to be able to control the directon of sofware development
we were dependent on. We spent more than 12 months walking the streets of
London looking for venture capital to fnance the acquisiton.
Eventually we were successful in raising US$1.5 million for 20% of our equity
from a corporate venture fund. A few years into the new structure, the business
was in trouble. Our investor was acquired and our investment did not ft in with
the investment objectves of the new owners. We were successful in buying back
most of the shares of the VC fund for about US$30,000. A few years later, with
160 employees, 16 distributors and more than 4,500 customers, we sold out to
a US-listed sofware company for US$9.6 million. Had the VC fund stayed in, it
would have made a positve return on its money, although not the ROI it would
have liked.
Afer working for the acquiring corporaton in the US for three years, I formed
a new frm, building supply chain optmisaton sofware. We started with 12
people from the former frm which meant that we had a proven development
team and proven management. Afer spending two years building the frst
modules of the new suite of products, a small company called Red Pepper sold
xvi
Raising Angel & Venture Capital Finance
optmised scheduling sofware was purchased by Peoplesof for something like
23 tmes revenue. Recognising that we were in a boom market we set out to
raise venture capital.
This tme I was wiser, with some prior success and a proven team. However, I
stll spent nine months going from VC fund to VC fund trying to raise US$2 million.
I discovered that the VC funds all specialised in industry, investment stage, size
of deal and locaton. However, rather than miss out on the next Microsof, they
would stll see you – just in case. Finally, we raised US$2 million from a corporate
venture capital fund for 20% of the equity.
Two years later, we had used up most of the money and had achieved litle.
The market proved much more difcult than we expected. The early indicatons of
a boom market were not realised and several frms in the sector were in trouble.
SAP, the world’s largest applicaton sofware provider, then announced a full suite
of products in our sector, quickly followed by similar announcements by their
major compettors. Most of these products were ‘in development’.
Soon our prospects had essentially disappeared. We were faced with
dramatcally reducing the size of the business or selling out. We decided to sell
out. Within a few weeks we had eight frms interested in buying and a week later
received an ofer from Peoplesof at six tmes revenue. The VC fund came out in
front with a reasonable return.
When I returned to Australia in 2001, I was appointed Professor of
Entrepreneurship at the Australian Graduate School of Entrepreneurship. Over
the next few years I had tme to refect back over 20 years’ experience as an
entrepreneur over four diferent ventures. I also had the opportunity of working
with many start-up ventures and with several venture capital frms. Certainly, in
the past 30 years, the venture capital market has matured. There are now many
Venture Capital Funds or General Partners in the US, UK and Australia with many
investments to their credit. We all now have a much beter idea of what it takes for
a new venture to be successful, although we stll don’t have the secret to success.
More recently I have become actve in an Angel Group and have been involved
in educatng Angels on selectng and exitng investments. One thing which is now
very clear to me is that the objectves of the Angel and VC fund are rarely the same
as the entrepreneur seeking venture capital. It is only when the entrepreneur
xvii
Raising Angel & Venture Capital Finance
understands that he or she has to tailor the venture to meet the requirements of
the investor, and not the other way around, that the partes have a real chance
of succeeding.
The objectve of this book is to show the entrepreneur how they can create
a business which matches the investment objectves of the Angel or VC fund. In
doing so, there is a high probability of raising fnance. Venture capital is not for
everyone no mater how proftable the venture might be. Angels and VC funds
are not in the business of solving an entrepreneur’s need for funding albeit that
may be the outcome. They are simply there to achieve a high rate of return for
themselves, their investors or limited investment partners. The entrepreneur
who understands this and builds a proposal to meet their objectves, should be
much more successful in gaining Angel or Venture Capital fnance.
Tom McKaskill
xviii
Raising Angel & Venture Capital Finance
Acknowledgements
A very large number of people have contributed to my knowledge of this topic.
Hundreds of entrepreneurs who have been through my classes and workshops,
Angels who have atended my training sessions and discussed their investee
frms with me and VC executves I have worked with on exit strategies for their
investee frms. Each conversaton, queston and problem has helped me refne
my knowledge of Angel and VC fnance.
My life partner, Katalin Johnson, has been with me every step of the way,
partcipated in the seminars, workshops and most of the conversatons. She has
assisted me greatly by asking the hard questons, reviewing the material and
making her own contributon to the content.
Tom McKaskill
Australia
August 2009
[email protected]
www.tommckaskill.com
1
Raising Angel & Venture Capital Finance
PART A
Angel and Venture Capital
Investment
2
Raising Angel & Venture Capital Finance
1
E
very entrepreneur I know expects to build a winning business. Whether
it is the business they have right now or the next one they have in their
plans, they hope, one day, to get it right. They are optmists. Fortunately for
all of us, they are prepared to risk their savings and their tme to have a go
because without their drive, creatvity and perseverance, many of today’s large
corporatons would not be in existence.
One could also say the same about Angel and Venture Capital funding.
Without their funding and actve involvement, many of the successful companies
of today would have foundered. This partnership between entrepreneurs and
private equity capital has created signifcant wealth for both partes and, along
the way, many jobs, new innovatve products and a major source of export
earnings. However, it is a very small part of overall private enterprise capital
and the chances of a successful outcome are only fair.
Because of all the public relatons and hype around venture capital, we are
lef with the impression that it is a major contributor to business growth and
job creaton but the truth is that it is relatvely insignifcant in overall terms.
Only about 1 in 10,000 private frms will have independent private equity at any
point it tme and only about 1 in 20 frms seeking external private equity will be
successful in receiving it. So why is it seen to be an important factor in business
development?
A Wealth Creation
Partnership
3
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
The answer is found in the role that private equity plays in early stage, high
growth ventures. To appreciate that role, we must frst understand what it is
and how it works.
There are various forms of independent private equity. Angels typically
provide fnance for very immature ventures. Formal Venture Capital funds
tend to undertake deals in the business expansion to late stage of venture
development. The large Private Equity funds invest in mature businesses which
are undertaking a reorganizaton through a management buyout or are aiming
for a public listng. Even the terminology is somewhat confusing. In some markets
the term venture capital refers to any independent private equity investment,
especially from investment funds, while in others the term refers to diferent
types of investment. In more established markets, such as the USA, Venture
Capital refers to seed, early stage and some expansion capital, while Private
Equity normally refers to late stage, mezzanine, buy out and management buy
out or leveraged larger scale investments.
Collectvely the term Private Equity (PE) can be used to cover all forms of
independent investments. In this book, the term Venture Capital (VC) will
be used to refer to the form of private equity most ofen raised by emerging
enterprises, that is, those seeking funds from business Angels or Venture Capital
Funds to develop their business concept or to support the inital growth phase.
The common feature of VC investments is that they provide business fnance
in relatvely high risk situatons where other forms of fnance, such as bank loans
or lines of credit are not available. Because there is a high risk, high reward
element in these deals, there are both signifcant failures as well as spectacular
successes. It is mostly the long term successes which give the VC sector its
reputaton.
Private equity flls a gap in the market of business fnance, however, it is
very focused and, therefore, the vast majority of businesses do not satsfy
the investment criteria. Private equity investors are seeking opportunites for
returns well above what an average public equity investment would achieve.
They accept that the investment will be ted up for some tme and the venture
they are investng in is of a somewhat risky nature. They look for investments
4
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
which have the potental for very high rewards. These ventures will always have
a high growth potental component. That, in itself, means these ventures are
unusual as only a very small percentage of businesses ever succeed in reaching
a few million dollars in revenue.
To generate a high return, lets say in excess of 20% per annum, the venture
has to have the possibility of generatng high revenue growth or creatng
signifcant strategic value. This potental exists in only a very small percentage of
early stage businesses. The vast majority of high growth potental ventures are
unable to inherently generate enough cash to fuel their business development
plans, thus creatng the opportunity for private equity investors to partcipate.
Without private equity, most of these ventures would fail or never realize their
potental.
This is the genesis of the entrepreneur/private equity partnership. These
two partes come together to create something which neither could do by
themselves. In doing so, they have the opportunity of creatng a business
venture which can generate signifcant rewards for both. This is the place where
the entrepreneur accepts that a small part of a larger pie is beter than no pie at
all or a much smaller pie which is not getng bigger. It is also a place where the
partes have to work together to be successful. As we will see in later chapters,
that is not without it challenges as these ventures tend to push the envelope and
risks, disruptons, delays and surprises are the norm rather than the excepton.
The Private Equity market is much misunderstood by the average
entrepreneur. They have litle understanding of the structure of the
private equity market and tend to see it as one size fts all - ‘Venture
Capital’ without appreciatng the diferent forms of private equity. Most
start-up entrepreneurs see Venture Capital as the soluton to all their
problems. Venture Capital it seems is simply there for the taking – if only they
can have those few minutes to pitch their groundbreaking idea. The limitatons
of lack of experience, a yet to be completed product in a yet to be proven
market seem to be small hurdles whichthe venture capital frm can surely solve
for them. However, few really understand how these funds work and very few
understand the impact that taking the money will have on themselves, their
businesses or their future.
Most entrepreneurs seek VC to solve a funding problem. They seem to think
5
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
that the purpose of VC is to solve their problems, whatever they might be, and that
access to money is the key to success. Almost as if throwing money at their great
idea will solve any basic faws in the idea. In high growth frms there are usually
lots of constraints to growing the business and lots of places where additonal
funds could be usefully directed. This might be to complete a research project,
launch a new product into the market, build out an executve team, expand the
capacity of the business or its market presence and so on. In their quest for Angel
or VC fnance, the entrepreneur ofen thinks that by solving their own problems
they will automatcally provide a good investment for the VC investor.
However, few have ever thought of the specifc needs of the Investor and what
they want out of the investment or what limitatons, constraints and motvatons
they work under. While they understand that the return sought by Investors is
higher than say a bank, they have litle appreciaton of the risks that Investors take
and how they manage those risks or what this means in terms of how they judge
applicants or negotate the investment agreement. Successful entrepreneurs who
have taken a business to an IPO or made substantal personal wealth through
an Angel or VC backed venture ofen only experience the good tmes and are
more than willing to recommend this form of equity fnance. However, a porton
of Angel and VC backed ventures fail or end in disappointment for both the
entrepreneur and the Investor. Investors antcipate some level of failure and
manage their investee frms accordingly as they have learnt over tme to take a
hands-on approach to their investments.
Entrepreneurs who have raised Angel or VC funds have ofen been confronted
with a whole range of issues which they have not experienced before, or were
not expectng. Ofen to the surprise of the founder, the Investor insists on a
formal Board, a say in the strategy, a veto over certain operatng decisions and
regular fnancial and operatonal reports. In additon, the investment agreement
or shareholders agreement may contain clauses which mean that, in certain
circumstances, the entrepreneur can be dismissed and their business sold from
under them.
This all sounds very painful for the entrepreneur – so why bother? What is
missing in this scenario is an educated entrepreneur who understands how Angel
or VC fnance works and how to optmise the use of such funding so that the
entrepreneur can achieve his or her objectves alongside those of the Investor.
Angels and VC frms play a very important role in the structure of venture
6
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
funding – but it has a limited role and is really only appropriate for certain types
of situatons and certain types of endeavours. But for those which can meet the
requirements of the Investor and understand how to leverage the relatonship,
it can provide a platorm for wealth creaton unparalleled by any other form of
fnance. Many successful entrepreneurs have launched lifelong careers in high
growth enterprises through their frst Angel or VC backed venture.
Perhaps the least understood aspect of Angel and VC fnance is the need
for an exit event for the investor. There are basically two types of Angel and
VC backed ventures; fnancial and strategic. The fnancial venture will strive for
high growth in revenue and proft and will exhaust the supply of cash to drive
growth. On the other hand, a venture which creates strategic value will use
whatever cash is available to build an asset or capability which will be atractve
to a large corporaton. Both these ventures eat cash and rarely throw of spare
cash to pay dividends to the investors. In fact, Investors assume this will be the
case and understand that they will only see a return of their original investment
and a proft on the actvity when the business is able to achieve an ‘exit’ event.
In the case of a fnancial venture that would be an Inital Public Ofering (IPO),
achieved by only a very small percentage of investee frms, or a fnancial trade
sale. Strategic ventures generate a return to the investors by being acquired
by a large corporaton in a trade sale. VC investments are ofen called ‘patent
capital’ simply because they have to wait for the venture to achieve one of these
exit outcomes.
The need for an exit event is fundamental to an Angel or VC investment. It
is the only practcal manner in which the investor will achieve a return of their
investment and a proft from the transacton. Given the critcal nature of the
exit, it is the most important characteristc of the decision to invest and the
highest priority aspect of the business development strategy. It also means
that an entrepreneur who seeks equity fnance needs to accept that his or her
venture will be directed towards an exit as a conditon of the investment. With
the excepton of the rarely achieved IPO, this means the business will be sold in
a trade sale within a few years of the investment.
Almost without excepton, a trade sale will see the end of the business as an
independent entty and, almost certainly, the senior management team will exit
7
Raising Angel & Venture Capital Finance
Chapter 1: A Wealth Creation Partnership
at the same tme. While this may seem like the end of the grand adventure, it
really is the start of a new one. The cashed up entrepreneur achieves a reward for
their creatvity, energy and innovaton and has the chance to do it again, retre,
become an Angel investor or become actve in philanthropy. Not a bad outcome
for their contributon. One journey fnishes and another starts, but they do need
to accept that by taking the funds, the likely outcome will be that this baby will
grow up and go its own way.
With a greater appreciation for how Angel and VC finance works, the
entrepreneur can decide if they want to take this path to wealth creaton. It is
not without its challenges but it a path worth exploring if the underlying venture
has the potental.
The purpose of this book is to help the entrepreneur decide if this is the right
path for them. It seeks to educate the entrepreneur on how Angel and VC fnance
works, what the Investor seeks in an investment and how they manage that
investment through to an exit transacton. It will help the entrepreneur to judge
whether they have a venture suitable for investment and whether they wish to
be part of such an actvity. It also lays out a comprehensive process which the
entrepreneur can follow that will assist them in raising Angel and VC funding.
8
Raising Angel & Venture Capital Finance
Private Equity comes in various forms and generally depends on the stage
of development of the investee frm. Knowing the extent to which the business
has matured is ofen an indicaton of the risks the business faces and the type
of support it needs to get to the next stage.
The Australian Bureau of Statstcs’ 2001 Special Artcle – Venture Capital
Survey uses a multple stage classifcaton to describe business maturity. The
defnitons describe stages at which Angel or Venture Capital fnance is invested.
• Seed: product is in development. Usually in business less than 18
months.
• Early: product in pilot producton. Usually in business less than 30
months.
• Expansion: product in market. Signifcant revenue growth.
• Turnaround: current products stagnant. Financing provided to a
company at a tme of operatonal or fnancial difculty.
• Late: new product or product improvement. Contnue revenue growth.
• Buy out: [leveraged buy out (LBO), management buy out (MBO) or
management buy in (MBI)]: a fund investment strategy involving the
acquisiton of a product or business, from either a public or private
company, utlising a signifcant amount of debt.
Source: ABS, 2001, Special artcle - Venture capital survey
2
Sources of
Private Equity
9
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
A similar classifcaton is provided by the Britsh Venture Capital Associaton.
In their case investments in private companies are classifed by the stage at
which the funding is needed. Stage defnitons are:
Seed Financing provided to research, assess and develop an inital concept before
Stage a business has reached a start-up phase.
Start-Up Financing for product development and inital marketng. Companies may be
Stage in the process of being set up or may have been in business for a short tme,
but have not sold their products commercially and are yet to generate a proft.
Expansion Financing for growth and expansion of the company which is breaking even or
Stage trading proftably. Capital may be used to fnance increased producton
capacity, market or product development, and/or to provide additonal working
capital.
Replacement Purchase of shares from another investor or to reduce gearing via the
Capital refnancing of debt.
Buy out The acquisiton of a signifcant porton, majority control or 100% of businesses
which normally entails a change of ownership. Funds are ofen used for
expansion, consolidatons, turn-arounds, and spinouts of divisions or subsidiaries.
Source: htp://www.evca.com Accessed 29/12/04
There are only a limited number of Venture Capital funds focused on fnancing
seed or start-up stages, although this is ofen the stage where Business Angels
play a major role.
An emerging company which has constructed an experienced management
team, a robust compettve positon and strong gross margins usually has litle
need for Angel or VC investment. Early stage ventures with strong proft and
high growth potental may be able to skip Angel fnancing and go direct to
formal venture capital. The Angel plays the middle role: funding the business
that has yet to stand on its own feet and not yet mature enough or with enough
potental to atract venture capital. Angels typically invest in seed, start-up or
early stage businesses.
Angels ofen play the fnancing role between ‘family, friends and fools’, ofen
referred to as ‘close money’ and formal venture capital. Coping with what has
come before and what comes afer their involvement in the venture is a challenge
for the Angel. On the one hand, Angels need to develop the business given the
10
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
constraints inherited from earlier investors and then they need to prepare the
business for the next round of investment, usually from formal venture capital.
Even though the majority of their investee frms will not require venture capital,
this will not always be apparent in the early stages of the Angel’s involvement
with the investee frm.
Business Angel fnance, the role of the Angel and the manner in which Angels
work will be covered in greater detail in the next chapter.
Family, Friends and Fools
Most new frms start with whatever funds the new enterprise team can
scrape up between them. This may be advances on credit cards, savings and
bank loans (generally secured on property). This is the entrepreneur’s money
and if they lose it, they have only themselves to worry about. Most ventures start
this way and may never require further shareholder investment. The profts are
normally re-invested to fund additonal working capital as the business expands,
however, funds for expansion are ofen limited as the founding team usually
exhaust their personal savings. To keep the enterprise going and to fund the
next stage of development, founders normally turn to their family and friends.
However, everything has a price and even money from those who are
close comes with its own problems. While they may not have the same ROI
requirements as an Angel or be subject to the regulatons and tmescales of the
VC, investment from family and friends (close money) has its own issues. Fools
are said to be investors who throw their money in on the of chance that it might
make a return, but generally don’t risk very much and have low expectatons of
getng the money back.
New ventures are not without their risks. Australian research indicates that
up to 70% of new start-ups will fail within fve years. Further, few will ever grow
beyond six people and very few will achieve signifcant size. The chance of losing
the money from relatves and friends is reasonably high.
One of the consideratons which new venture entrepreneurs face is the
impact on their relatonships with family and friends of the venture failing.
11
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
What happens when the venture fails and close relatves have invested life
savings into the business, having been sold on the dream of owning part of the
next Microsof? Few non-business people really appreciate the risks of a start-
up. Everything appears atractve up-front when it all looks so easy and they are
sold on the idea of their young relatve growing a monster company. But when
it fails and they accept that their relatve simply didn’t have the experience to
make it work, will they really be happy to write of the investment, or will this
be a lifelong problem between them?
The same could be said of close friends. Being work colleagues, school friends
or social friends hardly qualifes people to undertake the stress and rigor of
going into business together. What happens when their talent and experience
proves not to be the level required, they don’t really want to put in the tme or
they want to have the fnal say on all decisions? Then there is the dysfunctonal
team which may cause the failure of the venture or may need to be broken up
by forcing some of the team to quit. If they have money invested in the venture
and stll own equity, how are the remaining shareholders going to buy them out
or deal with their ongoing equity interest?
Many start-ups involve couples, business colleagues, school friends and
relatves. Not all of them will appreciate the tme and efort which must be
put into the venture to get it to a reasonably proftable, sustainable state.
There are many stories of partners working long hours, taking low salaries and
undertaking actvites they are not trained for just to survive. Not everyone
going into the venture is capable or willing to put in the efort and tme it takes
to get something up and running.
Close money may or may not come with other constraints. If a founding
investor is working in the business, they may well feel an equal partner and
want to be actvely involved in the decision-making on a day-to-day basis.
While this can work in very small frms, it becomes very problematc as the frm
grows. As more staf join and the frm becomes more complex, some formal
organisatonal structure is required. At this point, the queston of who is boss
and who makes the decisions becomes a real issue of debate and ofen confict.
With independent people, this can be more easily resolved; however, when
the other person is a spouse, cousin or best friend, the issue is not so readily
resolved.
12
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
At the same tme, family investors who don’t work in the business may feel
a need to interfere if they see something they disagree with, even without
understanding the situaton or the business requirements. So the wife of the
cousin who sees diferentals in remuneraton or diferent workloads may feel
compelled to voice critcism to the aunts and uncles. Now the managers are
spending tme defending their actons to people outside the frm who may have
no idea of the pressures they are under.
Then there is always the issue of a family member, friend or fool who decides
that they would like their investment capital back before the other shareholders
are ready to exit the business.
An issue common to many new ventures owned by married couples are the
problems which arise when they start a family or go through a divorce. Where
other owner/managers are involved in the business and one needs to take tme
out for family reasons, this can create tension and assertons of unfairness and
inequality. Where a divorce occurs, it may be impossible to contnue a close
working relatonship. The issue of ownership and involvement can become a
very messy problem, ofen resultng in the failure or sale of the frm.
A major consideraton for the entrepreneur is what happens to the original
team as the frm grows. Will they be capable of playing their part in the
management team of a frm which grows to 30, 100 or 500 people? If they don’t
have the experience, personality or capability to handle the tasks, how will the
problem be resolved?
Investors are ofen confronted with these complex personnel situatons.
As an external and perhaps a more objectve investor, the Investor needs to
tread carefully around these relatonships. Clearly, if they don’t see that a
constructve business environment exists, or one that can be readily resolved
through discussion and a realignment of roles, responsibilites, remuneraton
and objectve decision-making processes, they are beter of rejectng the
investment. If the Investor thinks the team is not capable of delivering the
growth and proft required, they will simply walk away from the investment
opportunity. If there is a problem between founders and early investors and the
Investor feels that this will limit the process of building the business, then they
are beter of not investng.
13
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
At the same tme, the Investor needs to acknowledge that the venture
probably would never have survived had it not been for the investment, tme
and commitment of those people who were willing to come in at the start. This
is an interestng problem for the Investor to deal with.
Before proceeding to invest, the Investor must be satsfed on the following
issues:
Will the family, friends and fools interfere in the negotiation for the
investment, the management of the company or the decision on the
exit strategy?
Do the family and friends who helped start and grow the company
form part of a management team? Does the investor have confdence
in them and is he willing to trust them to grow the business to achieve
its potential?
Current management and shareholders should be aware that these issues
will need to be addressed as part of the investment agreement. The Investor
may require that some of these problems be resolved as part of the decision
to invest. This may involve a restructuring of the business, new job descriptons
and a more formal organisaton structure. The Investor might also be willing to
buy out some of the early shareholders in order to simplify the shareholdings.
Venture Capital Funds
Venture Capital is the most formalised form of private equity investment.
Unlike most Angel investments where the Angel takes a personal role in deal
due diligence and management, Venture Capital provides a channel whereby
high net-worth investors can partcipate in higher risk ventures without having
to personally undertake the burden of venture evaluaton and management.
The VC fund itself provides the expertse in sourcing, evaluatng, investng,
managing and harvestng the venture investments.
Whereas most Angels invest in their own right, VC investment is through
a fund. The common structure of a Private Equity Fund or Venture Capital
14
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Fund is the Limited Partnership. This structure is commonplace in both the
USA and UK markets and has been introduced in Australia. The beneft of
this structure is that the fund itself is not a legal entty for tax purposes
for the investor. There is a pass through treatment of any gains for tax
purposes. Thus any gains and losses pass directly to the investor and are
taxed in their hands. The investor also has the beneft of limited liability at
the level of the fund itself. No liability from the investee frms can pass back
to the investor. A comprehensive descripton of the Limited Partnership
Agreement can be found on the Britsh Venture Capital Associaton website
(see www.bvca.co.uk/).
Funds are normally closed-end in structure, meaning that the investor has
very limited or no ability to withdraw their investment during the fund’s life.
Funds are typically established for a 10-year life, but may be extended in some
circumstances. The investor (also known as a Limited Partner) commits to make
available funds as needed for the underlying venture investments. Investments
are then normally made by the Investment Manager (otherwise called a General
Partner) generally over the frst one to fve years of the fund life. As investments
are harvested, proceeds are returned to the Limited Partners and not re-
invested into new opportunites. Since the tming of exits cannot be known in
advance, Limited Partners must be prepared to wait for some tme before they
start to see any return on their funds.
In his book, ‘Early Exits: Exit Strategies for Entrepreneurs and Angel Investors
(But Maybe Not Venture Capitalists)’ Basil Peters notes the following:
Most VC funds are designed for a lifetime of 10 years. But in
practice, the actual lifetime of technology (IT) VC funds averages
closer to 13-14 years.
Limited Partners typically give a wide degree of discreton to the General
Partner to invest on their behalf as they cannot know before the fund starts
to operate the types of investments which may present themselves. The fund
15
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
agreement typically specifes the minimum and maximum investments the
fund can make in any one venture. The Limited Partners are commited to the
investments made by the General Partner and there is generally no ability for
the Limited Partner to withdraw from any investment made by the General
Partner. Typically, General Partners or Fund Managers issue a Prospectus or
Informaton Memorandum to investors to raise their investment capital.
The typical Private Equity Fund terms are:
Minimum investor commitment Ofen $5 million or greater.
Manager’s commitment General Partners typically invest their own money in the
fund. Ofen this will be around 1% of the total fund and is
sometmes a prerequisite of the Limited Partners.
Partnership term The fund life is normally 7-10 years with the
possibility of limited extensions to facilitate exits.
Distributons may be made as investments are sold.
Investment/commitment period On average, Private Equity Funds invest commited
capital over a 3-5 year period.
Management fees Normally the management fee is set between 1.5% and
2% of commited capital.
Incentve/performance fees Typically 20% of the total returns and is usually only paid
once the Limited Partners achieve a predetermined hurdle
rate. This is known as the ‘carried interest’.
Preferred return or hurdle rate The carried interest may not be paid out untl total returns
exceed some agreed threshold. Currently (2004) this is
around 8%.
Source: htp://www.evca.com Accessed 27/10/03
A comprehensive glossary of phrases commonly used within the Australian
Venture Capital Industry can be found on the AVCAL website.
Source: htp://www.avcal.com.au
16
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
In Australia, The venture capital sector is relatvely small but is growing. As at
30 June 2005, the industry had the following characteristcs:
• Number of venture capital managers 140
• Number of venture capital vehicles 210
• Number of investee companies 912
• Venture capital under management A$11.2 billion
• Venture capital invested for the year
ended 30 June 2005 A$0.839 billion
Source: ABS 5678.0 Venture Capital 2004-5
By the tme of the 2007/8 ABS survey, the number of actve Venture Capital
and later stage Private Equity managers hasdincreased to 183 managing 286
ventures.
Source: ABS 5678.0 Venture Capital and Later Stage Private Equity, Australia, 2007-8
In the USA comparable data is difcult to fnd. However, the Natonal Venture
Capital Associaton (NVCA) represents 460 venture capital and private equity
frms (see www.nvca.org). In 2004, VC frms invested US$21.2 billion. Of this
65% went into early or expansion stage companies and 33% went into later
stage companies. One directory lists more than 1,400 VC frms in the USA (see
www.vfnance.com).
In the UK, there are several VC directories, one of which is published by the
Britsh Venture Capital Associaton (BVCA). The BVCA has more than 170 full
members and 150 associate members (see www.bvca.com.uk). Worldwide
investment by UK PE frms was £9.7 billion. The number of companies fnanced
was 1,301. Another VC directory for the UK is available from VCR Directory Online
which lists more than 3,000 investors across Europe (see www.vcrdirectory.net).
General Partners have the responsibility of sourcing, evaluatng and
negotatng investments in private frms. This can be a lengthy and tme-
consuming task. Due to the immature nature of many of the frms being
examined and the uncertaintes associated with their products and business
models, combined in many cases with the lack of proper systems or audited
17
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
accountng records, considerable expertse is needed to undertake the
task efectvely. Since such experience is in limited supply, Venture Capital
Funds have difculty recruitng senior managers, although the work may be
outsourced in some areas to external advisors. The ability of the VC Funds to
invest is constrained by the number and experience of their managers. At the
same tme, frms receiving investments (investees) are looking to their General
Partners for advice, contacts and help securing customers, grants and staf.
When investee frms get into trouble, such as not achieving targets, making
losses or losing key staf, General Partners need to devote considerable tme
to their current investments and have litle tme to source and evaluate new
investments. General Partners will also be actvely involved in setng strategy,
planning and executng the exit. Around 70% of the General Partner’s tme is
taken up working with their investee frms; hence the capacity of the Venture
Capital Fund is limited. Venture Capital Funds therefore typically make few
investments: only a few in any year. They ofen have limited tme to carefully
evaluate new investments and ofen spend only a few minutes on an executve
summary establishing whether the proposal is worth further investgaton.
Even when a propositon looks atractve, extensive tme will be spent with
the new venture team evaluatng them as well as the merits of the business.
Considerable due diligence will be undertaken before any investment is made.
Ofen 20-30 or more proposals will be investgated for every single ofer made.
The 2004 Australian Bureau of Statstcs (ABS) survey reported similar ratos.
‘The selecton of investee companies (into which venture capital is invested)
was an intensive process. The total of 137 venture capital managers reviewed
10,530 potental new investments during 2003/04 and conducted further
analysis on 1,067 of those, with 181 being sponsored for venture capital. These
managers spent a total of 179,000 hours with the investee companies (190,000
in 2002/03), advising and assistng in the development of the enterprises.’
Source: ABS 5678.0 Venture Capital, Australia Accessed 26/11/2004
18
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
In the 2007/8 ABS survey, fund managers spent on average 3.9 days a month
on each investee company.
Due to the complexity of the business proposals, VC frms will ofen limit
themselves to specifc industry sectors where they have both the expertse to
evaluate the deal as well as the experience and networks to add value to the
investment. In the US and UK markets some funds have a single industry focus;
however, in Australia most funds have a more general focus.
VC frms will also ofen limit themselves to certain development stages,
such as start-up, expansion or buy out, where they can add real value. VC frms
which spread themselves across too many sectors or too many stages will ofen
be viewed less favorably by investors as they will see higher risks in such a
spread. At the same tme, larger funds prefer only to invest larger amounts as
they can only support a limited number of investments. A typical fund invests
in approximately 10-12 investee companies with individual investments of
between 5-15% of the individual fund’s total investment capital. The increasing
cost of proposal analysis and subsequent due diligence is itself an inhibitng
factor. If only one in ten proposals investgated are being invested in, the
average cost of investgaton of an investee frm is quite high. Therefore small
investments are simply not economical.
The drif towards larger funds and the lack of early stage expertse within
the VC community has led to an increasing shif of investments towards later
stage investments. For example in 2003, 55% of venture capital investments
in Australia went into various types of buy outs of existng businesses – the
vital seed, start-up and early expansion phases accounted for only 16% of
investments.
Source: htp://www.smh.com.au/artcles/2004/04/11/1081621834935.html?oneclick=true
Accessed 31/12/04
In the ABS 2007/8 survey the percentage in later stage private equity fell to
36% of total funds invested.
19
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
The 2005 ABS Venture Capital report shows the following breakdown of
investments by stage:
Stage of development Number Value $ million
Seed 145 65
Early 313 665
Expansion 265 1,183
Turnaround 34 118
Late 65 267
LBO/MBO/MBI 90 1,234
Total 912 3,532
For the 2004/5 year, 49% of investments went into ventures which were 2-4
years old and 26% into those which were 5-10 years old.
USA data from the MoneyTree™ Survey for 2004 shows the following
breakdown:
Stage of development Number Value $ billion
Startup/Seed 178 0.391
Early Stage 850 3.883
Expansion 1,217 9.653
Later Stage 700 7.578
Undisclosed/Other – –
Grand Total 2,945 21.506
Source: PricewaterhouseCoopers/Thomson Venture Economics/Natonal Venture Capital
Associaton, MoneyTree™ Survey, Total U.S. Investments by Year Q1 1995 – Q3 2005 htp://www.
nvca.org
2004 data for the UK from the BVCA showed the following:
20
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Stage of development Number Value GBP million
Seed/Early Stage 264 188
Expansion 522 789
MBO 237 3,778
MBI 30 320
Grand Total 1,053 5,075
Of the total funds raised by UK VC frms in 2004 (£3.3 billion), 90% was
expected to be invested in the MBO/MBI stages, 6% in expansion and 2% in
early stage.
Source: htp://www.bvca.co.uk
Many of the more successful and longer established VC frms receive so many
business proposals that they restrict their tme to recommended proposals
from individuals or professional frms which have already reviewed the business
plans, so they can beter use their tme. It also means that to access the beter
VC frms, an entrepreneur needs to frst work with an Angel or professional frm
which has access to the General Partners.
The legal structure of the fund, the manner of remuneraton for General
Partners and the process in which Limited Partners achieve a return of
their inital investment plus their desired ROI, means that investments
need to be harvested within a relatvely short period of tme. Most VC
frms target a period of between 3-5 years for harvestng. However,
if you take out the last year for the exit executon, this leaves only
2-4 years to create the pre-conditons for a successful exit.
If investments go over the fve-year mark they are at risk of running up against
the fund term. This means the General Partner has to apply to the Limited
Partners for an extension or they need to force an exit event. To achieve a 25%
compound return, they need the value of the investment to double almost
21
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
every three years. An investment that has been in play for six years needs the
capitalised value to have reached 3.8 tmes the inital investment. If the VC fund
only held 20% equity in the investment, a $2 million investment in a $10 million
capitalised frm has to achieve an exit valuaton of nearly $38 million to provide
the VC frm with a 25% ROI over the six years. Since few frms consistently
achieve this type of growth, the pressure is on the VC frm to choose the right
investments and then to actvely manage them to get the desired growth rate.
Any slippage from the agreed targets will create considerable pressure on
the VC to intervene to sell the business or to replace the management team
to get the frm back on track. Few entrepreneurs seeking VC investment really
appreciate the impact on the frm of a 25% cumulatve growth in value and how
difcult it is to reach.
Usually the VC fund is a minority investor which normally would give them
litle power or authority to force a sale of the investee frm. However, the
investment agreement would typically provide the VC fund with the power to
intervene to ensure they are able to exit under certain circumstances. Typical
provisions would include the following:
Votng trust: Entrepreneurs hand over shares if they don’t perform. The VC
has the ability to take control, notwithstanding it is initally in a minority
positon.
Unlocking provision: A shareholder receives an ofer they don’t wish to
accept but the VC does – the shareholder must buy the VC out.
Put provision: The VC may have the right to sell the business to the ‘highest
bidder’ if an exit is not achieved by a given date.
Registraton and public ofering provision: The VC may require an IPO afer
a given date. If this is not possible, the frm will be sold.
Piggyback opton: The VC can sell their shares anytme the business sells
shares either in a public ofering or in a trade sale.
Come along: The VC can force the business to sell shares if the VC receives
an acceptable ofer for its shares.
22
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Drag along: The VC can force all shareholders to sell their shares if the VC
receives an acceptable ofer for its shares.
Tag along: If a shareholder receives a favourable ofer for its shares, other
shareholders have an opton to notfy the purchaser that they too wish to
sell their shares.
For additonal details see: D Gladstone and L Gladstone, 2002, Venture capital handbook
– An entrepreneurs guide to raising venture capital, Prentce Hall, pp 180-208 and B Ferris,
Nothing ventured, nothing gained: thrills and spills in venture capital, Allen & Unwin
Many people incorrectly think that VC General Partners are business experts
who are knowledgeable about growing a business. In truth, most of them
have a banking and fnance background, with limited management experience
outside the banking and fnance sector and litle hands-on experience in most
of the markets in which they have investments. In many cases, the investment
manager actng for the VC frm will be in their late 30s or 40s, have not worked
in any sector other than fnancial services and have never undertaken any
entrepreneurial actvity. Their ability to help with specifc experience in the
development of a long-term strategy or with market development is limited.
Some of the beter funds have expanded their investment team with managers
with operatonal experience, but these are certainly in the minority.
The more experienced General Partners will have learnt through a series of
investments, will have developed good networks across a range of industries and
will have partcipated in several exits as well as several write-ofs. However, this
experience can make them more cautous in their assessment of opportunites.
For the most part, VC General Partners are fnancial administrators. They
are good at fnancial analysis, working the ratos, accountng for the money and
making sure the legal requirements are satsfed. But they can only remain in
the VC business if they can raise a new fund, since funds have a limited life.
Raising a new fund means delivering healthy returns to their Limited Partner
investors. That means getng both the investment and the exits at the right
price. Without the exit returns, they don’t achieve their bonuses and they don’t
have the opportunity to raise a new fund.
Mature VC frms which have been actvely involved in funding emerging
companies for a number of years have discovered just how hard it is to cope
23
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
with innovatons, emerging markets and untried teams. Those VC frms
typically have recruited senior staf who have technical (and ofen business)
qualifcatons as well as a number of years of senior operatonal experience
if not direct entrepreneurial success. In mature markets such as the USA, top
VC frms will not employ an investment manager who does not have senior
operatonal experience. While they have discovered that fnancial administraton
can be outsourced, operatonal experience is a real asset when it comes to
understanding how a value propositon will achieve tracton in the marketplace
and understanding whether or not the management team has the atributes to
build a good business.
Occasionally a VC frm will be able to sell to another VC frm which might be
interested in taking the business to the next level of development. An early stage
VC frm may sell their positon to another VC frm interested in an expansion
investment. This may also involve a further round of investment in the investee
frm. VC frms atempt to maximise the value of their return through the most
favorable exit vehicle. IPOs generally achieve the best returns with buybacks
usually the lowest positve return. As an indicaton of the frequency of each
type of exit, consider the following data sets.
In Australia, from March 2000 to September 2002 there were a total of 209
exits, of which 117 or 55.6% were at a proft, 10 broke even, and 79 or 37.8%
were at a loss.
Source: htp://www.asto.com.au/news03/techbotoms.htm Accessed 27/12/04
In 1999/2000, 24 companies were sold, 12 companies went public, four
companies were bought back and 19 investments were liquidated. The value
of exits during the year 1999/2000 was A$536 million. The average trade sale
was A$3.7 million, while the value of all IPOs was A$346 million.
Source: Venture Capital in Australia (Research Note 28 2000-01)
htp://www.aph.gov.au/library/pubs/rn/2000-01/01RN28.htm Accessed 31/12/04
24
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Not all exits can be achieved quickly, as this data from 1995-2001 shows.
