Investment process
Startup point of view
Creating a startup from scratch takes a lot of energy, resources, patience amongst other things, such as money, teamwork and overall understanding of how VC/PE industry works. However, making MVP, creating UI/UX and making the app work is one thing, attracting investments from anyone (even from friends) is another.
Raising funds is not a rocket science, but it still takes founders’ precious time. However, over the time financing ecosystem has evolved so much that now it offers plenty of investment structure of any flavor – convertibles, SAFEs, warrants and every possible mixes of those three accompanied by other investment methods, including simple equity investments. Alternatively, startup can just apply for a grant from government or private funds.
This comprehensive guide on how the investment process works (from both startup and PE/VC sides) is designed to optimize founders’ resources, so they can spend more time on pushing their MVP to market and actual operations instead of googling what is a term sheet and how it works. This guide also includes links to market best practice examples of documents or relevant information.
PE/VC dictionary
Before any contact with investor is started, founders need to delve into PE/VC lingua not to get lost in all seemingly unknown ocean of words.
Mattermark has a great VC dictionary (see link to the right).
Preparation for fundraising
Before contacting any potential PE/VC, angel or any other investor it is highly advisable to have several basic things prepared (let’s call it a checklist):
- Incorporation: whether you are in the US, EU, Asia or any other region, it is much better when there is a legal entity (even if it’s just an empty shell now) with pre-investor shareholding structure in place. Use the equity calculator to figure out how the company can be split between founders before any investment is made. Alternatively, check the Sweat Equity or Media for Equity options.
- Name: every company/project should have a name (and preferably a logo).
- Website: the same goes for the website. It is the face of your project.
- Team: investors give money to people, not legal entities, so make sure that founder have nice LinkedIn pages and bios ready to be shared.
- MVP: have a working product to show to the investor. Get rid of the bugs.
- Investor types and investment stages: understanding the amount that is needed to be raised, who money is raised from. There are FFF (Family, Friends & Fools), angels, PE/VC funds and other types of investors. And there are pre-seed, seed, series A/B/C and other investment stages. Understanding what is expected from both startup and the investor is crucial as it helps to avoid misunderstandings and conflicts at early stages of investment process
- Information pack for investors: this deserves a separate section covered below.
Creating info pack for investors
Preparing high quality materials for investors is crucial. Investors receive hundreds and thousands of investment opportunities so if you don’t have anything to catch the investor’s eye, then all your previous efforts would be useless (unless you plan on bootstrapping all the time). Before approaching any investor, you should have the following info pack:
- Teaser: a short document (usually 2-3 pages) where you briefly outline the key aspects of your business or project – short description, problem and solution, addressable market, team, key figures, business model and how much money you need. Keep in mind, it should be an attention grabber!
- Pitch: a longer document (10+ pages) where the business or project is described in much more details. The key sections of the pitch may include executive summary, market (TAM, SAM, SOM), competitive landscape and key advantages, problem-solution, traction, overview of technology and operations, business segments, business model, development plan, team, financials (historical and forecasts) among other things.
- Cash flow model (CFM): this is basically an Excel spreadsheet with projections of all relevant operating and financial figures, such as revenue, costs, profits and cash flows for the next 5 or more years. Start at least with quarterly projections as yearly projections may not account for seasonality and other specifics. Why cash flow model? Is it because investors look at cash not revenue? Why? It is up to you to find out.
- Business plan (BP) or Information memorandum (IM): this is your project practically laid bare before the investor eyes. Usually a detailed presentation (30+ pages), where all the key things are described – IP and its protection, short-medium-long term vision of the business or project, strategy, use of funds, client portfolio and etc. This document is usually needed at later stages (due diligence), but it is better to have it completed as some investors can move very fast. Info memo may contain confidential information, so don’t forget to sing an NDA prior to sharing it!
- One more thing: Never write false facts in your documents. Investor will uncover any inconsistencies on due diligence stage.
