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Investment analysis of startups

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Investment analysis of startups

  1. 1. Anton Fedorov BURAN VENTURE CAPITAL tonyfedorov.com
  2. 2. Table of contents 1. Venture Capital overview  What is VC?  Business model  Risks – Reward curve 2. Investment framework  Team  Business Specifics  Market Opportunity  Exit returns  Risk mitigation 3. Lessons learned 2
  3. 3. 3 What is Venture capital and why it exists. Venture capital (VC) is type of funding for a new or growing business which usually involves high risk financial risks. Difficult for traditional financiers (banks / capital markets) to fund these firms due to low credible information and low ticket sizes VC’s address with three key mechanisms:  Sorting: picking the right entrepreneurs.  Controlling: limiting “agency” problems, through a mixture of incentives and monitoring.  Certifying: developing a tradition of quality and fair dealings. What Why Venture Capital overview
  4. 4. VС Business / Economic Model 4 Assets Investments Entry  Deal sourcing  Due diligence  Decision making  Deal documentation Value creation  “6-month plan”  Portfolio review:  Budgeting & strategic decision-making  HR Exit  Decision making  Organizing exit process  Deal documentation KPIs  Cash-on-cash multiple also known as multiple of cost  IRR Liabilities – Limited Partner commitment  Investment team  Track record  Investment philosophy (investment themes, investment approach)  Investment strategy (deal sourcing, structuring, return targets / risk-reward curve)  Fundraising Key deal metrics with LPs:  Carried interest rate (standard rate 20%)  Hurdle rate (standard rate 8%)  Management fee (standard rate 2%) Equity – General Partner commitment  “Skin in the game” Income statement Fund & investors Fund managers Investment income (+) MF income (+) Investment cost (-) Carry income (+) Deal expenses (-) Operational expenses (-) Gross result / IRR Net income / (loss)MF expense (-) Carry expense (-) Net result / IRR Venture Capital overview
  5. 5. 5 Risk – reward curve 100% 30% 10% 1% 3% Venture Capital overview VC’s goal is to provide 5-10x gross return over 7-10 years timeframe To accomplish one must focus not just on excess returns, but protecting downside 64.8% 25.3% 5.9% 2.5% 1.1… 0.4% 32.4% 48.6% 11.3% 4.8% 2.1% 0.8% 0-1x 1-5x 5-10x 10-20x 20-50x 50x+ Gross return based of companies '04-'13 Simulated returns if losses reduced by 50% By % of financings in companies going out-of- business, acquired, or IPO ‘04-’13. N = 21,460 3 Gross realized Multiple range %offinancings Gross return: 7.5% Cash-on-cash return: 2.1x Realized 14.7% 3.9x Simulated: Targetreturns Risk
  6. 6. Investment framework 6 Issues / Conclusions 1. Team 2. Business specifics 3. Market opportunity 4. Exit returns 5. Risk mitigation How to protect downside? (negative protections, liq. pref. and liq. value) Is founder's team an A-level one? Is there enough muscle in the company? (business model, traction, product market fit) Is there an opportunity to create a large company? (market, competition, defensibility / entry barriers) Is there an opportunity to return a >10x? ( successful previous exits in industry, good deal terms)
  7. 7. 1. Team: 7 Is founder's team an A-level one? • Sufficient management team industry expertise • Serial entrepreneurs • Founders’ capital contribution US$150k+ • Multiple founders 1 Integrity: Qualities of Founders: Reduce asymmetry of information risk Goal to accomplish Reduce founder “flight” risk Reduce chance of failure Reduce chance of failure Scoring questions Passionate vision: Experience & expertize: Leadership: Commitment.  Cash contribution  Time Reduce founder “flight” and asymmetry of information risk Investment framework