Exit path Full exit Partal exit %
IPO 22 16 29.3
Private (undisclosed) 10 1 8.4
Acquisiton 25 (cash) 5 (shares) 23.0
Secondary Sale 9 1 7.7
Buyback 9 8 13.1
Write-of 24 0 18.5
Total 99 31 100
Source: G Cumming and G Fleming, 2002, ‘A law and fnance analysis of venture capital exits in
emerging markets’ Working paper series in fnance 02-03, Australian Natonal University
The ABS 2005 and 2007/8 Venture Capital Reports show the following exit
statstcs:
Exit path Value A$ million 2005 2007/8
Trade Sale 291 456
IPO 246 376
Buyback 35 11
Write-ofs 49 45
Lef the Industry 215 162
Total 836 1,050
Ratos for the USA are comparable. Data from Q3 2005 from the NVCA showed
that there were 19 IPO exits compared to 76 trade sales (25%).
Source: htp://www.nvca.org/pdf/2005Q3IPOreleasefnal.pdf Accessed 5/12/05
25
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Data from the NVCA in the USA for 2004 show investment losses occurred in
61 of the 181 exits (34%); however, 20 of the 181 (11%) exits resulted in the
VC frm achieving more than 10 tmes their investment.
Source: htp://www.ventureeconomics.com/vec/news_ve/2005VEpress/VEpress05_04_05.pdf
Accessed 11/12/05
Exit data from the UK for 2004 shows that, by value, 28% was from trade
sales, 20% were sales to another private equity frm, 13% were write-ofs and
10% was from IPOs.
Unlike VC funds, Angels are not restricted by the closed fund limitaton, thus
they can stay with their investments longer if the occasion warrants. They can
also be more selectve with their investments. The General Partner of a VC fund
is under pressure to allocate the money during the early phase of the fund and
so a high volume of possible deals needs to be sourced for evaluaton. Angels
can invest without an expectaton of a positve return, perhaps to ‘give back’ or
to fund or assist a young entrepreneur. The VC frm can really only be involved
if it can see a healthy return for their Limited Partners.
Angels typically invest in one in three proposals which they evaluate where
VC funds only invest in one in one hundred. Perhaps, because of the higher
cost of investng and the higher return expected, the VC frm has a much more
difcult task in fnding appropriate investments.
Private Equity Funds
Another form of private equity is the Private Equity (PE) Fund, a term
normally reserved for funds which invest in late stage ventures. Where Venture
Capital Funds typically take a minority investment in a frm and actvely manage
through the original management team, the Private Equity Fund typically takes
100% or a majority stake in an investment. PE frms typically aim to acquire
frms where direct interventon can overcome prior problems or constraints
and provide a short-term turnaround situaton or performance uplif which will
yield an atractve return. PE frms look for inefciencies to exploit. Common
approaches are:
26
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
• Improve the proftability. Access to more experienced management,
networks and technical knowledge may provide the basis for a relatvely
easy improvement in proftability.
• Buy at a favorable price when the market is low and wait untl the
market improves when valuaton multples are higher.
• Break the business up and sell of the assets or business units. Some
businesses are undervalued where one part of the business is more risky
or where the market does not understand the business economics. More
focused businesses will ofen sell at a higher multple.
• Leveraged buy out. The PE frm uses debt to fnance a major part of the
buy out. When the value improves, the returns to the equity porton are
magnifed due to the high debt component.
• Management buy-out.
• Management buy-in.
• Make bolt-on acquisitons to generate economies of scale or gain access
to new products or markets.
PE could be used to remove the burden of existng debt which might allow
the business to reinvest and grow. Existng management may be retained with
incentves or may be allowed a minor equity positon as an incentve.
PE investment may be used to provide existng management with the
opportunity to buy out the existng owners, re-engineer the business and then
positon it for an IPO. The PE frm would use the IPO as their exit strategy leaving
the management team in control post IPO.
PE funds have become actve in ‘sell down’ transactons in recent years. This
occurs where the PE fund buys shares from a founder representng only part
of the ownership, although most ofen the majority. In this way, the founder
has the opportunity to cash out part of their investment in the enterprise. The
PE frm will then work with the founder to actvely progress the business to a
higher exit valuaton which could be achieved either through an IPO or a trade
sale. In undertaking the development strategy, the PE frm may arrange for
additonal debt fnancing, replace some of the management team, restructure
the Board of Directors, assist with acquisitons and development of new strategic
partnerships and so on.
27
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
This strategy has the advantage of allowing tme for the business to be
properly prepared for an exit with the actve co-operaton of the founder and
the management team. The founder may also achieve a secondary harvest at
a higher valuaton. An Angel might seek out a PE fund as an exit strategy if the
business could be substantally developed with signifcant capital injecton, a
new management team or as part of a roll-up strategy.
Corporate Venture Capital
An Investor may co-invest with a corporaton or seek follow-on funding
from a corporaton as part of an exit strategy. Many corporatons have Venture
Capital Funds specially for the purpose of investng in early stage ventures. The
manner in which these corporate funds are managed and the terms under which
funds are invested closely mirror traditonal Venture Capital Funds. Ventures
successful in acquiring a corporate investor can ofen gain additonal benefts
beyond those which can be ofered by the traditonal Venture Capital Fund.
Corporatons have a variety of reasons for investng in early stage ventures
although the most common are:
• access to specialised knowledge, intellectual property or equipment
• exposure to emerging technologies
• investment in potental acquisitons
• understanding of new or emerging markets
• access to entrepreneurial talent
• preventng compettors from acquiring a technological breakthrough.
For the new venture, a corporate investor could provide the following
benefts:
• access to industry expertse, networks, equipment and/or research and
development facilites
• access to a key customer or to an established distributon channel
• access to complimentary technologies.
28
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
Typically, Corporate Venture Funds invest in their core or closely related
technologies.
According to a joint study by Venture Economics and the Natonal Venture
Capital Associaton in United States, in 1994 only 2% of venture capital
investments were corporate venture capital, but in 2000, corporate venture
capital accounted for 17%, nearly US$20 billion. In four years, from 1996 through
the end of 1999, the number of companies investng in outside ideas increased
elevenfold, from 30 to 330. During the same period, corporate venture capital
spending rose from US$100 million to US$17 billion annually.
Source: htp://www.1000ventures.com/business_guide/corporate_vinvestng_external.html
Accessed 3/01/04
In 2003, US$1.1 billion was invested in the USA in growth orientated
companies by corporate venturing groups, representng 6% of all VC investment.
The amount invested by corporate venture capitalists has tracked similarly to
the trends of the overall VC industry. The 2003 fgures were close to the actvity
seen in the last pre-bubble year, 1997, when corporate venturing groups
invested US$957 million, also representng 6% of total VC invested in that year.
Source: htp://www.nvca.org/nvca02_04_04.html Accessed 3/01/04
There is limited informaton available about Corporate Venture Capital Funds
in Australasia.
Overseas and local corporatons may undertake venture investments through
a local fund, via a traditonal Venture Capital Fund or through a local subsidiary.
The major problem which most corporate businesses have with VC investments
is access to experienced VC executves. Since the VC investment model is one of
actve interventon as well as portolio investng, this type of investng is foreign
to most corporatons. Many will invest in an established VC fund in order to
access the investment evaluaton experience and venture investment skills.
An early stage venture which can clearly show how their innovatons relate
to the business of a large corporaton should include that corporaton in their
list of potental investors. However, corporatons not familiar with investng in
early stage ventures can be a mixed blessing. Because they are not familiar with
29
Raising Angel & Venture Capital Finance
Chapter 2: Sources of Private Equity
the norms of such investments, the frm may fnd itself wastng considerable
tme trying to convince the corporaton of the value of an external investment,
although benefts may come from a more favorable valuaton, access to
corporate resources and an early exit opportunity.
The entrepreneur should be wary of the motvaton of the corporate investor.
Their involvement is mostly driven by their own strategic objectves and their
support may be highly infuenced by wantng the investee frm to develop
in a partcular directon. They may inhibit, consciously or unconsciously, the
directon of the business and limit the exit opportunites.
30
Raising Angel & Venture Capital Finance
A
ngel investors, ofen simply referred to as Business Angels or ‘Angels’,
are high net-worth, non-insttutonal, private equity investors who have
the desire and sufciently high net worth to enable them to invest part of their
assets in high-risk, high-return entrepreneurial ventures in return for a share of
votng, income and, ultmately, capital gain.
Angel investment is normally the frst round of external independent
investment. Angels normally invest in early stage ventures where the founding
team has exhausted their personal savings and sources of funding from family
and friends. These ventures are not sufciently developed to stand on their
own, or sufciently atractve to gain venture capital funding. These ventures
exist in a halfway state, ofen between possible failure and take-of. Typically
the management team lacks experience in a growth venture and the business
needs not only the additonal funding, but also mentoring to take it to the next
stage of development.
Investng in early stage private companies has many drawbacks, which is why
this form of investment is typically undertaken by individuals who can aford to
lose the money and/or are willing to wait some years before they see a return
on their money.
3
Angel Investor
Finance
31
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
To put this into context, private early stage ventures have the following
atributes:
• The shares are not freely traded and no established market exists for
them. An investor is forced to wait for a liquidity event such as a trade
sale or a public listng.
• Novel business concepts and inventons are ofen associated with
emerging and untried markets. The risks in the venture are likely to
be higher and some aspects of the business subject to high levels of
uncertainty.
• Products may be new and/or under development and stll subject to
technical and market risks.
• The knowledge of the product and its design may be highly dependent
on a small number of key staf, who may not necessarily have proven
business experience.
• The small size of new ventures and their lack of presence in the market
mean they may be highly susceptble to changes in market conditons.
Timing may be critcal to survival. Small delays in product release or in
achieving revenue milestones may be sufcient to cause failure of the
enterprise.
• There is limited access to further fnance if the business encounters
delays or undertakes operatons which require additonal funds.
• Early stage ventures typically have litle collateral to pledge for loans.
• Early stage ventures ofen have a high cash burn rate as they have yet to
reach a critcal mass where they are self-funding.
• Funding for acquisitons or expansion can be limited.
• Valuatons are problematc – if not speculatve. Shares are not readily
traded and so no public market value exists for the frm. Ofen there
is litle historical performance and future revenues and profts are
uncertain.
• Minority shareholders have litle power unless it is through an
investment agreement. Even if they disagree with management actons,
they have litle power and can’t sell their shares easily.
32
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
Angel investments are both risky and problematc. Since most new venture
entrepreneurs lack the business experience to antcipate many of the problems
they will encounter as the enterprise grows, the investment risk is generally
seen as considerably higher than a public corporaton.
Private equity investment is ofen referred to as ‘investng in securites
through a negotated process’. Unlike purchasing shares in a public company,
the investor in a private enterprise negotates the terms and conditons under
which the investment will be made. A defning characteristc of Angel investng
is that it is a ‘transformatonal, value-added, actve investment strategy’, in
which the investor expects to have a hands-on approach to their investments,
not possible in public company investments.
Entrepreneurs ofen seek out Angel investors to help them develop their
business. Apart from the funding they bring, an Angel would be expected to
contribute in one or more of the following ways:
• industry experience
• experience in start-up or business building
• networks
• experience in raising venture capital
• access to VC frms
• access to strategic partners.
There are diferent types of Angels. An Angel with direct experience in the
frm’s industry and with entrepreneurial experience can help with business
development, recruitment, sales, strategy, contacts and so on. Their expertse
and experience can be an invaluable help in developing the business. Ofen
cashed-up entrepreneurs with start-up experience will invest back into new
ventures. They can bring the experience of a successful venture through its
growth stages. However, they may not have experience in the industry in which
the frm operates. Wealthy and/or retred corporate executves ofen make
investments in new ventures within their industry. They can assist with customer
introductons, recruitment and risk assessment. However, many Angels are
simply wealthy individuals with a desire to invest in the private sector and their
only real contributon is fnance.
33
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
The new venture entrepreneur may fnd Angel investment very useful as a
bridge to VC fnance. The Angel can provide much needed fnance as well as
assist in developing the business further to prove the business model.
One Canadian study showed that 57% of frms with Angel fnancing
subsequently obtained VC funding.
Source: htp://www.smartlink.net.au/library/riding/1 Accessed 31/12/04
However, Scot A. Shane in his book ‘Fools Gold?: the truth behind angel
investng in America’ disputes this as a general relatonship and indicates that
the probability of follow on VC is signifcantly lower.
So what does the typical Angel look like? There have been a number of studies
of Angels across several countries; however, because Angels typically stay out
of the public eye and are ofen retcent to speak of their investng experience,
data has been difcult to collect and therefore the samples have been relatvely
small. Even so, the fndings are relatvely consistent across several studies.
The Center for Venture Research at the University of New Hampshire
has created a profle of the ‘typical (USA) Angel investor’. The predominant
characteristcs are:
• Angels tend to invest close to their home base, usually no further than a
half-day’s drive.
• Individual Angels rarely invest more than a few hundred thousand
dollars in total.
• Angel investors tend to be older, wealthier and beter educated than the
average citzen, yet a large number are not millionaires.
• Angels antcipate an average annual return of 26% on their investments.
• Angels expect that up to one third of their investments will fail, resultng
in signifcant capital losses.
• Angel investors reject seven out of every 10 deals that cross their desks.
• Deals are rejected for a variety of reasons, including poor growth
potental, overpriced equity and inexperienced management team.
Source: htp://wsbe.unh.edu/cvr/cap_locator.cfm Accessed 21/01/06
34
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
In their book Angel Capital, Benjamin and Margulis describe the typical USA
Angel as follows:
• 46-65 years of age, male
• postgraduate degree, ofen technical
Example
‘The private nature of Angel funding means that much informaton about
actvity in Australia is anecdotal.
It appears that most investors are worth upwards of A$10 million, ofen have
an entrepreneurial background and take stakes of between A$250,000 and
A$4 million. Equity investment generally concerns small or medium sized
enterprises (SMEs).
Some Angels also provide loan fnance, independently or as part of packages
from lending insttutons.
Some government and industry studies suggest that the size of the local Angel
market is 35% to 50% of VC investng, signifcantly lower than that of Canada,
the US and UK where Angel investng is greater than the total of formal venture
capital funding.
Investment criteria appear to be similar to those of VC funds (e.g. rate of return,
cash fow, capital growth and tme to exit). Most Angels, in contrast to VC fund
managers, appear to be averse to publicity – one reason may be wariness about
approaches by entrepreneurs – and limited requirements for public disclosure
of investments means that informaton about the sector is problematc. They
appear to be biased towards early stage and start-up enterprises rather than
funding expansion capital or management buyouts.’
Source: htp://www.caslon.com.au/ecapitalguide3.htm Accessed 25/10/03
An overview of the Australian Angel investment environment is provided
below:
35
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
• previous management experience, started up, operates or has sold a
successful business
• invests between US$25,000 and US$1 million per transacton
• prefers partcipaton with other fnancially sophistcated individuals
• strong preference for transactons which match with technical expertse
• 23% prefer to invest close to home
• maintains an actve professional relatonship with portolio investments
• invests in one or two transactons per year
• diversifcaton and tax shelter income are not the most important
objectves
• term for holding investment is eight years
• looks for rates of return from 22% to 50%: minimum portolio return
20%
• learns of investment opportunites primarily from friends and trusted
associates; however, majority would like to look at more investment
opportunites than present informal referral system permits
• income is US$100,000 per year minimum
• self-made millionaire.
By contrast, a study by Professor Kevin Hindle and Robert Wenban of
Australian Angels found that: there were two dominant groups – those with
university educaton and those without, they were slightly younger than their
American equivalents, invested less per transacton and were mostly ‘general
managers’ or ‘people managers’ by background, although most had been
involved in several start-up ventures. They typically invested 10-14% of their
net worth in new ventures, although one quarter invested over 25% of their net
worth. They were investng in about one third of proposals considered.
Source: Kevin Hindle and Robert Wenban, 1999, Australia’s informal venture
capitalist: an exploratory profle, Venture Capital, p199, Vol. 1. No. 2
Motvaton for investng varies slightly among the countries for which survey
data is available. Benjamin and Margulis, in their book Angel Capital, provide
the following reasons:
36
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
• improve self-image, self-esteem and recogniton, ‘you never know how
much you know untl a small company turns to you’
• alleviate concerns – help others
• obligaton to give back, the ‘joy of giving’
• get ‘frst crack’ at next high-rise stock prior to IPO
• habit, addicted to high-risk ‘rush’
• fun and excitng
• ROI 30% minimum
• desire to take charge of the stock selecton process more directly.
It may be that their sample has more hi-tech Silicon Valley entrepreneurs
and thus is not representatve of Angels in other countries.
Data from Scotland shows similar reasons for becoming a Business Angel.
Reason Main Main Other Other
reason reason reasons reasons
number % number %
To give something back 11 7.9 49 35
For capital growth 64 45.7 46 32.9
For income 12 8.6 28 20
To create a full-tme job for myself 8 5.7 13 9.3
For tax advantages 2 1.4 36 25.7
To give myself a part-tme interest 18 12.9 55 39.3
Enjoyment and satsfacton 13 9.3 77 55.0
Other 4 2.9 4 2.9
Unidentfed 8 5.75 – –
Total 140 100 – –
Source: Stuart Paul, Geof Whitam and Jim B Johnston, 2003, The operaton of
informal venture capital market in Scotland, Venture Capital, October, Vol. 5. No. 4
37
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
In contrast, Australian Angels appear to have a greater focus on the
investment returns.
The amount of net worth invested in private equity by Angels varies
considerably and appears to be somewhat based on the total worth of the
individual as well as their prior background. Estmates vary from 5-50% of net
worth with the average difering across countries. For example, one German
study reported the average to be 20%.
Amounts invested by Angels tend to vary from country to country. Individual
investments tend to be somewhat larger than where Angels act in a group to
co-invest. The majority of Angel investments are co-investment situatons.
Co-investments by Business Angels:
Co-investor Investments in Investments in
technology-based non-technology
frms based frms
No. % No. %
None 5 10.6 24 29.6
Other Business Angels in 9 19.1 20 24.7
the same syndicate
Other Business Angels who 11 23.4 16 19.8
invested independently
Venture capital funds 6 12.8 7 8.6
Banks 1 2.1 8 9.9
Public sector 0 – 3 3.7
Multple (Two or more of the above) 15 31.9 3 3.7
Total 47 100 81 100
Source: Colin Mason and Richard T Harrison, 2004, Does investng in
technology-based frms involve higher risk? An exploratory study of the performance of
technology and non-technology investments by business angels, Venture Capital, October 2004,
Vol. 6. No. 4
38
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
In a Scotsh study, 38% of Angels had an SME background while 60% had no
SME experience. Similar studies have been undertaken in Australia, Germany
and Singapore. While the distributon of responses is not identcal for each
country, the results are not markedly diferent.
Rates of investment compared to deals screened seem to be comparable
across several western countries. A German study reported an investment
rate of one or two out of every nine investgated. Investments take generally
between 20 to 90 days from inital contact and involve, generally three to six
negotaton sessions.
Research in the USA suggests that Angels invest in about 10 tmes the number
of companies as the VC frms but the total amount of investment by dollar value
is somewhat similar. The most recent estmate (2002) is 400,000 actve Angels
in the USA investng US$30-40 billion in 50,000 early stage ventures.
‘Through 2001, the 220 members of Tech Coast Angels (Los Angeles, Orange
and San Diego Countes) made approximately 800 investments in 52 companies
totalling US$40 million in 81 rounds of investments. The average investment is
just over US$40,000 and 95% of the individual investments have been in the
range of US$20,000 to US$100,000. Fify per cent of the investment rounds
totalled US$500,000 or less.’
Source: William H Payne and Mathew J Macarty, 2002, The anatomy of an
angel investng network: Tech Coast Angels, Venture Capital, Vol. 4, No. 4
Returns on investment and exit paths tend to vary from country to country,
possibly depending on the state of the economy at the tme of the research,
the availability of a robust secondary public listng market and the type and
availability of potental deals.
A USA study published in 2002 showed that a quarter of the Angel investments
were achieving beter than a 50% rate of return and generally exitng the
investment through a trade sale.
Source: Jefrey Sohl, 2003, The private equity market in the USA:
lessons from volatlity, Venture Capital, Vol. 5 Issue 1, p 29.
39
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
Investment Investments in Investments in
returns IRR technology-based frms non-technology based frms
No. % No. %
Loss 17 36.2 34 42.0
Break-even (0-9) 11 23.4 17 21.0
20-49 6 12.8 13 16.0
50-99 7 14.9 10 12.3
100 and over 6 12.8 7 8.6
Total 47 100 81 100
Source: Colin Mason and Richard T Harrison, 2004, Does investng in technology-based
frms involve higher risk? An exploratory study of the performance of technology and
non-technology investments by business angels, Venture Capital, October 2004, Vol. 6. No. 4
Angel investor exits by the Tech Coast Angels, 1997-2001
Actvity Number
Investments 52
Operatng independently 32
Exits 20
• Out of business (–1X) • 10
• Partal return of capital ( 0 to – 9X) • 5
• Sale to private companies (exit pending) • 3
• IPO (2X – 3X) • 1
• Sale to public company (+120X) • 1
Source: William H Payne and Mathew J Macarty, 2002, The anatomy of an
angel investng network: Tech Coast Angels, Venture Capital, Vol. 4. No. 4
‘This paper provides the frst atempt to analyse the returns to informal
venture capital investment using data on 128 exited investments from a survey
of 127 Business Angel investors in the UK. The paper fnds that the distributon
40
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
of returns is highly skewed, with 34% of exits at a total loss, 13% at a partal loss
or break-even, but with 23% showing an IRR of 50% or above. Trade sales are
the main way in which Business Angels harvest their investments. The median
tme to exit for successful investments was four years. Large investments, large
deal sizes involving multple co-investors, and management buyouts (MBOs)
were most likely to be high-performing investments.’
Source: Colin M Mason and Richard T Harrison, 2002, Is it worth it? The rates of return
from informal venture capital investments, Journal of Business Venturing, Vol. 17. No. 3.
Exit routes for technology and non-technology investments
Exit route Investments in Investments in
technology-based non-technology
based frms
No. % No. %
Flotaton 6 14.3 3 3.9
Trade Sale 12 28.6 19 24.7
Sale of shares to existng shareholders 3 7.1 16 20.8
Sale of shares to third party 6 14.3 6 7.8
Writen of/shares have no value 15 35.7 32 41.6
Asset break-up 0 – 1 1.3
Total 42 100 77 100
Source: Colin Mason and Richard T Harrison, 2004, Does investng in technology-based
frms involve higher risk? An exploratory study of the performance of technology and
non-technology investments by business angels, Venture Capital, October 2004, Vol. 6. No. 4
‘On the average, 60 - 65% of these investments break even
or represent a partal or total loss. So a substantal porton, 6 out of
10, even afer metculous due diligence, result in no fnancial return
or in returns below that of a bank deposit account. Approximately
20% of these investments, based on our research, provide a two
to fve tmes multple on the investment. About 8-9% provide between 5 and
41
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
10 tmes the investment, and about 7 tmes out of 100, about 6.9%, we see a
return of 10 tmes or more the investment made.’
Source: htp://www.icrnet.com/faq/home.html#q17 Accessed 22/01/06
Angel Capital Educaton Foundaton reported that, for the 539 Angels
surveyed across 86 Angel Groups they reviewed in 2007, the average return on
the 1,130 exits of that year was 27%. (www.angelcapitaleducaton.org)
When they do invest, Angels will stpulate similar conditons to their
investments as VCs. Typically they will require:
• a positon on the Board of Directors
• remuneraton for their tme spent on the business
• veto power over the issue of new shares
• adjustment of the number of shares issued to the investor if milestones
are missed and/or a lower valuaton is set in a subsequent round of
investment
• veto power over further long-term debt
• approval rights over executve remuneraton
• approval rights over issue of optons
• the right to put the business up for sale if certain milestones are not
achieved
• the right to replace the CEO if certain milestones are not achieved.
Angels are normally actve ‘hands-on’ investors. They expect and ofen enjoy
being directly involved in the management of the venture. In fact, this is ofen
one of their prime reasons for investng. They typically spend tme with each of
their investments on a regular basis.
A study of Angel investors in Germany showed that Angels typically spent 6.2
days per month on their investments, averaging 1.34 days per month on each
investment, with the most tme being spent on their most recent investees.
More actve investments might involve a day per week.
Source: Malte Bretel, 2003, Business Angels in Germany:
a research note, Venture Capital, July 2003, Vol. 5. No. 3
42
Chapter 3: Angel Investor Finance
Raising Angel & Venture Capital Finance
Angel investors play a very important role in developing early stage ventures.
It is their combinaton of funding and mentoring that makes their contributon
so advantageous to a fedgling business. Certainly, without Angel help, many
early stage businesses would founder. Even though many fail, at least half grow
into more substantal businesses providing essental job and wealth creaton.
There are many sites ofering informaton on Angel fnance in the USA and
several directories of Angels and Angel Networks. One site ofers access to more
than 20,000 Angels (see www.vfnance.com). The Angel Capital Associaton has
an extensive list of Angel Networks.
For some background to Angel investng in the United States of America see
Note on Angel Investng – Prepared by Michael Horvath and Fred Wainwright,
Center for Private Equity and Entrepreneurship, Tuck School of Business at
Dartmouth University 01/05.
Source: htp://www.empea.net/peindustry/research.aspx Accessed 11/12/05
The UK Natonal Business Angels Network (NBAN) estmates that there are
currently 18,000 Business Angels in the UK investng roughly £500 million into
3,500 businesses every year. Informaton on Angels and Angel Networks within
the UK can be found through the Britsh Business Angels Associaton (BBAA)
which is the Natonal Trade Associaton for the UK’s Business Angel Network.
Source: htp://www.bbaa.org.uk/portal/content/view/12/50/ Accessed 11/12/05
In Australia, Angel Networks are listed on the website of the Australian Venture
Capital Associaton (see www.avcal.com.au). Australia has an associaton of
Angel groups called the Australian Associaton of Angel Investors (www.aaai.
com.au) where you can fnd details of Angel Groups.
A recent report on Australian Angels enttled “Study of Business Angel Market
in Australia’ by Professor Michael Vitale, Belinda Everingham and Richard
Butler (November 2006) is available at:
http://www.ausicom.com/filelib/PDF/ResearchLibrary/Business_Angel_
Report.pdf
43
Raising Angel & Venture Capital Finance
T
here are basically two types of ventures which atract Angel or VC
investment. These ventures create a return to the investor through their
exit event. Financial ventures create value on exit via a fnancial trade sale or an
IPO by assigning a value to the future proft generatng power of the entty being
sold. Alternatvely, a strategic venture creates exit value, not on the basis of what
proft it could inherently generate, but on the basis of what future proft could
be generated by the buyer exploitng the underlying assets or capabilites of the
entty being acquired. These are fundamentally diferent types of businesses
and the Angel or VC investor has to ensure that the business development
process and the exit preparaton align with the appropriate exit.
In order to assess the potental exit value of any entty, we must frst
understand how the business creates value for its buyer (fnancial or strategic
sale) or its future public shareholders (IPO). Those businesses which deliver
inherent proftability must create value for its future owners through enhanced
proftability and future proft growth. By contrast, strategic value businesses
create value by enabling a large corporaton, the strategic buyer, to exploit a
signifcant revenue opportunity enabled through the combinaton of the two
companies. The strategic seller builds value by developing strategic assets and
capabilites which a large company will exploit.
4
Strategic v.s Financial
Ventures
44
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
In the case of a strategic sale, it may not mater whether the selling business
is making a proft, has revenue or is growing. This is in direct contrast to a
fnancial exit which is entrely based on revenue and proft growth which the
business itself must deliver to its new owners.
Because these outcomes are very diferent, the manner in which the Angel
and VC investors will evaluate the investment and then should plan the exit
for their investee business depends greatly on which type of exit is most
appropriate.
I have grouped fnancial trade sale and IPO under the fnancial exit as they
both have the same basic value creatng process, they both need to generate
a future stream of positve earnings to create a successful exit event. The IPO
exit is an extreme situaton of a fnancial venture where the projected revenue
levels and the projected market capitalizaton is very high. While the IPO exit
requires a more sophistcated organizaton to be successful, the fact is that
both the fnancial sale and the IPO require a proven, high growth potental
business concept to generate a successful exit value.
Smaller frms and frms with limited growth potental which create value
through projected net earnings need to be directed towards a fnancial trade
sale as they will not be able to meet the rather high threshold of revenue
and potental growth requirements needed for a successful IPO. Given that
only a very small percentage of frms are able to achieve IPO status, the vast
majority of frms need to be prepared for a fnancial sale. For the purposes of
this discussion, I am going to refer to all fnancial exits as a ‘fnancial sale’ with
the understanding that some exceptonal frms will be able to achieve an IPO.
Also, for the purposes of this discussion, I am going to assume that all fnancial
exits will be to an individual or corporaton, that is a ‘fnancial buyer’, and that
the buyer is setng the purchase price based on the antcipated future stream
of earnings from the acquired frm alone. That is, the buyer is not assigning
any synergy or beneft to the acquisiton based on what is happening, or could
happen, in the rest of the buyer’s organizaton.
The fnancial sale is very diferent from a strategic sale where value is
created through the combinaton of the buyer and seller businesses. We
have all heard of businesses which were sold for many tmes revenue and
45
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
staggering multples of proft. These situatons are all cases where the business
being acquired had something which the large corporaton needed to counter
a major threat or to chase afer a major new revenue opportunity. Most of
these acquired businesses had unique intellectual property, deep expertse or
well established brands or rights (e.g. to exploit forests, minerals, fshing etc).
The assets or capabilites being acquired were considered by the buyer to be
too expensive to copy, build or develop, or would take the buyer too long to
assemble or to create internally. The delay in acquiring the asset or capability
may also expose the acquiring corporaton to an unacceptable level of risk.
In a strategic acquisiton, a small business can ofen provide the means by
which a large corporaton can quickly generate many tmes the purchase price
by leveraging its own assets and capabilites alongside those being acquired.
Such acquisitons are bought, not on the basis of the profts of the acquired
business, but on the value which can be generated within the combined entty.
Few acquisitons, however, ft this profle. I will use the terms ‘strategic sale’ and
‘strategic buyer’ to describe a situaton where a business is sold on the basis of
its strategic value to the acquirer.
Businesses which are typically sold to a strategic buyer are those in
biotechnology, informaton technology, research and development, designer
fashions, mineral exploraton, agricultural science, computer hardware and
telecommunicatons. Also companies in consumer packaged goods with strong
brands or with manufactured products which have global market potental can
ofen secure signifcant premiums on sale. Acquisitons which can deliver very
signifcant synergies in operatng costs through integraton would also ft into
this category.
Probably about 95% of all private businesses which are sold are acquired
by a fnancial buyer. In some, there will be synergies in the acquisiton but
these will be minimal and not sufcient to override the need for the acquired
business to show its inherent proftability. Most companies don’t have the type
of assets or capabilites to leverage large scale opportunites for an acquirer.
Instead, they build profts through their own inherent compettve advantages
for a local customer base.
46
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
A fnancial buyer seeking an acquisiton will ofen have many choices of
similar businesses, although sometmes geographically separate. The buyer
may be buying a business to own and manage or a corporaton undertaking a
consolidaton strategy by acquiring many businesses of a similar type. What the
fnancial buyer is acquiring is a proft stream and so the basis of the purchase is
simply how much proft the frm makes now and is likely to make in the future.
Purchase value is calculated almost purely on the inherent proftability of the
acquisiton with litle regard to the combinaton synergies in the acquisiton.
The seller to a fnancial buyer must put efort into increasing proft and proft
potental.
Businesses which would normally be sold to a fnancial buyer are professional
services frms, marketng frms, management consultancies, distributon
companies, trucking companies, most retail businesses, wholesalers, import/
export companies, agricultural enterprises, printers, professional practces,
builders, constructon companies and so on. Non complex manufacturing also
atracts a high proporton of fnancial buyers. Basically any business which does
the same as many other businesses will fall into this group.
Businesses acquired to be operated as a stand alone business will be purchased
on the basis of their inherent proftability as there are no synergistc benefts
in the deal for the acquirer. Therefore, a business bought by an individual who
wants to invest retrement or redundancy funds to buy a business to manage
will be a fnancial sale. Similarly, a business purchased by a private equity fund
which intends to increase its proftability through new management, increasing
its debt level and refocusing the business will also be a fnancial sale.
Businesses acquired by corporatons can be expected to have both fnancial
and strategic contributons. Many acquisitons are undertaken for roll-up,
consolidaton or expansion purposes. These businesses typically are purchased
to add revenue and proft generaton through their own inherent operatons
although the acquirer may gain some synergistc benefts from operatng at
a larger scale or some benefts through reducing duplicate functons, but the
prime consideraton is generatng operatng proft from the business purchased.
The purchase price would be driven by the current and potental proft of the
acquired business itself. While the additonal synergies may make it more
atractve, the seller would need to prepare the business for a fnancial buyer.
47
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Acquired businesses which are expected to contribute signifcant synergistc
benefts to the acquiring corporaton may contribute litle inherent proft. They
are acquired because of the benefts which the acquiring corporaton expects
to achieve through the combinaton of the businesses. In most cases, these
acquired businesses bring some asset or capability to the acquirer which the
corporaton is able to leverage through their own operatons thereby generatng
signifcant future revenue and profts for the acquirer. A seller who was able to
make such a contributon would seek out a strategic buyer.
Some frms will be able to do both. That is, they will have good proft
capabilites and also be able to provide strategic benefts to the acquirer. But
one will be more signifcant than the other. To the extent that strategic value
benefts are greater than inherent proftability benefts, the seller would be
much beter of seeking a strategic buyer. Financial sales are always going to be
limited by the proft generatng capability of the seller. A strategic sale, however,
is only limited by the size of the opportunity generated within the acquiring
corporaton. Thus, a very large corporaton that can signifcantly leverage the
strategic contributon of a small acquisiton may be prepared to pay many tmes
its fnancial sale value to ensure it receives the benefts of the acquisiton rather
than allow it to be acquired by one of its compettors.
I have extensively examined the process of a fnancial trade sale and have
documented a methodology in my book, The Ultmate Deal 1, which can be
used by business owners to signifcantly improve their sale value.
My book, The Ultmate Deal 2, examines strategies which owners of businesses
with strategic value will use to sell their businesses to a strategic buyer. Angels
and VC investors who wish to examine the strategic sale preparaton process in
greater detail should also read my e-book ‘Invest to Exit’.
48
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Financial v.s Strategic Buyer Strategies
Attribute
Strategic Buyer
Financial Buyer
Source of value
to the buyer
Proftability, risk
minimizaton, growth
potental.
Threat eliminaton and/
or revenue potental in
the combinaton of the
two businesses.
Value created by Increasing profts,
reducing risk, future
growth and proven
growth potental, roll-
up or consolidaton
opportunites.
Underlying assets and
capabilites which the
buyer will leverage to
eliminate a threat or
exploit a large revenue
opportunity.
Additonal value
created by
Increasing current
profts, increasing
growth rate,
developing additonal
substantated growth
potental.
Reducing integraton
tme, increasing rate of
scalability and speed
of exploitaton, adding
additonal strategic
assets and capabilites
for the buyer to exploit.
Individual, investment
trust, private equity
frm, corporaton
undertaking a roll-up or
consolidaton strategy.
Large corporaton which
can exploit the strategic
assets and/or capabilites
in a large customer base.
Buyer
Financial or Strategic Sale – Which One?
I ofen confront entrepreneurs with existng investments with a stark choice
– what is the best strategy to prepare your business for a sale – build up the
profts or develop underlying assets and capabilites for a strategic sale. You
might well ask ‘Why can’t you do both?”.
49
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Attribute
Strategic Buyer
Financial Buyer
Impact of
increased
proftability
Major impact on value. May be irrelevant. Profts
are only needed to
ensure survival prior to a
sale.
Size Any size.
Large acquisitons
may have difculty
creatng sufcient new
incremental revenue.
Existng growth Signifcant impact on
value.
Size must be sufcient
to allow a critcal mass
platorm for opportunity
exploitaton. Growth
itself may not be
important.
Growth
potental
Signifcant impact on
value.
May have no impact on
the buyer’s opportunity.
Underlying
assets and
capabilites
Must deliver
compettve advantage
within the seller’s
business as a stand
alone entty.
Must deliver a
sufciently large and
robust base for exploitng
a strategic opportunity
in the combinaton of
businesses.
Inherent risks Must be eliminated
wherever possible.
Must be eliminated
wherever possible.
Succession
planning
New buyer must
be able to run the
business if the senior
management leave.
Key manager and key
employees needed to
exploit the opportunity
must be retained.
50
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
Attribute
Strategic Buyer
Financial Buyer
Advisors Business broker,
professional services
frm, business advisor
Large professional
services frm, investment
banker.
Preparaton tme
18 months to 2 years Normally 2 years or more.
Level of
integraton
Most ofen contnues as
a sole business or might
be loosely integrated
bolt on acquisiton.
May contribute
administratve
synergies in a
consolidaton.
Varies. Ofen fully
absorbed. Sometmes
integrated into only one
part of the business.
Could be lef as a stand
alone entty passing
products, IP or processes
to group.
I am sure that some companies can do both, but when they look at the
processes involved and the priorites which will determine where to use their
surplus cash, you ofen see a clear choice – they don’t have the resources to
do both so they need to decide which strategy is going to give the highest exit
price.
There is sometmes the possibility that a single venture can throw of more
than one exit. This can happen where the frm has developed IP across multple
markets or solves quite diferent problems. It may be worth separatng the
diferent IP into distnct ventures and preparing each for an exit.
Another possibility is that a single venture may have quite diferent actvites
each of which could be directed towards their own sale, perhaps with some being
fnancial sales and others being strategic sales. This can happen, for example,
where IP is the basis of a sales transacton of a product but is then followed by
maintenance or service sales. The IP may appeal to a global corporaton but
they may have no interest in the local services business. In such a case, it may
51
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
be worthwhile splitng the business and selling the diferent parts to diferent
buyers.
Companies which are sold as a fnancial sale are those which provide the
buyer with a platorm which enables the buyer to generate a stream of future
earnings through the use of the resources contained within the acquired
business. While these might be augmented by the buyer through the inserton
of beter processes, more capable management and beter funding, essentally
it is the same underlying business which is generatng the proft stream. Thus
any acquisiton valuaton will be based on the net present value of those future
earnings. Most businesses fall into this category. Financial buyers typically buy
retail, wholesale, light manufacturing, transport, property and services based
businesses.
You increase the value of such businesses by reducing the inherent risks for
the buyer, improving the visibility and reliability of future earnings forecasts,
improving on-going proftability, building growth into the business and fnding
ways to create growth potental for the buyer.
