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How to Diligence a Deeptech Startup

How to Diligence a Deeptech Startup

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    Managing Startup Failure: Early-Exit Procedures

    2 min read Not every startup launched can be a success. It’s okay to fail. The important thing is that you recognize when the startup is failed and exit early. This allows for as much redemption as possible. Fail, but fail smart. In this article, we discuss early-exit procedures and redemption strategies. But first, let’s take a look at startup success and failure rates. Startup Success Rates The early-stage failure rate of startups is quite high. Out of 100 startups, only 40% go to the next level at Series A. Only 22% of startups reach Series B. Only 15% of startups reach Series C. Only 8% of startups reach Series D. As for the success rate, only 9% of pre-seed companies reach an acquisition. Only 12% of Series A companies reach an acquisition. Only 14% of Series B companies reach an acquisition. The most any startup can reach an acquisition is 16%. The failure rate is near exponential. It’s a hit business. You have a hit or you most likely will lose your investment. Redemption Strategies In an early-exit term sheet, the investors have the right to redeem their stake in the company before an acquisition. There are several redemption exercise strategies. The first strategy is to recover the principal investment. This makes the investor whole and now lets them play with “house money”. The second strategy is to place a third of the shares into a cash redemption to recover the initial investment, a third into the company as an equity stake, and a third as a cash redemption to place into the next startup. This keeps the investors’ fund evergreen, supports the current company, and expands the portfolio. The third strategy is to take half in debt and leave the other half for equity. This evenly divides the funds into both sides of the investment options. These are the most common strategies investors use to redeem their stake in an early exit term sheet. It’s important to take into consideration the needs of the startup and how best to support them. Payback Plans Not every funded startup continues on the venture path to a high payoff from the sale of the business. For those startups, investors using an early-exit term sheet can find a path out of the deal. There are several options for the startup to pay back the investors. The company can use a revenue share agreement. While the funds may not be available immediately for payback, the company can pay out of incoming revenue over time. This is typically 2-3% of top-line revenue and is paid monthly. In many cases, this will take more than a year to pay off. Other options include the following: The CEO can put the company up for sale and pay off the investors with the proceeds. The CEO can pay off the debt or assume the note with a personal guarantee. Other investors in the company can buy out the early-exit investors as well.  The follow-on investors can pay off the debt to remove the investors from the cap table.  The company could declare a dividend to the investors and pay it out over time.  The purpose of the early-exit term sheet is to provide the investor a path out of the deal. Operational Involvement In managing an early-exit term sheet, it’s important to facilitate the ongoing information rights due to the investors. Most term sheets provide rights to the company’s financial statements, including the income statement and balance sheet as well as the cap table. This duty is often left up to the founder to follow up. In the rush to close sales, hire employees, and make the company successful, the founder sometimes leaves the information rights duty undone. For an early-exit term sheet, it’s important to maintain this duty. It’s best to set up a service that accesses this information regularly, say monthly to provide the investors the information. Most investors believe that legal control is the best way to enforce the terms and conditions of the term sheet. A better way is operational control. By gaining access to the company’s accounting system and bank account, the investors gain a better understanding of the company. The more the investors know the company’s situation, the more they can help the company achieve its goals. Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    Managing Your Capital Effectively

