Raising Seed Capital

Luke Liem

Private Investor, USA

Agenda

This lecture will be structured as followed:

1. Financing Options and Investors

2. Case Discussion #1 – Google’s First US$100K

3. Case Discussion #2 – FaceBook’s First $500K

4. Cap Table and Venture Funding Rounds

5. Valuing the Business

Objectives

The lecture and case discussions are designed to help you develop the skills to:

1. Raise your first seed investment

2. Find the right investors

3. Make some good money and people decisions

Agenda

This lecture will be structured as followed:

1. Financing Options and Investors

2. Case Discussion #1 – Google’s First US$100K

3. Case Discussion #2 – FaceBook’s First $500K

4. Cap Table and Venture Funding Rounds

5. Valuing the Business

Startup Financing

• It comes in 2 flavors:

– Equity (Common and Preferred Shares)

– Debt (Typically convertible bond)

• Financing is typically provided by:

– Angel Investor at an early stage(Seed and Series A)

– Venture Capital at a later stage(Series A, B, C, D....)

Angel Investors – Who are They?

– Rich individuals, Ex-entrepreneurs, or both

– Motivated by wealth or their interests and passions in startups• Most of them really wants to help entrepreneurs

– Many are organized by networks (e.g. Keiretsu Forum, Band-of-Angels, etc). • They invest as a syndication (e.g. 10 angels investing $100K each to

fund a $1 million round)

– Super-Angels (Peter Thiel, Mark Andreessen) have their own venture funds, but also invest individually as angels.• Peter Thiel’s fund – Founders Fund• Mark Andreessen’s fund - Andreessen Horowitz• Look them up on https://www.crunchbase.com

Marc Andreessen – Angel Investor

Andreessen Horowitz

Angel Investors – Advantages

– Typically ask fewer questions

– Invest in earlier stage (Seed, Series A,..)

– Willing to get involved early:• Give advice about your business and your market

• Sit on your Board of Directors

– Many are well-connected and can introduce you to good lawyers, accountants, VPs and CEOs, venture capitalists.

– Depending on the angel, may have lower expectations than VCs.

– Can have a longer time horizon than VCs.

Venture Capitalists

– Institutional Investors – a number of partners who have raised $100 million to $1 billion from foundations, insurance companies, retirement funds.

– Typically not interested in making “smaller” $100-500K investments at the seed stage.

– Their rule of thumb:• Their goal is to grow the fund 3X

• To do that, each investment must have the potential to return 10X their investment (Series B, C, D investments can have lower returns)

• Expect only 1 out of 5 of their investments to do very very well

Venture Fund TimeLine

– Most VC funds are designed for ten year lifetimes

– Invest in year 1-4, Harvest in year 5-10

J-curve

Invest

Exits – IPOs& Acquisitions

Venture Capitalists Disadvantages(Early Stage)

• Short Time Horizon - Depending on where the fund on the J-Curve, VC firms may want to push the startup to grow too quickly so that they can get their investment back within three to five years.

• Forced Management Change - For the majority of venture capital agreements, management additions (Either CEO or COO) are a requirement to receiving funding.

• Loss of Equity - Venture capitalist requires large equity stake in the company to safeguard his or her initial investment.

• Loss of Decision Making Autonomy – By holding seats in the Board of Directors, business owners are required to consult with the venture capitalist prior to making any key decisions in capital spending, expansion and personnel changes.

• Staged release of funding - business owners need to hit milestones prior to receiving the financing they initially requested.

Agenda

This lecture will be structured as followed:

1. Financing Options and Investors

2. Case Discussion #1 – Google’s First US$100K

3. Case Discussion #2 – FaceBook’s First $500K

4. Cap Table and Venture Funding Rounds

5. Valuing the Business

Google Case Discussion

Who is Andy Bechtolsheim?

– Born 1955 near Ammersee, in the German Bavaria.

– Technology enthusiast since a child

– Left Stanford University in 1982 to found Sun Microsystems, as employee #1.

– Left Sun to found Granite System. Bought by Cisco for $200M (he owns 60% of the company).

Google Case Discussion

Andy Bechtolsheim as an Angel Investor

– Co-founded HighBAR Ventures, an early-stage venture capital investment firm, along with two Sun colleagues.

– As an angel, he invested $100K in Google $1.7B in Mar 2010 (GOOGL @$300 per share). This is his best investment.

Google Case Discussion

Why is Andy an angel investor?

• He is at the core an engineer and technologist:o passionate about the power of technology o love finding new ways to solve problems

• As a former founder, he was helped by angel investors. Now he wants to give back.

• He wants to be involved with an extremely valuable enterprise.

Google Case Discussion

What is Andy’s investment philosophy?

• His General Approach:

- Ideas that solved real problems he could understand- Businesses with the potential to produce real profits- Bright, passionate, and capable founders.

Google Case Discussion

How did Google’s founders gain Andy’s trust and investment?