By contrast, those businesses which appeal to strategic buyers have some
underlying assets or capabilites which a large corporaton can exploit through
the buyer’s own organizaton. Small companies will ofen develop products or
services which can be sold by the acquirer through their very large distributon
channels. In the right circumstances, a buyer might be able to scale the revenue
by 50 to 100 tmes that of the seller just by having the right access to global
customers. The key to a strategic sale is to fnd a large corporaton which can
exploit the underlying asset or capability of the seller to generate very large
revenues. In these situatons the size, revenue, number of customers or
employees or level of profts of the seller may be entrely irrelevant. It is the
size of the revenue opportunity of the buyer which is the key to strategic value.
A business which has the right type of assets or capabilites which can
generate strategic value may be much beter of putng additonal efort into
developing those assets and capabilites to provide greater or earlier revenue
generatng power for the intended buyer. A higher exit price will be achieved if
the buyer can scale or replicate the asset or capability faster and can integrate
the seller’s business quicker. The only size consideraton for the seller is to be
52
Chapter 4: Strategic v.s Financial Ventures
Raising Angel & Venture Capital Finance
big enough to provide the launch platorm for the buyer to fully and quickly
exploit the strategic value.
Entrepreneurs need to be sensitve to these two types of ventures as it
directly impacts the evaluaton of the venture for Angel and VC investment and
directly impacts on the manner in which the business would be developed for
an exit.
53
Raising Angel & Venture Capital Finance
B
usiness advisors ofen talk about a compelling business concept and
encourage entrepreneurs to create a venture which has high growth
potental. They then assist the entrepreneur to build a business plan around the
compelling business concept so that the entrepreneur can seek out investors
to help them realize the business potental. However, what they have missed
in all this work is that the Angel and VC investor is not that interested in the
business, the product, market or what customers think of the product or service
being developed or sold. What they really want to hear about is a ‘compelling
investment opportunity’. They want to be convinced that their investment funds
will be used to create a successful exit event so that they achieve a great return
on their investment. Their interest starts and ends with how the entrepreneur
is going to make them money not produce the world’s best widget.
The investor will approach the investment opportunity with a set of
assumptons as to how the business will be developed and how the exit will
be achieved. Almost without excepton, those assumptons will include the
following:
• The business is almost certainly going to be sold within 3-7 years.
Outside a boom market, very few frms make it to an IPO.
5
A Compelling
Investment Opportunity
54
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
• The entrepreneur and most of the equity holding management team are
unlikely to stay with the business once it is sold to a corporate buyer.
• The investor, in most cases, will not be involved in the day-to-day
operaton of the business but will play a mentoring and strategic role.
• The investor can be expected to provide specifc help in an aspect of the
business where they have deep personal experience.
• A primary actvity of the investor will be to ensure the business
implements formal operatonal management systems and good
governance processes.
• The investor will most likely hold at least one Board seat.
• The valuaton of the business at the tme of the inital investment has to
take into account the risks associated with the investment and therefore
is likely to be much lower than the entrepreneur thinks the business is
worth.
One of the evaluaton issues facing the investor is whether the business will
have a fnancial or strategic exit. Clearly, the fnancial venture must be able to
prove out an entre business model and be able to convincingly demonstrate a
capability to produce signifcant growth in revenue and proft. This is in contrast
to a strategic venture which must simply show that it is an ideal acquisiton for
a large corporaton. While there are a number of atributes which both these
ventures must demonstrate, the hurdle for the fnancial business is signifcantly
higher.
For a fnancial investment to have a serious chance of being successful,
resultng in an IPO or fnancial trade sale, it needs to show that it can demonstrate
the potental to achieve the revenue and proft levels to provide a good return
on the investment. In order to do so it is almost certainly going to have to satsfy
some basic high growth potental criteria. These include the following;
• Clearly identfable and reachable customer with a compelling need.
• An emerging and growing market with signifcant global potental which
is fragmented and where demand exceeds supply.
• A business model with sufcient barriers to entry to protect the business
over the frst few years.
55
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
• A growth strategy which can achieve the levels of revenue and proft
within 3-7 years to easily sustain the ROI needed by the Investor.
• A proven product or service which has clear customer acceptance.
• A management team which can demonstrate they have the skills and
experience to execute the growth strategy over the next several years in
conjuncton with assistance from the Investor.
• A set of shareholders and a management team willing to sell the
business within 3-7 years and walk away if necessary.
• A robust exit strategy with a high probability of executon within 3-7
years.
• A well-defned plan for the use of the investment funds which is directly
linked to clear and measurable targets which in turn support the exit
strategy.
• A robust business strategy and cash fow which can cope with things
going wrong and can stll, in the worst case, return the inital investment
to the investor.
• A team willing to negotate a realistc valuaton.
For a strategic investment to be successful it must be able to show a highly
probable exit through a strategic trade sale. In the assessment of a strategic
venture, the business needs to demonstrate the potental to achieve the strategic
sale. This means the business should display the following characteristcs;
• Clearly identfable and reachable customer with a compelling need.
• An emerging and growing market with signifcant global potental which
is fragmented and where demand exceeds supply or an established
market which would rapidly absorb the frm’s product or service.
• A product or service with sufcient barriers to entry to protect the
business over the frst few years.
• A level of scalability or replicaton in the product or service which can
generate signifcant new revenue for the strategic buyer in the frst few
years afer the trade sale.
• A proven product or service which has clear customer acceptance.
56
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
• A management team which can demonstrate that they have the skills
and experience to execute the strategic trade sale over the next several
years in conjuncton with assistance from the Investor.
• A well-defned plan for the use of the investment funds, which is directly
linked to clear and measurable targets which in turn support the exit
strategy.
• A robust business strategy and cash fow which can cope with things
going wrong and can stll, in the worst case, return the inital investment
to the investor.
• A set of shareholders and a management team willing to sell the
business within 3-7 years and walk away if necessary.
• A team willing to negotate a realistc valuaton.
You might argue that it is near impossible to fnd an early stage venture that
meets either of these sets of criteria. Your proposal to the investor should be
able to demonstrate that you can satsfy one of these business models. You
need to convince them that you and your management team can take them to
a successful exit.
Angels and VC investors generally invest where they can see that the venture
can be developed over a few years to the point where it can be sold to a corporate
buyer or taken to an IPO. Your task as the entrepreneur seeking investment
funds is to convince the investor that, with their funds and assistance, you can
develop the business to achieve the desired exit.
Your investment proposal will need to show that you understand what the
investor wants in an investment opportunity and that you have a business
venture which will satsfy their objectves. In setng out your business venture
you will need to examine a number of areas of the business to show that you
can meet their investment criteria.
The market analysis
There are many marketng texts that you can read which talk about market
segmentaton, customer buying paterns, pricing models and so on. Most likely
the Investor will have read those and so understands the jargon. The key to
57
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
an investable business is more about the executon of a business plan over a
limited period of tme to achieve the exit conditons. This might be a stated level
of revenue and proft, rather than developing a sophistcated marketng plan for
market dominaton. Alternatvely, it might be in preparing a product or service
for a strategic buyer’s market. If the life of the venture is to be 3-7 years before
an exit, then very specifc targets need to be achieved.
Whether it is the target market of the venture or the target market of the
strategic buyer, it can be expected to have the same fundamental atributes.
The target market defniton needs to be very simple, robust, obvious and easily
proven. The ideal model is characterized by the following:
• Well-defned, identfable and easily reachable customers who have a
high compelling need to buy, a willingness and ability to pay the price
and are in sufcient numbers that the revenue targets can be readily
achieved.
• A segmented market where it is possible to signifcantly diferentate the
product or service from compettors and where that diferentaton is
difcult to copy or neutralise.
A fnancial venture would also need to be able to demonstrate the following:
• A total market which is growing, has global potental and would be
atractve in the long-term to a major corporaton.
• A fragmented market which enables growth by acquisiton.
The customer
The beter business to be in is where the business has a list of all possible
customers for the product or service. Alternatvely, the customer can be readily
reached through an established, or readily built, distributon channel. The
investment proposal should be explaining:
• the profle of the ideal customer
• how contact will be established
• what their buying patern is
• how they have the purchasing power to readily meet the sales price.
58
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
You see businesses all the tme which reach out to the general public in the
hope that they will buy. A retail store, a restaurant and the internet marketng
frm are all hoping they can atract customers. But they have litle infuence over
the buying cycle. On the other hand, customers which can be clearly identfed,
named and are able to be approached with a value propositon are much easier
to sell to. This is not to say that other models are not successful, however, they
generally carry a greater risk.
The compelling need to buy
Few people understand just how hard it is to build a value propositon which
compels a customer to buy. Most products are chosen on a whim, can be readily
deferred or have many alternatves and substtutes.
Example
Distncton Sofware Inc. a business established in 1994 in Atlanta,
USA, by Dr. Tom McKaskill developed a sales forecastng and inventory
planning system for high volume, low cost consumer packaged goods.
Using prospect data the sofware could show a 15-30% reducton
in safety stock over a three month period providing an investment
payback of 3-6 months on the sofware cost. Even though many
corporatons expressed interest, few made the investment. Why?
Afer fve years it became apparent that only corporatons that
had deep-seated inventory problems were willing to make the
organisatonal and system changes to implement the sofware. For the
others, their proftability was high enough that the changes required
to implement the sofware were simply ‘too hard’. For the sofware to
work efectvely the customer needed to change job responsibilites,
reportng lines and data ownership. The ‘compelling need to buy’ only
existed in a few corporatons. For the others, it was a desirable, but
not necessary, thing to do.
59
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
Think about these questons:
What problem is the venture solving?
Is it satisfying a need or a desire?
What degree of compliance (penalty or cost) results from not buying?
What happens if the customer does not buy?
Are there alternatives to the frm’s product or service?
Who is required to solve the problem? What happens to them if they
don’t?
Market characteristics
Historically, most investors have preferred their investee companies to
operate in medium-sized global markets as this will ultmately atract the
corporate acquirer or will be the basis on which to launch an IPO. Investors
now are much more atuned to the need for an exit event and so for them, it is
not whether the market is small or huge, it is simply whether the target market
over the next 3-7 years can provide the frm with the capability to achieve the
valuaton required for the investor to exit. In the end, it all comes down to
valuaton on exit and ease of exit. The target market may be directly addressable
by the investee frm or could be the target market of a strategic buyer.
For a fnancial venture, a larger fragmented market where new products
and services can fnd a reasonable size niche market are preferred by investors
as this is easier to achieve than global dominaton or a share in a commodity
market. The frm has to demonstrate in its investment request that it can secure
the level of revenue and profts required to achieve the valuaton target. Even in
a very large market, a lack of customer demand for the specifc ofering of the
frm won’t make the target numbers.
60
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
For a strategic venture, it is whether the potental strategic buyer has an
existng market which can be readily addressed or a potental market which
they can exploit.
Basically the entrepreneur must establish, with a reasonable degree of
certainty, that the revenue, cash fow and proft targets of either the frm itself
or the intended buyer can be achieved. This requires a very good understanding
of the marketplace, an understanding of the needs of the customers and some
level of proof that customers will buy in the quanttes forecast. This might
be based on existng sales, prospect surveys or expert advice plus experience
within the executve team.
However, in order to show a probable exit path, the requirements of the exit
strategy need also to be shown. An IPO requires the company to confdently
build to, say, a $100 million valuaton within three years afer listng. Smaller
companies are not excluded from an IPO, in fact many companies smaller
than $100 million are successfully listed; however, they tend to miss out on
atractng insttutonal investors and in many cases do not atract broker
coverage, accordingly, they present a greater risk to maintain or increase values.
Furthermore, as the management team and the Investor usually have at least
part of their shareholding escrowed for a period of tme, the exit value may
ultmately be at prices below the inital listng price. For an IPO exit the frm
needs to confdently show that it can achieve the revenue, cash fow and proft
targets needed to support the share price over a 3-5 year period afer listng.
With an IPO exit, hopefully funding through the IPO and subsequent rounds of
public capital raising will fund growth. The business needs to have a very strong
product/market positon to fuel growth.
For a fnancial trade sale exit, the requirements for revenue and profts are
very diferent. The frm need only show that it can reach the level of revenue
and profts needed to close the trade sale deal. In the case of a strategic trade
sale, revenue and proft targets could be zero or limited, that is, the deal is
based on some other aspect of the business which needs to be achieved, such
as a product development stage. At other tmes, the acquiring corporaton may
want to see a limited number of customers actvely using the product as a proof
of design, marketng and operatonal use.
61
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
In many cases, corporatons enter into a strategic trade sale with an emerging
frm to acquire a product which has considerable global potental. In proposing
a trade sale exit strategy, the frm needs to convince the investor of the ultmate
size of the market which would atract the proposed buyers, whether they be
a fnancial or strategic buyer. Thus market size and compettve positoning
become important, not for the short term, but to secure the ultmate acquirer.
You should explain the structure of the industry and show an analysis of the
market dynamics to demonstrate the business or product potental.
Which companies are growing and why?
Which frms are declining and why?
Is this an emerging market where demand exceeds supply and thus
even poor businesses will survive?
Given the product positioning, which market is the frm attacking and
what retaliation, if any, can the frm expect from the current players?
Is this a market which will attract new entrants and, if so, how will the
frm defend its business from the new competition?
Competitive analysis
Angels and VC investors prefer their investee companies to sell products
or services which are diferentated from their compettors. They like to see
diferentaton based on some level of innovaton in product, process or business
concept. The innovaton itself needs to be difcult to match over the period of
tme needed to achieve the exit target.
If an IPO is planned, the product needs to be sufciently diferent to be able
to sustain a long-term compettve advantage. This is the only positon which
will allow the frm to achieve the revenue, cash fow and proft levels needed to
sustain the share price in the public market.
62
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
In a fnancial trade sale, the frm has to be able to demonstrate revenue
growth into the medium term. Compettve advantage is going to be a key
aspect of the business case to the buyer.
For a strategic trade sale, compettve positon is not as important as being
the right product for an acquisiton. However, if you look beyond the acquisiton,
you have to deal with the compettve positon of the acquiring corporaton and
the subsequent merged operatons. This means the investment proposal needs
to show how the acquiring corporaton would use the frm’s products to secure
signifcant revenue. Although, this may be in combinaton with the acquirer’s
other products or by selling the frm’s products into their own customer base.
The compettve analysis needs to show very clearly why the frm’s products
are preferred in some market segments and to demonstrate reasonable proof
of that asserton.
Barriers to entry
Whatever the exit, the future generaton of revenue and proft will require the
frm to establish that its products or services which drive revenue generaton
and have a level of compettve advantage which itself has a signifcant degree
of sustainability. This implies a reasonably high level of barriers to entry.
There are two fundamental questons which the entrepreneur needs to
answer:
Why would customers buy our products or services?
What is to stop a competitor from taking the business away from us?
The frst queston should be supported in the proposal by the product value
propositon, a market analysis, a compettor analysis and the compelling need
to buy. ‘Why you?’ is also an issue of credibility. The frm or the strategic buyer
needs to be able to convince the target customer that they can trust it to deliver
and support the product. In the case of the investee frm, establishing the
product or service in the market may be achieved through the experience of
the team, from existng customer testmonials or through customer trials.
63
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
The second queston is simply about protectng the business from erosion
from existng or new compettors. What is to stop a much beter funded,
larger, more aggressive compettor from duplicatng what the frm has done
and ofering greater incentves for their prospects to buy from them? This gets
down to: how is the frm or the strategic buyer going to protect its business?
Protectng the business is achieved by erectng barriers to entry. What can
the frm or the strategic buyer put in place to protect its compettve advantage,
distributon channel, ongoing customer revenue and source of supply.
Barriers to entry have one, or several, of the following atributes:
• high start-up costs
• expensive to acquire
• takes a long tme to acquire
• protected by patent, trademark or copyright
• restricted under licence, rights or agreements
• requires specialised knowledge which itself is in limited supply
• highly innovatve and not capable of reverse engineering
• protected by ongoing customer revenue through high switching costs or
contracts
• ownership of or contracted distributon channel
• restricted or contracted source of supply.
Strong barriers to entry usually create the basis for a sustainable compettve
advantage. This is also the foundaton of any longer term growth strategy for a
public listng. A strategic buyer will need to be convinced that these conditons
can be established by it subsequent to the acquisiton.
The management team
The literature in the venture capital area is dominated by the quest for the
‘A team’. This is the super team. The ‘A team’ has done it all before and has
the skills, capabilites and diversity to cope with anything under any conditons.
Regretably they rarely exist and Angel and VC frms have to put up with business
plan presentatons from ordinary mortals.
64
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
However, that is not to say that their objectve is wrong. It is simply that
executves who have done it before have probably learnt from their successes
and failures. They are well connected in the industry and are knowledgeable of
other experienced executves and can easily recruit additonal team members.
For the Angel or VC investor, it is all about reducing risk. If they can invest in a
well-rounded team with experience, they have a greater chance of achieving
their minimum targets.
The ‘A team’ also brings with them the following:
• a knowledge of Angel and VC investment requirements
• willingness to negotate a realistc valuaton
• experience with an exit
• not as emotonally atached to the ‘product’
• networks within the industry and with potental alliance partners.
For the Investor, members of an experienced management team are easier
to deal with and have a good understanding of the funding process.
Although the venture capital market has been operatng in Australia and
New Zealand for more than 20 years on a formal basis, there are stll very
few experienced management teams which have gone through a formal
private equity investment and exit cycle more than once, unlike the US and
European markets which have foatng management teams which move from
one investment with an Angel or VC frm through to an exit and on to another
investment.
Many of the deals brought to the Angel or VC frm for funding simply lack
an experienced set of executves. There can be no queston the entrepreneur
brings the idea, the passion, the vision and the energy, but other team members
usually make it work.
When the investor looks over the business plan, they are working on the
actvites which need to be executed to deliver the critcal targets. This might
be sales, marketng, product development, quality control and so on. For
each of these actvites, they want to know who on the team will deliver this
operatonally.
65
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
The real test to be applied here is operatonal. Given where the business is
today, can the team execute, with reasonable confdence, the actvites needed
to get them to the exit conditons within the 3-7 year period? In some cases the
investor will be making a judgement as to their own impact on the ability of the
frm to achieve such results. So the fundamental queston which the investor
has about the management team is: ‘Can the team and I together achieve the
targets needed to exit?’
For most exits, this will be a trade sale and the management team may not
be needed beyond that. Not all proposals need the 20-year veteran or the
executves recently cashed out from their IPO. In fact, this may be the wrong
team for a clearly defned trade sale exit.
The business propositon also needs to show who is going to deliver on each
of the major actvites needed to reach the exit conditons. Any weakness in the
team will need to be addressed by the investor. The management team can be
supplemented with experience from a Board of Directors, a Board of Advisors
and external consultants. Where the management team is not complete, the
Investor will want to see an acknowledgement that the existng management
recognise this defciency and accept that new talent will need to be recruited to
deliver on the business targets. Some of the founding shareholders may have to
step aside. This is a critcal tme for entrepreneurs as they need to put together
a team which has a high probability of meetng the targets.
Operations
Day-to-day monitoring of the business is an essental characteristc of a well-
run frm. The frm has to know where it is, what it needs to do and have the
systems, policies and procedures in place to monitor and correct defciencies.
The reason why Angels ofen become involved in early stage ventures is
because it is this experience they can bring to the venture. From their past
experience with start-up and high growth revenue ventures, they have learned
the importance of being well informed and taking remedial acton early.
Operatonal systems include all the budgetng, fnancial and operatonal
reportng systems, performance setng and monitoring processes, and systems
and reward schemes which encourage the right behaviour. High growth
66
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
businesses are fnely tuned because they consume cash in building capacity.
They have litle room for mistakes and therefore early warning systems and
quick response systems are very important.
At the same tme, the business must manage its contractual risks. Well
writen contracts with customers and suppliers, well-designed contracts of
employment, well documented intellectual property ownership and assignment
are all components of good management of risks.
Product development
It is unlikely that an investor will ever know as much about the product as
the entrepreneur and his team. Even if they have a technical background, this
can be out-of-date quickly and they are rarely in a positon to adequately judge
the quality of the product development systems or the reasonableness of the
tmescales. This is therefore a high exposure area for the investor. To overcome
this limitaton, the entrepreneur will need to show adherence to budgets
and targeted tmescales, or show how the available products are capable of
producing the results required. The entrepreneur must accept that keeping
development costs under control and meetng development tmescales is
critcal to ensuring the investors ongoing fnancial support.
Later Stage Investments
More mature frms with established management, proven products and
demonstrable revenue streams, ofen seek funds for market expansion, flling
out product portolios, acquisitons or working capital. Such frms ofer a very
diferent risk profle to the private equity investor compared to a start-up or
early stage venture. However, such investments are not without their risks.
Firms ofen seek external private equity fnance because they don’t have the
tangible assets needed by traditonal banking lenders. Thus the ‘assets’ which
underwrite the funding are ofen ‘sof’, such as patents, brands, copyrights or
simply a good business model. As such, they are harder to value and ofen hard
67
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
to liquidate. Even so, they may be good revenue generatng assets and can
provide some level of comfort to the investor.
The investor is stll concerned with an exit. He will need to balance two
opposing concerns, the upside potental of the business and the risks of failure.
The upside opportunity will be presented in terms of building market share,
establishing overseas ofces and penetratng existng markets with additonal
products. However, the risk will be in the executon. Does the team have the
skills and experience to deliver the target numbers? Will the market support
their growth?
With more mature enterprises, the investor has a much greater body
of evidence to examine how well the company performs strategically and
operatonally. The investor will stll need to conduct extensive due diligence to
uncover any weaknesses or risks. Established products and relatonships can be
examined to determine market potental and service excellence.
Many entrepreneurs seek fnance at this level to provide a boost to their
business so they can reach a size and proftability where they can convert equity
to debt or take the company to an IPO. This recapitalisaton enables them to
gain larger critcal mass while at the same tme gaining back the equity passed
to the investor as part of the fnancing deal. The entrepreneur is betng they
can generate the level of security needed to fund debt within a relatvely short
period of tme (3-7 years) to take out the investor.
Entrepreneurs are ofen reluctant to part with equity, seeing this as loss
of control and/or loss of upside potental. However, a deal which allows the
entrepreneur to redeem the investor’s shares at some agreed formula can be a
very atractve method of building up the business with an opportunity to buy
back the external equity. Expansion fnance which is used to build up tangible
assets, decrease revenue and proft volatlity or increase the portolio of revenue
sources, can provide a platorm for negotatng debt to repay an investor.
Entrepreneurs interested in short-term equity investment with redeemable
optons need to have a clear focus on the security requirements for debt
fnance. These factors then need to be built frmly into the business plan with
the agreement of the investor. Even partal redempton, swapping some equity
68
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
for debt, during the investment period, may be an atractve opton for both
partes.
However, the entrepreneur stll needs to accept that there is a potental pitall
in bringing in an investor. An investee frm which fails to meet agreed targets
or fails to generate sufcient free cash to fund debt obligatons is stll subject
to interventon by the investor. The investment agreement would normally
allow the investor to take acton if the investment is in trouble. No business
is entrely free of risk, even if this is external to the frm and even to their
marketplace. The entrepreneur seeking later stage fnancing cannot guarantee
they can recapitalise or take the business to an IPO. Failure to provide a liquidity
opportunity for the investor will result in interventon by the investor to ensure
that there is an exit opportunity while the business stll has real worth. This will
ofen result in the frm being sold in a trade sale.
In more mature businesses, the investor is likely to play a very diferent
role than that undertaken in early stage ventures. Where early stage ventures
typically need advice and directon in moving the business to proft, growth
and sustainability, later stage businesses ofen only need help at the Board
level. Their needs are more likely to be advice on strategy and creatng the right
foundaton for an IPO or major trade sale. Good governance, good reportng
systems and a structure which reduces internal risks need to be developed.
Investors in larger ventures ofen assist with global expansion, help establish
strategic relatonships and assist with VC rounds.
The Investment Proposal
Any request for Angel or VC fnance should have a comprehensive business
plan. It is not that the investor could not understand the business from a
discussion or presentaton, it is just that it is more efcient in the long run
for the entrepreneur to have it all documented in advance. The investor can
then reject it with a quick glance at the executve summary, review it prior to a
meetng, use it to open discussions with other co-investors and use it to drive
the due diligence process if they wish to proceed.
69
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
The general view is that, if the entrepreneur cannot put together a good
business plan explaining every aspect of their business, they probably don’t
understand the business well enough to grow it to the point the investor
desires. Part of the entry test for investment is that the entrepreneur have the
necessary literacy, numeracy and communicaton skills to run the business. The
business plan is one of the tests they need to pass.
The major beneft to the investor of the business plan is to provide an
opportunity for the management team to demonstrate they can build a model
of the business which an outsider can understand. The model needs to be
holistc. It has to explain every aspect of the business in sufcient detail to show
that they understand how all the parts have to work together over tme.
The investor is being asked to invest considerable funds in a business which
they are trying to understand. It is unlikely that they will ever understand the
business as well as the entrepreneur and the management team. Since the
investment is only for a short period, say 3-7 years, they need to see a strong
possibility of a trade sale or an IPO during that tme. What the entrepreneur
needs to demonstrate in the investment proposal, in non-technical terms, is
that he or she can achieve those objectves.
Most business plans are simply projectons of the past. It is simply Excel
madness. It is almost as if, by putng the data into Excel and projectng it
forward for three years, it will happen. Of course it may. But that would be
more hope than strategy. Forecasts need to be based on a set of realistc and
defensible assumptons. For many entrepreneurs, the business plan is an
expression of what they would like to happen. They work backwards from what
they would like to happen to establish the growth rate that will get them there.
Alternatvely, they use a set of assumptons which seem reasonable and build
their business plan on those assumptons. This is ofen presented as the classic
‘percentage of the market’ plan: ‘The market is huge and we only need 2% of
the market to be a $100 million business.’
However, most ofen this is not supported by any validaton that the customers
will buy the frm’s products or that they will buy in the volumes asserted. The
business plan needed by an Angel or VC frm has a very specifc purpose. It is to
70
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
convince the investor that the frm can deliver the objectves they have for the
use of their money. Put simply, that means:
• a 25% plus ROI
• known expansion opportunites
• an exit via an IPO or trade sale in 3-7 years
• identfed potental trade buyers
• limited support required
• relatvely low risk.
Many entrepreneurs think the purpose of Angel or VC fnance is to help them
grow their business, or they think that the investment is simply another form
of fnance that will help them overcome some constraint within their business.
What they fail to appreciate is that Angel and VC fnance is specifcally designed
with certain objectves in mind which can only be achieved by developing the
business so that the investor can achieve a good return on their investment
usually through an exit event in a relatvely short period. The purpose of the
business plan is to prove that those objectves can be met.
The business plan the entrepreneur needs to produce should have the
following three components:
Where is the venture now and what is the growth opportunity?
What is the exit strategy?
How are they going to achieve it?
The business plan should also include details of the management team
and their capacity to deal with the business development strategy along with
the how the funds sought are going to be utlised in support of the business
objectves.
Where is the venture now?
The entrepreneur should have a well-artculated business opportunity which
needs Angel or VC fnance in order for it to be achieved. So the frst part of the
71
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
proposal for Angel or VC fnance should be about the business opportunity and
the extent to which it has been validated.
It is almost always going to be the case that the entrepreneur will think only
in terms of building a fnancial business. They will seek to generate signifcant
revenue and proft to justfy the Investment. It is highly unlikely that they will
have thought of an IPO or a Strategic Trade Sale exit or be able to show how this
could be achieved. Their inclinaton will almost always be to prove a traditonal
business model concept. What they need to do is to switch focus and show how
the exit will be achieved.
The proposal should demonstrate the strength of the growth potental of the
underlying product or service as this will be critcal for an IPO or trade sale exit.
The entrepreneur should be explaining the following :
• What is the business concept?
• What is the size of the target market and how will the frm secure its
share?
• Who is the customer?
• What is the beneft to the customer and where is the compelling need?
• What price and why?
• How is the product or service distributed to the customer?
• What is the compettve advantage?
• How is sustainability of the business achieved?
If the business is already operatonal, the existng business should be able
to demonstrate the operatonal aspects of the business model. This should
validate the product/market informaton, the fnancial aspects of the business
and the management team’s capabilites. If there is a strategic exit opportunity,
this informaton may deal with how the strategic buyer would execute on some
of these elements.
In summary, the investor needs to be convinced that this is a good business
with a good idea or strategy, is well run and has a good chance of achieving the
fnancial or strategic exit required.
72
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
What is the exit strategy?
Most Angels and VC frms have similar objectves for their investments. While
they enjoy the involvement with emerging companies, they want their money
back with a 25% plus ROI within 3-7 years. Therefore, the investment proposal
should clearly set out how much Angel or VC fnance will be needed and how
the investor will achieve that objectve.
The investor needs to know which exit strategy is being proposed and why.
Potental multple exit opportunites are even beter as they bring fexibility
and reduced reliance on equity market cycles. The vast majority of frms simply
cannot meet the atributes of an IPO. For others, the IPO strategy cannot be
met with their existng business model and it will take a number of acquisitons
to create the right IPO vehicle. Only very few will have the right mix of products,
markets and potental to undertake an IPO and also meet revenue and proft
targets for several years beyond. Since an IPO generally achieves a much higher
ROI than a fnancial trade sale, the IPO strategy should be followed. However,
a trade sale alternatve should be artculated in the proposal for periods where
the market is unreceptve for an IPO.
For the trade sale exit, the entrepreneur should be setng out a comprehensive
road map for how the sale will be achieved. This should include identfcaton
of specifc potental buyers, the tactcs which will be employed to develop
relatonships with each and an estmate of the likely sales price.
How are you going to get there?
The business plan is simply about executon. The business is at point A (now)
and it needs to get to point B (the exit), what are you proposing to do to get
there? You need to set out exactly how you are going to put the strategy in place
over the 3-7 year tmescale.
Some Angels prefer to keep it simple. Knowing that the management team
is somewhat green and need help to develop the business, they need to ask:
Exactly what are you going to do with my money?
73
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
Say you are a $1 million revenue business. To get to the exit point, you may
need to grow the business to $4 million. Alternatvely, you may need to complete
product development or establish trial customers to prove the product. How
are they going to do it? It is not simply an extrapolaton of the numbers. You
need produce operatonal plans for every part of the business.
• A detailed marketng plan
– Size, growth, customer profle, competton
– Promoton, advertsing, PR plans
– Proof of efectveness
• A sales plan
– Closure rates, remuneraton plan
– Recurring business revenue and targeted prospects
– Sales targets and recruitment and training plan
• An R&D plan
– Product development and release milestones
– Quality assurance, recruitment and training plan
– Equipment plan
And so on.
There is nothing wrong with an entrepreneur admitng they need help to
develop such a detailed plan, but the investor is likely to delay making any
substantal commitment untl a proper business plan is in place, even if they
help develop it. Only by getng down to this level of detail will you understand
just how much fnance and efort you need, but also, just how likely the business
is to succeed.
74
Chapter 5: A Compelling Investment Opportunity
Raising Angel & Venture Capital Finance
Before commitng to the investment, the investor will need to review every
part of the plan and see exactly what each manager will be doing to contribute
to the overall plan. The business plan should also set out an organisatonal
plan (including recruitment and training) and plans for ofce accommodaton,
manufacturing and warehousing space, infrastructure and fnance. A set of
projected fnancial statements should be available.
An investor will ask; ‘Show me exactly how these revenue numbers are going
to be made?’ They may want to see a breakdown of forward revenue projectons
for both recurring revenue and new business. The recurring revenue should
be supported by actual contracts with customers. The new business should be
supported by a prospect generaton and sales closure plan that targets specifc
customers or specifc channels and so on.
The more you can show you really understand how to make the targets
and you have the people, systems and processes in place to do so, the more
convincing your plan will be.
At the same tme, the growth plans may call for new management positons
to be flled, in which case an executve recruitment plan should be included in
the plan.
Which business plan layout
There are many examples of conventonal business plan structures in
textbooks and on the internet. Those ofered by VC frms are good guidelines
for the content. However, it is the way it is put together that is important.
Remember that the business plan should be about how you are going to meet
the investor’s objectves, not how you are going to meet yours.
For an insight into how a typical VC business plan might be structured, review
the descripton provided on the Britsh Venture Capital Associaton website in
the document A Guide to Private Equity (see htp://www.bAngela.co.uk/).
75
Raising Angel & Venture Capital Finance
6
There are two major paths to a successful exit of the frm. One is to sell the
frm. This might be to another business (trade sale), usually a corporaton in a
similar or related feld or to another Angel or VC Fund (secondary buy out), or to
a wealthy individual. The second path is to list the frm on the stock exchange,
an inital public ofering (IPO).
Initial Public Offering
The requirements for listng a frm are quite onerous and expensive. Unless
the listng results in a share price which can maintain a positon at least as
good as the sector index, the listng will not achieve an exit the shareholders
antcipated (assuming the shareholders hold shares in the listed company). Just
having liquidity of the shares via a market listng does not in itself guarantee
the value achieved by the shareholders will be greater than an outright sale to
a corporaton.
Some private companies undertake an IPO, or a back-door listng (acquire
an existng but dormant publicly listed corporaton), with the intenton of using
it to raise funds or to sell shares. Typically, back-door listngs are done with
smaller companies. However, unless the size of the shareholding in public hands
is signifcant, generally thought to be above $100 million, there is insufcient
liquidity to create a market to sell shares.
Exit Strategies
76
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
The table below shows the types of characteristcs which best suit an Inital
Public Ofering (excluding speculatve ventures such as biotechnology and
resource ventures).
Atribute Requirements for long-term atractve public listng
Revenue $20 million plus ($100 million plus the most successful).
Net proft Proftable for three years with minimum of $2 million in the year prior to
listng. Projected profts growing over next few years.
Scope Natonal or internatonal markets.
Portolio Range of products with some in diferent markets.
Potental Major natonal leadership or global markets.
Management Majority with public corporaton experience and some with experience in
larger corporatons.
Board Signifcant industry and public corporaton experience.
CEO Able to deal with market analysts, insttutons and shareholders.
R&D Products in various stages of development to ensure contnued market
leadership.
Cash Sufcient funds to meet forecast plans without further capital raisings.
Funds use Funds raised to be used for market development, innovaton, overseas
expansion, acquisitons, working capital, repayment of debt.
Advantage Clear compettve advantage based on strong intellectual property and/or
proven innovatve business model.
Public awareness Products and their benefts are easily understood by the public.
Support Listed shares are large enough in value and number in insttutonal and
public ownership to encourage market analysts to track the stock. Generally
this means a market capitalisaton of at least $100 million.
Since few companies in private ownership can meet these requirements, an
exit strategy aimed at an IPO is not a viable opton for most privately held frms.
That is not to say the smaller companies cannot exit through an IPO, but the
above provides the best foundatons for success.
77
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
Generally it will take a minimum of $500,000 in legal and accountng expenses
for even the smallest and simplest IPO. According to KPMG Corporate Finance’s
2004 Australian Capital Markets survey, the average cost of raisings up to $10
million was 10.1%, falling to 4.7% for raisings greater than $500 million. If only
a small amount is to be raised, this cost is very high for the funds received. At
the same tme, an IPO usually involves signifcant work for the top executves.
This has ofen been thought to be 50% of the CEO and CFO’s tme over the
six months prior to the IPO. This is a very signifcant burden on the frm and
requires the rest of the management team to bear the burden of day-to-day
management during this tme. A USA listng would be more expensive in annual
expenses due to the greater disclosure requirements.
The overall consensus of private equity advisors is that only four factors are
considered key to a successful IPO. The frst factor is the venture should have a
strong compettve advantage and sufcient growth potental to achieve a $100
million capitalisaton value within about fve years of listng. Neither the current
level of revenue or proft is considered signifcant compared to antcipated
revenue and proft. This factor also goes a long way to explaining why low
growth frms which have low margins either don’t make it to the exchange or
have to be signifcantly larger before they can.
The next major factor is the depth and experience of the management team
and the industry experience of the Board of Directors. Again this is not surprising
when you consider that the shareholders are backing a group of individuals to
take them to the size necessary to support the $100 million capitalisaton. A
new management team or one which has signifcant technical depth but litle
management depth is not going to be received well.
Knowledge of the IPO process itself by the management team is a major
factor. This demonstrates just how important the roadshow to the brokers
and the presentatons to insttutonal investors are. Achieving signifcant share
purchase commitments up-front is almost a necessary conditon for a foat.
Knowledge of retail and insttutonal investor risk and return requirements and
being able to convincingly show growth potental is an imperatve. Investors are
typically risk-averse and will quickly zero in on potental risks in the venture.
The management team must be able to convincingly demonstrate knowledge
of their business, their industry and how to mitgate possible risks.
78
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
Finally the frm must have the best possible advisors. The best advisors and
investment bankers are expected to have the best due diligence processes,
require the highest standards of preparaton but also carry the highest level of
credibility to the market. They are also very selectve in who they represent.
Too many entrepreneurs see an IPO as a means of solving their own business
problems rather than seeing it as a means where retail and insttutonal
investors achieve a return on their investment. Without gaining the support of
a signifcant number of retail investors and/or support from some insttutonal
investors, the frm is likely to push themselves onto the market by satsfying the
minimum listng conditons and then fnd that just being publicly listed does
not solve their inherent problems. As we have seen many tmes – the market
penalises those which don’t perform. In many cases, these frms would have
been beter to wait untl they had more robust growth potental before listng.
It may not be possible for the major shareholders to exit at the tme of the
IPO or even within some years. Markets are very wary of public issues where the
key managers sell of their shares completely. In a situaton where the results
are not achieved subsequent to a sale of shares, the inside shareholders could
also face legal charges of insider trading.
A frm which wants to undertake an IPO exit needs to build the IPO profle
above. So, to the extent that it cannot meet the requirements within the existng
business, the additonal atributes need to be developed or acquired. With 3-7
years to execute the IPO strategy and especially with Angel and VC fnancing,
a frm may be able to achieve the necessary characteristcs given the right
startng point. Many companies which atract funding have already identfed
strategic acquisiton opportunites to bring economies of scale and growth to
the company.
In some sectors, building a company via acquisitons is a possible strategy.
Certainly in the years 2002 and 2003, frms in the biotechnology sector in
Australia needed to undertake consolidaton to gain additonal resilience,
product portolio spread and critcal mass. Too many biotechnology frms were
undercapitalised, had very narrow product ranges and too litle revenue spread
from licensing to longer-term producton products.