    2 min read Startups often struggle to obtain, preserve, and manage the amount of capital needed to get the proverbial ball rolling. Today, we share two tricks on how to get around this problem: equipment leasing and accounts receivable factoring. Learn how these methods can earn you capital upfront and help you maintain throughout your production and sales processes. Equipment Leasing Equipment leasing lets you borrow funds to obtain assets such as computers, machinery, and other items you may need to build your product and run your business. This method works best for cash-flow management when you have a long-term need for the equipment.  Instead of raising equity funding to buy the equipment, you can lease the equipment- an less expensive method that spreads the payments over a period of time rather than requiring the funding for the equipment upfront. This works well for businesses that are capital-intensive. There are two types of leasing. The Finance Lease (also called the Capital Lease) and the Operating Lease. The Finance Lease is a long-term arrangement in which the startup is required to pay the lease rent until the end of the contract, which is usually the life of the asset. The Operating Lease is for a shorter period of time and is often cancelable.  Providers of equipment leasing must have a license and cannot hold or offer real estate. The lease period cannot be fixed for less than three years, except for IT and computer equipment. Leased equipment appears as an expense on the income statement rather than on the balance sheet, which would reduce the startups’ liquidity. Over the long term, the cost of the asset will be higher than that of an outright purchase. It’s best to look for a closed-end lease without a balloon payment at the end. An open-end lease requires you to pay the difference between the value of the equipment and what you’ve paid for it so far. Factoring Factoring is selling your accounts receivables to a finance company at a discounted rate. It’s not a loan, you are not taking on debt. Rather you are selling your invoices for cash, albeit at a discount. Businesses with a cash-flow shortage often use factoring as it’s a fast way to access capital without taking on debt.  When you sell a physical product and invoice the customer, it can take up to sixty days or more before they pay.  Factoring provides funding by reducing your accounts receivable by selling the invoice. The factoring company gives you cash immediately when you sell and takes a transaction fee on the use of their funds. The factoring company is now at risk for non-payment. Factoring works well for consumer product companies that have cash-flow challenges as the business requires capital to build the product, sell and ship the product only to collect payment later. This method reduces the amount of working capital needed and may reduce the amount of funding you need from equity capital raises.  A typical factoring arrangement gives the business 85% of the value of the invoices and keeps 15%. The factoring company often charges a processing fee and a fee for however many days it takes the customer to pay the invoice. These two costs add up to be the discount the business is paying for the receipt of cash.  Keep in mind that your customers will know you are factoring as the invoice will be retitled into the name of the factoring company. Read more in our TEN Capital eGuides: http://staging.startupfundingespresso.com/eguide/ Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    Ways a Startup Can Achieve an Exit

    2 min read There are many ways to exit a business, each with its own benefits and drawbacks. In this article we discuss the many ways in which a startup can exit the marketplace. Buyer Options There are several options for selling your business. Below are a few buyers from which you can choose: Strategic: The buyer buys your business to provide strategic value for their company. Financial: This buyer looks solely at the financials, in particular the cash flow, and buys the company without consideration to the strategic implications of their business. Management Team/Employee: This buyer works in the company and wants to own the business or continue to run it. Competitor: This buyer is a competitor and wants to take your business off the market by merging it into their own. Private equity: This is a buyer who plans to take over the business with a new management team and business plan. Generational transfer: This is typically a family member who wants to take over the business. Other Exit Options There are several other ways to exit a business. Some options include: Selling the business to an investor. This provides liquidity to the owners. The downside is it’s not clear what happens to the employees and the direction of the company. Develop an employee stock ownership plan. This transfers ownership to the employees and brings tax benefits to you. The downside is that the valuation will most likely be lower than an outright sale. Use a management buyout. This provides liquidity to the owners but can take some time to complete, even years. Transfer the business to a family member. This provides the family member with an income and potentially a career. There are estate tax consequences that must be considered with this option. In exiting your business, consider the impact not only on yourself, but also on the employees, customers, and others associated with the business. What If It Doesn’t Sell? Most startups are launched with the idea of selling the business for a substantial gain in five to seven years. Many companies reach that stage and find they can’t sell the business, at least not for the price they want. Here are some options: Reduce your burn rate to zero and keep running the business. Split up the business into its component parts (team, inventory, technology) and sell to multiple buyers. Sell the business to the other founders or to investors and take a revenue share for your equity portion of the business. Line up a manager of the business to take your place and then dividend back to the investors a portion of the revenue until they receive a payback amount. While you may not reach a full acquisition as planned, there are several ways to exit the business and pay back the investors. Read more in the TEN Capital eGuide: http://staging.startupfundingespresso.com/how-to-achieve-an-exit/ Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    How To Plan for an Exit

