The Startup CFO - Chapter 3

• Financing of small amounts

• Financing is often provided free of charge

• Legal aspects of the funding are often not clarified

Advantages:

• Positive signaling

• Easy access

• Founder’s influence hardly limited

• Investors are more patient

Disadvantages:

• Limited availability

• Danger of losing friends in case of failure

• Often no added value in the form of know-how or expert advice

• A wealthy individual who invests in a start-up with his/her own money and expertise

• The individual provides equit or quasi-equity funding to growth-oriented private companies with the aim of achieving a financial return through capital gain at exit

• In addition to money, business angels provide value-added services

Business Angels usally provide higher investments than Family & Friends and provide strategic advice

• Crowdfuding is an intiative to raise money for a new project proposed by entrepreneurs, by collecting small to medium-sized investments from several other people/investors

• Crowdfunding has been boosted by recent technological developments that offer oportunities and scenarios where consumers can use, create and modify content and interact with other users through social networks

Crowdfunding is potentially the most disruptive of all the new models in finance

1. Expanding use case of crowdfunding

2. Changing demographics and consumer behavior

3. Viral growth: Crowdfunding is one of the most social categories of alternative financing, with the benefit of viral growth for specific campaigns

4. Strong network effects: Crowdfunding platforms benedit from network effects wherby the value of the platform is enhanced as both campaigns and funders grow

5. Regulatory changes: Amendments were adopted to permit general solication if all purchasers are accredited investors and the issuer takkes steps to verify investors status

• Equity based: Investors receive a stake in the company

• Donation-based: Contributions go towards a charitable cause

• Lending-based: Investors are repaid for their investments over time

• Reward-based: Investors receive a tangible item or service in return for their funds

Business Angel

• is well connected

• uses own money

• invests low capital in comparison

• does generally not require a board seat

• understands the nature of the idea and makes decisions

• his/her investments are based on own experiences

Venture Capitalists

• has access to senior executives

• invests large amounts of capital

• gives hands-on expert support to avoid mistakes

• requires a board seat to have a look on his investment

• manages invested capital by its employees

Pure investment company

• Most common venture capital form

• Invest into small and medium-sozed companies in all phases which are not traded on the stock exchange

• Mostly spezialized in certain phases or sectors

Corporate investment company

• Typical venture capital fund within familiar sectors or in completely new business ideas

Publicly funded investment company

• Make available capital from public sources

• Venture capital company often provides subsidized loans at reduced interest rates in the form of dormant stakes in companies

Incubator

• Provide venture capital in sufficient amounts forsufficient time

• Support start-ups with resources, dervices and advisory

• Operate in global networks

Corporate investment companies pursue strategic, financial and social goals by investing in ventures

Early investment in young start-ups

• Capital provided to young, technologically innovative, small/medium enterprise or to newly founded business units, which are legally independent in their goal state

Strategic exchange relationships

• Advisory services provided to the mangement team of the new venture

• Strategic partnership between venture and corporate

Minority participation

• Exchange on chances and risks between venture and corporate

• Industrial corporation receives its returns directly, over capital gains, and indirectly, via strategic benefits from the cooperation

Direct participation

• In consideration of the emphasis which is placed on strategic goals by industrial corporations with venture capital activities, the object under consideration is usually limited to direct investments

70-80%

• Investors ultimate goal is to maximize their return on invested capital in a start-up

• Investors and startups need to define exit strategies for the investor before entering into a relationsship

• The majority of business angels exit after 3-10 years

• The time horizon between initial venture capital investments and the investor exit varies, depending on the industry, region and company characteristics

Trade sale

• Trade sale is a common form of exit for a company’s management an investors. Business shares are either entirely or partaly sold to strategic investor after a pre-definied time perios

Liquidation

• Liquidation after an asset deal is another exit option in case the company experiences strong liquidity issues and is not viable anymore

IPO

• Initial public offerings include the sale of company shares to the public. The business becomes listed on a stock exchange

Merger

• A merger with another company is a valid exit option if cash flow or liquidity becomes an issue

Buy Back

• A buyback is the repurchase of investors’ company stake by the management team. It requires liquidity allowing the finance the investment with existing cash flow

Secondary Buyout

• In a secondary buyout usually only the investor and not the management team sells its investment in a company to another financial investor

Potential strategic investor: A strategic investor invests in a firm not only for financial reasons, but also strategic reasons

Potential financial investor: A financial investor invests in a firm only because of financial reasons, aiming to maximize their return on investment

1. Design a term sheet including the most relevant investment agreements of both parties. By sining the term sheet the investement agreement becomes binding for the investor and the start-up

2. Define liquidation preferences that indicate how the investor is given priority in case exits proceeds are distributed. Liquidation preferences are part of the term sheet

3. Ensure that it is obligatory for investors to first offer their ownership stake to internal capital holders who have the right to buy the ownership stake with the same conditions as potential external buyer

4. Define conditions for the “Tag-along” and “Drag-along” rights. Tag-along rights protect minority shareholders so that they can sell their minority stake when the majority stakeholder sell the shares. Drag-along rights enable majority to force a minority shareholder to join in the sale of a company

5. Seek legal review of your investment contract in order to ensure that all consequences of the contract are in your interest