We’ve known for years that Colorado has more startups per capital than anywhere else. Yes – per capita. It’s a great location to start up a company and maybe you’re wondering if there’s a Venture Capital infrastructure to support that? Well, now there’s incontrovertible evidence for Colorado’s leadership position in MicroVCs and it all comes down to … beer.
Just check out this CB Insights research relating MicroVC Tech Deals to Microbreweries. That’s right – the more microbreweries you have, the more MicroVC deals you get. And take a look at Colorado’s number 3 position in Microbreweries – what does that tell you?
Yes – a vibrant MicroVC community is brewing here in Colorado. We’re seeing a huge influx of MicroVC and NanoVC funds as the state begins to mobilize its local capital to support its burgeoning startup community.
Ok, maybe that’s just a facetious stretch of statistical comparisons – but there is definitely a rapidly moving trend in Micro Venture Capital and Colorado is feeling the benefits of new sources of capital coming on-line!
This trend mirrors a national trend in increasing Micro VC firms. Following the drastic drop in VC firms from over 1000 to just over 500 after the economic downturn in 2008, MicroVCs have flourished. There were fewer than fifty active MicroVCs in 2011 and today there are over 550 in the U.S. A tenfold increase in just a few short years and many of them are in Colorado.
MicroVC is changing the venture investing landscape and is responding to the needs of startups who need small amounts of capital to prove their product market fit and grow big. MicroVCs offer a scale that the big firms can’t efficiently provide and they get companies up and going quickly and efficiently.
MicroVCs aren’t just for small companies though. Check out these results from MicroVCs who are growing a new crop of Unicorns (private companies with valuations of $1B or greater) It’s not just the big funds that are hitting the grand slams – the Micro’s are slamming it home as well.
MicroVCs are creating a huge impact in the startup world and Colorado is the place to see this transformation taking place on a rapid pace.
You can learn more about MicroVC, NanoVC, and how accelerator VC funds are changing how startups get funded, and how angel investors can get involved in new ways previously unavailable to them. You’ve got just a few days to sign up for the Colorado Capital Conference coming up November 6-7, 2017 in Denver, CO.
Visit www. coloradocapitalconference.org for more
information and to register.
The conference is hosted by Rockies Venture Club, the longest running angel group in the U.S. Membership is NOT required to attend the conference, but if you’re an entrepreneur or angel investor, this would be a good time to look into the savings that RVC members enjoy on conferences, angel groups, workshops, masterminds and classes.
As the cost of starting a tech company has gone down, VCs have moved upstream, funding bigger and bigger deals while angels and angel groups have taken up the sub-five million funding space. Meanwhile, accelerators and platforms have also taken a place with funds to jump start companies going through their programs. MicroVCs are venture capital firms with assets under management of less than $100,000,000. That sounds like a pretty big fund to angel investors, but in the big picture venture capital world, these truly are micro venture capital funds.
MicroVCs have taken on a huge role in filling the gap between seed and angel funding and big scale unicorn-track venture funding. If you think about basic fund structure, a $100 million fund will invest about half of committed capital, or $50 million into its first round investments. The fund will want to diversify to twenty or more investments, so you might see an average of $2 million for a first round. Then they’ll have the remaining $50 million to continue investing in the top winners from the portfolio. $2 million is a great amount for a post-angel round, but is far less than the $10 million that an average VC deal is doing today.
The MicroVC area is more understandable if we look at what kind of entities fill this space. There are sub $25 million funds, also known as NanoVC Funds which operate very differently than $100 million funds. Then there are the accelerators which are actually MicroVCs. Also, more and more angel groups are creating funds (Like the Rockies Venture Fund) and are moving upstream a bit to do larger deals. Finally, angel groups are syndicating actively, so they can move into larger and larger deals. Some examples of the power of angel groups leveraging their investments by working in syndicates include Richard Sudek’s work at Tech Coast Angels who syndicated a $10 million raise via syndication and similarly Rockies Venture Club Participated in a Series F syndicate for PharmaJet locally. These are not deals that we would typically expect to see angels playing in. This means that angels, when working together can start filling the space occupied by the MicroVCs. Rather than competing, we’re seeing angels investing alongside MicroVCs at an increasing pace.
There are other considerations, however. MicroVCs will typically hold back half of their fund for follow-ons, while angels are less predictable and many still use a “one and done” approach to their investments. Even with MicroVC follow-on investment of up to $10 million, this is still not enough to propel some companies to the scale they’re shooting for, so they’ll still need to engage with traditional VC once they get big enough.
Angel investors should help startups to figure out their financial strategies so that they can work on building relationships with the right kinds of investors from the beginning so that they don’t paint themselves into a financial corner by working with the wrong investors. Similarly, startups need to understand the goals of any type of VC so that they don’t waste their time barking up the wrong tree.