79
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
Ofen in emerging markets there will be several frms with complementary
products, ofen selling to the same customers or working with the same alliance
partners. These could be brought together to provide a platorm for an IPO
vehicle. However, there needs to be an obvious and demonstratable synergy
between the products and the frms. Just lumping a number of frms together
to reach the revenue and proft targets is unlikely to convince the insttutonal
investors they are investng in a sound platorm of future growth.
At the same tme that the underlying product portolio is being built, the
frm needs to construct a management team capable of running a growing
public corporaton. Public corporaton experience, experience with larger
corporatons, deep experience in the industry and a good track record, are all
essental characteristcs for the IPO management team.
The IPO strategy needs to show, in considerable detail, how the IPO prospect
profle will be achieved. Underpinning the plan should be documented
representatons from respected accountants, lawyers, bankers and brokers who
are willing to work with the frm on building the IPO strategy.
Trade Sale
Most Angels and VC Investors exit or harvest their investment through a sale
to another frm. This is called a trade sale.
Where possible, the Investor will seek a strategic trade sale to order to meet
or exceed their return on investment (ROI) needs. A strategic sale occurs when
the value placed on the business exceeds its fair market value (FMV). The FMV
is most ofen determined by looking at the current business as an investment by
an independent investor looking for a return on their money. The current proft
is taken as indicatve of the ongoing proftability of the frm and ROI. Since few
owner/managers operate the business to maximise profts, this will normally
undervalue the business.
A conventonal sale based on an EBIT multple would certainly be atractve
to an Investor if a strategic sale was not possible. In that situaton, atenton
needs to be given to increasing operatng proft, decreasing risk and establishing
a growth potental in order to secure the best price.
80
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
However, normally a strategic sale can be expected to achieve a sale price
considerably above a conventonal sale price. The key to a strategic sale is to
fnd a corporate buyer which has a need for the assets and/or capabilites of the
frm. This strategic ft can come from any number of possible areas:
• customer base
• distributon channel
• brands
• patents, trademarks, licences
• key employees
• access to specialised knowledge and so on.
Strategic buyers most ofen come from within the industry in which the frm
is operatng. They can be suppliers, customers, alliance partners, joint venture
partners or compettors. Sometmes the sale will be to a corporaton not in
the sector. They may want to acquire a presence in a market/geography as a
foothold or may wish to diversify.
The Proactve Sale Strategy developed by the author defnes a process which
can be used for fnancial and strategic trade sales. This methodology has fve
major components:
• alignment of interests
• due diligence and good governance
• creatng value for the buyer
• selectng buyers
• building relatonships with potental buyers.
(a) Alignment of interests
In order to be prepared for a trade sale, especially when there is tme
pressure to set up and consummate a deal, the various stakeholders need to
agree on the possible outcome. There is litle point in progressing a deal if the
Directors cannot agree on what they want, or the shareholders cannot agree on
a reasonable price. A negotator cannot go into a meetng to secure a deal if the
interests of the major stakeholders are unclear. Experienced Investors usually
have the Board focused on exit strategies from the frst Board meetng.
81
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
The major stakeholders who are critcal to executng a deal are:
• members of the Board of Directors
• management
• Investor along with other shareholders
• key employees.
The Investor needs to ensure that all stakeholders are focused in regard
to the two extreme situatons: a forced sale due to decline in the viability of
the business or a planned sale over a longer term. Once the CEO has a list of
requirements, opinions, conditons and issues which need to be considered,
he/she can start to bring all elements together to arrive at a strategy which
could be followed in these two extreme situatons.
(b) Due diligence and governance
Nothing kills a deal quicker than an uncertain or immeasurable risk. Many
people think the valuaton on sale is due simply to revenue and proft. What
happens in practce is the buyer conducts an extensive due diligence into every
aspect of the frm’s operatons in order to uncover actual or potental problems,
risk and liabilites. Since each of these requires tme and funds to resolve, the
ofered price is likely to fall as the review goes forward. At some point the risk,
tme and cost to fx the problems become so great that a deal is not possible.
The task of the Board from a directonal perspectve together with the CEO
from an operatonal perspectve is to establish the frm and its operatons to
minimise risks to the buyer. This includes putng into efect such things as:
• Standardised and documented contracts with customers and
suppliers.
• Industry standard terms of employment, benefts and enttlements.
• Full ownership and tracking of intellectual property.
• Full compliance with industry, health, safety and environmental
regulatons.
• Comprehensive reportng, budgetng and planning systems.
• Policies, procedures and processes covering critcal aspects of the
operatons.
• Industry knowledgeable accountants and lawyers.
82
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
The key to passing a business to a buyer is to put yourself in the buyer’s
shoes and think through the integraton and operatons of the business afer
the acquisiton. The task of the CEO and management team is to ensure that
the business can operate efectvely afer the acquisiton without imposing an
undue burden on the buyer.
Included in the planning for a sale should be a consideraton of the roles of the
key employees. In most acquisitons some roles will change, some staf will be
made redundant and some key employees are needed to ensure a transiton of
knowledge. How can you ensure that this process happens without disrupton?
This means determining retenton terms for some, redundancy packages for
others and incentves for all staf to make the transiton happen as smoothly as
possible.
(c) Creatng value for the buyer
In a fnancial exit, the frm needs to create value through the generaton
of future net earnings. Preparaton for sale would focus on improving internal
processes, reducing expenses, increasing revenue and margins, adding revenue
growth and then seeking out opportunites for potental growth.
Strategic acquisitons occur because a corporaton has a need for some asset
or capability which the frm has. Generally this is something which the frm
already leverages to create its own compettve positon. As part of the Strategic
Sale Strategy, the Entrepreneur needs to think carefully through the operatons
of the business and isolate those things it has and those things it does which
could be used by a large corporaton to resolve a threat or generate signifcant
new revenue.
Assets or capabilites which create strategic value should be based on one, or
several, of the following characteristcs:
• difcult or tme-consuming to copy
• protected by patents, trademarks or copyright
• only available through licensing or registraton which is limited in
supply
• unknown due to confdentality or trade secrets
83
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
• requires specialist knowledge to acquire or utlise
(d) Selectng buyers
Financial buyers are ofen corporatons undertaking a roll-up or consolidaton
strategy. They are looking for well managed frms in their sector which can add
revenue and proft to group earnings.
A strategic buyer is a corporaton which is prepared to pay a premium over fair
market value because the business solves a critcal problem for them or ofers
them a good opportunity for additonal revenue and proft. The best strategic
buyers are ones which can exploit an opportunity by ofering a unique product
on a much larger scale than the frm is able to with its limited resources. The
Investor should look for corporatons which can overcome whatever constraint
is holding back the business.
Buyers normally come from within the industry, so start by listng companies
in the same industry as the investee frm. You then need to select those
companies which have the capacity and experience to do the deal. Corporatons
with experience at acquisitons and which have ample size and funding are
much easier to deal with. The ideal buyer will typically be at least 8 tmes the
size of the seller.
(e) Building relatonship with potental buyers
Trade sales are mostly made between partes which already have some
knowledge of each other. This could be informally through networking functons,
between prior colleagues or could be a formal trading relatonship such as a
partner or distributor. Other relatonships can exist through Boards of Directors
or Boards of Advisors or equity partcipaton. The key to a trade sale for an
Angel or VC funded company, as with any other company, is to be prepared.
Any early stage venture is going to experience some turbulence and not
everything will go according to plan. In terms of exit preparaton think of the
situatons you may experience.
84
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
1. You need to sell
Not everything is going to go according to plan. Sometmes market conditons
change and the business is no longer capable of reaching the targets initally
set or may no longer be viable. Rather than let the frm become insolvent or
bankrupt, the exit plan should be established early so that there is litle delay
in executng a trade sale. This way the maximum beneft can stll be extracted
from the failing business.
Ofen tme is against you. If the management team has not put an exit
strategy in place, they will have litle tme to prepare or to initate discussions
with potental buyers. If they have not set up the relatonships in advance,
especially with overseas buyers, it probably is not going to happen the way
you would like. Without planning, the ability to atract a buyer who will pay a
premium value for the company is signifcantly constrained.
By setng up relatonships in advance and by knowing why the corporaton
would want to buy the frm and who to deal with inside the potental buyer,
management can execute the acquisiton discussion quickly. As long as the frm
has several potental buyers, compettve tension in the deal can stll result in a
very atractve sale price.
2. The frm is approached with an offer to buy
Many Angel and VC funded frms are targets for acquisitve corporatons.
However, when the ofer comes management may be unprepared. They are
ofen unsure of an appropriate price. If management is unprepared and needs
to go through extensive due diligence, this not only takes considerable tme, but
it uncovers risks to the buyer. Instead of closing a good deal the frm will end up
with a disrupted business, staf who are stressed due to uncertainty and a price
the shareholders would normally not have accepted. Management may also
have talked themselves into the deal. Management will have taken their eyes
of the ball and will have much to do to recover.
How much beter would the situaton be if the frm had already lined up
several possible buyers? They can now announce that they are prepared to sell
and take on all ofers. Management will have prepared the due diligence fles
and can execute the deal quickly with litle disrupton. The staf understand the
85
Raising Angel & Venture Capital Finance
Chapter 6: Exit Strategies
process and have incentves to ensure the best deal is done. The exit strategy
should be canvassed with staf from an early stage so they understand the
objectves of the Investor as a shareholder in the company.
3. The Investor and management decide to sell
Experienced Investors and good management should already know of the
best potental buyers and through business operatons should already be in
a positon to actually know those partes. If management have prepared the
company for sale over many years, they are best placed to drive the exit process
rather than have it drive them. The Investor and management simply need to
decide on the tming.
It is a highly desirable characteristc of Angel or VC funding that the Investor
exits the investment within a relatvely short period. Few Investors like to have
their funds ted up for more than fve years in a venture. If the prospectve
investee frm artculates a viable and well-artculated strategy for a trade sale
going into the funding negotatons, it will greatly improve their case and the
Investor’s confdence for achieving the Investor’s exit objectves.
With the trade sale exit strategy outlined here, you can be reasonably assured
that you will gain the best price you can and know the corporaton doing the
buying will make more money out of it in the future. If the Investor has a very
good idea of the trade sale exit opportunity, he can spend the tme assistng
management to develop the business and build a strong case for the buyer. This
focus makes it easier for the Investor and the entrepreneur to work together
since they have clearly defned common objectves.
This process is well proven. If you think of the frms you have seen sold at
large premiums, you will always fnd they created signifcant value for the buyer.
86
Raising Angel & Venture Capital Finance
7
R
aising VC funds is a process that will involve several partes. The smart
entrepreneur wants the best investor, however, the best ones don’t go
looking for investment, they atract them from known and trusted business
colleagues. To fnd the right Angel or VC investor, the entrepreneur needs to build
up a network of knowledgeable contacts within the investment community. The
process may well start with a local professional advisor and then extend through
more experienced advisors to the ultmate Angel or VC investors.
Professional advisors help to educate the entrepreneur, prepare him or her for
the evaluaton and the negotaton and ensure that the ultmate deal is fair for
both partes. In the end, there is no substtute for quality – both in the professional
advice and in the Investor that the entrepreneur ultmately works with.
Only a small number of entrepreneurs will ever raise Angel and Venture
Capital fnance once and even fewer do it several tmes. Therefore
very few have built up knowledge of the venture capital investment process.
Working with professional advisors who partcipate in these transactons on a
regular basis can provide the entrepreneur with insight into how best to prepare
for discussions with the Investor. Not only can this save tme but it should lead
to a beter deal for the entrepreneur. The professional services frm should be
able to provide introductons to beter investors, ensure that the deal is fair and
Preparing for the
Investment
87
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
reasonable and set the right expectatons up front so that all partes understand
how best to work together for mutual gain.
Accessing the right Angel or VC frm is also an important part of the investment
process. Not all Angels or VC frms have the same capabilites, networks and
capacity to work efectvely with the entrepreneur. Finding the right one can be
critcal to the ultmate success of the venture.
The professional accounting and advisory frm
The type of advice and help which a professional accountng frm can provide
includes assistance in the following areas:
Valuation
The services frm can assist the entrepreneur to prepare a valuaton of the
business either prior to the investment or at the antcipated exit. If the frm
has prepared a valuaton of the current business and projected valuaton of
the business at the proposed exit point, this will contribute considerably to
the equity share discussion with the Investor. The advisory frm can assist in
the preparaton of the valuaton or review the fnancial projectons for the
entrepreneur, check the completeness and accuracy of the informaton and
review the underlying assumptons and values.
Checking the business plan
The business plan is the foundaton document which will be used by the
investor to evaluate the investment. It is important that the business plan be
prepared thoroughly, be properly explained and contain the informaton needed
by the Investor to undertake due diligence on the opportunity. The advisory frm
can review the business plan and show where additonal informaton is needed.
Reviewing fnancials
Current fnancials need to be prepared according to generally accepted
accountng principles and presented in a conventonal format which allows easy
analysis. The accountant can ensure that the statements are prepared correctly
and the accompanying data fully supports a detailed investgaton.
88
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Advice on use of debt and equity structures
The business may be able to support some level of debt as well as an equity
investment. Using debt should reduce the equity share which the frm would
give to the Investor. The advisors may also be able to show where cash may be
beter managed in working capital, accounts receivable and accounts payable
to reduce fnancing needs as well as provide independent advice on debt fees
and terms.
Helping with introductions and referrals
Well-established advisory frms partcipate regularly in transactons involving
Angels and VC funds. This would include investments, acquisitons, trade sales
and IPOs. They are, therefore, in a good positon to know local Angels and VC
funds on a personal basis and certainly by reputaton. The advisory frm can
assist with preparing informaton on the frm for an investment proposal and
assist with Angel and VC introductons. An accountng frm can help short list
the Investors to approach and can help with introductons or referrals. Since
many Angels and VC funds only deal with referred proposals, this can make
a big diference in accessing quality Investors. It can also assist in getng an
opportunity to the top of the pile as advisory frms act as a pre-reader of
opportunites and provide a deal fow which expects a tmely response from
the beter investors.
Reviewing term sheets
While term sheets are typically set out in a conventonal format, the
Entrepreneur may wish the advisory frm to review the term sheet before it is
sent back to the Investor.
Assisting in negotiations
The Entrepreneur who is represented by a well-established and respected
advisory frm is likely to be beter prepared for the negotaton. At the same
tme, the Entrepreneur should expect that the Investor will be equally
represented by their own advisory frm who would be familiar with private
equity transactons. The terms and conditons of the investment should be
reviewed by a knowledgeable party so that the Entrepreneur knows that the
terms of the investment are reasonable and standard. This should result in more
89
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
productve discussions and is likely to be beter for the ongoing relatonship
between the partes. Investors prefer to deal with entrepreneurs who are
represented by a professional frm as they know that the entrepreneur will not
need to be educated about the investment terms and conditons, the required
rate of return, management controls and exit requirements of the Investor.
Due diligence
Due diligence will be carried out by the Investor as part of the inital
evaluaton of the investment opportunity. This is mostly a product/market
evaluaton to see if the business environment can support the projectons of
the frm. Afer the term sheet is issued, the Investor will carry out an extensive
review to further assure he has a thorough understanding of the business and
the management and has uncovered any data discrepancies and investment
risks. The professional advisory frm can help the Entrepreneur prepare for a
due diligence investgaton by identfying any problems, risks and defciencies
which need to be addressed.
Advice on pensions, options schemes and remuneration
The professional advisory frm can review these before an investment is
made to ensure the current remuneraton and benefts are fair and reasonable
and provide the most positve basis for the planned exit.
Tax advice
The frm can expect to change signifcantly over the period of the investment
and beyond the exit. Their current tax planning may not be suitable for such
changes. The accountant can review the current business processes for
compliance, tax collecton and reportng.
Exit strategy assistance
A well-artculated and probable exit strategy needs to be prepared as part
of the business plan. If this has not already been prepared by the entrepreneur,
the advisors can help to defne acquisiton value, identfy potental buyers and/
or show how the frm can best positon itself for an IPO or a trade sale exit.
90
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Commercial review of agreements
The accountng frm can review legal agreements to ensure they are
commercially acceptable. This review should also be done in conjuncton with
the frm’s legal representatves.
The professional legal frm
The type of advice and assistance which a professional legal frm can provide
includes the following:
Review share purchase agreement
The share purchase agreement would normally be prepared by the Investor’s
lawyers. This is a complex legal document which few entrepreneurs will have
ever seen and certainly few would understand at any depth. The professional
legal frm can review the document, explain the terms and conditons to the
entrepreneur and work with the Investor’s legal representatve to fnalise the
agreement.
Prepare warranties and indemnities
The frm would normally be expected to provide warrantes, representatons
and indemnites to the investor. The professional legal frm can prepare
the warrantes and representatons and indemnites documents for the
Entrepreneur.
Review new employment agreements
The Investor should expect the key executves to enter into employment
agreements and will expect to have signifcant control over their remuneraton.
Those agreements would normally contain restraint of trade and/or non-
compete clauses. The professional legal frm can review these agreements.
Prepare disclosure letter
The frm should be prepared to disclose any issues which may afect the
decision of the Investor. It should also identfy any potental risks of the business.
The professional legal frm can prepare the these disclosures and advise the
Entrepreneur how to deal with theses in the negotaton.
91
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Review corporate documents
As part of the preparaton for investment, the professional legal frm will
review the corporate documents which authorize the frm to undertake business
to ensure that it meets the requirements of the Investor. This review would
normally extend to board minutes, shareholder agreements, opton schemes
and any material contracts the frm has entered into.
The Entrepreneur should plan for 5-10% of the money invested to be spent
in professional services fees, notng that smaller deals are likely to have a larger
percentage of advisor’s fees.
Not all professional services frms have the necessary experience to
undertake this type of work efectvely. An Entrepreneur seeking their frst
investment should not assume that their current professional services provider
has the expertse to properly advise him in this area. Before startng to incur
costs for this service, the Entrepreneur should undertake some due diligence
and investgate the extent to which the frm has a track record of success
advising Entrepreneurs seeking investment from Angels or VCs. Asking for
references would not be unreasonable and they also should be asked for a
list of transactons which the frm has partcipated in and some details of the
work performed for the clients involved. The Entrepreneur should also ensure
that the expertse is stll with the frm and ask to be allocated an advisor with
personal experience in these types of transactons.
Selecting an Angel or Venture Capital Fund
Angels and VC frms vary greatly in their
capabilites and the extent to which they desire or are
able to intervene directly. Some frms prefer a hands-of approach and thus seek
a management team able to execute the business plan without interventon.
Other VC funds prefer to assist with the selecton of some of the management
team, stay close to the acton and actvely partcipate in setng up deals,
promotng the frm and establishing networks.
Most experienced Angels and VC frms are reasonably good at declaring the
type of investments they are seeking. They will normally provide an indicaton
of the stage they prefer and the level of investment which they typically
92
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
make. These atributes will allow the entrepreneur to prune down the list of
Angels and VC funds to those which are actve in their target area. Next the
entrepreneur can exclude those Investors who target specifc industry sectors
that are inappropriate. This should leave a smaller list which the entrepreneur
can investgate more thoroughly.
The entrepreneur needs to assess what type of assistance (if any) is needed
from the Investor. Possible issues might be:
• recruitng senior executves;
• recruitng Directors for the Board;
• accessing industry advisors;
• helping with staf recruitment;
• providing accountng, tax and fnance assistance;
• providing legal advice especially in contracts and IP;
• helping with banking relatonships;
• providing assistance with closing large customer or distributor deals;
• access to possible acquirers;
• experience with an IPO process; and
• expertse with overseas markets.
The entrepreneur needs to identfy how important various characteristcs of
the Investor are. For example:
• How experienced is the Angel or the VC team? How many frms have
they invested in and what is their performance?
• What experience do they have with similar ventures at their stage?
• What experience do they have in their industry?
• What has been their success with prior entrepreneurs? Have they
been able to work with them or have they been replaced?
• Have they been able to secure follow on investment?
• What has been their success at trade sales and IPOs?
With larger funds, the day-to-day management of the investee will typically be
handled by either an Associate Director or Director of the VC fund. This person
or the Angel will most likely sit on the Board of Directors and be involved in the
development of strategy. It may be of some importance to the Entrepreneur just
how much experience the Angel or the VC fund representatve has. A person
93
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
with limited business experience may be more of a liability than an asset to the
business.
Part of your investgaton should be to investgate the Angel or VC fund to see
if you would want them as a partner in your business. Aspects that you should
look into include:
Reputaton
The beter Angels and VC funds are well known to the professional services
community. Ask for advice from your advisor, lawyer, accountant and banker. Most
Angels and VC funds will work with sets of lawyers and accountants on each deal
they conclude. The larger professional services frms do the majority of the deals.
Compatbility
You will be working with the Angel or the VC fund and its nominees on your
Board for some years. You need to be comfortable with the people you are dealing
with and the way in which they prefer to do business.
Investee references
Take the tme to talk to the CEOs of the investment portolio frms. You might
also like to talk to those entrepreneurs who have worked with the Investor and
have exited. What type of support did they provide to the frms? How did they
react to changes in plans, disappointments and missed targets? How did they
work with the frm on strategic issues, exit plans, subsequent fund raising rounds,
closing deals, providing access to networks etc? Would they recommend them
to you?
Generally speaking it is not wise to approach too many Angels or VC funds at
the same tme. The industry is quite small and most executves in the industry
know each other, ofen work together in consortum funding deals and partcipate
in industry functons. The Entrepreneur who shops around will be identfed
relatvely quickly and probably be dismissed or avoided as the Angels and VC funds
may not believe they will get enough tme and atenton from the entrepreneur
to undertake their own inital investgaton.
94
Raising Angel & Venture Capital Finance
Chapter 7: Investor Presentation Techniques
Some Angels and VC funds will only deal with referrals and not look at
unsolicited business plans. The VC Fund research data shows that most business
plans are only read as far as their executve summary (about 16 seconds on
average). Thus having a professional services frm make the introducton provides
the Angel and VC funds with some level of comfort that the basics have all been
covered. The professional services frm will also provide advice on which Angel
or VC fund is best suited for the investment sought.
Many frms with Angel investors will go on to raise Venture Capital fnance.
The inital due diligence undertaken by the Angel investor and his partcipaton
in the business can ofen provide the level of comfort that the VC fund is looking
for. Ofen angel investors have had prior experience co-investng with a selected
VC funds and thus the introductons carry greater weight.
The inital approach to a Angel or VC fund should be with an executve
summary. This way the Investor can have a brief review of the investment
opportunity without the complicaton of having to deal with a detailed business
plan. If the summary is of interest, it may request a meetng before going into
the business plan detail. It will use this meetng to assess the entrepreneurial
team as well as the proposed venture.
You may be concerned about confdentality. Normally this would not be an
issue with an established and reputable Angel or VC fund. However, you might
like to take some steps to provide yourself with a higher level of comfort. This
would include seeking advice from a professional services frm which works
actvely in the area of private equity fnance. Check to see that the Angel or VC
fund has no confict of interest with its other investments, provide confdental
data only during later discussions, initally just provide the executve summary
and consider using a confdentality agreement.
95
Raising Angel & Venture Capital Finance
8
T
here are as many diferent forms of investor pitches as there are investors.
If you are looking for a silver bullet, there isn’t one! For every investor
who prefers a two minute presentaton, there will be as many who want 20
minutes. For every Angel who wants you to tell them how much money you
are seeking up front, there will be just as many who would rather have that
informaton at the end when they know what you want to do with the money.
However, don’t be despondent. Over 50% of the presentatons I hear are
seriously lacking and almost all of them have some vital bit of informaton
missing. Rarely have I heard a great pitch. If you can avoid the obvious mistakes,
you will be in the minority and if you can provide the essental informaton,
you will be well received. There is nothing wrong with generatng questons at
the end of a presentaton, but what you don’t want is your audience to be lef
wondering why they wasted their tme because they don’t understand what
you do or what you want from them.
Building a story about your business and being able to present it to diferent
audiences is an essental requirement for any entrepreneur. If you are looking for
investment, recruitng a key executve, selling to that frst customer, borrowing
money from a bank or trying to convince a supplier to give you extended
credit, you need to be able to give a succinct and compelling explanaton of
your business. They can’t be expected to wade through all the details of your
Investor Presentation
Techniques
96
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
business to discover if it makes sense. Unless you can provide a short sharp
‘pitch’ on your business, you are going to miss out on some great opportunites.
The short version of your investor presentaton is ofen referred to as an
‘elevator pitch’ and is part of the language of venture capital. It derives from
an exercise that MBA students were required to do as part of their training in
entrepreneurship. You are told you have entered an elevator and next to you
is a venture capital executve who will get of the elevator in two minutes. You
have two minutes to present a compelling argument as to why he should meet
with you so that you can explain your venture in more detail. People who work
exhibiton stands know the drill very well although they rarely get 2 minutes. If
they are lucky they might get 20 seconds.
There is a lot to be learned from building a 2 minute pitch on your venture
and trying it out on people who know nothing about your business. The frst
thing you learn is that 2 minutes goes by real fast. You have to use words
sparingly and stck to the most important points. The next thing you fnd is that
your audience does not understand your business at all. They fail to grasp what
a great business idea you have, how great the product or service is and how
important it is that they invest in it. Basically – they don’t’ get it!! Of course
it does not take a rocket scientst to discover that this is not their fault. You
have simply failed to structure the explanaton in such a way that they could
understand it. So go back to the drawing board and start again.
Many people make the mistake of being too technical and providing too
much detail, forgetng that the aim of the pitch is to convince the non believer
about how fnancially atractve and robust the business venture is. Generally,
the greatest mistake is to fail to provide a clear explanaton of the essence of the
business; what problem are you solving, how you are solving it and for whom,
how big is the opportunity, what is your competton and why you think you can
be successful.
For an investor to be seriously interested, they need to see a customer with
a compelling need, a product or service that has unique, hard to copy atributes
which fulfll that need and enough potental customers to make it a reasonable
size business. You have to convince them that you have the team that can
execute on the opportunity. Lastly, it has to provide a good return on their
97
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
investment through a public listng or by selling the business within a relatvely
short period of tme, say, 3 – 5 years. You need to be able to deliver that message
in two minutes. A longer presentaton allows you more tme to present greater
detail but the core message is the same.
At one investment pitch session for angel investors which I atended, eight
seed and early stage ventures were given 20 minutes to present their investment
opportunity. The presentatons varied from poor to very good and from boring
to passionate. However, most of them failed to clearly defne the problem they
were solving and why their soluton was beter than the competton. Some
forgot to provide statstcs on market size, what porton they could capture
within a reasonable period of tme and how they were going to do that. Not
one of them had a clear explanaton of the exit strategy, perhaps the most
fundamental aspect of any angel investment.
I suspect that with further probing, all of these ventures could have been
made to look atractve. Angel and VC investors are not typically passive
investors who put their money in and wait for the cheques to come; they
are actve investors who typically assist the venture to develop. They do not
expect the business model to be ideal at the inital investment stage, but they
do expect to be given enough informaton to decide whether to spend more
tme in the investgaton of the opportunity. Most of these ventures wasted
their presentaton tme at this forum as they were poorly prepared, had failed
to test out their presentatons with non expert audiences and lacked practce.
Following each presentaton, the angel investors were given an opportunity to
ask questons and the teams were able to see where they had failed to present
essental informaton. Fortunately for them, they also received some very good
advice on areas where their business strategies could be improved.
Whether you have 20 seconds, two minutes or an hour to present your
business opportunity, you do need to prepare and practce the presentaton
otherwise you are wastng invaluable opportunites. As a potental recruit, a
prospectve customer or investor, I want to be convinced by both your passion
and your argument. If you can’t explain succinctly what you do and why I should
be a part of your grand venture, why should I waste my tme working with you?
98
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
What Investors Want to Know
Put yourself in the investor’s shoes. Why are they there and what do they
need to know to have an actve interest in talking to you further? Remember,
they hear lots of presentatons, don’t really care about the product or service
and are really interested in the risks and rewards for their investment. Keep in
mind that without a highly probable exit event, they don’t get their money back
and don’t achieve a return on their investment, so don’t forget about the exit.
While there is no ‘one size fts all’ presentaton, the basics should include the
following:
Introductions
Who are you, what is your positon in the business and what is the name
of the business.
What does the frm do?
You should be able to state what your business does in a few sentences.
“We provide security safety fences for high rise building developments”
“ We develop skin care products designed for tropical climates”
What problem or need are you addressing?
You would be surprised at how ofen I ask ‘What problem are you solving?’
at the end of a product presentaton. I hear all about the features and
functons, how it beats the competton and that customers love it, but
half the tme I am not told what problem or need it addresses. The key
here is to explain why customers need the product. What pain are you
addressing? What need are you satsfying? Why can’t the customers defer,
delay or avoid buying it? What evidence do you have that your soluton is
efectve and that customers will buy it at the price you propose?
Who is the customer?
I want to know exactly who the customer is and why they need it. How
99
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
do you put yourself in front of your target customer with a compelling
propositon?
What is your competitive advantage?
A strong compettve advantage means that you solve the problem beter
than anyone else and that customers with that need or problem prefer
your soluton. You also need to demonstrate that you can protect your
advantage over tme through some registered IP (patent, brand, copyright,
license, trademark etc) or a level of deep expertse which is difcult to
copy, mitgate, develop or acquire.
How big is the market?
This is where evidence is required about the number of potental buyers,
the manner of distributon and the conversion rate of prospects to sales.
“In our initial pre-release testing we had a take-up rate of 9 in 10 trades-
man. With 600,000 tradesman in our target region, we can expect
sales of $2 million within 2 years of the initial marketing campaign.
Replacement sales are anticipated to be at a rate of 20% per annum.”
What is your distribution strategy?
How are you going to distribute the product and put your product or service
in front of your target customer? There are a variety of strategies which can
be used; direct sales, internet, retail, wholesale and manufacturing license.
Which ones will you be using and why do you think they will be efectve in
meetng your revenue and proft targets?
What is your exit strategy?
Unless you have an exceptonal high growth venture which could achieve
an IPO, your business will need to be sold in a trade sale to achieve an exit.
What is your target exit date? Which companies have you identfed who
would be interested? Why would they buy your business and what is the
estmated sale price?
100
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
What do you need to do to achieve the exit?
What are the milestones you need to achieve and tasks you need to
complete to succeed in a trade sale or IPO event? This might include product
development, proof of concept, revenue targets, strategic relatonships
and so on. If the exit is a trade sale, you should have selected the potental
buyers, have a plan to approach them and understand why they would
want to acquire your frm.
Who is going to do the work?
Who is on the management team? What are their qualifcatons and
experience and which positons need to be flled for you to deliver on your
strategy? Why do you think this team is capable of achieving the milestones
and exit outcome? It is OK to have an incomplete management team but
you should show how you plan to fll those vacant positons.
How much investment do you need?
How much funding do you need, when do you need it and what is the
money going to be used for?
What are you offering the investor?
While this will certainly be negotated, if you can, you should give some
idea of the level of equity partcipaton and the likely return to the investor.
Be prepared! You may expect to have 20 minutes to present and then be told
you have only 5 minutes. You may antcipate doing a formal presentaton to be
told that they only want a short descripton of the investment proposal.
The Elevator Pitch
Sometmes you only have a minute or so to get the message across. In
those situatons you need to focus on the essentals and ensure your audience
understands what you do and why they should come and talk to you afer your
presentaton.
101
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Here are two examples from ventures which I have been involved with. Each
of these presentatons could be done is less than one minute.
Investor Pitch for Pioneer Computer Group (1990)
My name is Dr. Tom McKaskill and I am the President of Pioneer Com-
puter Group, a software development business located in Northamp-
ton, UK, with offces in London, San Diego and Auckland. The business
develops, markets, implements and supports integrated enterprise
wide resource planning (ERP) applications for both discrete and pro-
cess manufacturers and a set of software development tools (4GL).
The business currently employs 160 staff and has revenue of $15 mil-
lion.
PCG has over 200 customers for its ERP systems and over 2,000
customers for its 4GL products spread across 16 countries supported
by its own staff and over 20 distributors. PCG has partly completed the
world’s frst 4GL, relational database ERP system for process manu-
facturing which has received signifcant interest from early customers,
distributors and our major strategic partner, Digital Equipment Corpo-
ration. The process manufacturing ERP market is anticipated to be the
next big growth market in the software applications space. PCG have
just signed an agreement to install the system in 16 factories of a large
UK based manufacturer, the largest manufacturing software contract
signed this year in Europe.
PCG is seeking $2 million to complete the development of the process
manufacturing suite, set up trial sites in the USA and seek a strategic
US buyer for the business. We estimate sales of the new product to
exceed $100 million in the frst two years of release in the USA giving
a potential trade sale exit value of around $50 million within 2 years.
This explanaton would be improved if I had identfed the potental buyers
and the reason why they would be willing to pay a premium to buy the business,
but you can see how much informaton can be delivered in a brief statement.
102
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Investor Pitch for Distinction Software (1997)
My name is Tom McKaskill and I am President of Distinction Software,
a software development company which provides an integrated suite
of software modules for supply chain optimization for medium sized
process manufacturing companies who manufacture high volume, low
priced consumer packaged goods.
Our product suite optimizes the relationship between retail demand,
warehouse inventory, logistics, manufacturing capacity and raw mate-
rial inventory. The package uses a sample of client data and shows a
payback time on the cost of the software of less than 6 months.
The product suite is one of only a limited number of fully completed
and implemented supply chain optimization products worldwide.
The market for such products is growing rapidly and there is keen
interest from large application software providers to enter this market.
These products are highly specialized, take years to develop and are
expensive to complete.
Our exit strategy is to sell the business to a global software corpora-
tion providing them with an immediate revenue opportunity within their
existing customer base as well as a strong competitive advantage for
future sales. We estimate an exit price of around $60 million.
We are seeking $2 million to complete multi-lingual translation, multi-
country trial implementations and documentation and training material
required for a global release.
This descripton was my frst atempt. Note that I do not menton revenue,
staf numbers or projectons. With any presentaton, you should improve each
tme you do it. It is important to be able to explain your business in one minute
or in a descripton which is no longer than one page.
103
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Powerpoint Presentation Guidelines
There are lots of ways of doing a presentaton and therefore there is not one
format which is perfect but the basic rules of presentaton stll apply.
Do’s of Presenting
• Outline why you are there
• Tell them what you are going to tell them, tell them and then tell
them what you told them
• Have a logical fow, be confdent, positve, focused and professional
• Use photos, diagrams and videos to demonstrate your product
• Show you know what you are talking about
• Be honest (identfy problems, risks, outstanding work)
• Tailor your presentaton to the target audience (why are they there)
• Be realistc and reference your data sources
• Limit the number of points to a slide
• Use at least an 18pt font. Major bullet points should be at least 24pt
Don’ts of Presenting
• Don’t make ambiguous, vague or unsubstantated statements
• Don’t use technical or industry jargon
• Keep the sizzle down - stck to the meat
• Keep the slides simple and to the point
• Don’t be casual, uninterested or otherwise engaged - show you are
keenly interested in the decision
• Don’t read and don’t present fnancials to 3 decimal places.
Powerpoint is a very powerful tool but can be over-used. The slides are there
to allow you to convey informaton - remember that your audience can read so
you don’t need to read them out. The order of slides allows you to control the
fow and pace of the presentaton. You are telling a story, make it interestng but
stck to the central theme.
104
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Your audience should be able to read everything on the slide within a few
seconds. Don’t put so much informaton on the slide that it distracts them from
listening to your explanaton.
Use fonts you can read from a distance. Avoid TLCs and technical jargon if
you are presentng to a non-technical audience.
105
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Ensure the colours you use are easy to read. Put contrastng colours together
so the text can be read easily.
Avoid using backgrounds which have lots of diferent colours or shades. It is
very difcult to get contrastng colours when you have complex backgrounds.
106
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
You are presentng to a professional audience so avoid the gimmicks. Don’t
use fun graphics, noises or fancy animatons.
Your audience wants to read what is on the slide.
107
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Why Are You There?
Be very clear in your own mind what you want to achieve from your
presentaton and ensure you come back to that at the end. Listen carefully to
the questons and make sure you answer them rather than simply repeat what
was in your presentaton.
Learn from every presentation:
• What went right, what went wrong?
• What questons came up later - can this informaton be incorporated
in the presentaton?
• Find out where the weak points were.
• Where were you not convincing?
• In the story, strategy, concept - what did you miss?
• Who or what do we need to do to be successful?
Your presentaton is only the frst step, you need to have a plan to follow
up on the meetng. Ask for business cards of those who would like a further
discussion. You can also ask if you can send them additonal informaton.
Presentation Checklist
Afer you have put your presentaton together, check it against the following
list. Depending on the type of business and the type of exit, not all of these
items will be relevant and some will need more detail than others.
Almost without excepton, you will have made some assumptons about
your audience, especially their knowledge of your industry and technology. You
need to deskill your presentaton for a general audience. The best way to do
this is to give the presentaton to people from outside your sector. Try it on
friends, siblings, your spouse/partner/mother and your co-workers. If there
is something they don’t understand or have difculty following, you need to
change your presentaton. At the end of the presentaton, you might ask them
questons about your business and investment opportunity and see if they
understood it. These days it is not essental to wear a business suit and te but
neat and professional is important.
108
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
• Introduce yourself and your other presenters
• Who are you and what do you do?
• What problem or need do you satsfy?
• Is the customer clearly identfed?
• Are you showing why the customer should buy from you?
• Are you identfying your principal compettors?
• Are you identfying your sustainable compettve advantage?
• Are you showing who the management team is?
• Do you have fnancial projectons with worst, likely and best case?
• Are you identfying the risks in the deal?
• What problems are unresolved or needed additonal work?
• Do you have a well defned exit strategy?
• Have you identfed what needs to be done to deliver on the exit
event?
• Have you said why you are there and make the investment request?
• Is the investment opportunity well defned and convincing?
• Are your Powerpoints clear and easy to read?
Depending on whether you are a fnancial or a strategic exit, your explanaton
of what is important can be very diferent. With a strategic trade sale, the key is
to identfy the strategic buyers and explain why they would want to undertake
the acquisiton. In a fnancial sale or an IPO, you need to show that you can
create a high growth venture.
The last tme I raised venture capital I did over 30 presentatons to venture
capital frms in 5 cites up and down the eastern seaboard of the USA. Each
tme I learnt a litle more about what they were interested in and refned the
presentaton. What I also found was that even the best opportunity had to ft
into their investment criteria, investment portolio, sector preferences and
level of investment. You may need to do a number of presentatons to diferent
audiences before you fnd a match.
