How VC's Arrive At a Valuation - What Entrepreneurs Should Know | Claudia Zeisberger

hello and welcome back to my lecture series on venture capital today we will take the entrepreneur's perspective and we will ask ourselves how do those venture capitalists actually arrive at evaluation especially for an early stage startup and this is really important for any entrepreneur who is planning to approach venture capital for fundraising i spoke in one of my earlier lectures uh about the um the way that startups usually raise funding and we talked about staged fundraising so usually it starts off with a series with a seat around goes on to series a b c d and in this case in case of snap uh it goes to sirius f before arriving at an ipo so this was a very successful kind of like a picture book way of fundraising 2.6 billion dollars raised from venture capital and six years to ipo now how do those vcs actually evaluate their investments when they sit down with entrepreneurs and have a look at their business plan so first market size matters for vcs the larger the better obviously but also the percentage that the entrepreneur argues they will claim out of that market size what also matters are business model and milestones so clearly understanding the milestones that the entrepreneurs are trying to achieve with the present round race before they may have to approach the market again for a future fundraising round it will also give the vc a clear idea on how the entrepreneur understands the business that he's trying to uh to to to grow and to to create the team obviously matters who are the entrepreneurs do they complement themselves are there actual gaps in the team and how quickly can those gaps be filled the funding needs how much are you trying to raise and to what extent is this a fit with the mandate of the vc i will come back to that in a second but the target that every vc really has when assessing individual portfolio companies are important so number one what will they be looking for they are looking for an opportunity to make five to ten times their money invested at a minimum they will expect a very clear investment thesis and they will try to develop their or understand three to four risks that their involvement may help the entrepreneur to mitigate and last but certainly not least is potential exit how will the vc be able to exit from this potential startup can it grow to the size to be ipo able can it be sold to a strategic all the individual options will be carefully assessed most important though to understand for entrepreneurs there's no single type of vc each vc and each vc company in turn is quite different and entrepreneurs are well advised to find the vcs that fit their funding round their stage of development their industry their vertical their regional location before approaching venture capitalists bradfeld founder in the foundry group basically made that point here quite well and i hear from many vcs that they say they are being approached by entrepreneurs that either are trying to raise fundraising rounds in in areas that they are not investing in or that are trying to raise money for an ai startup but are approaching a vc that's purely focused on the consumer space so important to get this right now secondly vcs will use industry data to value an early stage company what does it mean first they will identify a peer group of companies to create a benchmark to measure the startup against secondly they will identify appropriate metrics to evaluate the startup to assess the startup those could be operational uh metrics this could also be operational considerations like customer acquisition cost head count total burn rate i.e how much money is being spent on a monthly basis and operational metrics something like monthly recurring revenue number of users number of customers app downloads active users right now again you can tell already this is very much proprietary or very much focused on the startup a very personal part finally they will apply those metrics to value to startup enterprise value which is equity value plus net debt whereby debt is rarely to be found in startups so enterprise value over monthly recurring revenue or enterprise value over up download and then they will compare the startups pitch or the startups state right now with its industry peers once an agreement has been reached verbally a term sheet is usually sent by the vc to the entrepreneur now what is a term sheet term sheets set out the parameters under which or the conditions under which the vc will be investing in the startups they basically form the base for negotiation so term sheets are i argue a negotiation tool they're not a contract they're not necessarily legally binding venture funds will ask for preferred shares so when you're raising as an entrepreneur your first round you will be issuing new shares those shares will not be common shares they will come with certain preferences certain goodies attached to it contrary to common shares so not common stocks but preferred stocks term sheets generically have two key objectives number one they define very clearly how the economics are being split i.e for the money invested in this startup how much in terms of equity stake how large is the equity stake that the vc will receive secondly they will also clearly define the monitoring and controlling rights that the that the vc will achieve so it's all about value creation and value capturing now some examples here for terms that you will clearly find in every vcs term sheet clearly price and price per share and evaluation a liquidation preference anti-dilution class pay-to-play provision investing rights monitoring and control rights will define the board composition does the vc receive a board seat or just observer rights some protective provisions and potentially a drag along right i will share below the video with some sources that will give you a chance to dive deeper into some of those terms but let me give you two examples first liquidation preference you will find this in every term sheet liquidation preference defines the net proceeds from liquidation or a sale that will first go to repay the vc before any other shareholders receive a payout so liquidation preference defines very very clearly upon a sale what will the vc receive purely the money invested multiple self and so on as you can see there are different versions of liquidation rights and you should clearly be aware of the impact of those different versions what you may find in a charm sheet not necessarily in all is drag-along rights a drag-along provision gives the vc the right to force the hand of other equity holders if and when he or she would like to sell the company or exit to a strategic investor more often than not strategic investors are not interested in minority stakes they would like to acquire controlling stakes vcs nevertheless rarely do have controlling stakes and startups so they may need to incentivize or drag along the other shareholders to be able to achieve an exit why is that so important for vcs as we discussed in earlier sessions vcs invest out of closed-end funds meaning funds with a finite lifespan those closed-end funds define that at one point the vc will have to achieve an exit out of its successful investments so if and when this occurs the vc would like to have free hand to exit from its investments now let me just remind you of the motivation or the mindset of vcs and this quote from peter thiel makes it very clear vcs look to invest in companies that have the potential to return at one point in the future the whole fund what does it mean that means scalability and size of a business matter incredibly for vcs simply because of their business model and the riskiness of their portfolio now that may not matter as much for entrepreneurs who may just be looking to build a sustainable business over time in which case bootstrapping or other funding methods will be maybe better suited for such entrepreneurs so we circled back to the entrepreneur's perspective today and we have we see perspective and valuing and structuring of investments inside a fund still coming up in future lectures so today we looked at the the mindset we try to understand the mindset and the thinking behind the valuation that vcs may send over in their term sheets so vcs clearly look for companies that may return potentially the whole fund due to the high risk of failure in startups they look for term sheets and they will send term sheets and those term sheets will define both the economic and the control rights and your first term sheet matters but so does the relationship with your vc thank you and if you liked this lecture please give it a like below and follow me for future lectures so you do get a notification thanks very much i'll see you soon you

Channel: Professor Claudia Zeisberger

Views: 19,012

Keywords: Private Equity, Venture Capital, #VC funds, #PE funds, fundraising, GPs, LPs, investors, education, institutional investors, Exits, Fee structure, management fee, carry, carried interest, Growth Equity, Private Capital, PE, VC, Turnaround, Risk Management, Angel investors, startups, unicorns, valuation, private equity vs venture capital, esg

Id: 2PxSAvkxq9I

Length: 12min 17sec (737 seconds)

Published: Tue Oct 13 2020