Zachariah George

Chief Operating Officer

U-START Africa

rzgeorge@u-start.biz

@zach_cpt

Understanding Investment

Valuation Methodologies

Access to Capital

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PART 1:

UNDERSTANDING INVESTMENT AND MAXIMIZING WAYS TO GET FUNDED

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1. VERIFY. VERIFY. VERIFY.

It takes time and patience to develop solid leads for investors. You can attract investors for a small business with preparation, planning, strategy and proper research.

Think of a realistic idea for a product or service, identifying a gap in the market that you can fill. Get an idea going and achieve a small success to prove it works. Investors are more confident investing in ideas that have already been proven. Timing is key!! (Google, Instagram)

IDEA

Consider what experience you have. Consider hiring people to fill the gaps in your skills or knowledge. Management experience is always a positive factor, since it directly relates to the credibility of the management team in the eyes of the investor. Teaming up with a co-founder who does bring the necessary experience, finding a mentor who carries personal credibility, or organizing a board of advisors with relevant experience and expertise are all ways of addressing the issue.

TEAM

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1. VERIFY. VERIFY. VERIFY.

Can you turn your idea into a profitable business? You should be able to demonstrate this in your business plan, which will set out your goals and how you plan to achieve them.

PROOF OF CONCEPT

How much money will you need to get started? Perhaps you can cover all the start-up costs out of your own resources, otherwise you need to investigate other sources of funding such as a bank loan or by selling part of your business to an investor. Determine the type of capital to be attracted

SOURCE OF INVESTMENTS

FEASIBILITY. SUSTAINABILITY. SCALABILITY

Pinterest, Twitter, Uber – Sky high Valuations despite minimal revenue!

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Getting the right investors for your project is just as important as being able to attract investors. Here’s what we advise upcoming entrepreneurs look for in

their investors:

2. FIND THE RIGHT INVESTORS.

DIVERSITY: The more well-rounded your investment group is, the better suited they’ll be to address the challenges your company will face. Look for investors with diverse backgrounds and experiences

CREATE AN INVESTOR LIST AND CONTACT THEM

POSITIVITY: Supportive people can be the difference between a project’s success and failure. No company can grow without encountering problems. Finding people who remain confident through these times can improve your chances of success

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The idea is important to explain but not as important as to whom the idea is to be sold

Every investor has their own criteria to judge companies and investment opportunities. Before presenting your business plan learn which kind of fund they handle, the last investment closed, their track record and professional background.

Don’t waste time and money by sending a great idea to the wrong firm!

3. KNOW YOUR AUDIENCE

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Many investors receive up to 5,000 projects per year. Only 10% of these plans are seriously considered, and 1-2% are actually funded. In a situation like this, the smallest details (punctuation, grammar, appealing graphics and concise writing) could mean the difference between you and the others. Ensure that your plan has all pertinent information and answers any questions that may arise.

4. ATTENTION TO DETAIL

BE CONVINCING AND CLEAR

If you participate at events and conferences, prepare a 30-second elevator pitch, pass out business cards and start establishing a first connection.

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Here are qualities we strongly believe are key with any investor:

5. BE COMMUNICATIVE AND HONEST

Communication: Honesty: Being truthful is obviously non-negotiable. If you misrepresent yourself or your business, you’ll be dead in the water.

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Investors are looking for three things: the people behind an idea, the idea itself and an answer to the question:

HOW WILL I GET MY MONEY BACK?There isn’t often a clear indication of how and when a return will be generated. If you are three-for-three in terms of offering investors what they’re looking for, that also means you’ll have a real business plan with cash flows, specific ROI projections and a true understanding of your market.

Professional investors will look to tangible indicators of success (website traffic, conversion rates, your ability to launch) and validation of the business model in evaluating a company’s prospects.

Be very realistic with your projections. Think carefully about cash-flow and bear in mind that not all clients will pay promptly.

6. DATA AND REALISTIC PROJECTIONS

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7. SCALE YOUR COMPANY. THINK GLOBAL.

1. Leave regional business models. In order to attract serious investors think about a scalable business on the first day.

2. Convince a VC that your venture targets a strong market with a valuable product. It follows logically that a combination of these two factors could mean your product will gain share rapidly in a fast-growing market — and that would give the VC a return on investment.

3. Understand markets’ dynamics, its operations and possible strategic industrial partners. If it’s possible forge partnerships proving your viability and position you for success and scaling.

4. Be prepared to relocate your company, if necessary.

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Interest among investors to tap into more start-ups outside of their traditional heartland of Silicon Valley is growing. Silicon valley is overcrowded not just with companies but also sharp-elbowed VCs jockeying for pole position to fund them.