Some organisatons will have a preferred presentaton outline which they
would like you to follow. Ask them if they have a specifc format which they
prefer. Ofen they will want an executve summary either in advance or on the
day. This needs to cover the major points of the investment proposal and should
include contact details for those who wish to explore your proposal further.
109
Raising Angel & Venture Capital Finance
Chapter 8: Investor Presentation Techniques
Some organizatons like to have a writen business plan available for those who
wish to examine the proposal further.
With formal Powerpoint presentatons, many organisatons like to hand out
a copy of the slides to the audience so they can make notes during and afer the
presentaton. Remember to invite the audience to ask questons and ofer your
business card for follow-up discussions.
Most investors try to put themselves into the shoes of the target customer
and ask the queston “Why would I buy this product and from this frm?” They
try to do this as early into the presentaton as possible so they can understand
the business. This means that it is really important to deal with this issue as
early into the presentaton as possible. Showing the product, demonstratng it
or showing a short video or photo of it in use can be quite efectve.
I have sat through many presentatons where I didn’t understand what the
product was or what problem it solved untl well into the presentaton. The
problem for the presenter was that most of the audience were not listening to
the content because they were stll focused on working out what the business
did. You should not be spending more than a minute or so on describing your
product or service. Once the audience understands what you do, move on to
the core of the presentaton which is about what you need to do to develop
the business, the investment required and the return which the investors
will receive by partcipatng in the venture. If you are at the idea stage or stll
developing your business concept, simply state that in your presentaton, but
ensure that your host understands that prior to the presentaton and has the
opportunity of setng the right expectaton for those who will be atending.
If you are not sure what level of detail is required in the presentaton or are
unfamiliar with some of the terms used by investors, ask your host. You can also
learn a lot about Angel and Venture Capital funding from artcles, websites and
books. The more familiar you are with the requirements, the beter prepared
you will be to deliver your presentaton and answer the questons.
110
Raising Angel & Venture Capital Finance
9
O
nce the investor has evaluated the investment proposal, the discussion
will usually move to the queston of valuaton. Entrepreneurs have
always seen the inital valuaton as the most important part of the investment
process – as this can impact greatly on what they walk away with on exit. At the
same tme Investors see entry valuaton as the key to the investment return –
if they get too litle equity they may not get a reasonable return on the exit if
the venture is not overly successful. Thus valuaton discussions can be stressful
on both partes and ofen somewhat emotonal. Finding a path through this
discussion is critcal if both partes are to proceed with the investment and stll
retain a positve working relatonship.
Traditonally Investors and entrepreneurs have used the existng revenue
and proft or near term revenue and proft as the basis of a valuaton discussion.
While the exit is always a consideraton, few use this to arrive at a current
valuaton. Typically, exit planning is deferred untl the investor has made the
investment and had some experience with the venture when the investor has
a beter idea of the market and the venture capabilites. But in fact, this is the
critcal event and should play a much greater part in the investment decision
and the valuaton discussion.
Valuation
111
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Valuation
Valuaton of an existng business before VC and Angel funding and valuaton of
a business following funding has to be the most controversial topic in the venture
capital literature. It is the greatest source of confict between entrepreneurs
and Investors, is plagued by emoton, misunderstanding, entrenched positon
taking and ignorance. It has ofen been said that 40% of deals fail to secure
funding due to a failure to agree a valuaton. What is regretable is that it is
highly possible that many of these ventures could have made both the Investor
and the entrepreneur considerable wealth.
Valuaton is the process of estmatng the monetary amount the frm is worth
based on its future expected returns. Valuaton is a functon of risk and return
and considers:
• the expected return from an investment in the frm
• the expected returns from investments in other comparable frms
• the risks associated with the expected return
• any other relevant characteristcs of the frm or the industry/
geography in which it operates.
A more conventonal defniton of market value is: the price that would be
negotated between a knowledgeable and willing but not anxious buyer and a
knowledgeable and willing but not anxious seller actng at arm’s length within
a reasonable tme frame.
While this is probably not true of Angels, entrepreneurs ofen refer to venture
capitalists as greedy, one-sided, ‘vulture capitalists’. On the other hand, venture
capitalists and Angels complain of entrepreneurs being unrealistc, unwilling to
negotate a fair value and ignorant of the balance between risk and return.
Valuation models
In the absence of an independent ofer to buy the frm, the valuaton of a
private frm is a highly judgemental process. Valuaton models are each designed
with diferent purposes in mind. Like the problem of identfying cost, (historical
cost, replacement cost, market price, incremental cost, infaton adjusted cost,
depreciated cost) it depends what you want to use it for.
112
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
The major valuaton models are:
• Earnings-based
- Capitalisaton of future maintainable earnings
- Discounted future cash fows (DCF).
• Asset-based
- Going concern value
- Realisaton value
• Industry-specifc based
- Market value
- Rules of thumb.
In emerging businesses seeking venture fnance, only the earnings based
valuaton models are relevant. Traditonal earnings based valuaton methods
have been established to value existng business where historical data can be
used to show revenue and proft trends and where established products have
a market presence. However, most emerging ventures which seek funding are
of limited life, have litle history and a somewhat speculatve future. Thus while
traditonal methods of valuaton don’t really apply, the entrepreneur should be
familiar with their use as valuaton discussions may involve them. In order to
start any sort of meaningful discussion, the conventonal approach to valuaton
for an investment has been to write a forward projectng business plan and
then to try to use this as the basis for discussion.
Most Investors will estmate a future (exit) valuaton based on a four to six
tmes earnings before interest and tax (EBIT) multple of the projected proft
at the tme of harvest of the investment and then work backwards using an
internal rate of return (IRR) to refect the risk in the venture to arrive at a
post funding valuaton. Early stage ventures may atract a 55% IRR with more
advanced ventures atractng 20% to 40% depending on the expected risk.
However, even this valuaton is highly speculatve as more funding rounds
may occur, each setng a new valuaton at the tme of funding. To arrive at
the equity percentage for the Investor, the investment required is deducted
from the post-funding valuaton and then the ‘pre-money’ valuaton is arrived
at. The Investor’s equity percentage can then be calculated from the rato of
investment to post-money valuaton.
113
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Strategic trade sales require a diferent approach as the valuaton is based
on the expected earnings of the buyer in the frst few years following the sale.
However, a valuaton can be applied to this stream of earnings to arrive at an
exit value.
Capitalisation of future maintainable earnings
Capitalisaton of future maintainable earnings methodologies include:
• Price earnings rato (PER)
• Pre-tax earnings multples such as earnings before interest, tax,
depreciaton and amortsaton (EBITDA), earnings before interest, tax
and amortsaton (EBITA) and earnings before interest and tax (EBIT).
Earnings-based valuatons are used as a proxy for the Discounted Cash Flow
(DCF) methodology.
The PER can be applied in two ways:
• Total value of the frm: PE multple x net proft afer tax (NPAT)
• Value per share: PE multple x earnings per share (EPS)
The PER is applied to an estmate of earnings afer tax. The value derived
using a PER is a valuaton of the ordinary shareholders’ interest. This is described
as an equity value.
Valuatons based on EBITDA, EBITA or EBIT multples calculate the Enterprise
Value of the frm before factoring in the way it is funded. The Enterprise Value is
typically adjusted for the following items to calculate an Equity Value:
• Interest-bearing debt
• Surplus assets
• Contngent liabilites
• Future capital expenditure
114
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
To further explain the diference between Enterprise Value and Equity Value
consider the following example of somebody’s house:
Item $ Value
Market Value 500,000 Enterprise value
Bank Debt 400,000
100,000 Equity value
Some sectors have well established valuaton norms. These can vary with the
economic cycles refectng likely growth or depression trends. Multples applied
to mature industries with litle likelihood of growth are generally lower than
multples applied to growth sectors. Firms which have experienced higher than
average historical growth will usually command a higher multple on the basis
that future growth is also expected to contnue at higher than average rates i.e.
history is ofen used as a predicton of the future.
The assumpton underlying the PER method is that the frm has stable or
predictable earnings, that these will contnue on a linear path for some years,
the business will not change from its current business model and there is an
appropriate debt/equity mix.
It is useful to set valuaton expectatons prior to going into a valuaton
negotaton. If the sector is currently valuing listed corporatons at 10 tmes EBIT
and the frm is seeking something higher, they have unrealistc expectatons. If
on the other hand they are seeking fve tmes EBIT, you probably have a basis
for negotaton.
The earnings used in a valuaton need not be the actual historical earnings.
Earnings should be adjusted for abnormal, extraordinary and non-recurring
items to determine a normal level of earnings. If the entrepreneur can show
highly probable growth with achievable revenue and proft targets, future
earnings might be used to calculate a market valuaton. However, it is important
to avoid double countng growth by using future earnings and applying a ‘growth
multple’.
115
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Discounted cash fow (DCF)
A DCF has two elements:
• forecast of future cash fows of the frm for a number of years into
the future
• discountng the forecast cash fows back to a net present value (NPV)
using a discount rate which refects the riskiness of those cash fows.
• The preparaton of a DCF can be challenging as it can be difcult to:
• accurately forecast cash fows for a number of years into the future
• select an appropriate discount rate.
The discount rate should represent the risks associated with generatng the
expected earnings of the frm. In many cases entrepreneurs and Investors will
simply use the Investor’s investment hurdle rate.
This method is somewhat more problematc. It is based on discountng
future free cash fow to a present value. The free cash fow, or uncommited
cash surplus, represents the cash available to pay of the inital investment plus
provide a return on that investment.
Most high growth businesses invest heavily in growth capacity. This might be
R&D, sales force, promoton, channel expansion and so on. Few entrepreneurial
ventures have spare cash.
The DCF discount rate in an Angel valuaton is likely to be 35-40% and a VC
fund 25% -35%.
When deciding on a valuaton for a strategic exit, a value is arrived at for the
exit price and then discounted to a NPV.
Fundraising alternatives
It is useful to put Angel and VC investment into context.
Let’s say the entrepreneur wanted to borrow $1 million. His choices are a frst
or second mortgage on his personal home, a loan secured on business property,
a loan secured on inventory, or a loan secured against debtors.
116
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Secured loans can normally be recovered by the lender as a market exists for
the pledged asset. The lower the likelihood of recovery, the higher the interest
rate and the lower the percentage advanced on the value.
Borrowing against the entrepreneur’s home would possibly result in a
professional valuaton, which may be lower than the entrepreneur would
willingly agree and a loan of probably not more than 80% of the valuaton.
A bank is likely to seek higher rates of interest on a second mortgage to
compensate them for the additonal risk of the second mortgage. If scheduled
repayments can’t be met, the bank has the right to sell the home and recover
their debt plus accumulated interest and costs.
Securing a loan on business property may be a litle more expensive as
business propertes generally experience more fuctuatons in value. A premium
above a second mortgage on a house is likely.
Taking a loan on inventory is of much higher risk as the inventory may sufer
from obsolescence or damage. Usually the recovery can only be made at an
aucton which itself ofen returns much lower values than in the normal course
of business. So an advance of not more than 50% of book value may be made
but with an interest rate higher than the above mentoned rates. A similar
treatment may be applied to debtors except that it may be limited to 50% of
approved debtors, perhaps only those aged 30 days or under.
Now let’s consider the typical early stage entrepreneurial business, which
will display some or all of the following atributes:
• uncertain cash fows
• few tangible assets
• some specialised equipment which typically becomes technically
obsolete
• few debtors
• litle inventory
• new and sometmes unproven products or services
• ofen an immature management team
• an emerging market which is yet to be stabilised
117
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
• no established market for shares, especially a minority holding
• uncertain tming of revenue and proftability.
So, unlike a secured investor such as a bank, the Investor has an illiquid
market in which to sell the shares, is dealing with high levels of uncertainty in
the business and the market and the management team has no security for the
investment.
If a risk free rate in Government Bonds is yielding, say, 6% over a long term,
what return should an Angel or VC investment under these riskier conditons
return over a portolio of such investments? The typical Angel or VC investor will
invest across a range of ventures expectng to return, on average, approximately
5% above long-term share market returns. However, within this portolio some
investments can be expected to be writen of, some may break even, some
may make a reasonable return and one may make a sizable return. In order
to achieve a 15-20% average pre-tax return, the Investor needs to set a pre
tax hurdle rate of at least 25-30%. Investors with a technology, biotechnology
or early stage investment focus tend to seek higher returns (potentally in the
order of 35-40%) due to higher failure rates. Only a small percentage of the exits
will exceed 7 to 10 tmes their investment, thus the Investor may set a relatvely
high hurdle rate knowing that those investments which fail or have poor returns
will pull down the average.
Most entrepreneurs will accept this logic. So where is the problem? The
problem is in the ofen extreme views of the likely outcome. Entrepreneurs
by their very nature are optmistc. Investors, while not being pessimistc, are
cautous and have been conditoned by failed ventures, all of which started out
looking very positve. In truth, it is the pursuit of the target value which ofen
causes the venture to fail. If the Investor has to achieve a high value to exit their
investment with a good return, the pressure is on the entrepreneur to push the
growth rate. It is ofen this pressure which creates the conditons for insolvency
and failure.
At the same tme, the gold medal for an Angel or VC investment is an IPO, not
withstanding that the most common exit mechanism is a trade sale. This means
ever growing revenue and proft targets. However, the successive yearly targets
are inherently risky. The growth rate puts huge pressure on the organisaton
and the cash needed to fuel the investment in inventory, debtors, recruitment,
118
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
training, accommodaton, research and development, development of
distributon channels, customer support and so on. Much of the investment is
in growth preparaton rather than in servicing the current customers.
Let’s consider an example:
The business is achieving $5 million in sales with 20 staf. It is currently
making 5% net proft afer tax ($250,000). The business is valued at six tmes
net proft afer tax, therefore the pre-investment valuaton is $1.5 million. The
frm raises $1.5 million for 50% share giving it a post-investment valuaton of $3
million. The Investor expects to achieve an ROI of 25% with a planned exit in
four years. Assume that revenue grows at 40% per annum and the revenue per
head remains constant.
Year Revenue NPAT Employees Valuaton Investor share
’000 ’000 $ million $ million
1(a) 5,000 250 20 1.50 0.00
1(b) 5,000 250 20 3.00 1.50
2 7,000 350 28 2.10 1.05
3 9,800 490 39 2.94 1.47
4 13,720 686 55 4.12 2.06
5 19,208 960 77 5.76 2.88
Notes:
• (a) Pre-investment valuaton
• (b) Post-investment valuaton which includes $1.5 million of surplus cash
• The Investor’s additonal capital of $1.5 million is used on capital expenditure to increase
business capacity.
• Years 2-5 assume $nil surplus cash and $nil debt
• Assumes 5% net proft afer tax in all years
• The Return on Investment is 17% which does not achieve the 25% target expected by the
Investor.
Imagine all the things which can go wrong over that fve-year period: the
market may change with new compettors, the market size may be considerably
less than estmated, new technology may make the product obsolete, the frm
119
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
may be unable to recruit quality staf at the rate needed and so on.
While size is not the only determinant of a company’s ability to undertake
an IPO, in the above example the growth rate would most likely be insufcient
to create an IPO opportunity and therefore the Investor would need to pursue
a trade sale as an exit mechanism. For the same frm to gain the level of sales
and proftability to achieve an IPO, they would have to grow at a signifcantly
higher rate.
The business risks associated with high growth rates are signifcant and
require a massive change in organisaton structure, processes, systems and
formalised controls.
The executves who are capable of running a 20-person frm are probably
unsuited to a 200-person frm. Very few entrepreneurs have the skills to make
this transiton.
The Investor who pushes an investee frm to an IPO may create the seeds
of their own failure. Regardless of the product/market opportunity, very few
management teams are capable of managing a high level of growth. Growing
frms tend to require signifcant levels of working capital and investment into
the business. Consequently, cash reserves are generally stretched and even
a small mistake can result in rapid diluton of cash reserves sending the frm
to the brink of insolvency. As Investors require an exit, in these circumstances
some Investors may panic, replace management and probably push the frm
into a fre sale to recover as much of their investment as possible.
The inital valuaton may create the platorm for future failure. The higher the
inital valuaton, the greater the pressure to grow and the higher the likelihood
of failure.
To protect the investment from some of the risks mentoned above, the
Investor is likely to push the inital valuaton down so that they have a greater
chance of gaining a fnal exit which will return the ROI needed. They also build
in conditons which allow them to replace management if the team fails to
achieve the milestones needed to keep them on track to reach the target exit
valuaton.
120
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
A lower valuaton has the beneft of taking some of the pressure of the
entrepreneur. Reaching a target ROI for the Angel or VC investment is more
likely, the intermediate milestones are likely to be more easily reached and
there is not undue pressure on growth. The downside is that the entrepreneur
will give up more equity at the lower valuaton.
Which valuation should you use?
Too many entrepreneurs produce fve year forecasts based on assumptons
which are, at best, educated guesses as to the state of the economy, the
reacton of compettors and the behaviour of prospects. They then use complex
formulae to work out a Net Proft Afer Tax (NPAT) over fve years. From this
proft forecast they calculate a valuaton to four decimal places using an assumed
discount rate. At the very best, it is one person’s view of the future, but it fails to
recognise that any other view might be equally valid.
In truth, no-one can accurately predict the future. The entrepreneur is
generally going to be optmistc and the Investor somewhat pessimistc.
Somehow they have to come to an agreement on a valuaton or the negotaton
simply never goes anywhere.
Entrepreneurs should be highly averse to high valuatons. While they look
good at the start of the venture, they place unrealistc expectatons on the
business to perform. Even the slightest slippage can lose the entrepreneur his
business. Investors are not known to take shortalls kindly. The problem is that
they have their own investment to protect. Far beter for both partes to agree
a lower/negotated valuaton where the Investor can readily make his hurdle
rate and the entrepreneur has a beter chance of staying in control and making
a reasonable return on his efort.
Negotiated valuation
One method of arriving at a valuaton is to consider what the valuaton of
the business may be at a future exit date and discountng this value back into
today’s dollars. This method also has more relevant applicaton to strategic
sales. The future exit valuaton of the frm is highly speculatve and is a metric
of real interest to both partes. If it was known with some certainty, the current
valuaton could be more readily determined by using a discounted cash fow
121
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
methodology. The discount rate could be adjusted for higher levels of uncertainty
but it would stll be a place to start.
So, for example, a frm with an exit valuaton of $10 million in three years
with a discount rate of 40% would be worth $3.64 million now. A $1 million
investment would thus gain the Investor 27.5% shareholding.
Possible alternatve valuaton scenarios to the above are:
• The Investor wanted some higher comfort factor. A higher rate of
discount may be used, say 50%, which would result in a lower Net
Present Value (NPV) of $3 million giving the Investor 33% equity.
• The Investor wanted some higher comfort factor. A lower exit
valuaton may be used, say $8 million, which would provide a NPV of
$2.9 million, giving the Investor a share of 34.5%.
• The entrepreneur is more optmistc than the Investor and believes
that an exit valuaton of $20 million is likely. This would give a NPV of
$7.3 million and the Investor share of this would be 13.7%.
The real problem lies in the balance of risk and reward. If in fact a low exit
value was achieved, both partes lose but the Investor is likely to be the one
with the highest cash investment loss. The entrepreneur and his team will have
put tme and sweat in but probably much less cash.
At the same tme, if a high value is achieved, both partes would seek the
upside. The entrepreneur would most likely claim that he deserves the most
credit because it is his vision, business model and leadership that are probably
the key to success, not the cash from the Investor. The Investor would most
likely argue that the business could not have achieved the high valuaton
without the cash injecton from the Investor. The Investor of course wants the
lower valuaton in case things go wrong and so the upside is much higher. The
entrepreneur wants a higher valuaton to limit the equity of the Investor if the
venture proves very successful.
A soluton for both partes lies in negotatng a valuaton formula which both
partes can live with. This could be a stated value at somewhere between the
Investor valuaton and the entrepreneur’s valuaton, or it could be a startng
value but with equity adjusted up or down for diferent levels of success.
122
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
So, for example, the partes could agree a strike point which would
determine inital shareholding. This could then be adjusted for higher or lower
exit valuatons. For example, the partes could take the two opposing valuatons
and use these as a basis for calculatng the shareholding at exit.
Negotiated valuation – Example 1
• Investment is $3 million for an inital 33% equity share.
• Exit afer three years.
• The Investor estmates a $25 million exit.
• The entrepreneur estmates $50 million.
In this example the partes have agreed on the following:
• Investor’s equity share will remain at 33% for all exit valuatons below
their expected valuaton of $25 million.
• The Investor’s ROI on exit valuatons between $25 million and $50
million are held at 40% thus giving the Investor certainty of returns.
• Where the entrepreneur’s estmate of $50 million is achieved, he
retains a greater proporton of the equity (i.e. the Investor’s share is
reduced to 16.4%), but the return the Investor earns is signifcantly
greater than at lower valuatons.
• Consequently in this example both the entrepreneur and the Investor
share in the upside of higher valuatons.
123
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Exit valuaton Investor porton ROI to Investor Strike Investor’s equity
$ million $ million % per year valuaton share %
5 1.64 Negatve 33.0
10 3.33 4 33.0
15 5.00 19 33.0
25 8.25 40 Investor exit estmate 33.0
30 8.20 40 27.3
40 8.20 40 20.5
50 8.20 40 Entrepreneur’s 16.4
exit estmate
80 13.10 63 16.4
100 16.40 76 16.4
Negotiated valuation – Example 2
Alternatvely, a much more aggressive model would see the valuatons
move in the Angel’s favour with lower exit valuatons and more security on the
downside for the Angel. This acknowledges the need for the Angel to achieve
their desired ROI. At higher exit valuatons, the pendulum swings the other way,
increasing the reward to the entrepreneur for outstanding performance.
In this example:
• Angel investment $3 million.
• Exit afer three years.
• The Angel estmates a $25 million exit.
• The entrepreneur estmates $50 million.
In the example set out below, the partes have agreed the following:
• Angel’s equity share increases at low valuatons thus providing more
security on the downside.
• The entrepreneur retains a greater share of equity at higher
valuatons while stll allowing the Angel to earn a signifcant rate of
return.
124
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
Exit valuaton Investor porton ROI to Investor Strike Investor’s equity
$ million $ million % per year valuaton share %
5 5.0 Negatve 100.0
10 8.2 19 82.0
15 8.2 40 55.0
25 8.2 40 Investor exit estmate 33.0
30 8.2 40 27.3
40 8.2 40 20.5
50 8.2 40 Entrepreneur’s 16.4
exit estmate
80 9.3 46 11.6
100 10.0 50 10.0
Negotiated valuation – Example 3
For a smaller deal the model might look like this:
Investment $3 million and an Exit afer three years.
Exit valuaton investor porton ROI to Investor Strike Investor’s equity
$ million $ million % valuaton share %
1 1.0 Negatve 100
3 3.0 Negatve 100
8 8.0 38.7 100
10 8.2 40.0 Strike valuaton 82
15 9.0 44.0 60
20 10.0 49.0 50
30 12.0 59.0 40
50 15.0 71.0 30
100 17.0 78.0 17
125
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
This type of formula can be used over successive rounds of Angel or VC
funding. Each round would put in place the formula for determining the share
of the fnal exit valuaton to the new investor.
The entrepreneur who is unwilling or unable to accept a lower/negotated
valuaton, should consider seriously a ratchet where the entrepreneur earns
additonal equity for achieving certain pre-agreed milestones/targets. These
targets could be qualitatve or quanttatve in nature.
Investors want to ensure that, at the very least, they don’t lose any money
on the deal. An investor is much more sensitve to a loss than to a signifcant
gain. There is considerable pressure on the Investor to push down the valuaton.
However, a lower valuaton means the entrepreneur makes much less when
they exit the business and therefore the Investor needs to fnd a valuaton fgure
which strongly motvates the entrepreneur.
Angels and VC investors can use a variety of techniques to achieve this
balance. One simple technique is to set the return to the Investor at a specifed
rate of return. Any excess over this amount from the exit proceeds goes to
the entrepreneurial team. Another technique is to establish the investment as
preference shares with an accumulatng dividend. Since preference shares are
paid before ordinary shares, the Investor will recover some or all of their money
before other shareholders share in the proceeds. An Investor may also have
some ordinary shares to give him a percentage of the higher exit valuatons.
Some Investors use optons to provide additonal incentves to the
entrepreneur and senior management to allow them to accumulate additonal
equity in the business. The optons may be set against certain milestones or
performance targets which represent higher potental exit proceeds. The
entrepreneur gains a greater percentage of the proceeds as the optons kick in
at higher exit valuatons.
An ant-diluton clause in favor of the Investor in an investment agreement
has the efect of protectng some or all of their investment in the event that
the valuaton falls with a subsequent funding round. This clause adjusts the
shares of the Investor so that their original investment retains its monetary
value under the new valuaton. In this situaton, it is the original founders who
126
Raising Angel & Venture Capital Finance
Chapter 9: Valuation
sufer the negatve adjustment. However, this type of adjustment is typically
not readjusted with a subsequent higher valuaton.
127
Raising Angel & Venture Capital Finance
10
M
ost formal Angel and VC evaluatons follow
a similar staged process. This approach
is commonly used by an experienced Investor with many investments and by
Angel syndicates, Angel Groups and VC frms. Individual Angels ofen go by their
gut feel or a ‘seat of the pants’ judgement, however, fewer mistakes are likely
to be made with a more systematc and comprehensive process. Also, if other
Angels are investng at the same tme, the individual Angel doing the evaluaton
would be beter able to later justfy and defend an investment recommendaton
if a more formal process was followed. Given the high level of Angel syndicate
investments over the past several years, the process set out here will apply to
an Angel co-investment situaton.
The purpose of the staged process is to eliminate, at the earliest possible
tme, those investments which fail to meet the criteria established by the
Investor. Each successive stage involves higher levels of expenditure on tme and
professional services and investgaton expense. Only very few frms progress to
the later stages.
The overall duraton of the process will vary according to the complexity
of the proposal and the ease with which the detailed investgatons can be
completed. Larger Angel syndicates and VC frms can be expected to have more
formal processes and perhaps more sign-of stages. It is unlikely that funding
Finalising the
Investment
128
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
would be provided in less than three months with the average taking closer to
six months.
(a) Initial contact
The beter and more established Investors prefer to receive their inital contact
through a referral. However, whether it comes with a recommendaton from
another Angel, professional services frm, personal contact or simply through
the mail, the inital review of the proposal will be a quick read of the executve
summary to see if the size of funds required, the stage of investment, the
industry and the geographical locaton are of interest. If interested, the Investor
will ask the Entrepreneur and one or two members of the senior management
team to come to a brief meetng where the proposal will be discussed.
(b) First formal meeting
The purpose of the frst meetng is for the Investor to evaluate the Entrepreneur
and the management team. The Investor should set the expectaton that the
management team should come prepared to answer detailed questons about
all aspects of their business. They may be asked to do a formal presentaton on
the business opportunity for 10-30 minutes.
(c) Exchange of information
If the inital meetng goes well and both partes are interested in going forward,
the Investor would normally request a business plan (if the management team
has not already provided one) as well as contact details of other executves in
the frm, names of referees, key customers, suppliers and distributors. The frm
may be unwilling to provide confdental informaton at this stage but should
provide sufcient informaton for the Investor to decide if they wish to expend
more tme and expense on evaluatng the investment.
(d) Informal due diligence
The Investor would normally conduct a limited investgaton into the market,
the frm and the business propositon. This will ofen involve contacts with
industry executves they already know or with other Angels or VCs actve in the
sector. The Investor might also visit the ofces of the frm and interview the
key executves and key employees. The market analysis would normally include
129
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
an investgaton of compettors and some validaton of the customer benefts
associated with the products or services ofered by the frm.
(e) Term sheet negotiated
The Investor would then brief the frm on the evaluaton of the proposal
and the terms under which an investment would be undertaken. During this
discussion the Investor and frm agree a valuaton or valuaton formula, discuss
costs and fees and decide on the equity to be taken by the Investor.
(f) Investor quality review
Before proceeding to issue a term sheet, the Angel syndicate or VC frm
may wish to have the proposal presented to them with a justfcaton of the
investment to be made. This is an internal check to ensure that due process and
adequate product/market opportunity evaluaton has been carried out. The
presentaton would normally include a limited fnancial model of the business
over the likely term of the investment. Additonal analysis may be required
following the discussion and before individual Angels or the VC Fund issue the
term sheet. Larger deals may require more extensive and expert investgaton.
In these situatons the Investor may outsource part of the work to professional
services frms and specialist market analysis consultancies.
(g) Term sheet issued
Once the inital due diligence has satsfed the Investor that the investment
should move forward to a detailed investgaton, the Investor would issue a
formal ofer in the form of a heads of agreement called a term sheet. This sets
out the terms and conditons under which an investment will be made if the
proposal satsfes a more detailed and formal due diligence investgaton. The
term sheet is not binding on either party at this point. However, the Investor
may expect the frm to deal exclusively with them during the detailed due
diligence period.
(h) Investment approval
Once the term sheet has been issued and accepted by the frm, a more
extensive fnancial modelling exercise may be undertaken to help other Angels
or other VC Fund partners understand the risks and opportunites in the deal.
This analysis would look at the likely investment returns under diferent risk
130
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
conditons. Exit strategies will be formulated under diferent performance
assumptons. Once this additonal work has been undertaken, the proposal will
again be reviewed, perhaps by a larger number of Angels or the full investment
commitee of the VC Fund. Larger Angel syndicates and VC Funds will have a
formal authorisaton process for the detailed investgaton. This protects the
syndicate and VC frm from an over enthusiastc Angel or investment manager
and allows a wider range of expertse and experience to review the proposal
before the syndicate incurs the expense of a detailed due diligence investgaton.
(i) Formal due diligence
Upon signing the terms sheet, the Investor and their professional advisors
will examine the company’s corporate structure, assets, intellectual property,
fnancial statements, material contracts, employment agreements and any
actual or threatened litgaton. Technical specialists may be hired to review R&D
results and plans, specialist equipment or foreign market plans.
(j) Formal approval
Once the detailed due diligence has been completed the proposal is reviewed
again to ensure that risks have been adequately assessed. If the Angel syndicate
or VC frm is stll comfortable with the investment and the ability for the lead
Angel or investment manager to manage it, formal approval will be given to go
forward with the investment.
(k) Legal documentation
Upon completon of due diligence, partes typically prepare and sign the
following formal legal documentaton:
Subscripton agreement: which sets out the number and price of shares,
funding tranches and dates of subscriptons, detailed warrantes
concerning the company, rights ataching to shares and conditons
precedent to funding. Subscripton agreements may also cover future
subscriptons by the Investor, the founders, other shareholders or key
staf and ratchet mechanisms to re-allocate shares in the event of over
or under performance by the business.
Shareholders agreement: which sets out the ongoing relatonship between
the shareholders and the company as agreed in the term sheet.
131
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
Intellectual property acknowledgment deeds: is an acknowledgment by
other partes that they have no rights to any intellectual property which
they develop and assigns all such creatons to the company.
Executve service agreements: will bind ‘key’ employees to the company
for a period (usually two or three years), and will set out the employees’
terms of service, remuneraton and bonus enttlements.
Source: htp://www.oznetlaw.net/facts.asp?acton=content&categoryid=226 Accessed 31/12/04
Once the fnal documents are signed, the Investor will issue the frst tranche
payment to the frm. Follow on payments will be made under the terms of the
agreement, but may be subject to performance achievements.
Normally the investee would be expected to reimburse the Investor for all
the expenses associated with making the investment if the investment is made.
If an investment is not made, only where the frm has misrepresented material
facts or withdraws afer the due diligence costs have been incurred will the
Investor expect to recover their investgaton costs.
Where an investment is made, the frm would normally reimburse the
Investor for the external expenses incurred in the due diligence process. This
would include professional fees and external consultant’s costs and will occur
with or without a transacton proceeding. Even on a small investment these can
be expected to be $50,000 to $70,000. For a larger deal, it could easily exceed
$250,000. Some funds charge an advice fee if they have helped to structure
part of the deal with external partes. If the venture is relatvely small and the
product/market issues are straightorward, it may be sufcient for the Investor
to undertake a limited due diligence and use a regional or local professional
services frm thus cutng down on the costs.
The Investor is normally appointed as an external Director to the frm and
the company would normally be expected to pay a Director’s fee, in most cases
it would be around $15,000 to $25,000. Larger companies will incur higher
Directors’ costs.
Some Angels and VC frms charge an annual management fee which might
vary but ofen can be around 1% of the amount invested.
132
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
Term Sheet and Deal Structure
The term sheet sets out the terms and conditons of the investment in the
frm. Term sheets can vary in length and complexity but would normally contain,
at least, the following clauses:
• The number and price of the shares in the company to be purchased.
These are normally set up as preferred shares with cumulatve
dividends (where declared). The preferred shares would normally be
paid out in full prior to any payment to ordinary shareholders in the
event of the liquidaton or sale of the frm. This secton would also
state what other shares are issued as well as the capitalised value of
the business. The value of the business is then used to calculate the
percentage of the shareholding that would be owned by the Investor
subsequent to their investment. The preferred shares are normally
converted to common shares on liquidaton or exit. However, in the
event of failure, the preferred shares are enttled to frst call on the
liquidaton proceeds. The Investor would normally be enttled to at
least one seat on the Board of Directors and would have certain veto
powers or power of approval over:
– the capital expenditure budget
– the annual operatng budget
– any debt or asset lien over a specifed value
– appointment of CEO, CFO and senior executves
– remuneraton and employment conditons of senior
management
– any issue of additonal shares
– a change in the number of Directors
– any dividend
– any major change in structure, assets, merger, acquisiton or
disposal
133
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
– the use of the invested funds.
• The Investor may require their percentage of the total capital of the
frm not be reduced in a subsequent share ofer at a price lower than
the one they came in on (ant-diluton rights).
• The Investor will be enttled to ‘piggyback’ the registraton of their
shares with other shares being registered for sale.
• If at least 75% of the shareholders accept an ofer to sell the company
the balance of the shareholders agree to the same conditons of sale
(‘drag along rights’). This may be extended to enable an Investor to
‘drag along’ the other shareholders where the Investor accepts an
ofer to sell shares afer an agreed period of tme.
• The Investor has the right to purchase shares in any new issue of
shares in the same percentage as their holding.
• If a founder has an ofer to sell his/her shares, the Investor has the
right to partcipate by selling the same percentage of their shares
(‘tag along rights’).
• The Investor can require their shares be purchased plus accumulated
and unpaid dividends afer a specifed date in specifed stages
(redempton rights).
• The ofer to invest will be conditonal on adequate due diligence and
the producton of various documents.
• The ofer is confdental and will only be open for acceptance for a
specifed period of tme.
• Each party will be responsible for its own professional fees.
The term sheet is an ofer to invest. Untl accepted, any terms and conditons
can be negotated, although many of the terms and conditons are standard
and are unlikely to be varied since they protect the Investor in the event of the
business failing to meet their objectves.
In most circumstances term sheets are not legally binding, but provide
guidelines on maters to be documented in subscripton and shareholders
agreements.
134
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
An example of a term sheet is provided by the Britsh Venture Capital
Associaton under the ttle Example of a Term Sheet for a Series A Round (see
www.bvca.co.uk). While these are local UK legal documents, the terms are
very similar to those which would be present in most other legal jurisdictons.
Another example is given at:
htp://www.angelblog.net/The_One_Page_Term_Sheet.html
In most cases the term sheet is issued prior to the completon of due
diligence. As such the Investor will usually reserve the right to amend the terms
of the term sheet should anything of concern be found during the due diligence
process.
Due Diligence
Once the Investor has issued a term sheet and this has been formally accepted,
the Investor will proceed to a full analysis of the investment opportunity. At
this point commercial analysts, lawyers and accountants actng on behalf of
the Investor will undertake a due diligence investgaton. The Investor will incur
considerable costs in this investgaton and will want to ensure that the frm
is actng in good faith during this period. To protect himself, the Investor will
normally request the frm execute an exclusivity agreement where the frm
agrees not to seek investment from any other party during the due diligence
period. A penalty may be agreed for a breach of this conditon.
One objectve of the due diligence process is to investgate the frm to see
if the business itself has any major problems which have not been identfed in
the informaton already provided to the Investor. The due diligence process will
undertake a validaton of all aspects of the existng business as presented in the
business plan. This would include most of the following:
• background checks on the key executves and key employees
• review of all fnancial informaton and additonal investgatons where
necessary to validate key numbers
• inspecton of all key contracts
• interviews with major customers, suppliers and distributors
135
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
• verifcaton of costs, expense levels and purchase commitments.
This process will check the integrity and honesty of the frm as well as provide
a view on how well the business is managed and on the adequacy and accuracy
of the informaton which is being used in the business. It will also uncover how
well the key executves understand their own business and the ease with which
they are able to access and provide additonal details necessary to the analysis.
A key part of the due diligence process is for the Investor to identfy anything
which would incur additonal costs, create delays or expose the business or
the Investor to actual or potental liabilites not identfed in the informaton
provided to the Investor. Items which frequently create problems include:
• non-standard customer contracts
• non-standard supplier agreements
• harsh lease conditons
• loose IP agreements
• overly generous reward and remuneraton systems
• generous health or vacatons benefts
• shareholders’ rights, legal structures, joint ventures, opton schemes
and
ant-diluton arrangements
• poor reportng systems
• out-of-date equipment
• poor quality products or services
• personal use of company funds or resources
• pre-existng obligatons, rights, commitments or restrictons
• non-standard rights of existng debt holders.
A business which is efectvely and efciently run, has good customer,
distributor and supplier relatonships and has good internal reportng systems
which monitor performance, ensure adherence to compliance regulatons and
protect the business from mistakes, should have few problems in satsfying the
Investor.
Afer the frm has satsfed the Investor with regard to its current operatons,
the Investor will examine the business projectons and other planned targets
and milestones which underpin the business plan. This is the area which exposes
136
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
the Investor to the greatest risks. This investgaton will review the following:
• the identfcaton of the prospectve customers and the quality of the
benefts the customers gain from the product or service
• the size and growth rate of the prospectve market
• the size, strength and strategies of current and potental compettors
• the quality of the intellectual property underpinning the business
plan
• the quality of the sales, marketng and distributon strategies
proposed
• the likely ability of the management team to be able to execute the
business plan
• availability of executve and specialised staf needed to grow the
business
• the quality of the exit strategy proposed
• the likely cash fow over the expected investment period.
