kbs+ Ventures Fellows #6: Raising Capital Part 2 - VC Math

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FELLOWS CLASS #6: RAISING CAPITAL PART 2
JANUARY 8TH, 2015
Thursday, January 8, 15

• THIS WEEK’S READING / VIDEO
• UPCOMING CLASS ANNOUNCEMENTS
• INTRODUCTION TO VC MATH / DEAL STRUCTURING
• VC MATH EXERCISE!
• QUESTIONS
• HOMEWORK ASSIGNMENT #3 QUESTIONS
• DON’T FORGET TO SEND ME YOUR “TWEETABLE TRUTHS!”
IN TODAY’S CLASS...
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UPCOMING CLASSES:
*FRIDAY, JANUARY 16TH: 12-130P
•BRIAN COHEN, GUEST SPEAKER
•PART 3: PITCHING INVESTORS
•**HOMEWORK #3 PRESENTATIONS!!**
*THURSDAY, JANUARY 22ND: 12-1P
*WEDNESDAY, JANUARY 28TH: 12-1P
• REFLECTION AND DISCUSSION
• REQUIRED READINGS & INDUSTRY TRENDS
• BUSINESS ACCELERATION, EXITS, IPOS
• REAL WORLD PERSPECTIVE: TIM VARNER

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UPCOMING CLASSES:
FEBRUARY 5TH: 12-130P - HYDE SPACE
• “PERFECTING YOUR PITCH”
• DEMO DAY DRY RUN
• HERE PITCHES FROM THE PROS... OUR KBS+ VENTURES FOUNDERS!
• BREAKOUT WORKING SESSIONS WITH VENTURES PORTFOLIO FOUNDERS

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UPCOMING CLASSES:
DEMO DAY: FEBRUARY 19TH, 12-230P IN THE HYDE SPACE
• 8 MINUTES TO PITCH
• 7 MINUTES OF Q&A FROM THE JUDGING PANEL
• AUDIENCE OF SENIOR KBS+ AND MDC MANAGEMENT, FELLOWS ALUMNI
• NOT EVERY COMPANY IS GUARANTEED TO PITCH.... STEP IT UP.
BARRY LOWENTHAL
PRESIDENT, TMK
ED BROJERDI
CEO, KBS+
AJ PLOTKIN
PARTNER, FF CAPITAL
MATT POWELL
CO-PRESIDENT, KBS+

RAISING CAPITAL: PART 2
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PART 1: PART 2: PART 3:
FUNDRAISING
OVERVIEW
VC MATH /
DEAL
STRUCTURING
PITCHING
INVESTORS

LET’S DO A QUICK REFRESHER....
QUICK REVIEW...
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FUNDRAISING REVIEW
...<1% GET VENTURE FUNDING
http://www.entrepreneur.com/dbimages/article/where-startup-funding-really-comes-from-infographic.jpg
ACCORDING TO THE SMALL BUSINESS ADMINISTRATION,
~565,000 STARTUPS ARE LAUNCHED IN THE US EACH MONTH...
6.7M LAUNCHED IN THE US PER YEAR

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FUNDRAISING REVIEW

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~57%
OF STARTUPS
~38%
OF STARTUPS
~0.91%
OF STARTUPS
~0.25%
OF STARTUPS
~0.05%
OF STARTUPS
~$0-$25K ~$25-$150K ~$150-$1M ~$1M-$10M ~$10M+
BOOTSTRAPPED FAMILY & FRIENDS ANGELS EARLY STAGEVC LATE STAGEVC
IT’S TOUGH OUT THERE:
http://www.entrepreneur.com/dbimages/article/where-startup-funding-really-comes-from-infographic.jpg
FUNDRAISING REVIEW

FUNDING ROUNDS
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EARLY LATE
BOOTSTRAP
FAMILY &
FRIENDS
ANGEL
ACCELERATORS
SEED
SERIES A
SERIES B
GROWTH EQUITY (SERIES C AND BEYOND)
PRIVATE EQUITY
RAISING
< $2M
RAISING
~$2-10M
RAISING
~$10-20M
RAISING
~$20M+
FUNDRAISING REVIEW