    2 min read At some point, every startup will need to exit the marketplace. Being prepared is key to doing this with success. In this article, we discuss how to plan for an exit and how to prepare for exit negotiations. Planning For an Exit Here are some key steps to take in planning the exit for your company: Understand why you are exiting the business.   Is this exit going to be seller motivated or buyer motivated? Explore the options. Consider who would be the best acquirer or which company would be best to merge with. Consider the market and industry. Is your industry consolidating? Is the market growing? Know what your company is worth. Research comparable valuations of similar companies. Revenue is typically a key factor along with profit. Start talking with potential acquirers and update them regularly on your progress. Ask other founders and CEOs for their exit experience. Find out what they discovered in going through an exit. Ask your current investors about their experience with exits to see what they know. Once you have a target acquirer, make a list of what they want to see in your company in order to buy it. This list becomes your strategic plan. Negotiating an Exit In negotiating the exit with an acquirer you’ll need to know the following: Key metrics about your business, both those that show the company in a positive light as well as a negative one. The total addressable market for your company. The top three opportunities your company can attack. The company’s competition and competitive advantage. The company’s track record in meeting forecasts and accomplishing milestones.  Why are you selling the company, and why now? Why is the acquiring company a good fit for your company? How closely aligned in operations is the company to the acquiring company’s operations? How much integration work will need to be done? What role will the CEO play after the acquisition? Think through the answers to these questions as most of them will come up. Preparing to Achieve an Exit At every fundraise stage the CEO can choose to raise funding or sell the business. If you choose to sell your business, how can you go about doing so? Meet all the C-level people at companies that could acquire you, and the CEOs of companies who are potential acquirers. Gain an introduction and then generate an ongoing dialog with the CEO. In the process of doing so, you can determine their interest in your type of business. If they like what you do and can see how it fits into their business, then you have an opportunity to pursue being acquired. As always in business it is about starting and building relationships. Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    Startup Organizations: Finding Funding

    2 min read Every startup eventually asks the question: “Where will our funding come from?” There are several sources of funding that your organization can tap into. Some of the most common funding sources include consultation, contractor, crowdfunding, and supplier funding. Let’s take a closer look at each. Consultation Funding Consultation funding is using consultation work to pay the bills and salaries while you are building out your product. Consider looking for consultation work in addition to selling the product as some customers want more assistance in installing and using the product than in just buying the product itself.  The consultation also brings new insight into how the customer intends to use the product and what problem they are trying to solve. This is useful information to guide your product roadmap. Consulting work gives you more information about the market and the competition as you’ll encounter competitive solutions. This is also a great way to generate positive references to use when you launch your standard product into the market. While consulting may not be your ultimate goal, it can be a useful way to fund a portion of your product development. Contractor Funding Many enterprise software programs come from service businesses solving a problem for their clients. In searching for a solution on the market, they find none, so they build their own. Later, other clients come ready to buy it. This is one of the most overlooked forms of funding in the startup space. In contractor funding, you sell a customized version of what you want to build to an anchor customer for a substantial one-time fee and then use the funds to build out the platform you envision of which the customer gets a non-exclusive license.   The advantage here is you have a customer telling you exactly what they need and what they will pay for. They improve the product by testing it and telling you what changes to make. They become a happy customer that you can use to attract prospective customers. After three more of these engagements, you will have $1M of investment in your platform with zero dilution. Crowdfunding Crowdfunding can be sourced as prepayment for a good or service, or from accredited or non-accredited investors. Prepayments let you pre-sell your product before you build it. This works best for physical products that require funding for the design and manufacturing of the product. It’s a great way to test the market for a new product as it provides customer feedback on the product, price, and promotion. There are several platforms available for showcasing your product. There’s also crowdfunding from non-accredited investors. On these platforms, anyone can invest in your startup. It is for equity, so you need to understand the implications of it on your cap table. Finally, there’s crowdfunding from accredited investors which is no different than raising funding through angel investors and venture capitalists. The only difference is using a crowdfunding platform to find and engage the investors. There are a growing number of crowdfunding portals offering both general and specialized sites. Crowdfunding works well for startups with a product that is clear to grasp and easy to understand.  Supplier Funding Another source of funding is supplier funding. Supplier funding comes from those who provide services to your company such as contract manufacturing, software development, legal, accounting services, and more. Suppliers provide their services in exchange not only for cash but also for equity. This reduces the amount of equity funding you need to raise from investors. Contract manufacturers will invest in your business and in exchange they look for the startup to use their manufacturing services. Software development firms invest in startups by taking a portion of their software development fee in the form of equity. There are other examples, including lawyers and accountants who provide services in return for equity. This aligns their interest with your interest as the business must succeed for the equity to be worth something.  Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group

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    Tips For Using Your Financial Model