“Three key components stick out when it comes to companies from this region:• they think global from day one, • they’re lean• they put a user-friendly design at the

forefront of their agenda.

8. HAVE NORDIC DNA

We live in the “age of excellence” where products are either gorgeous or they’re ugly. There are only 10s, with no room for 7s, 8s or 9s. Don’t leave design or branding for another day—do it right now.

This makes the products and businesses scalable from very early on

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A big investor mantra over the past few years has been “SoMoLo,” an acronym for three megatrends

SOCIALMOBILE LOCAL

Investors are looking at very LOCALLY FOCUSED companies – like UBER, Yelp, Trulia, locally focused companies, that thanks to the advent of the mobile phone and social media can refer and capture the market both offline and online.

These companies think and grown locally have a global vision to scale both nationally and globally. Creating a company focused at the local level is a challenge but it is very rewarding and gratifying, so investors are attracted to them!

The advantages? Ability to CREATE ECONOMIES of SCALE and NETWORK ECONOMIES, difficult to replicate in a short time.

9. BE «SoMoLo»

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Save a significant sum of your money to invest in the business before seeking investors for the rest. If you approach an investor after you have put time and your money on the line, he may take your idea more seriously.

“Why should anyone else be willing to risk his or her money in your business idea?"

10. TAKE RISKS

«Having Skin in the Game» Tim W. Knox

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PART II: VALUATION

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Groupon and its ‘True’ Valuation

• “Groupon Valued At $250 million” – TechCrunch, December 17, 2009

• “Groupon Raises Huge New Round at $1.2 Billion Valuation” – TechCrunch, April 13, 2010

• “It’s Official: Groupon Announces That $1.35 Billion Valuation Round” – TechCrunch, April 18, 2010

• [Moment of Context #1: "Google's Groupon Offer: $5.3 Billion" - All Things D, November 29, 2010]

• “Groupon’s Valuation Could Be As High As $7.8 Billion” – TechCrunch, December 28, 2010

• “Groupon Closing $950 Million Round, Valued At $4.75 Billion” – TechCrunch, December 28, 2010

• “Groupon Said To Be Valued At, Like, $15 Billion” – TechCrunch, January 13, 2011

• “SharesPost Report: Groupon Is A Deal At $6 Billion” – TechCrunch, February 3, 2011

• “Is Groupon Worth $25 Billion? Revenue Now ‘Multiple Billions Of Dollars’” – TechCrunch, March 17, 2011

• [Moment of Context #2: Groupon files their S-1, opening their finances to the world - June 2, 2011.

• “Groupon’s IPO Valuation Could End Up Being Less Than $6 Billion” – TechCrunch, October 3, 2011

• [Moment of Context #3: "Groupon Seeks Valuation at Close to $12 Billion" - Dealbook, October 19, 2011]

• To be fair, TechCrunch was far from the only offender on playing in Groupon’s crazy sandbox o’ numbers.

• [Moment of Context #4, from March 17, 2011: "Groupon Valuation Soars as Possible I.P.O. Nears." The article noted that Groupon's then-possible I.P.O. could "value the company at close to $25 billion, according to a person close to the matter who was not authorized to speak because the talks were private." The article appeared in Dealbook.]

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Misconceptions about Valuation

• Myth1:A valuation is an objective search for “true” value

– Truth 1.1: All valuations are biased. The only questions are how much and in

which direction.

– Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid.

• Myth2:A good valuation provides a precise estimate of value

– Truth 2.1: There are no precise valuations

– Truth 2.2: The payoff to valuation is greatest when valuation is least precise.

• Myth3:The more quantitative a model, the better the valuation

– Truth 3.1: One’s understanding of a valuation model is inversely proportional to the number of inputs required for the model.

– Truth 3.2: Simpler valuation models do much better than complex ones.

Young companies are difficult to value:

o Some are start-up and idea businesses, with little or no revenues and operating losses.

o Even those young companies that are profitable have short histories,

o Many of the standard techniques used to estimate cash flows, growth rates and discount rates either do not work or yield unrealistic numbers,

o The fact that most young companies do not survive has to be considered somewhere in the valuation.

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Setting up the Value of a Company

• Valuation:

- Looking backward: Cost – No.s: can be sunken cost

- Looking at the present: Comparables

- Looking towards the future: Market perspective / revenues

• Most often: Value ≠ Cost

• Plan for follow-on financing rounds:

While fixing current valuation, anticipate next rounds & leave space

for up-valuation

Investor’s value

Founder’s pre-money value

Post Money Valuation

Pre Money Valuation

CASH

• Business idea creates business opportunities

• Readiness to ‘Jump’• Achievements/

Assets (Patents)• Typically not based

on revenues• Definitely not zero

Determining Future Value• New R&D results (‘Milestones’)• Patents filed and granted• Corporate deals• Set up of labs, etc.• New employment• Research grants• Commitments of renowned VCs• Income

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How Does Value Increase Over Time?