To the extent that uncovered risks reduce the probability of achieving
the desired outcome or delay the tme to execute, the value of the potental
investment declines. In some cases problems can be overcome by installing
additonal controls, renegotatng agreements and putng in place alternatve
strategies. However, these may result in additonal costs or delays in executng
the business plan. To the extent that problems cannot be easily resolved or the
entrepreneur is reluctant to make changes, the investment will incur greater
risks. At some point the Investor will decide that the risks are too great and will
decide not to make the investment.
If the investgaton results in an agreement to proceed with the investment,
the frm will most likely incur the costs of the due diligence plus the legal fees
associated with the preparaton of the investment agreement. Fortunately,
emerging businesses are ofen quite small and the amount of investgaton
needed to understand their current operatons is also small. Due diligence costs
should be reasonable relatve to the size of the investment.
Part B of this book sets out an ideal operatons checklist against which the
current business can be measured. Start-ups and early stage frms are unlikely
to have sophistcated control and reportng systems in place, but these can be
introduced over tme as the business develops. The checklist can form a guide
137
Raising Angel & Venture Capital Finance
Chapter 10: Finalising the Investment
to the development of the governance and operatons management within the
frm as it prepares for its next stage of growth. Firms which antcipate accessing
venture capital or expect to undertake an IPO will need to score highly across all
elements of the operatons Index.
138
Raising Angel & Venture Capital Finance
11
F
or the entrepreneur to dramatcally increase the probability of
successfully raising Angel or Venture Capital fnance he needs to create a
business proposal with these characteristcs:
• a well-artculated and highly probable exit strategy within three to
fve years;
• a detailed plan to achieve the exit conditons;
• an experienced executve team that can deliver on the plan;
• a product/market opportunity that has sufcient compettve
advantage that it has a high probability of reaching the exit
conditons; and
• an inital valuaton and a likely exit valuaton that will provide the VC
fund with a 25%+ plus ROI.
The entrepreneur needs to accept at the outset that there is a high probability
that the exit will be by way of a trade sale, in which some of the executve team
may be made redundant. Even if an IPO strategy is planned, a trade sale should
also be considered as part of exit planning.
The successful entrepreneur creates a business opportunity which meets
the objectves of the Angel or the VC fund, not the personal ambitons of the
executve team. Private equity investors are not solely in the business of building
frms or the commercialisaton of inventons. Whilst this may be a by product of
Conclusion
139
Raising Angel & Venture Capital Finance
Chapter 11: Conclusion
their investment, their principal focus is simply to invest their own funds or the
funds of their private investors and administer that investment to an exit to gain
a high rate of return to the investors. In the case of the executves of a VC fund,
their personal remuneraton is ted to that of their investors and their future
ted to the total return on the fund, thus their motvaton is the return on the
investment, not being nice to the entrepreneur or keeping the business going.
The entrepreneur who creates a business opportunity which meets these
needs has a high probability of raising fnance.
140
Part B: Indices
Raising Angel & Venture Capital Finance
PART B
Investor Ready Indices
141
Raising Angel & Venture Capital Finance
A
ngels and VC investors typically invest in start-
up or early stage ventures where the business is
somewhat unsophistcated, management ofen inexperienced, products
are in development or in their early release stage and internal systems are
poorly developed. In these circumstances it is unrealistc to expect that the
business will be as ‘investment ready’ as it would be for an expansion stage
or late stage venture capital investment. Therefore, instead of measuring the
business proposal against an established business, the Investor will look at the
management team and the underlying assets and capabilites of the business
and try to measure whether it has the potental to emerge into a proftable,
sustainable, growth business or a strategic value business which could provide
the Investor with the exit they desire.
Antcipated development of the business should provide the potental
of taking the frm to an ‘investor-ready’ state if further capital injectons are
required. At the same tme, the Investor should be preparing the business for a
trade sale, since this is the most likely exit path. An IPO is unlikely, but possible;
the Investor should keep this in mind as they investgate the business and help
it grow and develop.
Part B sets out pre-investment selecton criterion of the prospectve investee
frm. The frst evaluates the alignment of the investee shareholders and
Introduction
Part
B
142
Part B: Indices
Raising Angel & Venture Capital Finance
management and then there are three major development charts; the frst
assists the Investor to evaluate the venture potental and the second provides a
means of guiding the development of the internal governance and management
processes and systems which will be needed for an efectve exit. Using these
Indices, the Entrepreneur can judge the atractveness of the venture for outside
fnance. Finally, the Strategy Index guides the entrepreneur on the process of
raising fnance.
The Awareness and Alignment Index (AAI) has been designed to capture the
attudes and preparedness of the entrepreneur, shareholders and management
team of the business to a possible injecton of external capital. Using the AAI,
the Entrepreneur can work through the issues which will confront the Investor
as he assesses whether the management and shareholders are ready for an
injecton of external equity fnance. The Entrepreneur can use the AAI to
prepare the venture for investment.
Once the Investor is convinced that the frm understands the nature of an
external equity investment and the impact it will have on the current managers
and shareholders, the Investor will then use the Venture Potental Index (VPI) to
measure the quality of the investment proposal. The VPI provides a systematc
method of measuring the quality of the business concept in terms of its ability
to support development of the business to a point where a proftable exit can
be achieved. An investor ready business is generally regarded as one in which an
Angel or Venture Capital (VC) fund would be keen to invest. The list of atributes
has been refned in consultaton with a number of successful entrepreneurs who
have raised venture capital, a number of private equity professional advisors as
well as a number of venture capital general partners.
The Entrepreneur who is keen to develop their business using external
private equity can use the VPI to measure their ‘investor ready’ state. Where
they see defciencies, they can, where possible, adjust their business concept,
change products, markets and organisatonal structure and so on, to create a
beter candidate for investment. However, a venture which scores low on the
VPI and which cannot be readily changed, will be an unlikely candidate for
external private equity fnance.
The Entrepreneur should also be sensitve to the fact that the VPI keeps in
143
Part B: Indices
Raising Angel & Venture Capital Finance
mind the potental for a trade sale exit and assesses whether the venture has
the potental for either a fnancial or strategic exit.
The next Index is the Operatons Development Index which (ODI) should
be used as a checklist in evaluatng the quality of operatons management in
the venture. Its primary purpose is to provide a guide for the development of
governance and operatons management once the investment has been made
and to indicate to the Investor how much work needs to be done to prepare
the venture for an exit. A business which scores more highly on the ODI will
be a venture which is easier for the Investor to work with and will be beter
positoned for an early exit. Certainly those frms which achieve a higher score
on the ODI will be more efectvely and efciently managed and so allocatng
resources to improve their situaton according to the ODI would beneft day-to-
day operatons.
Raising Angel or VC fnance is a process which needs to be managed over
tme. There are a series of actons which need to be taken both within and
outside the frm to secure the investment. The fnal Index, Strategy, provides a
process whereby the frm can assess its progress towards closing an investment
proposal.
Each atribute of the Indices helps to defne the state of readiness of the
frm either for investment or exit. It is unlikely that any frm would have an ideal
positon on every item; however, the scoring will indicate where improvements
can be made or problems addressed. The AAI will show the Investor where
the frm is currently in their preparaton for external investment and should be
used by the entrepreneur to stmulate discussion and acton within their frm
to ensure the frm is beter prepared for inital discussions with an external
investor.
The VPI can be used to undertake an inital evaluaton of the likelihood of
being able to secure investment and then later to guide development of the
business to an investor ready or exit objectve. The ODI will help identfy just how
well developed internal processes of governance and operatons management
monitoring systems are and guide development work on their implementaton
and improvement. In many cases, specialist assistance will be required to
implement changes needed to reach higher Index scores.
144
Part B: Indices
Raising Angel & Venture Capital Finance
The purpose of the Indices is to help the Entrepreneur evaluate their own
chances of securing investment and to manage the process of securing the
investment. The frst three Indices mirror what an Angel or VC investor will
evaluate in assessing the venture for investment. It is thus a comprehensive and
systematc way of investgatng a proposed investment and should help isolate
any serious defciencies in the proposed business. Each queston or atribute
will provide an insight into the business and the work which will be needed to
make it investor ready.
Angel and VC investng is a process not an event. Historically, many Angels and
VC Investors thought that they could rely on their gut feel or on their evaluaton
of the entrepreneur and a quick walk around the frm’s ofces to judge the
quality of the investment proposal. While these factors are important, the
investng process has become much more formal and sophistcated, especially
through the development of formal Angel syndicate investng. Angels and VC
investors now appreciate that a systematc and comprehensive review is more
likely to catch fatal faws and problems.
In many cases, the efectvely managed frm will score highly on an atribute.
In other areas, where no atenton has been given to preparing the business for
an external investment, litle will have been done. By scoring these atributes,
you will fnd out the status of the business and identfy what needs to be done
to prepare it for external investment. Alternatvely, you may fnd out something
which will cause you to abandon seeking external investment.
The Indices are constructed with an ‘atainment’ or ‘achievement’ scale of
1-5. To complete an Index, you should circle the descripton which is closest to
the current positon.
Nothing Litle Reasonable Signifcant Fully N.A.
done progress progress progress atained
1 2 3 4 5
N.A. = Not applicable
Once you have identfed where the frm is on the atribute, you will be able
to see from the later descriptons the actons which you might need to take to
turn this venture into one which will atract Angel or VC investment.
145
Raising Angel & Venture Capital Finance
Awareness and
Alignment
A
A
ngel and VC investment is benefcial for
many businesses, but it is not for everyone. In
fact, it may directly contradict some shareholder’s plans for the business. At
the same tme, the venture may be inappropriate for an external investment.
What is clear is that the shareholders and senior management team should
understand the domain and objectves of the Investor and seriously consider
whether they are willing to meet the conditons and obligatons inherent in
that type of investment. The business which is able to show the potental for a
successful exit sought by an Investor would stand a good chance of gaining Angel
or VC investment, but the conditons which come along with the investment
may stll be unacceptable to the business. Thus some educaton in this area is
certainly benefcial for anyone considering this type of investment.
Once the nature of an Angel or VC investment is understood, there stll needs
to be a clear understanding on the part of the shareholders and management as
to the objectves to be achieved through the investment. Those objectves need
to be aligned closely with those of the Investor.
146
Part B: Indices
Raising Angel & Venture Capital Finance
A1. Majority shareholders agree on an external equity
fnancing strategy
The obvious implicatons of an external investment are:
• A diluton in existng shareholders’ equity.
• Some constraints on executve decision-making, especially with regard
to the issue of shares, extensions of debt and executve remuneraton.
• Management will be expected to agree to various performance targets.
Failure to achieve those may result in a loss of votng rights, terminaton
of management contracts and the business being sold.
• Internal systems will become more formal and a higher emphasis will be
placed on record keeping, governance and compliance.
• A formal Board of Directors will be required (if it does not exist already)
and the Investor will almost certainly want at least one positon on that
Board.
• An exit strategy for the Investor will most likely have to be achieved
within 3-7 years. This may be in the form of a buyback, trade sale or IPO.
• Additonal rounds of capital injecton may be required from Angels or a
VC.
The majority shareholders need to seriously consider the implicatons on
their own ownership positons and, where appropriate, their roles as managers
and directors. The majority shareholders need to agree on the need for the
external investment for there to be an efectve plan to proceed to raise the
investment.
Self-assessment
1. Discussions have not been undertaken with or between the major
shareholders.
2. Majority shareholders have talked about taking on an external
investment but have not taken the discussions seriously or established
any consensus about tming.
3. The shareholders have agreed on raising external capital but as yet have
not decided on a strategy.
147
Part B: Indices
Raising Angel & Venture Capital Finance
4. The majority shareholders have agreed how they will approach the
project of raising external capital and have formulated a strategy but
have not taken professional advice on whether the strategy has a
reasonable chance of success.
5. The majority shareholders have refned a strategy in conjuncton with a
professional advisor.
A2. Managers and owners agree on use of funds
Any approach to an external investor should be able to show how the use of
the investment funds will directly contribute to the development and growth of
the business and to achieving the objectves of the Investor. Too ofen applicants
seeking Angel and VC investment are focused on solving business problems,
refnancing an ailing business, buying out a shareholder or trying to build a cash
bufer, rather than directng their atenton to providing the external investor
with an outstanding opportunity. Even where there is an obvious investment
opportunity, there may be disagreement among the managers and owners over
how the growth and proft objectves are to be achieved.
Angel and VC investors are rarely experts in a specifc business, especially
when a business works with complex technologies or is based on specialist
knowledge. Thus the investor is reliant, to a large extent, on the managers of
the business to come up with a resilient plan to achieve the growth objectves
needed to satsfy the investment objectves. Unless the management have taken
the tme and efort to develop such a plan, disagreement is likely to occur in the
management team as the investor digs into their intended strategy. Nothing is
likely to kill of a deal faster than an investor being exposed to a lack of agreed
strategy or a team which clearly is not in synch.
The management team needs to be able to show the Investor a robust
business plan which incorporates the use of the investment funds and shows
the expected growth of the business and how the objectves of the Investor can
be achieved. This needs to be endorsed by the majority shareholders and by the
current Board of Directors. To ensure the plan is consistent with the requirements
of the Investor, it should be presented in a way that the Investor can evaluate
it and build an investment proposal for discussion with any co-investors. It
would be helpful to the Investor if the business plan had been reviewed by
148
Part B: Indices
Raising Angel & Venture Capital Finance
professional advisors who work frequently with Angel and VC investors. This
would be helpful to the Investor as the professional advisor’s recommendatons
for layout, style and detail and any changes they advise on the use of the funds
could be agreed with management and majority shareholders and incorporated
into the business plan before it is sent of to the Investor for evaluaton.
Self-assessment
1. Senior management and majority shareholders have not discussed how
any investment would be used.
2. Discussions have been held by senior management but there is no
consensus on how or where the funds will be used.
3. Managers and majority shareholders are agreed on the priorites for the
use of investment funds but have yet to integrate this into a proposed
investment business plan.
4. A detailed investment business plan has been created which shows how
an external investment would be utlised and has identfed the results
which would accrue to that investment; however, professional advice
has not been sought as to whether this would meet the needs of the
Investor.
5. Professional advice has been sought on the use of the funds and
adjustments have been made to the investment business plan to
incorporate that advice.
A3. Entrepreneur and key managers are committed to
the venture
Without the entrepreneur and the key management team the venture is
unlikely to be successful. The Investor needs to see a commitment on the part
of the key individuals to ensure they will put their best eforts into the venture.
The Investor is not a full-tme member of the management team and so is reliant
on the entrepreneur and the management team to take the business forward.
The business has to be operated on a daily basis by those most commited to
it, even if the task becomes onerous or stressful. The Investor wants to see that
these individuals have something at risk if the venture fails and much to gain it
if is successful. The Investor needs to have some assurance that members of the
149
Part B: Indices
Raising Angel & Venture Capital Finance
team won’t bail out when things go wrong or when they need to step up their
commitment to see the venture through hard tmes.
A conditon of many external investments is to have senior management
share in the risks as well as the rewards. This may be through an equity stake,
employee optons, generous bonuses on successful completon of milestones
and/or a bonus on a successful exit. A business which does not refect this
balance of risk and reward for key individuals will need to implement ownership
and bonus structures which provide the Investor with an assurance that the key
individuals are commited to making the venture successful.
Self-assessment
1. The frm has not considered this issue. Some key individuals do not have
equity or optons and bonus systems are not in place to motvate long-
term commitment.
2. Most senior management have equity but, for some, their allocaton is
not at a sufcient level to ensure long-term commitment. Small bonuses
are possible on achieving individual objectves.
3. Each of the senior management team has adequate incentves in the
form of equity and/or optons to be commited to the venture. Other key
employees have bonuses for personal achievement.
4. Senior management and key employees have equity and/or optons
sufcient to motvate them to stay commited to the venture. In
additon to personal bonuses, there are corporate-wide bonuses for
major milestones. The system of rewards has not been reviewed by
a professional advisor to ensure it would be sufcient to support an
external investment.
5. The allocaton of equity and optons and the system of bonuses have
been reviewed by a professional advisor and adjusted to assure an
Investor that it provides a good basis for key executve and key employee
commitment to an external investment.
150
Part B: Indices
Raising Angel & Venture Capital Finance
A4. Key shareholders are familiar with exit conditions
External investors are faced with a lack of liquidity when it comes to
recovering their investment in a private business. Generally few investors wish
to hold a minority positon in a private company as they have litle control
over the events of the business and generally are unable to recover their
money when they need it, especially if the business gets into trouble. Thus the
investor imposes on the frm a series of conditons which will efectvely force
the business to undertake a liquidity event within a reasonable period of the
investment, say 3-7 years, in order for the Investor to recover their money and
hopefully achieve a reasonable return on their investment.
The exit conditons are mainly as follows:
• If an ofer is received for the business, the Investor may force the
shareholders to accept it.
• If the shareholders wish to sell their shares, they will not be able to do
so without selling those of the Investor.
• The business may need to undertake an IPO within a set period or, failing
that, be put up for sale.
• The existng shareholders may be required to buy back the shares of the
Investor afer a certain period where failure to do so would result in the
sale of the business.
• Failure to achieve agreed performance targets may result in the Investor
taking control over the business. Once this is achieved, the Investor
might decide to sell the business in order to liquidate their investment.
Self-assessment
1. Key shareholders have litle or no knowledge of Angel and VC
investment conditons.
2. Key shareholders are agreed which the frm could be sold if they fail to
meet targets but are unaware of how this would work operatonally.
3. The key shareholders are aware of the diferent conditons which will
be imposed on them in terms of the performance requirements of the
Investor but senior management and majority shareholders have not
151
Part B: Indices
Raising Angel & Venture Capital Finance
discussed how this will work or how they will manage the business to
meet those targets.
4. Senior management and key shareholders have developed an external
investment plan, with events and targets which senior management
believe are achievable, which will meet the management and exit
requirements of the Investor and stll leave them in control during the
investment phase.
5. The frm has engaged a professional advisor to brief them on the
investment conditons of an external Investor and has reviewed the
investment plan to ensure that management has a reasonable chance of
meetng the Investor’s conditons.
A5. Cost and time for raising funds is understood
Few entrepreneurs appreciate the level of tme, efort and costs which they
will incur during the process of raising external investment. Those who have
been through the process estmate that 50% of the CEO’s tme and much of
the CFO’s tme over a period of three to nine months will be consumed with
preparaton, presentatons and negotatons. In additon, the due diligence
actvity can easily consume many months of staf tme. During this process, the
business has to be directed and managed without impactng on revenue and
proft – a very tall order indeed.
Beter preparaton can considerably ease the burden on the executve team
and administraton staf. This may include compilaton and update of due diligence
fles, a periodically updated business plan, regular and comprehensive monthly
management reports, compliance audits and performance reviews based on key
performance indicators and budgets. By working with knowledgeable advisors
during preparaton for an investment, the tme to fnd the right investor will
be cut and the discussions streamlined as the executve team will be beter
prepared for the negotatons.
An Investor will want to spend tme with the senior executves to get to know
them and to develop an understanding of the business. This will take most
senior executves away from the business for signifcant portons of tme. The
business needs to have a plan in place so that the rest of the executve team can
carry on without undue disrupton to the fow of actvity.
152
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Senior management and majority shareholders have not discussed the
tme and resources required to raise external investment.
2. The frm has some idea of the tme and efort required but has yet to
allocate these or consider how the business will operate while senior
management is diverted into that actvity. The cost incurred to raise
funds has not been estmated.
3. Advice has been sought on the process of raising investment and the
amount of tme and efort has been clearly identfed but responsibilites
for actvites and succession plans have not been planned or agreed. The
cost incurred to raise funds has been estmated.
4. Responsibilites for the investment raising actvity have been allocated
but responsibility for managing the ongoing operatons has yet to be
clearly allocated and assigned.
5. A plan has been agreed with senior management and subordinates with
respect to roles and responsibilites for undertaking the investment
actvites as well as the running of the day-to-day operatons. A budget
has been allocated for the costs associated with raising the investment.
A6. Board of Directors accept authority limits of an
external investment
Many immature businesses seeking external investment have litle
experience with formal Boards of Directors and will fnd the process of setng
up a Board and handing over authority for signifcant strategic decisions very
uncomfortable and ofen frustratng. No longer can the executve team meet
whenever they feel like it and make a decision which materially afects the
shape of the business. More developed frms which have consttuted a Board
of Directors may have friends and family on the board and perhaps a trusted
family advisor, such as a local lawyer or accountant. With the introducton of the
external investor, the role of the board will change markedly and the existng
executve directors will have to justfy their actons, defer major decisions to
the Board and allow the Investor to have the fnal say on a number of strategic
actvites. This can be very confrontng to the entrepreneur who is used to
having the Board rubber stamp his or her actons.
153
Part B: Indices
Raising Angel & Venture Capital Finance
The investment agreement will specify that a number of actvites can only
be taken with the approval of the external director. This would almost certainly
include issuing new shares, declaraton of a dividend, changes in senior
management remuneraton, changes in levels of debt and approval of capital
expenditure. The following descriptors refer to the Board of Directors prior to
an investment.
Self-assessment
1. The Board of Directors have litle understanding of the authority limits
imposed under an Angel or VC investment.
2. The Board of Directors understand that there will be some constraints
on decisions they make but are unfamiliar with the type and extent of
such limits.
3. The Board of Directors has reviewed a list of the limits on authority
which will be placed on them by an Investor but have yet to translate
these into operatonal or strategic impact.
4. The Board of Directors understands and accept the limits on their
authority imposed on them by an Investor but have yet to translate this
into operatonal details and procedures.
5. The Board of Directors have reviewed the authority limits imposed by an
external investment with a professional advisor and has implemented
various limits on the authority of management and established
procedures for how issues relatng to those items will be handled in
Board meetngs.
A7. Post-investment management roles and
responsibilities accepted
Experienced Investors place great emphasis on having the right management
team in place. This refects the wisdom of having an experienced team with
the right mixture of qualifcatons, skills, networks and industry experience but
also the lessons learned over the years by Angels and VC Investors that few
plans are implemented as expected. The experienced entrepreneurial team
adapts to changing circumstances and copes well with unforeseen events. The
current management team will be thoroughly scrutnized and gaps exposed.
154
Part B: Indices
Raising Angel & Venture Capital Finance
The Investor may well suggest (and impose) management changes either
through a new alignment of roles and responsibilites or the introducton of
new executves.
Clearly it is in everyone’s interest to have a successful venture. The business
which sees an investment as an opportunity to introduce new talent into the
business will be well received by the Investor. Finding experienced executves
who have experienced growth to the level the venture needs to achieve can
make all the diference in the success of the venture. At the same tme, the
entrepreneur will need to acknowledge that some of his current team may be
inappropriate for the new growth plan. Regretably that means that some of
the current executves may lose their jobs or be relegated to more junior roles.
Understanding that such changes may occur and being willing to work through
them to fnd the best overall soluton, will be critcal in securing an investment.
Self-assessment
1. Senior management and majority shareholders are not aware that any
changes could or would be made to their senior management team or
their responsibilites.
2. Senior management have reviewed their management experience and
functonal expertse and experience and have determined that they have
some gaps but are yet to develop a plan to address them.
3. Specifc skill gaps have been identfed in the management team. Senior
management and majority shareholders have acknowledged that the
Investor may require changes in responsibilites, a new organisatonal
structure or some new senior executves. However, this has not been
accepted by senior management and they have not accepted that it
might be a conditon of the investment.
4. Senior management and the majority shareholders have acknowledged
and agreed that they lack a number of skills, the organisaton structure
may need to be changed, an Investor may require some new executve
talent and their current roles and responsibilites are most likely to
change.
155
Part B: Indices
Raising Angel & Venture Capital Finance
5. A professional advisor has reviewed the management team, organisaton
structure and responsibilites and proposed changes in structure and
roles. The advisor has also helped the frm to develop a proposal for
flling gaps in the management team which has been included in the
investment plan. The current management acknowledge that an Investor
may have a diferent view and the new structure and roles will need to
be negotated and agreed with the Investor.
A8. Angel and VC valuation models are understood and
accepted
Many deals are never concluded or, in fact, never proceed to substantal
business negotatons because the majority owners have quite unrealistc
views about what the business is worth. It is important that the frm seeking
external investment have some understanding of valuaton methodology.
While it is always possible for valuaton formulae to be used which are based
on performance or on an exit value, it is unlikely that this will be agreed in the
early stages of the discussion.
It is important that each party accept the valuaton norms of the Angel or VC
investment sector prevailing at the tme they are seeking investment. This way
valuaton does not get in the way of the negotatons proceeding. Variatons to
the norm can then be negotated based on how future risks may be translated
into equity share. The process set out here provides a basis for negotatng value
but it starts with an understanding of conventonal valuaton techniques. From
that point, the entrepreneur or Investor can argue for a variaton which perhaps
beter refects the risk tolerance of each party.
Few entrepreneurs have current knowledge of what is happening in the Angel
and VC investment sector and this is where access to knowledgeable advisors
can be a great help. The advisor can provide the entrepreneur with informaton
on current transactons and also work with the frm to develop a valuaton
which could be used in the investment discussions. An Investor will recognise
that the entrepreneur has sought professional advice and will be expectng that
the valuaton proposed will be close to the fnal negotated value.
156
Part B: Indices
Raising Angel & Venture Capital Finance
In the case of a potental strategic trade sale, the entrepreneur or the Investor
may have some view on the value to the potental buyer and this may be used
as a basis for a valuaton discussion.
Self-assessment
1. The frm has no appreciaton or knowledge of how an Angel or VC
Investor will establish valuaton and equity arrangements.
2. The frm understands conventonal valuaton formulae and antcipates
that this will be used by the Investor as a basis for negotaton but has
no real understanding of how the fnal valuaton and equity share will be
determined.
3. The frm has some familiarity with valuaton techniques used by the
Angel and VC investment sector and some knowledge of how equity
will be structured following an investment but does not have a good
understanding of how this might be applied in their venture.
4. The frm has built a valuaton model based on conventonal Angel and
VC valuaton methods and has determined what they believe will be
a reasonable basis for valuaton and equity share but has not had this
validated by a professional advisor.
5. The frm has engaged a professional advisor to assist in the development
of a valuaton and equity share model which would be acceptable as a
basis for negotaton with an Investor.
A9. Level of fnance required is realistic
What can go wrong will go wrong. Perhaps not – but this is the view which
most Investors take when evaluatng the level of investment required to provide
a frm basis for development of the venture. Under-funding during the critcal
growth stages can place the business in a desperate situaton where product
development is not quite fnished, cash fows are not yet positve or market
development has not reached a critcal turning point. Typically, the only opton
frms have at this point is to seek a further injecton of cash. Unfortunately this
can ofen only be achieved at a valuaton lower than the one established when
the inital Angel or VC investment was made. Investors will negotate hard to
avoid this situaton.
157
Part B: Indices
Raising Angel & Venture Capital Finance
A realistc view of the funds needed can only be achieved through a thorough
simulaton exercise of the venture. Various scenarios need to be created across
a range of possible outcomes which include worse case, most likely and best
case situatons. In this way, the sensitvity of the venture to the level of funding
needed and the estmated return to an Investor can be ascertained. With this
knowledge, the frm can beter negotate the investment. It may be possible
for the investment to be taken in tranches to refect funding needs and for
the equity positon to be adjusted accordingly. The Investor can then set aside
the maximum likely investment funds but recognises that not all of it may be
needed.
Self-assessment
1. Senior management has not undertaken any rigorous analysis of the
fnancing requirements of the business.
2. The funding requirements of the current business are well known
and understood but this has not been reviewed in light of the ROI
requirements of an external investor.
3. The frm has considered the ROI requirements of an Investor and has
considered the impact this might have on the business strategy and but
has yet to translate this into the business plan.
4. The ROI requirements have been worked into the business strategy
and into the operatonal business plan, establishing the level of funding
which would be required from an Investor, but this has not been
reviewed by a professional advisor.
5. A professional advisor has reviewed the funding requirements,
requested a sensitvity analysis on the strategy and assisted the frm to
establish the level of funding they believe an Investor would be expected
to provide in order that the investor’s desired ROI has a reasonable
chance of being achieved.
158
Part B: Indices
Raising Angel & Venture Capital Finance
Awareness and Alignment Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
A1 Majority shareholders agree on an external fnancing strategy
A2 Managers and owners agree on use of funds
A3 Entrepreneur and key managers are commited to the
venture
A4 Key shareholders are familiar with exit conditons
A5 Cost and tme for raising funds is understood
A6 Board of Directors accept authority limits of an external
investment
A7 Post-investment management roles and responsibilites
accepted
A8 Angel and VC valuaton models are understood and accepted
A9 Level of fnance required is realistc
159
Raising Angel & Venture Capital Finance
B
Venture Potential
T
he essence of any Angel or Venture Capital investment
evaluaton is the quality of the management
team (as discussed in Awareness and Alignment) and the quality and viability of
the business concept itself. That is, how and where is the money made and how
does the investor get a return on their investment? The Investor is looking for
a set of atributes which, in a holistc manner, provide a strong and compelling
business case for an investment. Each atribute should lead to a high probability
of a successful outcome. Any atribute which has a weak situaton leaves a gap
in the plan and can lead to failure or erosion of the business by an internal or
external weakness or threat.
We need to diferentate in our evaluaton of a potental investment between
those ventures which are being prepared for a fnancial exit, a fnancial trade
sale or an IPO, from those which are destned for a strategic exit. In a fnancial
exit, the robustness of the business concept and its ability to generate growth
in revenue and profts are critcal. In a strategic exit, what we are seeking
are strategic value assets or capabilites and a management team to take the
venture to a strategic trade sale. In a strategic sale the buyer will be providing
the horsepower to take the product or service to market, capabilites to drive
revenue and proft growth may be of litle consequence in the proposed venture.
160
Part B: Indices
Raising Angel & Venture Capital Finance
The atributes listed in this Index are those which have been found to have
a signifcant impact on the success of fnancial ventures. While they apply to
all fnancial businesses, later stage businesses may already have moved past
the point where they can substantally change their market positon, however,
these should have proven revenue and proft to show a viable business concept.
Many of the product/market atributes are also critcal for strategic ventures.
An Investor in unlikely to fnd a venture which scores highly on all atributes,
but since they are constantly seeking investment opportunites, each possible
deal must compete with other investment opportunites which the Investor has
reviewed. The Investor is looking for those ventures which have the greatest
potental and the highest probability of success. It is almost certainly the
case that assistance from an Investor would improve the business, afer all,
this is what the Investor is looking for – an investment where they can add
value through their knowledge and fnance. The Investor may be able to fnd
additonal executve talent to fll out the team, connect the frm with strategic
customers or alliance partners or secure a strategic supplier.
In evaluatng the venture potental, it may be that the Investor, with superior
knowledge of a partcular market, may see greater potental than has been
evidenced by the entrepreneur. For example, the Investor may know a strategic
partner relatonship which can be readily secured or a potental acquirer for the
business. While such insights cannot be guaranteed, the Entrepreneur should
seek out an Investor who has experience in their sector so that synergistc
benefts can be tapped.
B1. Business and economic conditons support the venture
Ventures which are most likely to succeed are driven by signifcant change,
whether this is in technology, legislaton, consumer values or the economy.
New technology ofen solves problems which were previously not able to be
addressed or signifcantly enhances productvity or reduces cost in solving
existng problems. Obvious demographic trends create new needs in housing,
aged care, infrastructure, travel services and so on. New legislaton ofen creates
new opportunites in compliance training and auditng.
161
Part B: Indices
Raising Angel & Venture Capital Finance
Investors look for the problem the business is solving. The more obvious
the problem and the greater the imbalance between demand and supply, the
more urgent the need is and the higher is the likelihood that the business will
be successful. Businesses need to solve a problem or meet a need and the
entrepreneur should be able to show the source of that need and the size of it.
This should be able to be validated with independent data.
Self-assessment
1. Evaluaton has not yet been undertaken.
2. There are changes which appear to support the venture but evaluaton
has not been undertaken. The proposal is based on personal opinion.
3. There are clear indicatons of changes which support the venture in
external independent informaton. Validaton has not been undertaken
of the strength or likely duraton of the need or to what extent the need
is currently being satsfed.
4. Business and economic conditons which support the venture are well
documented and supported by externally validated data. Informal
research shows that the business need is unsatsfed and a strong
demand for a soluton exists.
5. Business and economic conditons strongly support the venture either
through legislatve changes, strong demographic changes, major shifs
in consumer values, major changes in technology or major economic
shifs. The proposal is strongly underpinned with validaton data, expert
opinion of customer needs and the lack of a currently available soluton.
162
Part B: Indices
Raising Angel & Venture Capital Finance
B2. Well artculated, focused vision of the purpose of the
venture
More successful ventures have focus. They clearly know the problem they
are solving and have a very good descripton of their customer. They are able
to artculate why they exist, ofen in very simple terms. The purpose of creatng
a short, focused vision of the venture is to ensure that all parts of the business
are heading in the same directon and are supportng the various parts and
not undermining it. Decision-making should become easier, actons are more
targeted and results can be measured in terms of where the business should
be heading.
Few external investors have the specialist knowledge to evaluate the technical
merit of a range of diverse business ventures. However, they can appreciate a
clear non-technical statement of what the business does and the need or problem
it is addressing. Nothing is more of-putng to an investor as the entrepreneur
who has a product that solves everything, which will be available everywhere
and should be bought by everyone. Nor do they appreciate the venture team
which can’t decide which of the many problems they are going to address frst
or which market they are targetng. A clear, focused vision statement which has
been carefully crafed, matches the compettve advantages of the venture and
is agreed to by the venture team, is an essental part of the investment request.
In the context of a strategic venture, the vision of the venture may simply be
to prepare the business for sale. However, the venture needs to see its vision in
terms of the way in which the buyer would see the vision of the acquired frm.
Thus a clearly artculated vision of product/market positoning is stll important.
Self-assessment
1. The venture does not have a vision statement.
2. The vision of the venture is stated in broad terms, lacks focus and may
be overly technical or lengthy.
3. The vision is brief but is overly technical, too long or fails to clearly state
who the customer is or the problem being addressed. The vision may
be stated in terms of a product for sale rather than a problem being
addressed.
163
Part B: Indices
Raising Angel & Venture Capital Finance
4. The vision clearly states the target customer, the problem being solved
and is well focused and brief but is overly technical. The vision may be
focused on a single product rather than a range of problems which may
be addressed within a complimentary set of products or services which
could be developed and delivered over tme.
5. The venture has a well-artculated vision of the business concept
including the problem being addressed and the solutons which are and
will be ofered. The vision is brief and to the point and is stated in terms
that an educated non-industry investor can clearly understand.
B3. Innovatve product, process or business concept
A business which does the same as every other business in the sector will
ultmately be forced to compete on price. If the product or service is the same as
others in the market, then without a compettve cost advantage over the major
expenses in the business, the venture has litle chance of growth and certainly
is not going to reach the levels of revenue and profts which the Investor is
seeking. Cost advantages rarely drive signifcant exit values. What the Investor
will be seeking are products or services which are diferentated sufciently so
they can command a premium price in a niche market.
The Investor looks for an edge. What is it that this business has or does which
will provide it with a compettve advantage? This almost certainly is driven
by an innovaton in product, process and/or business concept. The size or
impact of the innovaton is a metric which conveys informaton about the likely
compettve advantage. A substantal innovaton which signifcantly changes
the cost structure of an industry, greatly improves customer value or opens up
solutons to formerly unsolved problems, provides the underpinning for high
rates of growth.
Obviously, the more unique the innovaton and the more the customers
value the impact, the more it adds to the potental compettve advantage of
the venture. Innovaton which does not add to customer value may in fact
detract from the worth of the venture. If the innovaton adds costs to the
product but fails to add additonal customer value, the venture is unlikely to
164
Part B: Indices
Raising Angel & Venture Capital Finance
succeed. Innovatons which add costs but at the same tme signifcantly improve
customer value can create a solid foundaton for a business.
Self-assessment
1. The product or service is the same as many others in the market.
2. The product ofered has only minor diferences to the competton.
3. The product has clear diferentaton from others in the marketplace but
the diferences are not sufcient to necessarily capture customers from
compettve oferings.
4. The product has major diferences from compettve oferings and
customers will value those diferences. Products have a strong
compettve advantage.
5. The product has breakthrough advantages which clearly separate it from
compettors. Customers highly value the advantages and this will create
a leadership positon. Products are the only ofering in a new emerging
market or are the only products able to solve the target problem.
B4. Clear and compelling customer need
Clearly the most desirable positon for any frm to be in is for their product
to be needed desperately by a set of customers. This does not mean something
they desire or would like to have, or even something they want to have. This
refers to something they must have and, beter stll, must have now! You may
well argue that few products can ever be so compelling but, in fact, many basic
products would ft that need. Each person has a need for food and water, basic
accommodaton and security. Without electricity, water and sewage services,
life in urban areas would be impossible. This is possibly the major reason why
these services are regulated. Food is of course satsfying a basic need although
there are many alternatves. But the compelling need is stll there.
Some conditons do create compelling needs. Virtually all regulatons
have compliance requirements and associated penaltes for non-compliance.
A product or service which stops you from being fned or going to jail has a
high compelling need to buy. Products and services which neutralise or reduce
physical or psychological pain and sufering easily fall into the class of products
165
Part B: Indices
Raising Angel & Venture Capital Finance
which have a compelling need to buy. However, products which have litle
impact if not purchased, have many near substtutes or can be indefnitely
delayed have a low compelling need.
Some products, such as designer labels, well established and trusted brands
and products with high repeat-purchase atributes have a higher score on
compelling need to buy.
Self-assessment
1. The product or service has many compettve and substtute oferings
and is highly discretonary or optonal. Customers regard the purchase as
a nice to have rather than a must have.
2. The product satsfes a clear customer desire but it is neither urgent nor
pressing and can be satsfed by a large number of alternatve solutons
or products. Customers can decide not to buy without being overly
concerned.
3. There is a clear need, but satsfying the need can be deferred as it is
not an urgent need to satsfy. Customers have a strong preference to
purchase and would be concerned if they were not able to. There are
some acceptable near alternatves.
4. The need is obvious and of high value to the customer but may be
temporarily deferred or can be partly satsfed by poor alternatves.
Customers have a strong desire to purchase and would be seriously
concerned by deferring the purchase.
5. There is a compelling need to purchase to avoid high physical or
psychological pain, to avoid severe penaltes or costs or to obtain/
maintain compettve advantage. Deferment is not really an opton, nor
are there any substtute solutons.