To learn more about the evolving role of MicroVCs, consider attending the RVC Colorado Capital Conference. It’s coming up November 6-7th in Denver, CO. Visit www.coloradocapitalconference.org for more information on speakers and presenters. This event is on of Colorado’s largest angel and vc investment conferences of the year and there are great networking opportunities. We hope that the audience will come away with an idea about how all these types of capital are evolving and the different strategies that companies can take in choosing who they want to pursue for their capital needs.
Many professional organizations have a certification test of competency that members must pass to demonstrate their knowledge and ability to perform at a high level. Doctors, Lawyers, CPA’s and other professions must also take continuing education credits as well.
The criterion for being an angel investor, however, has nothing to do with knowledge and does nothing to provide the knowledge that an accredited investor needs to know to both make good investments and to exercise prudence with regard to their portfolio strategy. Accredited investors qualify to be angels simply by wealth (having assets in excess of $1 million) or income, (having annual income of $200K per year or more, or $300K for married couples)
The SEC has proposed recently that a knowledge based criterion for accredited investors be added. This would allow people with expertise to participate in angel investments. The proposal, however, suggested that existing certifications such as a FINRA Series 7 might be a good benchmark. Having passed the Series 7 test myself, I can assure anyone that the knowledge one acquires to pass that test, though it is significant, has nothing to do with what someone needs to know to be an angel investor. Angel and venture capital investing has its own set of language and guidelines that have very little overlap with what a Series 7 certificate holder would have. If the goal of accreditation is to protect the investors from themselves, then providing a certification that tested knowledge that was relevant to the asset class would be most useful.
A good certification test for angel investors would include several parts. Here’s an overview of what it might look like.
- Portfolio strategy. The presumed reason for the accredited investor guidelines is that people of high wealth have excess money to lose and can withstand a complete loss. Just having money to lose isn’t really a great way to build a portfolio strategy. Smart investors will allocate approximately ten percent or less of their investable portfolio into the angel investing asset class. Within that ten percent, they will be invested in a minimum of ten deals and preferably twenty or more. That means that a marginally accredited investor with a $1 million in investable assets will create an angel investing portfolio of about $100,000 which will be in at least ten $10,000 deals or even twenty $5,000 deals. Someone with a $5 million investable portfolio will put $500,000 to work in angel deals, perhaps with twenty deals at $25,000 each. Some angels really spread out their risk with fifty or more deals and it’s generally agreed that the more deals you can get into the better. Finally, angels should understand the difference between making a “one and done” investment in a company vs. follow-on investments and how they can benefit a portfolio.
- Exit strategies. Angel investors have only one way to get their money back and that’s through an exit. Anyone investing in this asset class should have a sophisticated knowledge of how exits work, how to analyze the market for exit potential, what typical exit multiples are and what the typical exit amounts are for startups in any particular industry. An angel who doesn’t understand exits will not likely do well as an investor and may end up investing in a lot of great ideas that never see a liquidity event.
- There are some who say that “valuation doesn’t matter”. These are the VC hacks who think they can make up for any valuation by investing only in “unicorns” ( private companies that reach a valuation of $1 billion or more). That’s a great theory until you realize that only one in several thousand deals results in a unicorn deal and most that exit at all will exit for under $50 million. For these, understanding valuation and putting together a fair deal is critical. A smart angel should have a valuation toolbox under their belt with several different valuation methods available to them.
- Due Diligence. Smart angels know that the more diligence you do, the better your chances for investment success. Just having lunch with a startup CEO and getting excited about their passion and commitment is not a good way to do diligence. Investors should thoroughly investigate the market, the team, the product, IP and legal landscape, valuation, comparable transactions, financial projections, competition, exit potential, key documents and agreements and much more.
- Term Sheets. Investing requires good knowledge of the terms used in negotiating the deal. These terms are far from obvious and many that sound similar can result in a difference of millions of dollars when the company exits. g. “preferred liquidation preference” or “participating preferred”. I’ve seen angels who have caused serious problems for themselves and the companies they invest in by creating situations that make follow-on investment by VCs all but impossible.
- Securities and Tax Law: Angels should be familiar with the various points of securities law to understand the registration exemptions that offerings are using, and to know the boundaries of proper securities offering processes. They should understand the difference between Regulation D 506B and 506C registrations, the proper filing of Form D, numbers of investors allowed, and verification of accredited investor status. They should also understand tax law as it applies to angel investment including Section 1202, 1244, and 1045 as well as state breaks for economic development and federal breaks for research and development.