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Angel Investors: Valuing Pre-Revenue Companies

The Scorecard Method

Compares the target co. to typical angel-funded startup ventures and adjusts the average valuation of recently funded companies, to establish a pre-money valuation of the target.

1. Strength of team (weighting factor WF = 0-30%)

2. Size of the opportunity (WF = 0-25%)

3. Product/ Technology (WF = 0-15%)

4. Competitive environment (WF = 0-10%)

5. Marketing/ Sales/ Partnerships (WF = 0-10%)

6. Need for additional investment (WF = 0-5%)

7. Other factors (WF = 0-5%)

The Venture Capital Method

uses three scenarios, base, low and high cases, to estimate the valuation range. heavily depended on the projected sales revenues at the time of exit (harvest or terminal value).

8. Pre-money valuation = Post-money valuation - angel investment

9. Post-money valuation = Terminal Value / anticipated return on investment (ROI)

10. Terminal value = (Net-After Tax Profit in exit year)*(Industry price / Earnings ratio)

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Venture Capital Method: An Example

Terminal Value: TV is the anticipated selling price (or investor harvest value) for the company at some point down the road; let’s assume 5-8 years after investment. The selling price can be estimated by establishing a reasonable expectation for revenues in the year of the sale and, based on those revenues, estimating earnings in the year of the sale from industry-specific statistics. For e.g., a software company with revenues of $20m in the harvest year might be expected to have after-tax earnings of 15%, or $3m. Using available industry specific P/E ratios, we can then determine the T.V. (a 15X P/E ratio for our software company would give us an estimated Terminal Value of $45m). It is also known that software companies often sell for two times revenues, in this case, then, a Terminal Value of $40m. OK…let’s split the difference. In this example, our Terminal Value is $42.5m.

Anticipated ROI: Angel investing is risky business. Based on the Wiltbank Study, investors should expect a 27% IRR in 6 years. Most angels understand that half of new ventures fail and the best an investor can expect from nine of ten investments is return of capital for a portfolio of ten. Consequently, the 10th investment must be a home run of 20X or more. Since investors do not know which of the ten will be the homerun, all investments must demonstrate the possibility of a 10X-30X return. Let’s assume 20X. Assuming our software entrepreneurs needs $500,000 to achieve positive cash flow and will grow organically thereafter, here’s how we calculate the Pre-money Valuation of this transaction:

Post-money Valuation = Terminal Value ÷ Anticipated ROI = $42.5m ÷ 20X = $ 2.125m

Pre-money Valuation = Post-money Valuation – Investment = $2.125 – $0.5m = $1.625m

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Venture Capital Method: An Example (Contd.)vcmethod.com

Annual Earnings(Projected NI) 1 $2,500,000.00 (at exit date)In Year 2 5 (at exit date)PE(multiple) 3 15Required Rate of Return 4 50%Value of firm 5 $4,938,271.60

Initial Investment 6 $3,500,000.00Equity Stake 7 70.88%

Current Outstanding Shares 8 1,000,000 (pre)Total Outstanding Shares 9 3,433,476 (post)VC Owns # Shares 10 2,433,476Share Price 11 $1.44

Pre-Money Valuation 12 $1,438,271.60Post-Money Valuation 13 $4,938,271.60

Discount the Terminal Value to Present Value

Calculate the Required Ownership Percentage

Notes:1 Projected Net Income at exit date.

2 Investment exit year.

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The choice of multiple for the valuation is something that will be a matter of discussion during the venture capital negotiations. PE ratios for comparable public companies will be used as a benchmark to select a PE for the company, recognizing that PE ratios for public companies are likely to be higher due to their greater liquidity relative to a private company.

The venture capital investor uses the target rate of return to calculate the present value of the projected terminal value. The target rate of return is typically very high (30-70%) in relation to conventional financing alternatives.

Pre-Money Valuation = New Price x Old Shares: [11] x [8]Post-Money Valuation = New Price x Total Shares: [11] x [9]

Here the terminal value is discounted to the present value. The terminal value of the company is estimated at a specified future point in time. That future point in time is the planned exit date of the venture capital investor, typically 4-7 years after the investment is made in the company.