166
Part B: Indices
Raising Angel & Venture Capital Finance
B5. Sufcient, willing, funded, identfable and reachable
customers
A great number of businesses target 16-25 year olds, tme poor executves,
free thinkers or people with a desire to feel young at heart. The problem with this
approach is that it is difcult to be proactve, to actually reach out and connect
directly with the target customer. These businesses are highly dependent
on passing trafc for business. It is far beter to have a clearly identfable
target customer who you can directly and proactvely approach. You need to
ofer something for which you know they have already expressed a need. For
example, a product for registered dentsts, members of a gym or subscribers to
a journal are easily approached with an ofer to purchase.
A clearly reachable, identfable customer is one you can get in front of with
your product or service message. Potental customers must be identfed with
a locaton where you can deliver your message. This also needs to be cost
efectve, thus a TV advertsement aimed at registered dentsts does not make a
lot of sense when a trade journal, a dental conference or a direct sales visit to a
registered dental surgery would have a higher conversion rate.
An important atribute of the target market must be that they have the
willingness and the ability to spend on the product or service. Furthermore, the
business needs customers in sufcient numbers in order that the business can
make enough revenue and proft to be a viable entty.
In a strategic sale, it will be the ability of the buyer to reach a customer base
which will be critcal to new revenue generaton but the need to have a clearly
defned customer is stll important for the strategic buyer. The defniton of the
customer profle will ofen provide the key to the identfcaton of the potental
strategic buyers. The customer/market defniton required in a strategic sale
is that of the potental buyer. That is, which large corporatons have a large
customer base of the target customer and have the capability and capacity to
sell the venture’s products or services into their customer base.
167
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Numbers of customers, their defned atributes and locatons and
whether they are willing and able to buy have not been established.
2. Customer defniton is reasonably clear but no atempt has been made
to establish whether they can be approached proactvely, are willing to
purchase or are in sufcient numbers to make the venture atractve.
3. A clear defniton of the customer exists, intenton to purchase has been
established but the size of the market has not been established nor has
a program been developed to proactvely reach them.
4. The size and locaton of a clearly defned existng and/or potental
customer market has been established. The size of the market has been
established and the level of buying intenton has been estmated.
5. A clearly identfable and reachable existng and/or potental customer
market has been defned and validated. There is a clear intenton to
purchase the specifc product of the frm and the size of the market
would support the projected revenue of the venture.
B6. Obvious and meaningful compettve advantage
If you have a product or service in a marketplace which is simply litered with
comparable oferings, you can have very litle hope that your venture is going
to be successful. If everything you do to be diferent can be readily copied with
litle efort, clearly you are in a business which has litle chance of success. Only
by fnding a strong point of diference in an atribute that the target customers
value will your own products or services carve out a segment of the market. The
most desirable positon to be in is to have a product which not only fully meets
the needs of the target customers, but has no compettor or near substtute and
has signifcant barriers to entry.
For a compettve advantage to be meaningful it needs to be validated
by actual or potental customers. The diference must be meaningful and
sufciently important to the target customers that they have a clearly expressed
preference for the product or service you are ofering. Validaton is also needed
to ensure that a close alternatve product is not available. A compettor analysis
is necessary for you to validate your compettve advantage.
168
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. A compettve analysis has not been undertaken.
2. The frm knows of a number of compettors but has not done any
systematc analysis of their positon relatve to the competton.
3. A compettve analysis has been undertaken and shows the frm has
some diferentaton which should appeal to potental customers.
4. The frm has a clear compettve advantage in its target market and
has validated this with potental customers who value the diferental
features.
5. The frm has outstanding diferentaton which is highly valued by
the target market or there are no obvious compettors and there are
signifcant barriers to entry.
B7. Well protected sustainable atributes
While the frm may have established a compettve advantage with its product
or service, this is really only benefcial if it can sustain and/or protect it over the
long term. Sustainability can be achieved from registered intellectual property
(IP) such as is the case of patents or copyrights. Protecton may lie in the fact
that the frm has certain rights which are exclusive or limited such as mining or
forestry rights or a licence to practce. Expert knowledge, if hard to acquire, in
limited supply or requiring extensive experience or training, may provide the
basis for a sustainable advantage.
Protecton can be legal rights which atach to patents or licences. Products
and services can be protected by being difcult, expensive or tme consuming
to copy. A business may protect itself by controlling elements of the market
such as preferred outlets, distributon channels or essental components. Other
frms may be efectvely locked out of a market through customer or supplier
agreements or by controlling the source of an essental resource input. The
ability to defend encroachment is an essental factor in maintaining protecton.
The frm which cannot defend a patent infringement, for example, has litle
protecton against a large well-funded predator.
169
Part B: Indices
Raising Angel & Venture Capital Finance
The value achieved in a strategic sale is directly related to the level of
exploitaton of the venture’s products or services by the buyer. Therefore, the
buyer is keenly interested in the level and sustainability of the compettve
advantage which will be passed to them by the seller.
Self-assessment
1. The venture has not been able to establish any long-term protecton for
its products or services.
2. Products or services have short-term protecton but this can be eroded
by a determined compettor or antcipated new products in the market.
3. Products have some level of long-term protecton but only through an
aggressive product development process, strong customer service and/
or features which appeal to a niche market.
4. The frm has strong intellectual property protecton through patents,
copyright or registraton rights but these may be overcome or eroded
by a determined and well-funded compettor although this would take
some years to be efectve.
5. The frm has very strong intellectual property protecton through
patents, strong branding, high customer loyalty or highly specialised and
difcult to acquire knowledge. Signifcant funding and/or strong alliance
partnerships are present to defend IP which can be expected to deter
copying.
B8. Resources and channels to distribute are in place or able to
be acquired
Great products or services which cannot be placed where customers can see
them, try them or buy them are simply not going to generate revenue in any
volume. A business which has an intenton to grow, especially one wishing to
grow aggressively, has to fnd channels to market which will put its products
in front of the intended target customers in sufcient numbers for growth to
be achieved. There are many possible channels to market and the business
needs to choose those which are most appropriate for the type of product or
service being ofered as well as the type and purchase preferences of the target
customer.
170
Part B: Indices
Raising Angel & Venture Capital Finance
Some products suit direct sales or telemarketng and/or telesales, so capacity
must be built within those channels. Can the business acquire, aford and train
sufcient skilled numbers of staf to handle the intended volume? If the product
suits a high volume distributon channel, can that be acquired or contracted at
a price which is cost efectve? Is the business able to utlise alliance partners
or joint ventures to take the product to market? Many small frms lack the
distributon reach to efectvely scale their business and need to fnd partners
to help them get to market. Is the business able to clearly show how the target
volumes will be achieved through the chosen distributon channels and is it able
to show that those channels are available, willing and afordable?
In the case of a strategic sale, it is the buyer who will provide the channels
to market. The assessment of the venture potental will measure whether the
product or service being developed can be readily rolled into the potental
buyer’s distributon channel. If it can, then the venture can easily satsfy this
atribute.
Self-assessment
1. Distributon channels are not in place.
2. The frm is constrained by limited in-house distributon capabilites, lack
of access to distributon partners and/or powerful distributon channels
which control the interface to customers.
3. The frm has a well-defned distributon strategy but lacks an exclusive
presence, incentves for distributon channels to put above average
efort into the products or a lack of capacity to handle signifcant
volumes.
4. The distributon strategy is well defned, is efectve in reaching the
target customers and can handle the volume of sales antcipated but
lacks robustness to be able to adapt to disruptve events or shifs in
channel commitment.
5. The distributon strategy is able to directly connect with the target
market in an arrangement which provides the frm with excellent and
tmely exposure to the customer. The channels are highly motvated
171
Part B: Indices
Raising Angel & Venture Capital Finance
and incentvised and have the depth and scope to cater for changed
circumstances and can readily support the volumes required to meet
fnancial objectves.
B9. Sales price and cost model provides robust achievable
margins
The business needs to be able to validate both price to customer and expected
costs of goods sold as well as fxed costs at each antcipated level of output. Prices
might be established relatve to compettors, perhaps supported by marketng
survey data. Cost data may also have been established through compettor
informaton or perhaps through a cost build-up model using quotatons for
external costs and cost allocaton for internal costs. For established products,
prices and costs should have already been validated through existng sales.
The business model will need to show that reasonable levels of proft can be
achieved within a short period of tme. Alternatvely, a business which cannot
move into reasonable proft must have a reliable source of contnued subsidies
to allow it to stay in business. The fnancial model should also be tested across
a range of possible business conditons to see if the business concept is robust
under worst, most likely and best case scenarios.
In the case of a strategic venture, the price and cost modelling must be
sufcient to encourage the strategic buyer to go ahead with the deal. If the
buyer can see a signifcant revenue opportunity with good margins and can
readily justfy the acquisiton, this will make it easier for the frm to be sold.
Self-assessment
1. Sales price and costs have not been established.
2. Sales prices are estmated and costs have been partly established but
neither validated.
3. Sufcient informaton on prices and costs has been ascertained to
establish that the products can be sold for a proft. However, a sensitvity
analysis has not been undertaken.
172
Part B: Indices
Raising Angel & Venture Capital Finance
4. Prices and costs have been established and margins have been
determined to be atractve. Volume sales show that proft targets
can be reached, however, sensitvity analysis to cost variaton or price
variaton has not been undertaken.
5. Sensitvity analysis has been undertaken across a range of possible price
and cost scenarios and over worst, most likely and best cases and all
scenarios produce acceptable levels of proft achievement.
B10. Integrated volume operatons (development,
manufacturing, logistcs, support and infrastructure) are
achievable
Many products or service businesses look great when the volumes are small.
This is ofen because the founders take special care over the development and
delivery of the customer soluton and the customer is given additonal assistance
to ensure a satsfactory outcome. However, when the business grows, volume
producton requires a level of planning and control which is not required or
needed when volumes or outputs are small. Logistcs need to be much beter
integrated, quality needs to be controlled throughout the entre value chain
and the business needs to have purchasing, human resources, marketng,
administratve and IT infrastructure to support complex operatons.
Businesses which can handle 10 or 100 transactons need to be massively
redesigned when the volumes reach hundreds and thousands. How will the
business cope if it needs to manage multple locatons? Does the business
have the right people, structure and resources to build a larger, higher volume
business?
Scalability and/or replicaton are critcal to a strategic sale. The venture needs
to be able to demonstrate that, in the hands of the buyer, signifcant volumes
will be able to be produced with stability in quality and reliability in tming.
173
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Assessment of volume operatons has not been undertaken.
2. An operatons plan has been produced but a detailed operatons plan
has not been constructed to see if the plan is achievable.
3. The operatons plan has been established at a low level of detail but
supportng plans for staf recruitment, training and infrastructure have
not been established.
4. A detailed operatons plan has been compiled which fully supports the
growth plans of the venture. Supportng detail shows infrastructure, staf
and resource requirements, however, sensitvity analysis has not been
undertaken in areas where delays, variatons in productvity or shortages
might occur.
5. A detailed, integrated, robust operatonal plan has been prepared which
includes all support operatons. The plan has been reviewed under
various risk conditons and contngency plans have been developed to
mitgate or negate likely risk situatons.
B11. Management team is experienced, complete, commited,
capable and entrepreneurial
Experienced investors know that business plans are very rarely implemented
as writen. Every plan is based on a number of assumptons and those ofen
prove to be unfounded or are invalidated by economic, environmental and
industry changes. The business may not develop in the manner in which it was
originally planned. Experience tells the investor that the best soluton to this
problem is to have a proven management team which has the experience to
cope with the changes that inevitably will occur. They look for an executve team
which has the qualifcatons, experience, mix of skills and industry networks to
implement the original plan but can also react to changing conditons and is stll
likely to achieve reasonable results.
In the case of a venture being prepared for a strategic sale, the management
team, in conjuncton with the Investor, must have the ability to undertake the
sale preparaton process. This may include completng product development,
174
Part B: Indices
Raising Angel & Venture Capital Finance
establishing trial customers, building relatonships with potental buyers and
engaging professional advisors.
In the case of a fnancial venture, it takes more than industry knowledge and
a capable management team to grow a business over tme. Very few markets
are stable over many years, being impacted by new inventons, new entrants
and changing business models. Any business which grows over an extended
period of tme must have an entrepreneurial capability. This is the ability to
see opportunites where others don’t, an ability to construct diferent business
models, a strong sense of tming about market changes, a willingness to have a
go in the face of incomplete or ambiguous market data and the acceptance that
some projects will fail.
Driving a business forward in the face of changing conditons also requires
leadership and good judgement. A strong vision, a sense of partnership
and involvement and a sense of personal achievement and growth are all
characteristcs of a positve work culture. A business grows over tme, not
by doing the same thing all the tme, but by evolving to take advantages of
opportunites in the market place. A business which is open to new ideas,
willing to try new approaches to doing business and encourages people to try
small experiments will proactvely generate avenues for growth.
Whether the intended exit is fnancial or strategic, Investors know that
they work in start-up and early stage ventures where the passion, drive and
energy of the entrepreneur and the management team are critcal to success.
A good product or service, by itself, will not be sufcient to provide the tracton
necessary to drive the business to success. The Investor needs to see indicatons
of what the team members have achieved individually and collectvely; that
they have the ability to take initatve, be proactve and creatve and have the
determinaton to succeed in this venture. The Investor also wants to see that
the executves are commited to the venture. This may occur through their own
personal fnancial investment, tme invested in the venture or the fact that
they have put their personal reputatons behind the business. Where there are
missing skills, the investor wants to see these are acknowledged and a proposal
put forward to recruit the necessary talent.
175
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. Assessment of the current management team has not been undertaken
or no team has yet been assembled.
2. The current management team lacks some key skills, experience and
knowledge and plans are not yet in place to recruit to fll the gaps. The
current team has not acknowledged any defciencies which need to be
flled. It is not obvious whether the team will stay with the venture if
the going gets tough. The team has not demonstrated entrepreneurial
actvity.
3. The current management team is highly competent in most of the key
areas and has the skills and experience to take the venture forward. Key
gaps have been identfed but a plan has not been developed to fll the
gaps. Some members of the team have made personal fnancial or tme
commitments. Individuals within the team have shown entrepreneurial
actvity but they have yet to demonstrate this as a team.
4. The management team has the experience, capability and knowledge
to take the venture forward and have plans in progress to recruit some
key individuals as part of the growth planned. Succession plans have not
been developed. The team has made signifcant fnancial, tme and/
or reputaton commitments to the venture. The team demonstrates an
entrepreneurial capability.
5. The management team is experienced, has the necessary range of skills,
experience and entrepreneurial capability to grow the venture and has
an organisatonal plan for both growth and succession. It is clear that the
team is very commited to the venture and will put in the tme and efort
even if the venture proves to be more difcult than expected.
B12. Financial projectons show robust acceptable ROI
The business concept should to be tested across multple scenarios to ensure
that a reasonable fnancial return can be achieved even in the most unlikely
circumstances. When possible funding is added to the fnancial forecasts, the
forecasts should show that the Investor is able to achieve very good results.
Robust fnancial forecasts should declare and test the validity of the basic
assumptons. By changing basic assumptons to diferent possible situatons,
176
Part B: Indices
Raising Angel & Venture Capital Finance
the model can be tested for robustness. Those assumptons which have the
greatest sensitvity can then be addressed with counter measures or additonal
actvites to minimise their impact.
Within the period of the investment where survival and operatonal
performance are critcal, fnancial projectons should include income statements,
balance sheets and cash fows. A breakeven analysis should be shown. These
various fnancial projectons should be created under several possible scenarios
including worst case, best case and most likely case.
Estmates of exit values should be undertaken to show that the business is
able to achieve the rates of return desired by the Investor under all possible
exit scenarios. Remember that in the case of a strategic exit, revenue and proft
growth may not be relevant. What is important is to produce something which
the strategic buyer wants.
Self-assessment
1. Financial projectons have not been prepared.
2. Financial projectons have been prepared but are at a high level of
aggregaton and are based on assumptons which have not been
validated. Detailed cash fows are not available.
3. Detailed fnancial projectons have been prepared which show
acceptable levels of profts (if relevant) and ROI but some assumptons
are questonable and a scenario analysis has not been undertaken.
Detailed cash fows are available.
4. Detailed fnancial projectons have been made which show acceptable
levels of proft and revenue growth (if relevant) and ROI. Underlying
assumptons have been validated and are acceptable. Scenario analysis
has not been undertaken.
5. Detailed fnancial projectons with worst case, most likely case and
best case have been undertaken. Underlying assumptons have
been validated. Projectons have been validated by an independent
professional advisor. Proft and ROI targets are robust and achievable
under all scenarios.
177
Part B: Indices
Raising Angel & Venture Capital Finance
B13. Risk analysis shows resilience to possible delays, shortages,
compettve retaliaton, quality issues, failure to recruit the
right staf, etc.
Most simulatons of fnancial projectons concentrate on changes in revenue
levels but fail to take into account other risks which may be equally damaging
to the venture. The Investor needs to isolate those factors within the business
which can have the most disruptve impact on desired targets. It is only by
undertaking such an analysis that the Investor can uncover the likely risks which
can severely impact target achievement.
Once a risk assessment has been undertaken, those risks can be subjected
to their own mitgaton planning exercise. A business plan which antcipates
potental problems can build contngency plans and take steps to avoid, mitgate
or reduce the impact of possible negatve events. Risk analysis may result in
strategies being developed which change the order of introducton of products,
the tming of selected capital expenditures or planned targets.
Self-assessment
1. Risk assessment has not been undertaken.
2. Some major risks have been identfed but a plan has not been
developed to deal with these when they occur.
3. Major risks have been identfed and plans have been developed to deal
with them when they occur, but mitgaton or avoidance plans have not
been implemented.
4. A risk analysis across the enterprise has been undertaken and plans have
been put in place to counter, mitgate or avoid them.
5. The business strategy has been developed and implemented to take into
account those risks which would have a damaging efect on the business
achieving its objectves.
178
Part B: Indices
Raising Angel & Venture Capital Finance
B14. A robust and well-artculated exit strategy has been defned
Investors need to see a path to liquidity for their investment. Few Angel
or VC investors invest for dividends; most will be investng for capital gains.
However, whether they invest for dividends or capital gains, they stll need to
have a mechanism for releasing their original investment. The normal form of
harvestng is either a sale to another business (trade sale) or a listng on a public
stock exchange (an inital public ofering or IPO). Many investment proposals
use such exit phrases as ‘sell to a corporaton in 3-5 years’ or ‘list on the stock
exchange in fve years’ with no substance behind the statement. They have
neither identfed who the potental buyer might be nor how they would be an
ideal candidate for an IPO.
The business proposal needs to demonstrate to the Investor a well-artculated
exit strategy which is meaningful. A trade sale strategy should have identfed
potental buyers and have convincing arguments as to why the selected
corporatons should buy the business. An IPO strategy should show how similar
businesses, with comparable products, services and growth paterns, were able
to list on the target exchange.
Self-assessment
1. An exit strategy has not been identfed.
2. The exit strategy is very general and lacks detail or validaton.
3. A possible exit strategy has been artculated which looks feasible but
lacks detail and resilience.
4. The exit strategy is very detailed, seems highly probable and includes
estmates of tming, resources required and costs for professional
services.
5. Professional advice has been received to validate the exit strategy and
adjustments have been made as a result. The exit strategy is highly
probable and resilient. Alternatve exits are capable of being executed
depending on market circumstances.
179
Part B: Indices
Raising Angel & Venture Capital Finance
Venture Potental Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
B1 Business and economic conditons support the venture
B2 Well artculated, focused vision of the purpose of the venture
B3 Innovatve product, process or business concept
B4 Clear and compelling customer need
B5 Sufcient, willing, funded, identfable and reachable
customers
B6 Obvious and meaningful compettve advantage
B7 Well protected sustainable atributes
B8 Resources and channels to distribute are in place or are able
to be acquired
B9 Sales price and cost model provides robust achievable mar-
gins
B10 Integrated volume operatons(development, manufacturing,
logistcs, support and infrastructure) are achievable
B11 Management team is experienced, complete, commited,
capable and entrepreneurial
B12 Financial projectons show robust acceptable ROI
B13 Risk analysis shows resilience to possible delays, shortages,
compettve retaliaton, quality issues, failure to recruit the
right staf, etc.
B14
A robust and well artculated exit strategy has been defned
180
Raising Angel & Venture Capital Finance
C
Operations Development
T
he Operatons Development Index (ODI) has been designed so that an
Investor can measure the quality of governance and operatons
management within the investee frm. It can be used to evaluate the potental
investment as well as provide a tool for measuring the progress of development
of internal systems once the investment has been made.
A business can only be run efectvely if it has the measurement and
reportng systems in place to set targets and review performance. The use of
KPIs, budgets and proper reportng systems are critcal. Governance issues deal
with compliance and risk management and can be seen in good relatonships
with customers, suppliers, bankers and so on. Operatonal excellence should
be an objectve of the Angel as this can positvely contribute to the value of the
business at the tme of sale or as preparaton for an IPO.
As part of the inital due diligence of the frm, the ODI can help the Investor
assess potental risks in the investment. When an Angel or VC investor enters into
an investment, they are exposed to the trading risks of the investee company.
They are also exposed to any current or contngent liabilites, current and
potental employee disputes, customer issues and supplier disputes. Once the
investment has been made, these risks will be managed through management
oversight and restrictons on how monies can be used and what loans can be
incurred.
181
Part B: Indices
Raising Angel & Venture Capital Finance
The Investor will also have arrangements in place where they can more
actvely intervene and sometmes take complete control if the business fails
to perform to agreed schedules and targets. However, this is litle comfort to
an Investor who is reliant on the management team to operate the business.
Pre-existng conditons may be underwriten somewhat through warrantes
and representatons and failure of the business to perform may be somewhat
compensated for by a share diluton formula which adjusts the Investor’s
percentage of ownership, but this is litle comfort to the Angel or VC frm which
has invested in a lemon.
The Investor needs to establish the level of risks associated with the
investment before they do the deal, not afer. So an extensive investgaton
will ofen be undertaken to uncover any skeletons which may lie in wait for
the unwary investor. Depending on the size and complexity of the frm, this
process can take many months and be very expensive. While this cost is usually
absorbed by the Investor, it is almost certainly factored into the valuaton or use
of the investment funds. In some cases it may be underwriten or reimbursed
by the investee company.
The Investor will be trying to estmate the costs and tme needed to be
devoted by the Investor, executves within the frm and external advisors to
bring the investee company up to the quality needed for an ongoing stress-free
operaton. As items are uncovered, the Investor will need to estmate the tme
and cost that will be incurred to resolve the issue. Of course, some may not be
that simple, cheap or quick to resolve. Other items may be serious and there
may not be an easy way to estmate the likely damage or cost to resolve. This
is partcularly true with contngent liabilites, intellectual property ownership
doubts and unclear customer obligatons which have not been fulflled.
At some point, the Investor may simply decide that the level of risk is too high
to proceed, or they might decide that it will take too long and be too expensive
to establish the level of exposure in the outstanding issues.
Clearly a frm which appreciates the concerns of the Investor and has closely
managed its operatons, managed its risk exposure and ensured that it has
fully complied with industry regulatons, is a good candidate for Angel or VC
investment.
182
Part B: Indices
Raising Angel & Venture Capital Finance
The ultmate due diligence test which could be used by an Investor is the
following:
Can I leave the investee frm alone to continue managing its opera-
tions without incurring any unreasonable level of risk?
Can I achieve my required ROI in the investment by devoting my effort
to where I can add the most value without being distracted with having
to clean up problems frst?
Not all issues will be resolved by the frm in advance of an Investment, but
the more the frm can do prior to the investment, the easier it is for the Investor
to complete the due diligence investgaton and move to consummate the
investment arrangements. A frm which is prepared for due diligence is a major
advantage for an Investor.
The inital investgaton can provide the Investor with a checklist to be used
afer the investment to drive improvement in the governance and operatons
management of the frm. An Investor keen to see a trade sale or an IPO within
a few years of his investment should be sensitve to the positve impact a clean
bill of health on the ODI will have on the potental exit value of the frm.
In a trade sale situaton where the potental buyer is a corporaton, aspects
of the acquirer’s due diligence will deal with the actual integraton of the two
companies. This will involve reviewing the costs, problems and delays of merging
the acquired business into their own organisaton and will involve such things
as personnel systems, beneft systems, IT infrastructure and so on. The only
way the frm can prepare for this possibility is to ensure that they use industry
standard processes wherever possible.
183
Part B: Indices
Raising Angel & Venture Capital Finance
C1. Monthly fnancial and key performance indicator reportng
exists
The existence of a comprehensive reportng system is important for several
reasons. These are:
• It demonstrates that the frm is well run.
• It shows that the management is efectve.
• It shows atenton to detail.
• It demonstrates that an underlying infrastructure is in place.
• If comprehensive, it should show that problems are identfed early and
addressed.
The fnancial reportng systems should produce balance sheet and income
statements, cash fow projectons, aged debtors and aged creditor reports.
More sophistcated systems go beyond monthly fnancial reportng. Every
business has key performance indicators (KPIs) which demonstrate health
and compettve alertness. Reportng systems should be able to demonstrate
that the company is operatng efciently in all major areas of operatons. For
example, in sales, reportng systems might examine tenders received, tenders
sent, contracts under review, contracts received and revenue to estmates.
In producton, it might refer to actual producton versus planned producton,
overtme hours worked, rework hours, inventory levels and so on.
In a due diligence investgaton, the Investor will be atemptng to estmate
the level of interventon that is to be put in afer the investment. To the extent
that good management systems are in place, this should considerably reduce
the Investor’s concerns.
Self-assessment
1. Internal reportng systems are unsophistcated and incomplete.
2. Monthly fnancial reportng exists but is not comprehensive.
3. Monthly reportng exists but few KPIs are tracked.
4. Monthly reportng systems and KPIs are tracked but have not been
audited for completeness and efectveness.
184
Part B: Indices
Raising Angel & Venture Capital Finance
5. Comprehensive monthly fnancial and KPI reportng exists. Professional
advice has been taken to ensure completeness and efectveness.
C2. A formal business plan has been prepared and is updated
periodically
Most business people would agree that business plans are outdated as soon
as they are printed. However, the discipline of preparing the business plan
captures the holistc nature of the enterprise. This is one of the few tmes where
management have the opportunity of rethinking the vision, goals and strategy
of the frm. It is by pulling it all together that they will gain insights into areas of
weakness and opportunites where the business can be improved.
For the Investor, a good business plan provides insights into the business. For
example:
What is the vision and how is this translated into strategy?
What are the competitive assets and competencies of the frm and
how are these being leveraged into competitive advantage?
Which markets do they compete in and how are they placed?
What are the assumptions behind the numbers and have these been
validated?
What risks are present in the business and how are these being ad-
dressed?
What is the worst case scenario?
Do they understand their underlying cost and revenue structures and
has this been translated into a breakeven analysis and a breakdown
of recurring and new business?
185
Part B: Indices
Raising Angel & Venture Capital Finance
Can they demonstrate clearly where the business comes from and
why?
Do they have clearly articulated marketing and sales plans with identi-
fed targets?
Has business growth been translated into a headcount plan and a
funding plan?
The business plan demonstrates that the management team understand
what it takes to be successful. It should be more than a spreadsheet, it is an
explanaton of why the business is successful and should be backed up with
validaton of assumptons.
The queston that should be asked by the Investor is:
Can this business be run successfully without me having to intervene
to make it work?
It may not be the Investor’s intenton to leave the business the way it is,
afer all, part of the reason for selectng a specifc investment is to leverage the
Investor’s knowledge and contacts. However, he should be trying to estmate
the level of efort he is going to have to put in to improve their operatons
management. If the business can be lef alone to run itself for some period
of tme, the Investor can concentrate on future plans for the business without
having to shore up normal operatons.
The business plan may also indicate where additonal potental lies for the
frm. This helps the Investor to evaluate the opportunity and perhaps see how
the opportunity may be developed with additonal resources or assistance from
the Investor.
Self-assessment
1. A business plan does not exist.
2. There is a business plan but it is out-of-date and/or incomplete.
186
Part B: Indices
Raising Angel & Venture Capital Finance
3. There is a comprehensive business plan but it simply projects past trends
and is not a strategy document.
4. A comprehensive business plan exists and is up-to-date but does not
have the depth or validaton needed to provide a good explanaton of
strategy or how the business might perform in the longer term.
5. A very comprehensive business plan exists which is of professional
quality and fully explains the business strategy, the capabilites and the
likely outcome of the business in the longer term.
C3. A formal budget is prepared and actual performance is
monitored against budget
The preparaton of formal budgets (proft & loss, cash fow and balance
sheet) serves a number of purposes including:
• quantfcaton of formal business plan.
• identfcaton of projected proft and loss and cash fow.
• a basis for fnancial discussions with external partes such as debt and
equity provider.
• a basis for monitoring the actual performance of the business against
the business forecast.
• a basis for performance evaluaton of key staf and departments.
The budget should provide the basis for monitoring actual performance
against budget and should link the formal business plan to the actual
performance of the business.
Budgets should be prepared and monitored on a monthly basis. Budgets
should be prepared on a geographic and department basis in order to properly
assign responsibility and facilitate the management of variances.
Preparaton of a formal budget and analysis of actual performance against
budgeted performance should provide the following benefts to the business:
• assist in identfying under or over performance against budget
• enable tmely actons to be taken where actual performance is
187
Part B: Indices
Raising Angel & Venture Capital Finance
signifcantly diferent to forecast performance
• ensure key fnancial informaton is monitored at various levels
throughout the business
• promote accountability of key individuals and departments.
Evidence of regular budget to actual analysis by the business will provide the
Investor with greater comfort that the business has been actvely monitored
and proactvely managed and that business risks are being assessed on a regular
basis.
Self-assessment
1. A budget is not prepared and analysis of actual results to budgeted
results is not performed
2. There is a budget, but it is out-of-date, or not regularly monitored.
3. There is a summary budget, but it is not detailed enough, does not
link to the business plan, does not ensure accountability of key staf/
departments and is not regularly monitored.
4. A budget exists which partly assists in monitoring actual to forecasts of
the business (including accountability of key staf/departments).
5. A comprehensive budget exists which supports the formal business
plan and is a major tool in the ongoing monitoring and assessment of
business performance including monitoring accountability of key staf/
departments.
C4. Full compliance with regulatory issues (e.g. environmental,
health and safety)
The Investor will be investgatng the health of the business in terms of the
quality of its underlying systems. These will include all the compliance areas.
These will vary from industry to industry but may include:
• tax reportng (income, payroll and sales tax (BAS, VAT, GST, etc))
• company fnancial reportng
• corporate governance (shareholder tracking, board minutes, etc)
188
Part B: Indices
Raising Angel & Venture Capital Finance
• employment law reportng
• mandatory insurance
• health and safety practces and accident reportng
• environmental compliance
• industry-specifc regulatons.
These areas are critcal in a review as they can point to weak management,
lack of concern for potental exposure and the possibility of litgaton and
penaltes. The exposure may not only be for ongoing practce, but may be
retrospectve in more severe cases such as environmental issues.
Self-assessment
1. Compliance is not treated seriously and is inconsistently implemented.
2. The frm is concerned about compliance and has some systems in place
but a comprehensive program does not exist to ensure compliance or to
ensure completeness of coverage.
3. Compliance is treated seriously but is lef up to individual managers and
there is no system in place to ensure that all areas are covered and full
compliance is occurring.
4. A full list of compliance issues exists, responsibilites are defned and
some areas have reportng systems to ensure that compliance is being
adhered to. Professional advice is being sought to undertake an audit in
order to put a comprehensive reportng system in place.
5. Compliance reportng is comprehensive and efectve and is audited by
professional advisors on a periodic basis to ensure completeness and
efectveness. No outstanding or antcipated litgaton exists.
189
Part B: Indices
Raising Angel & Venture Capital Finance
C5. Customer relatonships are managed to minimize litgaton
Litgaton and potental litgaton occur when aspects of the business are
not conducted fairly, transparently and according to accepted standards of
good conduct. It is not sufcient to hope that external and internal relatons
are managed well. The Investor will examine whether the frm has policies,
procedures and systems in place to ensure that they are doing so.
In the case of customers, the frm needs to conduct its business so that
customers clearly understand the obligatons of the frm, customer expectatons
are clearly understood and performance to documented and implied contractual
conditons is monitored. Products and services need to be ft for purpose, of
merchantable quality and sold with clear explanatons of intended use. The
frm should be prepared to assist customers to ensure that efectve intended
use can be readily achieved. Failure to understand the customer’s needs and
intended use exposes the frm to potental complaints, wasted resources and
possible litgaton.
The frm should have in place fair and reasonable contracts or agreements
with customers, efectve complaints handling processes and monitoring
systems to ensure obligatons are met.
Investors will be concerned about potental risks. Poor customer handling
and poor internal processes suggest exposure to potental litgaton, workplace
unrest and/or loss of customer respect and retenton. These seriously damage
the company as a place to work or do business, potentally threatening the
viability of the business. The Investor does not want to inherit problems which
may distract from achieving the objectves in the investment. A frm with
underlying potental litgaton can severely disrupt the frm and will probably
exclude it from a successful trade sale or IPO. The Investor may be beter of to
walk away from the investment than to take the risk.
Self-assessment
1. Special efort is not taken by the company to avoid litgaton in external
customer relatonships. Accounts are not reviewed for current or
potental problems on any systematc basis. An escalaton process does
not exist to deal with unresolved issues.
190
Part B: Indices
Raising Angel & Venture Capital Finance
2. The frm acknowledges that it can do beter. Staf have been advised of
the implicatons of unresolved customer issues. A complaints system is
in place.
3. A formal customer complaints system is in place with proper escalaton
procedures. Formal agreements exist with customers which deal with
outstanding problems.
4. Professional advice has been taken on establishing formal systems
of dispute resoluton, complaints handling and problem escalaton.
Contracts have been reviewed by professional advisors. Relatonship
management training has been given to staf where appropriate.
5. Formal review systems are in place for all agreements with customers.
The frm is proactve in dealing with customers to ensure that
expectatons are set correctly and are monitored on an ongoing basis.
Formal complaint handling systems and dispute resolutons systems are
in place with staf trained and advisors available. Professional advisors
review any serious disputes and provide advice on problem resoluton.
C6. Supplier relatonships are managed to minimize litgaton
Good supplier management is essental for the efcient operatons of a
business. Litgaton and potental litgaton occur when aspects of the business
are not conducted fairly, transparently and according to accepted standards of
good conduct. It is not sufcient to hope that external and internal relatons are
managed well. The Investor will verify that the frm has policies, procedures and
systems in place to ensure that they are doing so.
Some suppliers are more critcal than others where they supply essental
parts, where there are no efectve substtutes or the switching costs of moving
to another supplier is high. Managing supplier relatonships is essental for the
health and ongoing efectve operaton of the business. The frm should have fair
and equitable agreements with suppliers and these should be industry standard
wherever possible. Supplier relatonships should be managed by people in the
company who understand that relatonships are more than simply placing
purchase orders and negotatng the best price.
191
Part B: Indices
Raising Angel & Venture Capital Finance
The frm needs to be able to demonstrate to the investor that goodwill
exists in those relatonships, the business values their suppliers and issues and
complaints are dealt with in a tmely and reasonable manner.
Investors are always concerned about potental risks and disrupton. Poor
supplier relatonship management and poor internal processes to resolve
problems suggest exposure to potental litgaton, workplace unrest and/or
potental loss of key suppliers. Failure to monitor payables and resolve disputes
may also afect credit ratng. No Investor likes to inherit problems which may
distract them from achieving the potental in the investment. An investment in
a frm with underlying potental litgaton can severely disrupt both the frm as
well as the Investor who may have to become involved to resolve the situaton.
Self-assessment
1. Special efort is not taken by the company to avoid litgaton in supplier
relatonships. Accounts are not reviewed for current or potental
problems on any systematc basis. An escalaton process does not exist
to deal with unresolved issues.
2. The frm acknowledges that it can do beter. Staf have been advised of
the implicatons of unresolved issues. A complaints system is in place.
3. A formal complaints system is in place with proper escalaton
procedures. Formal agreements exist with suppliers to deal with
outstanding unmet obligatons and disputes.
4. Professional advice has been taken to establish formal systems of
dispute resoluton, complaints handling and problem escalaton.
Contracts have been reviewed by professional advisors. Relatonship
management training has been given to staf where appropriate.
5. Formal review systems are in place for all agreements with suppliers.
The frm is proactve in dealing with suppliers to ensure that
expectatons are set correctly and monitored on an on-going basis.
Formal complaint handling systems and dispute resoluton systems are
in place with trained staf and advisors available. Professional advisors
review any serious dispute and provide advice on problem resoluton.
192
Part B: Indices
Raising Angel & Venture Capital Finance
C7. Employee relatonships are managed to minimize litgaton
The Investor will want to know that good management practce systems and
fair and reasonable workplace conditons are in place for efectve employee
management. Employees should understand clearly what is expected of them,
be provided with opportunites to provide feedback on their experience and
be given performance appraisals to ensure they understand how they are
meetng expectatons. Processes should be in place to deal with harassment
and discriminaton in the workplace. Only through efectve and systematc
performance monitoring and correctve acton can the frm adequately deal
with dismissals without creatng situatons which might lead to unfair dismissal
claims and possible litgaton.
Every business is dependent on its employee’s goodwill and motvaton. If the
workplace conditons are not fair and reasonable at a minimum and if justce
is not done and seen to be done, this creates a poor working environment. It
is inevitable that the frm will go through a series of changes of management,
systems and directon afer the investment. This is going to take a lot of goodwill
and support from existng staf. An Investor doesn’t wish to start of this process
at a disadvantage. In additon, poor performance management processes expose
the company to claims for unfair dismissal or discriminaton. No Investor wants
to be exposed to potental unquantfable future litgaton costs and damages.
Contngency liabilites are normally the death of a future trade sale or IPO.
Self-assessment
1. Special efort not is taken by the company to avoid litgaton in
employee relatonships. Workplace issues are lef to local supervisors
and local management to resolve. There are no full-tme or dedicated
employees responsible for compliance or to assist in resolving workplace
relatonship issues. A systematc process does not exist to set and
evaluate performance.
2. The frm acknowledges the need to introduce more formal processes.
Job descriptons are in place for most of the employees and an
evaluaton process is used for performance review and setng pay
increases.
193
Part B: Indices
Raising Angel & Venture Capital Finance
3. Performance targets and formal reviews of achievement are in place. A
member of management is responsible for compliance. Management
has been briefed on workplace issues of harassment, discriminaton and
performance review documentaton and dismissal processes. However,
these are not systematcally followed.