TYPICAL STRUCTURE OF A VC FIRM
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VC FIRM
(GENERAL PARTNERS)
LIMITED PARTNERS (“LPs”)
• Public/Corporate pension funds
• High net worth individuals, Family ofﬁces
• Endowments, foundations, insurance companies
VC FUND (LIMITED PARTNERSHIPS)
2% MANAGEMENT FEE + 20% OF PROFITS
$$ FUND
MANAGEMENT
$$ FUND OWNERSHIP
INVESTMENT
(OWNERSHIP %)
INVESTMENT
(OWNERSHIP %)
INVESTMENT
(OWNERSHIP %)
$$ $$ $$

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REASONS TO BE A VC
• YOU TRULY LIKE WORKING WITH STARTUPS & TECHNOLOGY
• YOU ARE OPEN AND CURIOUS
• YOU ARE ABLE TO RESIST GROUPTHINK
• YOU ARE ABLE, AND WANT TO TO MENTOR YOUNG CEOS
• YOU ARE A CONNECTOR
• YOU WANT BE PART OF AN EXCLUSIVE CLUB
• YOU THINK YOU’LL GET RICH QUICK
• YOU ARE GOOD AT PICKING STOCKS, SO WHY NOT
• IT JUST SOUNDS PRETTY COOL
GOOD REASONS:
BAD REASONS:

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WHAT DOES THE IDEAL INVESTMENT LOOK LIKE?
THE SEVEN QUESTIONS EVERY BUSINESS MUST ANSWER:
THE ENGINEERING QUESTION
THE TIMING QUESTION
THE MONOPOLY QUESTION
THE PEOPLE QUESTION
THE DISTRIBUTION QUESTION
THE DURABILITY QUESTION
THE SECRET QUESTION

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THE ENGINEERING QUESTION
CAN YOU CREATE BREAKTHROUGH TECHNOLOGY, RATHER THAN
INCREMENTAL IMPROVEMENTS?
THE TIMING QUESTION
IS NOW THE RIGHT TIME TO START YOUR PARTICULAR BUSINESS?
THE MONOPOLY QUESTION
ARE YOU STARTING WITH A BIG SHARE OF A SMALL MARKET?

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THE PEOPLE QUESTION
DO YOU HAVE THE RIGHT TEAM?
THE DISTRIBUTION QUESTION
DO YOU HAVE A WAY TO NOT JUST CREATE, BUT DELIVER YOUR PRODUCT?
THE DURABILITY QUESTION
WILL YOUR MARKET POSITION BE DEFENSIBLE 10, OR 20 YEARS FROM NOW?
THE SECRET QUESTION
HAVE YOU IDENTIFIED A UNIQUE OPPORTUNITY THAT OTHERS DON’T SEE?

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EXAMPLE OF A COMPANY THAT NAILS ALL 7
• TECH - SO GOOD OTHER CAR COMPANIES RELY ON IT
• TIMING - JAN 2010, SECURED $465 MM LOAN FROM US GOV’T
• MONOPOLY - STARTED WITH A TINY SUBMARKET THEY COULD DOMINATE
• TEAM - CEO IS A CONSUMMATE ENGINEER AND SALESMAN
• DISTRIBUTION - OWN ENTIRE DISTRIBUTION CHAIN. NO DEALERSHIPS.
• DURABILITY - COVETED BRAND AND A BIG HEAD START
• SECRETS - KNEW THAT FASHION DROVE INTEREST IN CLEAN TECH

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OK! LET’S DO THE DEAL!
TYPICAL VC DEAL TYPES:
• PREFERRED STOCK (EQUITY - AKA “PRICED ROUND”)
• CONVERTIBLE NOTE (DEBT)
EQUITY (PRICED) ROUND:
✓ PRE-MONEY VALUATION
✓ POST-MONEY VALUATION
✓ DEFINED OWNERSHIP %
(OFF THE POST)
DEBT ROUND:
✓ VALUATION CAP
✓ DISCOUNT (~20%)
✓ INTEREST (~8%)