Investment amount Entreprenuer is seeking.VC requires this ownership %. Valuation assuming no future dilution.Formula: Initial Investment / Value of the Firm

The company currently has [8] shares outstanding, which are owned by the current owners. If the venture capitalist will own [7]% of the shares after the investment (thus, 1-[7]% owned by the existing owners), the total number of shares outstanding after the investment will be [8]/(1-[7]%) = [9] shares. Therefore the venture capitalist will own [10] of the [9] shares.

Since the venture capitalist is investing [6] to acquire [10] shares the price per share is [6]/[10] or [11] per share

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Convertible Note Financing

A convertible note is a loan that typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing.

Conversion Discount: A conversion discount (or “discount”) is a mechanism to reward the noteholders for their investment risk by granting to them the right to convert the amount of the loan, plus interest, at a reduced price (in percentage terms) to the purchase price paid by the Series A investors.

For example, if the investors in a $500,000 convertible note seed financing were granted a discount of 20%, and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price (referred to as the “conversion price”) of $0.80 per share and thus receive 625,000 shares ($500,000 divided by $0.80). That’s 125,000 shares more than a Series A investor would receive for its $500,000 investment and a 1.25x return on paper ($625,000 divided by $500,000). (The foregoing example does not include accrued interest on the loan, which is typically about 5%-7% annually. Discounts generally range from 10% (on the low side) to 35% (on the high side), with the most common being 20%

Conversion Valuation Cap: A conversion valuation cap (or “cap”) is another mechanism to reward the noteholders for their investment risk. Specifically, a cap is a ceiling on the value of the startup (i.e., a max $amount) for purposes of determining the conversion price of the note — which (like a discount) thereby permits investors to convert their loan, plus interest, at a lower price than the purchase price paid by the Series A investors. Using the example above, let’s assume the cap were $5 million and the pre-money valuation in the Series A round were $10 million. If the noteholders invested $500,000 and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price of $0.50 per share ($5,000,000 divided by $10,000,000) and thus receive 1,000,000 shares ($500,000 divided by $0.50), which is 500,000 shares more than a Series A investor would receive for its $500,000 investment and a 2x return on paper ($1,000,000 divided by $500,000), not including any accrued interest on the loan. Notice that if there were a 20% discount and no cap, the noteholders would only receive 625,000 shares or a 1.25x return, as noted above.

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Valuing Post-Revenue Companies

The 4 most commonly used techniques are:

1. Market Valuation - Comparable companies analysis involves the comparison of operating metrics and valuation multiples for public companies in a peer group (the comparable "universe") to those of a target company.

2. Comparable Transactions Method - based on the premise that the value of a company can be estimated by analyzing the prices paid by purchasers of similar companies under similar circumstances.

3. Discounted Cash Flow (DCF) Analysis - In simple terms, discounted cash flow tries to work out the value today, based on projections of all of the cash that it could make available to investors in the future.

4. Multiples Method (or Earnings Multiples) - Consists of calculating a company's value by multiplying its sales by a factor used in the industry.

IN SUMMARY –

5. Valuation is trying to assess the current value of a future potential -> a projection

6. Trying to calculate your value? More and art than a science (50+methods …).

3. Anticipate the future valuation be at different milestones : the financing plan ?

Conclusion: the value = what the investor is ready to pay and that you’re ready to accept : you value the money

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PART III: FINDING YOUR INVESTORS

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Which Investors?

Founders (mandatory) : ____________ Friends : ____________ Family : ____________ Fools : ____________ Foundations : ____________ Family Offices : ____________ Business plan awards/grants : ____________ Economic Promotion (guarantees) :

____________ Research Projects (TIA, …) : ____________ Bank (Mezzanine Financing) : ____________ Business Angel (BA) : ____________ Venture Capitalist (VC) : ____________ Suppliers/Customers ? : ____________ Industrial Partners ? : ____________ Bank (Classical instruments) : ____________ IPO (Initial Public Offering) : ____________

Early Stage

Later Stage

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Preparation of a Financing Round

• Plan early – time is negotiation power (6–12 months)

• Availability of management – time consuming process

• Be well prepared and execute fast

• Co-operate with experienced advisors (lawyers, IP, fiduciaries)

• Negotiate essential and delicate terms early (Term Sheet)

• Disclose everything

• Define your type of investor: long and short list

• Action plan

• Very often (always?) several financing rounds needed (infrastructure, growth,…)

• Each round (can be) divided into milestone payments

• With every round the share price (valuation) should increase (value creation)

• New investors will receive shares (new or existing), diluting the previous shareholders.

• Co-financing very common

• EXIT usually not possible from round to round

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Financing Instruments

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Financing Needs, Stages and Players

Why different players?

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Bootstrapping: Pulling Yourself Up!