Researching financing options and preparing a long list of investors
By this stage you must know that there are numerous financing options including:
- Private equity funds (PE)
- Venture capital funds (VC)
- Government funds
- Angels/angel networks
- Grants
- Incubators + Accelerators
- Family offices
- Corporate investors
- Venture debt funds
You can also visit your country’s PE/VC associations to find local options of financing.
After choosing the most suitable financing option, you need to compile a long list of investors.
DOs:
- Keep the list organized (better in Excel or CRM system)
- Mark the contacts of key people in the funds (better investment directors)
DON’Ts:
- The list shouldn’t include investors whose investment criteria doesn’t match your business or project (size, industry, location and etc.)
Contacting and meeting investors
- Sending the letter: Before contacting the investors prepare a draft of the letter you will send. Ideally, write a general letter for every investor and then tweak certain parts of it when sending to certain investors, who require special attention. Send the letter with a teaser/pitch to the investor. In case if it is a fund, then send the materials to investment director / investment manager as they are the ones that filter the projects. Please don’t spam the investors!
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Feedback: feedback can come in different forms:
- No feedback at all: it means that investor is not interested in your project or simply didn’t had a chance to take a look at it. A kind reminder in 2-3 weeks would do a job here.
- Formal feedback: it is either rejection unless the feedback letter has specifics when the investor can return to you.
- Invitation for a call/meeting: means that you transition to the next stage
- Short list of investors: after receiving a feedback from investors at your long list, mark communication status with all investors in your investor list to arrive at a short list. This is where the fun begins.
- NDA: most investors don’t like NDAs because it is the team and execution that matters not the idea itself. VCs can be looking at 3-7 similar deals in the same segment (say EdTech) and as VC funds generally have small teams, it would mean more unnecessary work for VC legal team. But that doesn’t mean that you need to share your “secret sauce” with everyone. So if you agreed with investor that you sign an NDA, then it is better to have a good template ready well in advance. This mostly applies to FFF/angel investors as VCs usually have their own NDA form.
- Calls and meetings: this usually is pre-due-diligence (DD) phase when project strategy, cash flows plans, business model and addressable market are discussed. Investors also analyze competive landscape and the technical side of the project, and can even do reference calls. Understanding project roadmap is also a concern on this stage. If all goes smoothly, you can move into pre-final stage. Usually investor asks for Information memorandum at this point, which has to be ready. And be prepared to defend all information and assumptions in your materials!
Deal structuring and due diligence (DD)
If the project passed all first meetings, calls and successfully answered all questions, then you move to the next stage and the following two processes start:
- Structuring stage, where all written/oral agreements turn from general words to quite detailed mechanics in legal investment documents. This is where term sheet (TS) comes on stage. Term sheet is basically an agreement between parties which contains basic terms for financing. Simply put the skeleton of the legal investment documents that are going to be drafted after investment committee of the fund approves the deal. TS includes the conditions under which the financing is transferred, rights and obligations of parties and many other things. Capitalization table is also usually a part of TS that shows how the company is owned before and after investment is done. You can find several examples in the right part of the screen.
- Due diligence (DD) stage, where all financials, internal legal documents, staff and nearly all other project’s documents are checked. Investors also analyze and evaluate potential risk and mitigations.
Structuring and DD processes can start simultaneously, but all investors have their own process maps, so some prefer to make DD first and then make the TS, some – the other way around.
Legal documents signing and money transfer
The final part of investment process is document drafting, signing and money transfer.
- Drafting and signing investment documents: usually investors have their own drafts of investment documents and they modify for each new deal, but basic things always remain the same (like confidentiality clause). In case the investor doesn’t have the samples, there are some examples for you. Investment documents usually include SHA (Shareholders’ agreement), SPA (Share purchase agreement), SAFE (Simple agreement for future equity) and so on. In best case you should hire an investment lawyer, so you don’t get lost in legal terms. After legal documents are drafted and approved by both sides, they are signed. By the way, there is a great book to understand the legal side of deal. Be sure to read it!
- Conditions precedents: Legal documents usually have conditions precedents (CPs), which have to happen/things needed to be done by the company until the money is transferred. Keep in mind than until all the CPs are met, the deal isn’t closed!