    2 min read Financial models contain numerical data about the past, present, and future of your business. This information can be used to make business decisions, analyze the financial health of the company, and can also be presented to potential investors. In this article, we provide tips for using your financial model. Using Your Financial Model in Your Pitch The financial model is a key component of your pitch. You should be using key financial numbers from the model to tell the story of how your business can scale up. To do this, start with your unit economics to show the business works. Show how the systems you have built drive the business using the financial model. Highlight the market size and how fast the market is growing as well as how you will go to market if you are in the early stage. Call out key cost figures to demonstrate you know the numbers that drive your customer acquisition process and retention rates. Show how you will use the funds by pointing to the costs for building products, generating leads, or closing sales. Show your cash burn and how the fundraise will give you runway. The financial projections alone don’t tell the story of your business. You have to pull out key numbers to tell the story. Using Your Financial Model in Your Pitch Deck Many founders cut and paste cells from the financial model spreadsheet into a slide. This renders the information unreadable as the spreadsheet doesn’t fit with the presentation format. To show your financial projections, consider the following: Don’t cut and paste from the spreadsheet. Investors cannot take in a detailed spreadsheet on a slide, only the high-level information. Instead, choose specific numbers from your financial model and place them into the slide using the same font and format as the rest of the deck. Choose three sets of numbers: Revenue, costs, and profits. For these categories, show last year, this year, and projections for the next three years. This provides a five-year window into the company. For each of the three categories, create a line graph. Avoid hockey sticks as investors will discount those numbers as unrealistic. Investors will look for the growth rate you are projecting. They will look to see when you go cash flow positive. Investors will look at the burn rate on the profit line and then check the fundraise to see how much cash runway you are proposing. The key takeaway regarding how to present your financial projections is the importance of calling out three key numbers such as the growth rate, months to cash flow positive, and the number of months of cash runway. How Investors Use Your Financial Model Investors use the financial model to understand not only the business but also to learn about the founder and their skills.  Here are some key points investors look for: Salaries: How well is the team compensated, and does this fit the stage of the business? Customer acquisition and retention: Have you built a system for acquiring customers and retaining them? Traction: What traction do you have going so far? Knowledge of the business: How well do you know the costs of running the business as well as what factors drive revenue? Scale factors: Based on the costs and customer acquisition model, how well can the business scale? Use of funds: How are you are going to spend the funds raised? Does it make sense for the stage of the business? Potential outcome: Is this a venture business or a lifestyle business? Consider how the investor will view your deal in building out your financial projections.  Feel free to try out our calculators and contact us if you would like to discuss your fundraise: http://staging.startupfundingespresso.com/calculators/ Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group.

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    What to Include in Your Financial Model

    2 min read  Your Financial Model will consist of several KPI’s, or key performance indicators. The metrics show the business’s overall health and can influence business decisions. You will also share the metrics with investors to glean financial projections when choosing whether or not to invest. Below, we cover several KPI’s to include in your financial statements. Cost of Goods Sold (COGS) The cost to build and deliver your product or service. This includes the building costs of the product or hours to deliver the service.  Capital Expenditures  This KPI accounts for investments into assets. This includes real estate, intellectual property, equipment, facilities, buildings, computers, servers, and office equipment. Depreciation  Depreciation represents the reduced value of assets based on their useful lifetime. One can expense a portion of the value each year over the life of that asset.  Personnel Expenses  Each employee has a salary, benefits, and payroll taxes. Payroll taxes are a calculation off of the salary. In addition, commissions need to be included but are variable expenses related to sales.  Financing  Any financing you have must also be accounted for in the financial statements. So you’ll need to set up a tab in your spreadsheet to capture the details of a loan or other types of financing, such as accounts receivable financing. Valuation  For later-stage startups with revenue, one can use the financial projections to estimate the company’s valuation for fundraising purposes. Your financial projections should have the key elements, including projected cash flows, a chosen discount factor, and a net present valuation of the free cash flows to generate the DCF valuation. Operating Expenses Operating expenses are the day-to-day expenses a business incurs. They support the operational side of the business covering sales, marketing, product development, and administration. Working Capital Working capital is the capital you need to run the business’s daily operations and includes anything converted to cash. This includes cash, accounts receivables, and inventory. Accounts payable reduces your working capital as you must pay it out each month. Taxes  Taxes include payroll and social security taxes, which are based on employees’ salaries and are paid monthly. In addition, income taxes are taken from your profit and loss statement results.  Revenues  For sales forecasting, begin with your current sales funnel and revenue history. Next, use your current sales process for the first two years and then switch to your growth initiatives in years three to five.   Feel free to try out our calculators and contact us if you would like to discuss your fundraise: http://staging.startupfundingespresso.com/calculators/ Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group.