Bootstrapping literally means developing the company with little or no outside funding (no salary, alternative revenues for founders/company (consulting, etc.), support for partners (suppliers). Bootstrapping is not for everyone!

Why go bootstrap:

• Build your business on a legitimate, real-world value proposition

• Initiate the critical sales learning process sooner, not later

• Don’t waste money; make it

• Accelerate time-to-market and time-to-profitability

• Be less likely to make big, fatal financial mistakes

• Force yourself into unconventional thinking

• Have more freedom and flexibility

• Own much, if not all, of what you create

The Dangers Involved in Raising External Money:

• Masks hard questions about viability

• Raising money takes time away from customers

• Adds an additional set of masters

• With money you can make a fatal mistake

• Money removes spending discipline

• Fixes your exit strategy and timing

• You sell your equity very dearly

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Business Angels (BAs) and How They Invest?

• Wealthy individuals ready to invest own money

o Often providing “smart money”: Experience, network in industry, knowledge and providing a mentor role

o Whole spectrum: Philanthropic to exclusively financially motivated individuals

• How to find the right BA

o Keep on being active: Internet research, activate network, call potential BA clubs, go to conferences, pitch to everybody, …. and evaluate!

• How to raise capital from BAs

o Sign up people they know or have heard of

o Don’t underestimate them: Be professional

o Understand their motivation

o Enable them to live your story

• Investment focus of BAs

o Early stage of company, often 2nd round of financing for high-growth start-up (after FFF, competitions, etc.)

o Usual investment amount: USD 100K – 1m. Can also go much higher : ”Super angels”

o Focus of investment: Depending on background of BA

o Often investing in clubs / with other individuals

o Investment instrument: Convertible Loans (postponed valuation) or Equity

o Expecting high returns and looking for important stake (professional BAs: 20% equity and 10x over 5 years)

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Venture Capitalists: Structure & Strategy

• VCs invest the money of their Limited Partners into “good ideas” and seek a financial return over a (defined) time period.

• Not own money - have to raise funds / have investors

• Exiting deals is compulsory

• Core competency is (should be):

o people interaction: network, connections

o strategy

o expertise bundling

o risk management

• VC investment strategy is mostly defined along:

o thematic focus

o geographic area

o stage of financing

o investment size per invested company

o investor role: lead, co-lead

• Portfolio perspective:

o focus creates expertise

o manage risk

o risk diversification (technology, indication, market,…)

• At the end of the day it is all about opportunities:

o sourcing opportunities: systematic and network

o shaping opportunities: prioritization, resources, risks based

o opportunity costs

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VC Investment Process:

From Pitch to Exit:

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What VCs Look For:

• Experienced management

• A strong value prop:

• Competitive product/tech platform

• “Open seas” market

• Financials

• Cash runway to exit

• Strong, aligned investors

• Translating into foreseeable exit opportunity

• Via trade sale or IPO

• Within 3 to 5 years

• With >3x multiple or >100% IRR

Exits for Investors: • EXIT: the liquidity event – when investors get their money back, conditions

the investor’s ROI• Exit pathways have to be prepared (discussed) at the time of investment• The business will we built to be a “nice bride for the wedding time”

Exit Options:• Acquisition by a large company - the most common• Initial Public Offering (IPO) – very rare• Partial exit : Licensing per product, joint ventures• But also… high level of dividends (for BAs)

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The Terms that Matter:

• Price / Valuation

• Type of security: preferred shares

• Liquidity preference over precedent rounds

• Anti-dilution protection

• Right of first refusal

• Drag along rights

• Vesting on founders’ shares and ESOP

• Board membership and voting rights

• Time-specific exclusivity

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Choose Investors Like They Choose Enterprises

If you have a good opportunity, VCs will spot you ! But you still have to do your homework (due diligence !):

• Identify them at Conferences / previous deals

• Criteria for selecting Investors (BAs, VCs)

o Personal fit – relationship – trust

o Understanding of the field

o Deep pockets and dry powder

o Sweet equity (e.g. geographic network for fundraising and business development)

o Investment time horizon

• Convincing the investors

o Be prepared! (Document preparation, industry network)

o Active network of advisors: science & business

o Create a sense of urgency

o Build up VC relations management: track, update, follow-up

o Communicate, communicate, communicate!

• Be aware: You need to work/deal with the investors you select for the next couple of years; divorce is not a baked-in option

• Nevertheless: It does not matter how much you love each other, the investor eventually wants a successful exit

• Usually, the investor has many eggs, you only have one

Zachariah GeorgeChief Operating Officer U-START Africarzgeorge@u-start.biz@zach_cpt

THANK YOU !