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PREFERRED STOCK
WHAT IS PREFERRED STOCK? (EQUITY)
• A CLASS OF STOCK THAT CONFERS CERTAIN RIGHTS
• A SUPERIOR SECURITY COMPARED TO COMMON STOCK
• “PREFERRED” TAKES ITS NAME FROM THE LIQUIDATION PREFERENCE
• DEFINES A STOCK PRICE, VALUE, AND OWNERSHIP % TO THE
INVESTMENT
THE LIQUIDATION PREFERENCE IS A KIND OF DOWNSIDE PROTECTION

TITLE / HEADER
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CALCULATING OWNERSHIP %:
SCENARIO #1:
YOU INVESTED $500,000 IN A $3MM POST MONEY VALUATION. HOW MUCH DO YOU OWN?
ANSWER = $500,000 / $3MM = 16.7% OWNERSHIP
SCENARIO #2:
YOU INVESTED $250,000 IN A $5MM PRE MONEY VALUATION. HOW MUCH DO YOU OWN?
ANSWER = $250,000 / $5.25MM = 4.8% OWNERSHIP
SCENARIO #3:
YOU WANT TO OWN 10% OF A COMPANY, THEY ARE RAISING $1.5MM AND HAVE A $5MM POST
MONEY VALUATION. HOW MUCH DO YOU NEED TO INVEST?
ANSWER = $5MM * .1 = $500,000 INVESTMENT REQUIRED (33% OF THE ROUND)

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THE OTHER DEAL TYPE: THE CONVERTIBLE NOTE
WHAT IS A CONVERTIBLE NOTE?
• IT’S NOT EQUITY, IT’S DEBT!
• COMPANY BORROWS MONEY FROM INVESTORS, WITH THE INTENTION
OF CONVERTING THE DEBT INTO EQUITY AT A LATER DATE
• DEFERS THE PRICE OF THE ROUND TO A LATER DATE (SERIES A)
• FASTER, CHEAPER FUNDRAISING APPROACH FOR THE ENTREPRENEUR
(EASIER PAPERWORK = LOWER LEGAL FEES)
• VALUATION “CAP” REWARDS INVESTORS WITH A MAXIMUM PRICE

TITLE / HEADER
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CALCULATING A NOTE CONVERSION:
*HOW DOES THAT CONVERT INTO EQUITY?
($1MM / .8) = $1.25MM
INVESTMENT 20% DISCOUNT EQUITY AT A
KBS+ VENTURES INVESTED $1MM NOTE WITH 8% INTEREST FOR FABCO.
THE TERMS WERE A $8MM CAP, 20% DISCOUNT.
*INTEREST TBD BASED ON TIME DURATION

TITLE / HEADER
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CALCULATING A NOTE CONVERSION:
KBS+ VENTURES INVESTED $1MM NOTE WITH 8% INTEREST FOR FABCO.
THE TERMS WERE A $8MM CAP, 20% DISCOUNT.
WHAT IF 1 YEAR LATER, FABCO RAISES $4MM SERIES A AT A $12MM (PRE)
VALUATION?
CAP KICKS IN!
•DIVIDE THE CAP BY THE A VALUATION TO GET THE DISCOUNT
($8MM / $16MM) = 0.5
•$1MM / 0.5 = $2MM.
IN OTHER WORDS, THE $1MM LOAN IS NOW WORTH $2MM IN EQUITY

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OK! LET’S DO THE DEAL!
VCS WILL ALWAYS ASK FOR THE FOLLOWING:
• LIQUIDATION PREFERENCE
• PRO-RATA RIGHTS
• BOARD SEAT (OR AT LEAST OBSERVER SEAT)