• Referral from a Trusted Source - They have been referred to him by David Cheriton, a professor at Stanford University, a friend who is in his “circle of trust”.

• Working Prototype and Demo - The team has a working prototype and successfully demo their search engine. Andy became convinced that he had seen and understood the demo of a better technology with potential to address a real problem.

Google Case Discussion

How did Google’s founders gain Andy’s trust and investment?

• Believable Path to Profitability - Instead of making money through advertising, they proposed that the company can make money by licensing their superior search technology to portal companies.

• Good Impression - They Impressed Andy :

- They explained Google’s engineering approach to producing superior search results, that they need money to build their own inexpensive computers and networks to create the search database.

- They wanted to build a valuable superior product that “speaks for itself” instead of wasting money on marketing and advertising.

Agenda

This lecture will be structured as followed:

1. Financing Options and Investors

2. Case Discussion #1 – Google’s First US$100K

3. Case Discussion #2 – FaceBook’s First $500K

4. Cap Table and Venture Funding Rounds

5. Valuing the Business

FaceBook Case Discussion

Who is Peter Thiel?

– Born 1967 in Frankfurt am Main, West Germany. Emigrated to the USA

– Attended Stanford University. Philosophy undergrad and JD (Law).

– Formed friendships with other students at Stanford (e.g. Keith Rabois, David O. Sacks, and Reid Hoffman). Some later worked together at PayPal (co-founded by Thiel) and became part of the PayPal Mafia.

FaceBook Case Discussion

Who is Peter Thiel?

– Career in law, investing, then Paypal.

– In 1998 Thiel co-founded PayPal with Max Levchin. The company later merged with X.com, then headed by Elon Musk. PayPal was sold to eBay for $1.5 billion later that year (Thiel owned 3.7% or $55M).

– A technologist, investment genius and social critic. Not a hardcore engineer.

FaceBook Case Discussion

Peter Thiel as an Angel Investor

– In 2005 Thiel created Founders Fund, a San Francisco-based venture capital fund.

– In 2004, Thiel made a $500,000 angel investment in Facebook for 10.2% of the company and joined Facebook's board. He sold most of his shares during the FB IPO in 2012 for $1B.

FaceBook Case Discussion

How did the Facebook team gain Thiel’s investment?

• Referral from a Trusted Source - They were referred to him by Reid Hoffman, a member of the “PayPal Mafia”. The two had worked together at PayPal.

• Working Product that is Scaling - The team were able to demonstrate :

- When a new school joins Facebook, it captures all the students within a few days, and 80% of them return to the site daily. These statistics demonstrate (1) Virality, (2) User Engagement.

-The website only allows people with .edu email address to register.

- Schools are begging to join the site.

FaceBook Case Discussion

How did the Facebook team gain Thiel’s investment?

• Previous Experience in the Sector:

- Peter Thiel understands the economics of social networks through his previous investments in LinkedIn and Friendster.- He knows Sean Parker

• Good Impression:

Peter Thiel is impressed with Mark Zuckerberg – introverted, technical, visionary, asks questions, willing to admit when he does not know something.

FaceBook Case Discussion

FaceBook’s Seed Round:

Convertible Loan

Pre-Money

Common

Shares

Convertible

Note Post-Money Ownership

Peter Thiel $500,000 10.2%

Founders $4,400,000 89.8%

$4,400,000 $4,400,000 $500,000 $4,900,000 100.0%

Seed Round

(After

Conversion)

Pre-Money

Common

Shares

Convertible

Note

Preferred

Shares Post-Money Ownership

Peter Thiel $0 $500,000 10.0%

Reid Hoffman &

Others $100,000 2.0%

Founders $4,400,000 $4,400,000 88.0%

$4,400,000 $0 $600,000 $5,000,000 100.0%

Agenda

This lecture will be structured as followed:

1. Financing Options and Investors

2. Case Discussion #1 – Google’s First US$100K

3. Case Discussion #2 – FaceBook’s First $500K

4. Cap Table and Venture Funding Rounds

5. Valuing the Business

Cap Chart.xlsx

Key Takeaways

• It is better for Founders to take no salary or very low salary until Series A (VC funding).

• An option pool should be created for attracting new employees.

• The less you need the money, the more the investors want to give money to you and accept a higher pre-money valuation.

Agenda

This lecture will be structured as followed:

1. Financing Options and Investors

2. Case Discussion #1 – Google’s First US$100K

3. Case Discussion #2 – FaceBook’s First $500K

4. Cap Table and Venture Funding Rounds

5. Valuing the Business

Key Takeaways

• Valuation is meaningless during Founding Stage.

• At Seed Stage, valuation is based more on negotiation between angel investors and the company:– If company has revenue, valuation can be a multiple of

revenue (3-10x).– If there is no revenue, the investors will project how much

the company can be sold for or IPOed for, than work backward so that they get a 10-50x return.

• A US Silicon Valley startup is typically valued at $1.0-5.0 million pre-money at Seed and Series A stages.

Q&A