  8. 8. 2. Business specifics 8 Scoring questions • Buran primary investment theme • First revenues recorded • Multiple sources of revenue • Tested and scalable business model • No external working capital funding required • Breakeven achievable with Buran investment 2 Business and Financial Metrics  Revenue recurrence (ARR / MRR)  Customer Concentration Risk  Gross margin  LTV (Life Time Value)  CAC Product and Engagement Metrics  Downloads / Active Users / Customers  Month-on-month (MoM) growth  Net Promoter Score (NPS)  Cohort Analysis / churn:  Gross churn  Net churn Is there enough muscle in the company? Company metrics: Threshold levels: MRR > US$40k Concertation <15% margins > 30% LTV / CAC >4-5x CAC payback 6-9 months 100’s of paying customers / 100k’s of users Growth is >2-2.5x y/y, >10-15% M/M NPS >0 Gross (max): -10% per annum for SaaS or 20% for marketplaces Net is hopefully negative Investment framework
  9. 9. • Addressable market size US$100m+ • Market CAGR for next three years 50%+ • #1 position in niche achievable • Sufficient entry barriers 3 3. Market opportunity 9 Is there an opportunity to create a large company? Scoring questionsMarket metrics: Threshold levels: Market Size:  TAM (Total Addressable), SAM (Served/Serviceable Available), SOM (Serviceable & Obtainable)  SAM Market growth  HHI of customers Competition  HHI of competitors  Porter’ 5 Forces analysis Opportunity timing  Regulatory changes  Technology adoption  UX / Behaviors shifts SAM >US$100-150m SOM share 20-30% in 5-7 years 20-50% Highly fragmented market HHI* - Herfindahl-Hirschman Index Few competitors Bitcoins Whatsapp, Youtube, Dropbox, Autonomous driving Examples: Dating, Taxi, Snapchat Investment framework
  10. 10. • Successful international peers • At least one equity exit in this niche occurred in the last three years • Target EBITDA margin > 20% • Fairly priced rounds (vs. revenue metrics, vs. previous capital raised) 4 4. Exit returns 10 Is there an opportunity to return a >10x? Scoring questionsReturn characteristics: Targets: Exit environment  Diversity of buyers  Sustainable company cash flow in future Deal parameters:  Entry valuation  Deal structure  Healthy captable Investment framework Fairly priced rounds (vs. revenue metrics, vs. previous capital raised) No secondary Founders own >50% of the company EBITDA margin > 20% Gross margin >50% Ability to create auction
  11. 11. 5. Risk mitigation 11 How to protect downside? Scoring questionsRisk mitigation: Portfolio diversification: Minority protective provisions:  Board seat  Reps and warranties  Covenants  Pre- and post-closing conditions  Anti-dilution provisions  Liquidity rights / transfer provisions (tag, drag, pre-emptions, ROFR, CoC)  Information rights  Indemnities (protection if rights are breached) • Investment size between US$500-5,000k • Liquidation preference over 1x • Liquidation value over BVC investment size • Board seat and minority protective provisions • Positive feedback from industry experts 5 Investment framework Liquidation value: Liquidation preference > hurdle rate Important pieces:  Title to the shares  Level of indebtedness  intellectual property Fraud is a real issue. Protections: due diligence, personal guarantees, funding in installments. The only real levers that we have are: 1. Funding schedule and triggers 2. Instigate management changes 3. Forcing a default or an exit Main consequences: Follow investment strategy
  12. 12. Lessons learned 12 Founder is the key: • He needs to be a true entrepreneur: leader, ready to experiment, never gives up • Better to have several founders than one – improves probability that they have a real entrepreneur inside • Key founder skills: product, technology, HR, marketing and sales Our how-to toolbox: • We are investors, not entrepreneurs. Better to pull the plug early, than become the CEO • Right motivation builds the business • If the management is not focused, they lose • Simpler is better • Product wins over development Cream of the crop guide: • Best investments are counterintuitive – betting against the market. What does this really mean? - You need to spot the value way before anyone else - Insider trading is not prohibited on private markets • Winner takes all” does not always apply • Underfunding could kill the best idea
  13. 13. 13 Thank you

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