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    Financial Models for Startups

    2 min read A financial model is a summary of a company’s financial performance for a set duration of time. Financial models can be used externally to share information with investors and internally to make important business decisions. In this article, we look at what you need to include when building your financial model, the benefits of using an up-to-date financial model, and possible uses. What To Include in a Financial Model When you are building your financial model, make sure to include the following: Revenue projections: This is an estimate of revenue from all sources. Cost of Goods Sold: This projects how much it will cost to build and deliver the product or service. Customer acquisition costs: This is an estimate of the sales and marketing expenses required to acquire the customer. Operating expenses: This is the cost of running your business, such as the monthly price for office space and utilities.  Capital expenditures: This is an estimate of the cost to acquire physical assets such as equipment and machinery. Cash runway: This refers to the amount of cash available based on operations as well as any fundraises. It is also useful to include metrics such as customer acquisition cost and customer lifetime value. Benefits of Using a Financial Model An up-to-date financial model is a must-have for every startup as it can help you make management decisions. It can be used to: Determine what positions to hire and when. Measure the performance of the team and highlight problem areas. Shows areas that are out of their target cost or performance zone such as having too much of a given resource. Determine your valuation range for a fundraise or exit event Find ways to reduce the risks in the business. Create consistent results by managing both cost and revenue drivers. Provide ongoing monitoring of the business. Consider setting up the financial model for daily and monthly operational use as well as for fundraising. Ways To Use a Financial Model After building your financial model you can use it in several ways. Examples of use cases include: Raising funding for the business by determining how much you need to raise and when. Generating financial forecasts and projections for managing the business. Projecting key financial statements such as profit and loss statements, balance sheets, and cash flow statements. Setting up budgets for daily management of the business, particularly around cash flow. Determining hiring decisions including what roles to fill and when. Setting strategic plans for growing the business. Estimating the value of the business for negotiating acquisitions by other companies.    Feel free to try out our calculators and contact us if you would like to discuss your fundraise: http://staging.startupfundingespresso.com/calculators/ Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group.

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    How to Use Financial Projections

    2 min read Information derived from financial statements is used to create financial projections and is usually done on a five-year scale. These projections are used internally for business planning and managing. They are shared externally with investors, potential donors, tax agencies, and more. Below, we cover some of the ways you can use your financial projections. Purpose of Financial Projections Your company’s financial projections document, also called the pro forma, is a key document you’ll need for your fundraise. Investors will want to see a detailed, five-year financial projection to show that you’ve thought through the financial side of the business.  A quality financial projection shows investors you know your business and have a good idea about what things cost and what customers will pay. Additionally, investors also glean from the financial projections how you are going to use the funds they offer you. Financial projections are not about predicting the future with great accuracy, but instead showing the causalities and interdependencies of your business. This document answers questions such as: If sales double, what is the impact on costs? If sales drop by 50%, what happens to cash flow? Fundraise Your financial projections will be important for your fundraise. Banks will want to see your projections when you apply for a loan, and investors will want to see them when you raise equity funding.  There are two basic forms of capital: debt and equity. Debt is in the form of a loan with specific terms, including the interest rate and payback plans. Debt has some advantages including: You can maintain ownership over your business. Interest is tax-deductible. Debt can keep management focused on the core business, in particular cash flow and profits. The advantage of equity is that you don’t have to pay it back immediately, only when you sell the business or go public. Your financial projections will help you decide how much funding you should take from debt and equity. Best Case Worst Case After completing the financial projections, you may want to create various scenarios of your financial model. Startups are often optimistic, while investors are pessimistic, so it can be helpful to create a best-case scenario and a worst-case scenario. For the worst-case scenario, keep your revenue at the current level or only with small increases. Check your cash position and runway and adjust the expenses and fundraise plan accordingly. For the best-case scenario, use the revenue targets you have in mind. Check your cash position and runway and adjust the expenses and fundraise plan accordingly. Here are several common errors: As sales grow, so do sales costs – in particular commissions. Make sure these costs are included with the revenue ramp. Fundraises typically take longer than expected. For every $1M of funding you seek, it will take you one calendar year to raise it. Include your working capital needs for your fundraise planning and its impact on cash position. Founders typically work long hours for little to no pay. This is not true with non-founders. Make sure you include reasonable salaries for the work you expect from others.    Feel free to try out our calculators and contact us if you would like to discuss your fundraise: http://staging.startupfundingespresso.com/calculators/ Hall T. Martin is the founder and CEO of the TEN Capital Network. TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: hallmartin@tencapital.group.

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