Chapter 6

• founder (the agent)

  • has a lot of information about their project, e.g., about their experience, the technological state of developments, the status of negotiations with potential customers, …

  • only he can realistically assess their personal abilities; the “hidden characteristics.”

  • If he does not present their abilities to the investor correctly, e.g., opportunistically or clearly too optimistically, this can lead to adverse selection

• investor (as principal)

  • can only get a partial insight into the situation as an outsider before the contract is concluded.

    • only critical if interests differ between them

these are theoretical models that assume disadvantageous information asymmetries in the contractual object and show how failure can

be avoided.

• Bad management decisions

• Lack of commitment of the founding team and key people

• Differences of opinion about the right timing to generate value

• Expansion to include new shareholders, as this may lead to conflicts

• also called letter of intent LOI or memorandum of understanding MOU

• investor and the founder define the key points of the planned cooperation at an early stage

• later leads to the final contract

• not legally binding in themselves (except for the confidentiality declaration and exclusivity agreement, which are legally binding

• regulations on

  • essential financial aspects

  • strategy

  • financing or distribution policy

  • employment contract of the management

  • put and call options

  • much more

• After positive result of economic and legal circumstances during the due diligence process, the negotiations between investor and founder will begin. participation and shareholders’ agreement will be negotiated (subscription or shareholders’ agreement) and then notarized.

  • description of the company and the capital development

  • further information on the investment and the conditions (call options, if applicable)

  • special rights of the investor

  • the liquidation preference

  • the rights and obligations of co-sale

  • the obligations of the founders (guarantees and

    vesting)

Put option is the right to sell a share at an agreed value within a period of time; call option is the right to buy the share

this involves a careful examination and analysis of the

project with the aim of identifying risks

In this case, the investor has preferential rights to liquidation or disposal proceeds.

This term refers to the loss of shares upon leaving the

company.

• The investor is not sufficiently committed and does not contribute enough of his network and knowledge.

• New investors enter the company and upset the existing balance.

• The investor withdraws at the wrong time and therefore less capital is available.

• Surprises at the time of exit lead to the financing plan not being adhered to and the planned increase in value not being achieved.

• The idea phase: do I want to realize the project

• Licensing negotiations: like intellectual property (IP)

• Co-founder agreements

• The equity collection

• A pitch

• The team members

• Business angels

• The first customers

• The term sheet

Discounted Cash Flow (DCF), Net Asset Value and Market Value methods.

• estimate all its future cash flows

  • information regarding the past performance of the company, the evolution of the market, and future investment plans are nedded

• then calculate their present value by discounting them using an appropriate measure for the cost of capital of the company

‘-obtaining the information is often difficult

‘+if such information is available, it takes the future cash flows of the company into account

‘+It takes the company’s cost of capital into account.

• all assets are estimated at their current market value

• Then all debts (such as accounts payable and all other liabilities) are subtracted from the total value of the assets

• The resulting amount shows the equity value of the company – essentially ‘what the company’s assets are worth after deducting its liabilities (net of its liabilities)

‘+simple and straightforward

‘-not very insightful when it comes to new companies and start-ups. havent acquired many tangible assets yet... Much of their value may be found in their intangible assets,such as the development of new knowledge and technology.

• focuses on the price that can be achieved for the company on the market

  • for stock corporation value of the shares at the current price

  • for non-listed companies, comparison with companies of the same type is made by means of benchmarking

‘+simplicity

‘-Risk of differences that may play a role, such as culture, image, or age of machinery

If there is a high brand value, the market value method is more meaningful than the income or asset value, because otherwise the biggest success factor—the brand—would

not be recorded at all.

Typically, the quality and experience of the management/founding team, the sales forecasts, the risks, the financial market environment with supply and demand, the price level, and the time factor via time-to-market/break-even/exit are added to the valuation methods.

A typical principal-agent situation exists between investors and founders, since the founder (agent) has more, and more detailed, information than the investor (principal).

The process between the founder and the investor initially provides for the signing of the term sheet, a first declaration of intent. An in-depth review of the documents by the investor then follows during the due diligence period. In the event of a positive result, the investment agreement is then negotiated.

Investors have an interest in increasing the value of the company so that their shares increase in value until they exit. The focus of the founders is primarily on the commitment of the investor, the provision of the network and the investor’s knowledge, as well as a stable situation that is as calculable as possible.

In order to determine the value of the company, primarily earnings, substance, and market value methods are used. Combinations of these methods are also often implemented. Due to the lack of historical values, other factors such as the quality and experience of the team, sales, risks, or the time factor also play a major role inthe early phases of start-ups.