4. Formal processes exist for defning job descriptons, setng and
assessing performance targets and dealing with employee workplace
issues. Management has been trained on all aspects of compliance
and workplace performance and dismissal processes. No external
professional advice has been sought to audit the quality of the
processes.
5. Systems and procedures are fully documented and audited to
ensure full compliance with best practce in performance reviews,
dismissal handling and workplace incident handling. The company has
professional internal staf and/or external advisors to assist with any
serious incident.
C8. Credit worthiness with suppliers is excellent
The quality of external relatonships is ofen an indicator of the quality and
integrity of the management team and the culture of the frm. As the business
grows some level of disrupton to the business is likely to occur. During this
period the goodwill of suppliers is going to be necessary so that additonal
problems don’t create crisis events. By reviewing credit payment performance
informaton and interviewing suppliers, the Investor can obtain a measure of
the way in which management has dealt with issues in the past.
Few companies are able to avoid fuctuatons in their cash fow. However,
problems can ofen be mitgated by good relatonships with suppliers. Suppliers
who are normally paid promptly and dealt with fairly are ofen willing to extend
additonal credit for short periods during difcult tmes. This is especially true
if the frm has dealt with them honestly and shown past behaviour of bringing
situatons back to prompt payment.
Those frms which keep their suppliers informed, proactvely tell them about
impending issues and show good management skills in correctng problems
194
Part B: Indices
Raising Angel & Venture Capital Finance
promptly, are much more likely to be given extended credit to cover short-term
situatons. A review of supplier credit performance will help the Investor gain
an independent measure of the quality of management and their culture and
values.
Self-assessment
1. The frm deals with suppliers at arms length and makes no special efort
to value their relatonship. The frm makes no special efort to keep in
regular touch with them or to keep them abreast of business issues.
2. The frm is sensitve to dealing with suppliers and pays when possible on
agreed terms. However, suppliers are only contacted when payments are
already late.
3. The frm has processes for reviewing credit with suppliers and keeps
them informed of any issues where extended payment may be taken.
The frm has a member of management who meets with them on an
informal basis when the occasion arises.
4. The frm actvely informs suppliers of account status and will pay early if
cash permits. Suppliers are kept informed of the level of likely business
which will be placed with them. When payments have been delayed,
senior management will personally contact the supplier to review the
situaton.
5. Professional advice has been sought on credit worthiness best practce
and systems implemented. Senior management keeps suppliers
informed of any payment issues well in advance and before payments
are overdue.
C9. Banking relatonships are excellent
The quality of a frm’s relatonship with their bank is a very good indicator of
the way in which they conduct most of their business. External relatonships
are ofen an indicator of the quality and integrity of the management team and
the culture of the frm. With any signifcant business development, which can
be expected afer an injecton of capital, some level of disrupton to business
is likely to occur. During this period the goodwill of suppliers, customers and
bankers is going to be necessary so that additonal problems don’t create crisis
195
Part B: Indices
Raising Angel & Venture Capital Finance
events. By reviewing formal and informal contact with the bank, the Investor
can determine the manner in which management has dealt with issues in the
past.
Few companies are able to avoid some fuctuaton in their cash fow.
However, problems can ofen be mitgated by good relatonships with suppliers
and by working closely and honestly with the bank. Those frms which keep
their bank informed, proactvely tell them about impending issues and show
good management skills in correctng problems promptly, are much more likely
to be extended a line of credit or a loan from the bank to deal with short-term
fuctuatons. By examining how the frm has dealt with issues in the past, the
Investor can gain an independent measure of the quality of management and
of their culture and values.
Self-assessment
1. The frm deals with its bank at arms length and makes no special efort
to value the relatonship. The bank is simply treated as a facility and the
frm makes no special efort to keep in regular touch with the bank or to
keep it abreast of business issues.
2. The frm is sensitve to dealing with its bank, however, the bank is only
approached when a need arises.
3. The frm has processes for reviewing its patern of business with its bank
and keeps it informed of any issues where cash fow might be seriously
afected. The frm has a relatonship with a named bank ofcer and
meets with them on an informal basis when the occasion arises.
4. Informal arrangements are in place with the bank to review business
performance and banking requirements. The frm also has periodic
formal meetngs with the bank to review their banking arrangements
and banking facilites.
5. The frm has established formal meetngs with the bank on a regular
basis where current and future banking requirements are reviewed.
Senior management of the frm are known to the bank and informal
social relatonships are encouraged by the frm.
196
Part B: Indices
Raising Angel & Venture Capital Finance
C10. Customer interacton, contracts and agreements are
industry standard
A frm incurs problems and costs when obligatons under contracts are
unclear, incomplete, harsh or generous. Risks escalate when procedures
for handling disputes, complaints, claims or clarifcaton are not clear or not
followed. When customers can make claims on the company which cannot
be substantated internally, where the obligatons are not clearly set out and
where the terms of payments are unclear, the frm can be exposed to potental
litgaton, loss of resources or signifcant under payments.
A situaton in which contracts can be customized to suit the customer
becomes an administratve burden. Few frms have the processes in place to
track individual contracts where obligatons and terms vary from one contract
to another and so the likelihood of making a mistake in this situaton is very
high. Problems can be greatly exacerbated if contracts are voluminous or held
at a place away from where actvity is being undertaken.
Investors want to see a smooth administratve operaton. If the contracts are
not standard or vary from contract to contract, costs increase. Risks may occur
if personal undocumented knowledge is required to manage the relatonship.
If the person with that intmate knowledge leaves, so does the ability to handle
issues which arise.
Policies for dealing with customers should be clearly set out and staf trained
in the various actvites which require interacton with customers. Errors are
easily made where inconsistencies in processes are allowed to occur.
Self-assessment
1. Interacton, contracts and agreements with customers are informal and
vary in approach, terms and conditons.
2. Staf are advised on how to deal with customers but this is not formally
supervised or reviewed. Contracts and agreements with customers are
mostly writen but variatons exist and these are not well documented.
Formal sign of of customer contracts is not in place where complex
projects are undertaken.
197
Part B: Indices
Raising Angel & Venture Capital Finance
3. Staf are trained to deal with customer issues. The frm has policies
in place for most customer interacton but these are out-of-date and
compliance is not reviewed formally. Formal contracts and agreements
are used with customers but variatons are common. Variatons are well
documented and agreed by both partes. Formal progress monitoring is
in place and sign of occurs at key stages in projects.
4. Formal policies are in place for interacton with customers and staf
are trained on these. Compliance is monitored and issues dealt
with promptly. Standard contracts and agreements are in place with
customers and progress on long-term projects is monitored. However,
steps have not been taken to ensure that contracts are industry standard
and best practce for monitoring are in place.
5. Professional advice has been taken and recommendatons implemented
to ensure that contracts with customers are industry standard and that
progress monitoring and sign of procedures are in place and being
followed. Periodic audit of customer contracts and progress tracking are
in place. Formal policies for dealing with customers are in force and are
regularly monitored.
C11. Supplier contracts and agreements are industry standard
A frm incurs problems and costs when obligatons under supplier contracts
are unclear, incomplete, harsh, or generous. Risks escalate when procedures
for handling disputes, complaints, claims or clarifcaton are not clear or not
followed. When suppliers can make claims on the company which cannot be
substantated internally, where obligatons or the terms of payments are unclear,
the frm can be exposed to potental litgaton, loss of resources or signifcant
over payment.
A situaton in which contracts can be customized for each supplier becomes
an administratve burden. Few frms have the processes in place to track
individual contracts where obligatons and terms vary from one contract to
another and the likelihood of making a mistake is very high. This situaton is
exacerbated if contracts are voluminous or held at a place away from where
actvity is being undertaken.
198
Part B: Indices
Raising Angel & Venture Capital Finance
Investors are looking for efcient administratve operatons. If the contracts
are not standard or vary from contract to contract, smooth operatons are
not possible. Further risks may occur if personal undocumented knowledge is
required to manage the relatonship. If the person with that intmate knowledge
leaves, so does the ability to handle issues which arise.
Self-assessment
1. Interacton, contracts and agreements with suppliers are informal and
vary in approach, terms and conditons.
2. Staf are advised on how to deal with suppliers but this is not formally
supervised or reviewed. Contracts and agreements with suppliers are
mostly writen but variatons exist and these are not well documented.
Formal sign of of supplier contracts is not undertaken where complex
projects are undertaken.
3. Staf are trained to deal with supplier delays, missing or incomplete
orders, quality issues and relatonship problems. The frm has policies
in place for most supplier interacton situatons but these are out-
of-date and compliance is not reviewed formally. Formal contracts
and agreements are used with suppliers but variatons are common.
Variatons are well documented and agreed by both partes. Formal
progress monitoring is in place and sign of occurs at key stages in
projects.
4. Formal policies are in place for interacton with suppliers and staf
are trained on these. Compliance is monitored and issues dealt with
promptly. Standard contracts and agreements are in place with suppliers
and progress on long-term projects is monitored. However, steps have
not been taken to ensure that contracts are industry standard and best
practces for monitoring are in place.
5. Professional advice has been taken and recommendatons implemented
to ensure that contracts with suppliers are industry standard and that
progress monitoring and sign of procedures are in place and being
followed. Periodic audit of supplier contracts and progress tracking are
in place. Formal policies for dealing with suppliers are in force and are
regularly monitored.
199
Part B: Indices
Raising Angel & Venture Capital Finance
C12. Contracts can be assigned to an acquirer
Companies which are expected to be sold must have the ability to assign
the rights under their contracts, licenses and agreements to the new buyer.
Agreements which do not allow this inhibit the ability of the new owner to
operate the business. Some agreements have clauses which allow assignment
only with the permission of the other party. This agreement should be obtained
prior to going into an acquisiton discussion.
Many agreements do not allow for assignment to a compettor. This is not an
unreasonable conditon if such a change could potentally harm their business.
In this case, the frm needs to have a contngency plan to be able to replace that
part of their business if it is critcal to their operaton. Where such an agreement
might stop the acquisiton from happening, the best acton is to terminate the
agreement and replace it prior to preparing to sell.
Self-assessment
1. The frm is not aware of this requirement and does not know what the
status of its various agreements are in this regard.
2. The frm acknowledges that this would be desirable but has not
reviewed the contracts for compliance.
3. Contracts have been reviewed and those which do not allow assignment
have been identfed and responsibility given to an executve to
renegotate this conditon.
4. Contracts have been renegotated (where possible). The frm does not
see any situaton which would inhibit an acquisiton. Contracts have not
been reviewed by professional advisors.
5. Contracts, licences and agreements have been reviewed by professional
advisors and no critcal impediment remains to assignment of rights.
200
Part B: Indices
Raising Angel & Venture Capital Finance
C13. Intellectual Property is able to be traded and is
appropriately protected
Intellectual property (IP) covers those knowledge assets of the company
which can be sold independent of the people who created that knowledge.
Knowledge in the heads of employees which is not documented cannot be
sold without the employees who have it. Documented knowledge, where
the ownership may be in dispute or where ownership is unclear, cannot be
efectvely traded. Other IP rights which are purchased and are critcal to the
operaton of products or services, need to be able to be sold or assigned to a
new owner. Any contractual impediments to the use of internal or purchased IP
will seriously inhibit a frm’s ability to exploit the IP and may seriously damage
the potental of a sale of the business.
Many acquisitons are targeted at acquiring compettve advantage through
the acquisiton of frms which hold patent rights. Patents which have considerable
revenue generatng potental can atract litgaton over ownership rights if this
has not been carefully managed from the outset of a research and development
project as any employee who has worked on the project could potentally claim
an ownership share. The only way for the frm to protect itself from such a claim
is to have employees assign all rights of any inventons, or those relevant to
their workplace, to the frm. Alternatvely, rights could be assigned to the frm
with acknowledgement of an ownership share, this leaves the frm in a positon
to have full rights to exploit the patent subject to a royalty based on an agreed
formula.
Another aspect of IP is that the frm must ensure the IP was adequately
managed throughout the development process. IP management must ensure
that IP does not infringe any other IP rights, that the IP is appropriately registered
and that rights are kept current. Since many IP rights require registraton in
other countries, the frm needs to have documentaton of the extent of the
registered rights and be able to show how these may be further protected in
any future acquisiton negotaton.
201
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. An IP management program does not exist.
2. The frm acknowledges the importance of IP management but has no
formal system to register or protect it.
3. IP management is considered important and the frm has registered
various IP but the ownership trail is incomplete and may be subject to
dispute by current and/or past employees.
4. Formal IP management processes are in place. Rights are registered in
countries deemed appropriate for the business. Employees are required
to sign over IP rights as a conditon of their employment. IP acquired
externally and used in the business will be able to be traded by a new
owner.
5. The frm has undertaken an audit by a professional advisor and
implemented systems and procedures recommendatons to ensure full
protecton of its IP rights.
C14. Post acquisiton changes in employment are planned for
Detailed consideraton of the organisaton structure following a possible
future acquisiton will indicate which roles will need to change and which roles
will be redundant. Rather than leave this issue for the new owner to resolve,
the frm can negotate potental changes with those employees who are likely
to be afected and put in place agreements which will smooth the transiton.
A future buyer will almost certainly be confronted with the need to
make organisatonal changes. These will involve changes of management,
redundancies, roles and reportng lines. Many of these changes could
potentally efect compensaton packages. Efectng these changes and avoiding
unrest, disrupton and de-motvaton will be challenging. The potental for
litgaton is present where current conditons of employment are at odds with
the new situaton. An employee who feels he or she has been misled or feels
constructvely dismissed through the changes, may feel compelled to seek legal
advice.
202
Part B: Indices
Raising Angel & Venture Capital Finance
Managing expectatons, providing acceptable optons for employees who
are efected and preparing staf for the likely change, is all part of preparing to
sell the business. Some employees may decide to take early retrement or seek
alternatve employment. Others may see the change as benefcial and want to
stay on. Key employees need to be retained and need to be handled carefully
so that there are incentves for them to stay during a transiton period. Others
may need to be given incentves to leave where their roles are being changed
signifcantly or where they are being made redundant.
In antcipaton that the business will be sold in the future as part of the
strategy agreed with the Investor, the frm should put in place employment
conditons which will ease the path to sale and transiton across to a new
owner. For example, current terms and conditons of employment may include
the opton for the business to make the employee redundant on transfer of
ownership and state the level of compensaton to be paid. Alternatvely, a
retenton bonus may be specifed for key employees to encourage them to stay.
Benefts may be able to be changed on sale of the business.
Self-assessment
1. Atempts have not been made by the frm to implement changes in
employment conditons to facilitate the future sale of the business.
Discussions have not been had with employees about post acquisiton
roles.
2. The frm has reviewed its organisaton structure and determined those
positons which are likely to be changed, made redundant or are critcal
to the transiton. Some informal discussion at management level
has occurred. Formal changes have not been made to employment
conditons.
3. The frm has constructed a post acquisiton scenario and identfed
employees who will be afected. Retrement, redundancy and key
employee incentves have been constructed. Employment conditons
have been changed to refect the possible future sale of the business.
4. Key employee conditons have been discussed with key staf and as a
result their conditons of employment have been changed to incorporate
a retenton bonus. A terminaton package has been incorporated into all
203
Part B: Indices
Raising Angel & Venture Capital Finance
employment agreements to cater for redundancies. Bonus, commission,
proft schemes and share purchase arrangements have all been modifed
to lapse on change of ownership. Professional advice has been sought
on the arrangements.
5. Changes and incentves necessary to ensure a smooth changeover to
a new owner have been reviewed by a professional advisor and fully
implemented.
C15. Employment conditons, salaries and benefts are industry
standard
Following any future acquisiton of the investee frm, employees of the
acquired frm will normally be integrated into the employment, health benefts
and bonus systems of the parent company. When this happens, any deviatons
between the two schemes will have to be resolved. This is normally a tme of
considerable change in the acquired frm with employees fearful of their jobs.
The less change that is imposed, the smoother this transiton will be.
Where remuneraton systems are industry standard, few problems tend to
arise. Staf are neither paid too much nor too litle. If the health insurance is
standard and bonuses are in line with industry standards, these can normally
be contnued or transferred. However, if (say) vacaton enttlements are overly
generous, this can create problems where they need to be curtailed or need to
be contnued alongside fellow employees who receive less.
Self-assessment
1. Litle or no efort has been made to ensure employment conditons are
industry standard.
2. The frm has no formal process for setng pay scales or for performance
evaluaton. They believe they are paying reasonable levels to atract and
retain employees.
3. The frm recruits employees at compettve rates but internal procedures
for advancement are not checked with industry norms.
204
Part B: Indices
Raising Angel & Venture Capital Finance
4. The frm is familiar with remuneraton in their industry and tries to
follow industry norms. An external review has not been made of their
practces.
5. The company uses an outside frm of specialists to assist in setng pay
scales and conditons of employment.
C16. Opton schemes and benefts are compliant with stock
exchange regulatons
Many smaller frms ofer incentves to atract and retain key employees.
These include optons, share purchase schemes, bonuses, share allocaton and
so on. Ofen these deals are done privately between the owner and the new
employee. Sometmes advice is not sought on the long-term implicatons of
these schemes on a possible sale of the frm.
Share purchase schemes and opton schemes have atracted atenton by
both the fnancial reportng agencies and tax authorites around the world and
so there normally exists a vast body of regulatons governing these schemes.
While a scheme might be legal and even appropriate for a small unlisted frm,
the same scheme might be non-compliant for a listed company. Since most
acquisitons are by listed companies, this can be a real problem for a future
sale of the frm to a listed corporaton. An employee will not be happy losing
benefts and may well resist any such change if they have a contract in place
which protects their benefts.
Self-assessment
1. Litle or no efort has been made to ensure opton schemes and benefts
are compliant with stock exchange requirements.
2. The frm is familiar with the need to have compliant schemes but has
made no efort to have their own schemes checked for compliance.
3. The frm has sought professional advice to check the degree of
compliance of their schemes and to advise of changes which may be
necessary.
4. The frm is implementng changes to their schemes to bring them into
compliance.
205
Part B: Indices
Raising Angel & Venture Capital Finance
5. Opton and beneft schemes are compliant with stock exchange
requirements.
C17. Due diligence fles are complete and up-to-date
The purpose of due diligence is to check the health of the frm and to identfy
any potental risks. It also checks that the informaton provided by the frm is
complete and accurate. Checks will include:
• supplier and customer contracts
• licences, patents, trademarks and IP management systems
• leases, distributon agreements and hire-purchase agreements
• employment contracts, health insurance and bonus systems
• complaints processing, dismissal processes and warranty systems
• quality control systems
• fnancial reportng systems, aged debtors and aged creditors
• reference checks with customers, suppliers and professional advisors
• background checks on key executves
• R&D, manufacturing and distributon processes
• banking relatonships and loan conditons
• shareholder agreements, opton schemes and share-purchase schemes.
The informaton required for a due diligence investgaton is extensive and
very tme consuming to collect and collate. Ofen there are documents missing
or incomplete. However, it is through this process that the Investor will uncover
internal and external risks which can cause problems with their investment and
may create problems in a later trade sale or IPO. A check of the documents
themselves can ofen be a long and exhaustve process. Every contract, lease
and agreement is sometmes checked to ensure that it does not overly expose
the investor or acquirer. To the extent that professional advice from industry-
knowledgeable legal and accountng frms has been used, this process can be
dramatcally shortened. Sometmes only a sample needs to be reviewed.
206
Part B: Indices
Raising Angel & Venture Capital Finance
Self-assessment
1. The frm is not conversant with a due diligence process and preparatons
have not been made.
2. The frm is aware of the requirements of a due diligence process but
does not have internal policies to ensure that records are complete and
up-to-date.
3. The frm has a policy of maintaining complete and up-to-date fles but
has not had this process audited or checked compliance with this policy.
4. A professional audit of the accuracy and completeness of records has
been conducted and recommendatons are being implemented.
5. A complete and up-to-date fle has been assembled to enable a full due
diligence audit to be undertaken.
207
Part B: Indices
Raising Angel & Venture Capital Finance
Operatons Development Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
C1 Monthly fnancial and key performance indicator reportng
exists
C2 A formal business plan has been prepared and is updated
periodically
C3
A formal budget is prepared and actual performance is
monitored against budget
C4 Full compliance with regulatory issues (eg. environmental,
health and safety)
C5 Customer relatonships are managed to minimize litgaton
C6
Supplier relatonships are managed to minimize litgaton
C7
Employee relatonships are managed to minimize litgaton
C8 Credit worthiness with suppliers is excellent
C9 Banking relatonships are excellent
C10 Customer interacton, contracts and agreements are industry
standard
C11 Supplier contracts and agreements are industry standard
C12 Contracts can be assigned to an acquirer
C13
Intellectual property is able to be traded and is appropriately
protected
C14 Post acquisiton changes in employment are planned for
208
Part B: Indices
Raising Angel & Venture Capital Finance
Operatons Development Index (Cont.)
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
C15 Employment conditons, salaries and benefts are industry
standard
C16 Opton schemes and benefts are compliant with stock
exchange regulatons
C17
Due diligence fles are complete and up-to-date
209
Raising Angel & Venture Capital Finance
F
i r ms s e e k i n g t o r a i s e An g e l o r Ve n t u r e Ca p i t a l f i n a n c e
o f t e n k n o w v e r y l i t t l e a b o u t t h e n a t u r e o f An g e l o r VC
investment or the role and objectives of Angels and VC funds. Well established Angels and
VC frms with good track records are actively sought by both investors and entrepreneurs
and don’t have the time nor the resources to deal with the many approaches they have,
thus need to screen entrepreneurs seeking fnance and concentrate their efforts where
they can achieve the highest productivity for their time.
Investors often complain about the naivety of the entrepreneurs. Few they encounter really
understand the purpose of Angel or Venture Capital fnance or the criteria which they use
to select investments. They often say that their frst task is to educate the entrepreneur.
This environment provides, in fact, a very fertile ground for the entrepreneur who
approaches the Investor with a well thought out proposal put in terms which they can
appreciate and with the support of a professional advisor they respect. Where they can be
assured they are being offered a chance to look over a proposal which has been reviewed
by a knowledgeable professional advisor, it makes their life easier and more productive.
In fact, some Investors won’t entertain looking at a proposal unless it has come from a
respected angel or professional advisor.
Even when the Investor is approached using the proper channels, the well prepared
entrepreneur must still be able to deliver a written proposal in a form which allows the
Investor to easily evaluate the investment in their terms – that is from the viewpoint of the
D
Strategy
210
Part B: Indices
Raising Angel & Venture Capital Finance
investor not the business builder. The proposal should be backed up with a management
team who can clearly articulate the benefts of the business in terms of growth, ROI, risk
exposure and likely exit and do so in non-technical language.
The entrepreneur should also be well versed in valuation techniques and normal terms
of Angel or VC investment. Discussions with an Investor will be much more meaningful
and productive if the entrepreneur understands how Angels and VC funds work, how they
manage their investments and how they achieve a harvest on their investments. Using a
professional advisor to educate, advise and assist in this process will ensure that neither
the entrepreneur nor the Investor waste their time.
D1. Investment advisors have been appointed
Few entrepreneurs ever have the experience of raising Angel or VC fnance and even less
do it more than once. Thus few ever build up the required knowledge and experience to
effciently work through the requirements. A professional advisor who deals with Angels
and VC funds on a frequent basis not only understands the requirements of the investor
but should have contacts within the investor community to best advise the entrepreneur
on which investors to approach.
The process of securing an investment requires the frm to prepare a wide array of
information, not just on the business concept itself, but extensive information on
the business for the due diligence process. The professional advisor can assist in the
preparation of the investment proposal as well as ensure that the frm is well prepared for
the due diligence activity. A creditable and experienced professional advisor will ensure
that the frm does not waste their executive time pursuing the wrong strategy. Angel and
VC investors have a specifc set of business and legal requirements and the frm needs
to ensure that it can meet these conditions.
Part of the process of selecting a professional advisor should be some form of reference
checking as well as a degree of comfort and ft between the parties. A frm which knows
what it is doing should have little hesitation in providing references to clients which they
have assisted through the same process.
211
Part B: Indices
Raising Angel & Venture Capital Finance
Self assessment
1. Advisors have not been approached or appointed.
2. Advice has been sought as to which advisors the frm should work with but
approaches have not been made.
3. The frm has made an approach to one or more advisors and discussions have
commenced but appointments have not been made.
4. The frm has negotiated terms with one or more advisors, undertaken reference
checking and interviewed one or more clients which the advisor(s) have assisted
but agreements have not been entered into.
5. An investment advisor has been appointed.
D2. An equity investment/debt strategy has been formulated
Angel and VC investment should be part of an overall funding strategy being constructed
for the business. While equity investment has the advantage that it has no repayment risk
associated with it if the business is temporarily unable to fund dividends, it does dilute the
founders equity. On the other hand debt, while not diluting equity holdings, does carry
a risk in the event of non payment of interest and principal. Failure to pay interest when
due or to make the periodic loan repayments can result in the business being put into
receivership and perhaps assets seized and sold. Thus fnding the right balance between
equity dilution and repayment risk is essential for longer term funding of the business.
The frm should be prepared to discuss the fnancing strategy with the Investor and be
able to show how the business will fnance any external debt which it intends to take
on. Generally the Investor will require the frm agree to seek the Investor’s permission
before it commits to any additional external debt.
Self assessment
1. A strategy for the use of debt and/or equity investment has not been formulated.
2. The frm has identifed a need for funding but has not translated this into how much
or what mixture of debt and equity would be appropriate.
3. A plan incorporating a desired level of debt and equity has been constructed but
this has not been tested against the business plan to see if it will adequately cater
for different levels of success in business outcomes.
4. The funding model has been incorporated into a business plan and has been tested
against various scenarios.
212
Part B: Indices
Raising Angel & Venture Capital Finance
5. The funding model has been reviewed by a professional advisor and adjusted
accordingly.
D3. A realistc valuaton formula has been constructed
The valuation of the business prior to an Angel or VC investment (pre-money) is usually
a contentious issue for both founders and investors. The founders clearly want as little
dilution as possible while the investors want the downside protection of a low valuation
going into the deal. Unless both parties can move past the valuation issue, no deal will
be consummated.
Most Investors will argue for a lower valuation based on their experience of past
investments which went sour. Even when everything looks positive at the outset, their
experience shows that forecasts are rarely achieved and activities take much longer than
anticipated, thus their initial valuation needs to refect this. On the other hand, the founders
will want to hold onto as much equity as possible, especially if the venture proves highly
successful. If the initial opening positions are too far apart, it is possible the discussions
will simply be terminated and no investment will be forthcoming. It is in the interest of
the frm to start with a realistic valuation and negotiate from that position. In the end, a
formula based valuation may be the best way to resolve any major differences in valuation.
Self assessment
1. A valuation fgure or valuation calculations has not been undertaken.
2. Crude valuations have been discussed based on market transactions and industry
norms but specifc calculations have not been made.
3. Conventional valuations using a fair market value formula have been undertaken.
Market information of similar transactions has been assembled.
4. Valuations have been reviewed by professional advisors. Market information of
similar transactions has been reviewed with the professional advisor to identify
appropriate norms.
5. A valuation formula has been constructed to refect different possible outcomes at
exit. A preferred valuation or formula has been documented with reference to fair
market valuation and recent industry transactions.
213
Part B: Indices
Raising Angel & Venture Capital Finance
D4. An executve summary and an investment business plan
have been prepared
Most businesses seeking external investment will have prepared a business plan but few
will have constructed the plan with the requirements of the Angel or VC investor in mind.
Most business plans are designed to develop the business rather than to show the Investor
how they can protect their investment and achieve their exit requirements. An investment
business plan needs to be constructed somewhat differently from a normal business plan.
Investors are unlikely to be familiar with the intricacies of the business and its marketplace,
thus the business plan needs to place the business into a context of customers, benefts,
competitors and market dynamics. Within this context, the investment business plan
needs to show how and why the business will be able to achieve the revenue and proft
projections and show how these numbers have been validated.
Investors often deal with hundreds of proposals and so a well articulated executive
summary needs to encapsulate the essence of the business opportunity, the investment
required, the proposed exit strategy and the expected returns to the Investor. Unless the
summary captures their attention, it is highly unlikely the rest of the business plan will
be read.
Self assessment
1. A summary or business plan has not been prepared.
2. Financial projections and annual budgets have been prepared but do not contain
information which would enable the business to be evaluated by an external party.
3. A business plan has been prepared for the normal operations of the business but
does not refect the special needs of an Investor.
4. An investment business plan with an executive summary has been prepared
specifcally for the purpose of raising equity investment but has not been reviewed
by a professional advisor.
5. An investment business plan including an executive summary has been prepared
specifcally for raising equity fnance and has been reviewed by a professional
advisor and adjusted based on their advice.
214
Part B: Indices
Raising Angel & Venture Capital Finance
D5. Appropriate Investors are identfed
While there are many Angel and VC investors, each one has their own preferred investment
objectives which are based on their industry experience, the amount they have to invest,
the time they have available to manage their investments, their existing commitments,
travel preferences and so on. Just because an opportunity looks compelling from an ROI
point of view, does not mean that investors will be focking to review the proposal. They
will know they will often have to get involved with the management of the business
or with the development of its market penetration or the fnal exit. These often require
familiarity with the sector and possible access to alliances, senior executive talent and
possible corporate acquirers.
At the same time, their desire to invest may depend on what other investments they have
and their risk tolerance. A Investor which has substantially allocated their investable funds
may not be in a position to make new investments. A VC fund which is fully allocated
may not be in a position to allocate new funds for some time. Angels and VC funds need
to balance their investments across different risks, thus an Investor may feel over extended
in one sector and not be willing to make further investments in that area. Alternatively,
a different Investor may be seeking investments in the frm’s sector.
Self assessment
1. Investors have not been identifed or approached.
2. Angels and/or Venture Capital frms have been selected based on location and
personal introductions but this has not been done scientifcally or with the advice of
a professional advisor.
3. A number of Investors have been identifed based on their preference for industry
sector, size of investment and geographical preference but reference checking has
not been done and no professional advice has been taken.
4. Professional advice has been sought on the selection of Investors and a small
number identifed for approach but no reference checking has not been undertaken.
5. A select number of Investors have been identifed based on their preference for
industry sector, size of investment, geographical preference and so on. References
have been sought from current and former investees and other professional parties.
215
Part B: Indices
Raising Angel & Venture Capital Finance
D6. Creditable introductons to Investors are achieved
Some Investors have a policy of not reviewing unsolicited proposals. This is partly
based on the fact that they have a good pipeline of referred proposals from professional
advisors, former investees and colleagues but also because they simply don’t have time
to read a proposal which has not been professionally prepared and reviewed before they
see it. Investors prefer not to waste their time with poorly prepared information or with
unrealistic proposals. They expect proposals which they receive to have been referred
to them by knowledgeable persons and that they will not only be complete but also the
applicant will have realistic expectations on valuation.
Investors often complain that they spend too much time educating the entrepreneur about
how Angel or VC investment works. Some of the conditions attached to an investment
are confronting to an entrepreneur, especially when they see there is a chance they may
lose control of their business or their business can be sold from under them. While these
conditions may appear harsh, they refect the reality of dealing with high risk ventures
where liquidity is a serious issue. Rather than having these diffcult discussions, the
Investor would rather deal with proposals which have already taken into account the
manner in which the investment will be constructed and managed. At the same time,
they would rather deal with proposals which have the necessary information in them to
allow them to undertake a proper evaluation.
Self assessment
1. Introductions have not been arranged.
2. The frm has secured a letter of introduction from friends or a suburban accountant
or lawyer. The contacts with the Investor are not personal and are mostly ones of
professional courtesy.
3. Personal introductions have been arranged by friends and acquaintances of
the Investor. These individuals, however, are not familiar with Angel or VC
investments.
4. Introductions have been arranged to the Investor by individuals knowledgeable
about Angel and VC investments but not specifcally about the preferences of the
specifc Investor.
5. Introductions have been arranged by creditable professional advisors and/or other
investors who are actively involved in Angel or VC investment transactions and are
216
Part B: Indices
Raising Angel & Venture Capital Finance
known to the Investor. The introductions have taken into account the investment
preferences of the Investors being approached.
D7. Key messages are practced and refned
Investors evaluate many proposals before they make a single investment, thus they tend
to use their time as effciently as possible. They look for a venture team which can clearly
articulate the essence of both the business and the investment proposal. This is not just
because it helps them in their evaluation but because they know the team will have to do
this task many hundreds of times to customers, suppliers, alliance partners and potential
employees. A venture team which is unable to provide a precise defnition of who they
are and why they are going to be successful probably has not yet come to grips with the
essence of the business and how it needs to be developed to be successful.
The vision of the business needs to be both compelling and succinct. The business
concept should clearly show how and why the business will be successful. The investment
proposition should show how much investment is required, what it is going to be used for,
what exit strategy will be undertaken and what return the investor can expect to receive
on their investment. The investment proposal should be presented in non-technical terms
if appropriate, be able to be adapted to different presentation lengths and show that the
supporting detail will demonstrate validation of the critical business issues.
Self assessment
1. No effort has been made to develop a clear vision and defnition of the business
concept.
2. The frm can discuss their venture knowledgeably but this has not been tuned for an
investment audience.
3. The vision and defnition of the business concept is well understood and has been
developed for an Investor but is too long, overly technical, lacks fow or is not
convincing.
4. The frm has developed a series of presentations for Investors including a short
pitch and a 20-30 minute business plan presentation. This has been tested and
practiced with colleagues and friends.
5. The frm has a well articulated set of informal and formal presentations which have
been reviewed with professional advisors and suit a variety of different technical
and non-technical audiences.
217
Part B: Indices
Raising Angel & Venture Capital Finance
D8. Multple Investors are engaged
A good proposal should be offered to a small number of selected Investors. This is not to
suggest that it is shopped around, but each Investor will have their own portfolio strategy
and the worth of your venture, while attractive, may not suit the investment position or
timing of some of the Investors. You also want to have the opportunity of comparing
what additional value each Investor can bring to your venture. If the money available
is the same across the Investors, their added contribution in terms of networks, access
to experienced staff, ability to open doors to alliance partners and potential customers
should also be evaluated.
You also need to be comfortable with the people you will be dealing with, especially the
Investor or Investor’s representative who will be sitting on your board. You don’t want
to fnd yourself stuck with someone who has a different view of the world or a different
cultural or ethical position. It may be the case that the terms under which the Investors
are willing to invest are different in which case you need to weigh up the different tangible
and intangible benefts. Some may be much more willing to negotiate a formula based
valuation, for example.
Self assessment
1. Investors have not been engaged.
2. The frm has approached a number of Investors but has yet to move to a second
round of discussions.
3. Detailed discussions have been undertaken with several Investors and some level
of interest has been expressed.
4. Discussions with a small number of Investors have progressed to strong
expressions of interest or one Investor has been selected for extensive discussions.
A professional advisor has reviewed the discussions and advised on which Investor
to proceed with.
5. A small number of Investors have expressed strong interest and the frm has
agreed to proceed to develop a Term Sheet with them. A professional advisor has
recommended which Investor should be taken to Term Sheet stage.
218
Part B: Indices
Raising Angel & Venture Capital Finance
D9. Ofers received and negotated
After the various Investment offers have been evaluated and some due diligence
undertaken on each of them, Heads of Agreement will be negotiated. This is something
that must be negotiated as there are many possible components to the investment deal.
You should spend some time prior to the meetings becoming familiar with the normal
terms of an Angel or VC investment and request clarifcation from your professional
advisor if you are not familiar with the implications of the various terms and components.
The verbal offer which you receive is not necessarily the last position of the Investor.
Investors are competing for your business in the same way that you are seeking theirs.
You should be trying to fnd a balance between your interests as founders and shareholders
with theirs as independent investors. If you push your position too hard, however, you
will probably not end up with a deal. But marginal aspects of the deal may still be subject
to movement on their side and you may be willing to offer some concessions on yours.
In the end, however, you still need to make the numbers and the timescales to protect
your investment in the business.
Self assessment
1. Offers have not been received.
2. At least one Investor has expressed strong interest but no discussion of an offer has
eventuated.
3. One or more Investors have expressed strong interest and have discussed the
investment evaluation process with the frm. One or more have indicated that
offers would be forthcoming after some additional due diligence steps have been
undertaken.
4. One or more Investors have indicated the broad terms of an offer. These have not
been responded to and not reviewed with the professional advisor.
5. Verbal offers have been received by the frm and have been reviewed by the
professional advisor. A response has been given to at least one Investor which
indicates that a written Term Sheet would be seriously considered.
219
Part B: Indices
Raising Angel & Venture Capital Finance
D10. Term Sheet received and negotated
The Term Sheet is the formal offer by the Investor. This will be issued only after they
have reached an understanding with you and have done initial due diligence on the frm
and the market opportunity. The Term Sheet means they are ready to put some serious
time into the full due diligence and working with you to make sure each party has a full
understanding of the journey that you will undertake together over the next few years.
However, even a Term Sheet can be negotiated to some extent. Often additional clauses
have been added by the Investors which have not been fully discussed or they have
assumed you are familiar with. These need to be examined, often in conjunction with
a professional advisor and then clarifcation sought. Sometimes minor items within the
Term Sheet can still be negotiated.
Often at this point, you have settled on your preferred Investor and only one Term Sheet
will be dealt with. Providing you have done your reference checking and are comfortable
with the Investor and the deal, there is no reason why you should not proceed at this point.
Make sure all the parties to the agreement on your side are willing to sign off on the deal.
Self assessment
1. Term Sheets have not been received.
2. A Term Sheet has been received but is unacceptable or has not been responded to.
3. Negotiations on the Term Sheet have commenced but there is still some gap
between the parties.
4. Negotiations have concluded on the Term Sheet and verbal agreement reached on
an acceptable arrangement. The frm is waiting on a new terms sheet.
5. A Term Sheet has been received which is acceptable to the frm and has been
recommended by the professional advisor.
220
Part B: Indices
Raising Angel & Venture Capital Finance
Strategy Index
Nothing
done
Litle
progress
Reasonable
progress
Signifcant
progress
Fully
atained
N.A
1
2 3 4 5
Item Atribute
1 2 3 4 5
N.A
D1 Investment advisors have been appointed
D2 An equity investment/debt strategy has been formulated
D3 A realistc valuaton formula has been formulated
D4 An executve summary and an investment business plan
have been prepared
D5 Appropriate investors are identfed
D6 Creditable introductons to investors are achieved
D7
Key messages are practced and refned
D8 Multple investors are engaged
D9 Ofers received and negotated
D10 Term Sheet received and negotated
doc_682068194.pdf