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LIQUIDATION PREFERENCE
WTF IS A LIQUIDATION PREFERENCE?
• LIQUIDITY EVENT IS EITHER AN ACQUISITION (EXIT) OR IPO
• A TYPE OF SECURITIZATION
• PROTECTS THE INVESTOR, GIVES THE OPTION OF EITHER:
1. GETTING THEIR INITIAL INVESTMENT BACK (BREAK EVEN)
2. GETTING THE % OWNERSHIP RETURN

SCENARIO #2: AWESOME.CO EXITS FOR $3MM, 40% LOWER THAN THE LAST ROUND VALUATION ($5MM)
• YOU GET YOUR $500K BACK ---> BREAK EVEN
• THE OTHER PREFERRED INVESTORS GET THEIR $2MM BACK --> BREAK EVEN
• THE COMMON SHAREHOLDERS SPLIT THE REMAINING $500K, WHICH WAS ONCE WORTH $2.5MM
80% LOSS
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PREFERRED STOCKLIQUIDATION PREFERENCE: EXAMPLE
YOU INVEST $500K AND OWN 10% OF AWESOME.CO, AWESOME.CO IS VALUED AT $5MM
•40% OF AWESOME.CO IS OWNED BY OTHER PREFERRED EQUITY HOLDERS (VCS LIKE YOU) = $2MM VALUE
•REMAINING 50% IS HELD BY COMMON SHAREHOLDERS (FOUNDERS, EMPLOYEES, ADVISORS) = $2.5MM
SCENARIO #1: AWESOME.CO EXITS FOR $40MM. YAY! YOUR $500K INVESTMENT IS WORTH $4MM, 7X RETURN
• THE OTHER PREFERRED SHAREHOLDERS GET $16MM TOTAL
• COMMON SHAREHOLDERS GET $20MM TOTAL
• EVERYONE IS REALLY HAPPY AND YOU HAVE A HUGE PARTY WITH RIHANNA AND TIESTO! #CRUSHIT

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PRO-RATA RIGHTS
WHAT ARE “PRO-RATA” RIGHTS? WHY ARE YOU SPEAKING LATIN?
• THE RIGHT TO PARTICIPATE IN FUTURE FINANCINGS
• MAINTAIN YOUR EQUITY STAKE
• AVOID DILUTION

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CALCULATING PRORATA RIGHTS: EXAMPLE
KBS+ VENTURES OWNS 2% AFTER INVESTING $100K IN THE SEED ROUND.
THE STARTUP IS NOW RAISING $4MM AT A $8MM PRE-MONEY VALUATION.
STEP 1: CALCULATE THE POST MONEY VALUATION
$4MM + $8MM = $12MM
STEP 2: CALCULATE THE TOTAL AMOUNT NEEDED TO MAINTAIN 2% OWNERSHIP
$12MM * .02% = $240,000
STEP 3: SUBTRACT THE INITIAL INVESTMENT FROM THE TOTAL AMOUNT
$240,000 - $100,000 = $140,000 PRORATA REQUIRED
WHERE DO YOU START?

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THE BOARD OF DIRECTORS
OWNERSHIP, POSSESSION AND CONTROL
• OWNERSHIP: EQUITY HOLDERS IN THE COMPANY
• POSSESSION: THE MANAGERS OF THE COMPANY
• CONTROL: THE BOARD OF DIRECTORS
CHARACTERISTICS OF AN EFFECTIVE BOARD:
• SMALL (UNLESS PUBLICLY HELD)
• ACTIVE & ENGAGED
• ALIGNED IN TERMS OF DESIRED OUTCOME

LET’S TRY IT!
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• OFFICE HOURS: MONDAY MORNING
• NEXT CLASS: FRIDAY JANUARY 16TH, 12-130P
• HOMEWORK #3 DUE!
• SEND ME YOUR TWEETABLE TRUTHS
• DON’T FORGET TO FINISH YOUR READINGS...
NEXT WEEK...
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CONTACT:
JESSICA PELTZ, INVESTMENT DIRECTOR
JPELTZ@KBSP.VC
JOSH ENGROFF, MANAGING PARTNER
JENGROFF@KBSP.VC
QUESTIONS?
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