Venture Capital

Arushi Bhandari, CPA, MBA

Agenda
What is Venture Capital?
Venture Capital vs. Angel Investors
VC Structure
Due Diligence
Term Sheet and its offering terms
Pre-money vs. Post-money valuation
Impact of dilution on a Cap Table
Funding Options Convertible Debt and Equity
Crowdfunding
What is Venture Capital?
Financial capital provided to startups.
Raised mostly from investors, Limited Partners,
which are entities like banks, large
corporations, institutional investors and high
net-worth individuals.
Typical investment made after seed funding.
VCs invest in return for preferred stock.

Venture Capitalists
vs.
Angel Investors


Angel Investors


Venture Capitalists

Investment

Own money.

Money raised from
investors (LPs).

Board Seats

Typically do not take
a Board seat

Typically take a Board
seat
VC Fund Structure
Consists of 3 entities
Management Company
Venture Capital Fund
General Partnership

Details:
Management Company, incorporated as LLC or LP, is the franchise of the VC firm and
employs the staff and pays day-to-day expenses.
Venture Capital Fund, incorporated as LP, is the entity which basically consists of a big pool of
capital made by the individual investors and then invests this money in different privately-held
companies.
General Partnership is the legal entity which serves as General Partner to Venture Capital
Fund providing investment advice and in return receives carried interest.

Typical Investment Workflow
Ideas
Founders
Angel Investors (FFF)
Business
Plan
Venture Capitalists
Term
Sheet
Due
Diligence
Series A,
Series B,
Bridge
Seed Capital
Investments
Due diligence
Term
Sheet
Business
Plan
Due
Diligence
Due Diligence
Process by which VC or an investor determines
whether s/he should invest in a startup ensures
worthiness of the deal.
Due Diligence process enlists documents which need
to be completed Due Diligence Checklist.
Details depend on how long the company has been in
business and also involves:
Legal and Financial diligence
Technology diligence
Reference checks
Corporate diligence
Term Sheet
Document which outlines terms of investment,
both legal and financial, in a startup.
Key offering terms in a term sheet:
valuation (pre-money or post-money)
price/share
protective provisions
liquidation preferences
anti-dilution provisions
Pre-money vs. Post-money
valuation
Pre-money valuation:
Companys deemed value prior to financing
Usually appears on the first page of the term sheet
Post-money valuation:
Value of the company after the financing
Relationship:
Pre-money Valuation + Investment = Post-money Valuation
Price/Share and Protective
Provisions
Price/Share
Pre-Money valuation / Pre-Financing Fully Diluted Capital
Example:
Common stock held by founders = 1,400,000,
Option pool = 600,000 (10% of outstanding shares)
Pre-money valuation = $2m
Price/Share =$1/share ($2m/2m)
Protective Provisions :
Veto rights that investors have on certain actions by the company.
Example:
Unless investor agrees the following cannot be done:
1. Change terms of stock owned by investor
2. Issue other kind of stock
3. Pay or declare dividend
Excerpt of Liquidation Preference
Sample Term Sheet ( source: www.nvca.org)
Template of a Term Sheet (Source: NVCA)





Dilution & Cap Table
Dilution:
Decrease in an owners percentage interest in the company.
Example:
4 million shares outstanding AND founder holds 1 million shares
Founders % ownership = 25% (1m/$4m).
Company issues another 1 million shares,
Founders new ownership percentage to 20% ($1m/$5m)
Ownership diluted on the issuance of new shares.
Cap Table:
Summarizes major shareholders and their pro-rata
ownership of the companys securities before and after
venture capital financing.
Cap Table Sample
Example: Cap Table
At the time company is founded:
Authorized shares = 10m
Authorized issued shares to founders at $0.01/share
are 9m shares for a purchase price of $90,000
(9m*$0.01)
Authorized unissued shares (option pool) = 10m - 9m =
1m
At the time of Series A, Pre-money valuation = $10m,
Investment by Venture Capital firm = $5m, Term sheet
requirement to create a new option pool 20% of the
total shares outstanding.
Example contd..
Calculations:
Post-money valuation = $10m+$5m =$15m.
VCs ownership percentage is 33.33% ($5m/ $15m).
Founders new ownership percentage is 46.67% (100% -
33.33% - 20%) and it is represented by 9m shares
previously owned.
Total outstanding shares =19,285,714 shares (since Total
outstanding shares *46.67% = 9,000,000)
Preferred shares owned by VC = 6,428,571(19,285,714 *
33.33%) and
Number of shares in the employee pool = 3,857,143
(19,285,714* 20%)
Funding Options: Convertible Debt vs.
Equity
Convertible Debt:
(Principal/investment + interest) either paid off or
automatically converted to equity at maturity or upon the
closing of a round of financing.
Must have interest rates at the Applicable Federal Rates
(AFR) published by the IRS monthly at AFR Rates.
Bridge notes/loans are an example of convertible debt.
Convertible Equity:
Investment at the expiration/maturity of the agreement is
converted to common stock generally at the set valuation
cap.

Example: Convertible Debt
An investor As investment = $300,000 convertible
note with terms:
10% discount and
automatic conversion after a financing of
$1,000,000.
Financing of $1.5m and price/share= $1 for the
current round of funding.
Other investors get share(s) for $1
Investor As purchase price = $.90 ($1 *90%) i.e.
at a10% discount.
Shares received by investor A for $300,000
investment = $300,000/$0.90 = 333,333 shares.
Example: Convertible Equity
Issued and outstanding shares = 1,000,000
Pre-money valuation =$1,000,000
Investors investment = $250,000
Price/Share = $1 ($1m pre-money valuation /1m
outstanding shares)
Investor receives 250,000 shares at expiration of
convertible equity agreement.
Percentage ownership of investor = $250,000/$1,250,000 =
20%
Post-money valuation = $ 1,250,000 (Pre-money valuation
+ Investment)
Crowdfunding
Raising money from general public (also known as
unaccredited investors)
Sale of equity/security through 3
rd
party intermediaries:
registered brokers and dealers
web portals
3
rd
party intermediaries register with SEC and subject
to FINRA rules
Additional disclosure requirements for companies and
3
rd
party intermediaries


Crowdfunding
Disclosure Requirements
For companies:
Name of officers and directors
How raised money will be used
If money raised > $ 500,000 provide audited financial
statements

For intermediaries:
Provide investors with educational material
Cannot solicit or provide investment advice
Caps on Crowdfunding
For entrepreneurs:
raise up to $1M in a 12-month period

For investors:
Net income < $100,000, individual invest greater of
i. 5% of net income or
ii. $2,000
Net income > $100,000, individual invest greater of
i. 10% of net income or
ii. $100,000


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