- Proformas and financial analysis. Like it or not, there’s a lot of finance knowledge required to be a good angel investor. Being able to look at a proforma and understand if it’s believable, or just a “hockey stick” graph someone put together to make it look good. A proforma is a treasure trove of information about the company, its strategy and how it expects to operate. Even though it’s never going to be right, the way that the information is presented gives the investor a window into how the CEO and team thinks. Finance risk is significant for most companies and understanding how many future raises will be required, how big they will be and what the cumulative dilution to both founders and investors will look like is critical to assessing the potential for the deal.
- Market Analysis. Understanding the trends in a market, competition, actual pain points and return on investment for customers is one of the most important parts of understanding the viability of a deal. These require sensitivity to the particulars of specific industries and are not easy. Many startup founders are technical wizards and they may have some insight into the needs of their markets, but many have no idea about how to create a go-to-market strategy, assess which channels are appropriate for their market, or how to allocate scarce resources to create the lowest Cost of Acquiring a Customer relative to the highest Lifetime Customer Value. Many startups are blind to their competition and claim that they “have no competition.” This should cause any investor to run from a deal. Creating “virality” is an art that is lost on many tech or healthcare founders and angels should be able to assess the viability of the market strategy.
- Post Investment Management and Serving on Boards. The work of the angel investor is just beginning after the check clears. Managing the investment after the check requires expertise to help ensure alignment and to guide the CEO towards the best exit opportunities. Serving on boards carries fiduciary responsibilities.
Unlike the questions for the FINRA Series 7 exam, most of the knowledge required for angel investing certification centers more around principles, definitions and best practices rather than distinct points of law. Only about 10% of the angel certification test is about specific regulations and point of law, yet the knowledge the test represents is what angel investors should know. This ratio represents the ratio of technical to legal know-how in other professional exams and would represent a step-up in the professionalism of angel investing.
The SEC has set income and asset limits to the definition of accredited investors with good intention. Unfortunately, simply having wealth does not make one qualified to make good investments and there are plenty of stories of wealthy people making imprudent investments that resulted in disaster. Better to allow a criterion based on knowledge, so that investors understand how to balance risk and opportunities through diversified investments and well accepted principles of successful angel investing. We hope the SEC will consider this certification as a means to becoming accredited, and open up angel investing to a broader audience while accelerating American economic development through greater investment in our job creating startups.
It seems like a majority of pre-Series A deals are done with convertible debt these days and I’d like to point out a few reasons why this is a bad thing for entrepreneurs and investors alike.
Just to get definitions out of the way, we’re talking about the decision to raise funding for startups by either equity investment in stock of a company, or in a convertible debt instrument. Equity is pretty straightforward – invest money, get stock. Convertible notes, on the other hand are not widely known to those outside of startup investing. Convertible debt works like regular debt in that there’s a promissory note and an interest rate. The interest is rarely paid in cash for convertible notes though, and it’s usually rolled into equity when the note converts into equity. There are usually a few “triggers” for h
aving the note convert to equity, but the most prominent one is that there is a “qualified financing round” which is usually around $1 million. The idea is that the professional investors at that stage know how to value the business and set the terms. The first early investors who invest will convert at the terms set by the VCs, but usually with a 20% discount in price to compensate for investing earlier. Convertible notes today also have a “valuation cap” which is equal to what the equity valuation would have been if the deal had been a stock transaction in the first place. So, when the qualified round causes the note to convert, it converts at the lower of the 20% discount or the valuation cap.
Ten Reasons to Avoid Convertible Debt
Reason 1: Convertible Notes do not qualify for Section 1202 QSBS Tax Breaks
Angel investors get a 100% capital gains tax break if they invest in equity in early stage companies that meet certain criteria such as being a C Corp., being under five years old, under five million in revenue and they hold the
investment for five years. Convertible notes don’t qualify for this tax break, so if all things were equal, the investor makes 20% LESS on convertible note deals since they have to pay capital gains tax on the investment, whereas investors who invest in equity do not have to pay any tax at all.
Reason 2: Equity is cheaper than convertible debt
You may have heard that it’s cheaper, faster and easier to do a convertible note, but the fact is that convertible notes are going to end up costing the company approximately 25% MORE than an equity deal. The reason for this is that when the note converts, then it converts into EQUITY. That means that the company pays twice for the legal: once to do the note and another time to do the equity. So if a convertible note cost $2500 in legal fees and the equity deal cost $10,000, then the convertible note all-in is going to cost the company $12,500. Why not just do it right in the first place and put all that money to work for the company?
Reason 3) 80% of Angel Investors Prefer Equity
If you’re selling something to a customer, wouldn’t you want to sell them what they want and not some more expensive and inferior product? The American Angel Survey shows that investors prefer equity and I suspect that if the remaining 20% of angels read this blog, they’d prefer equity too.
Reason 4) You can lose your company if you default on a convertible note
When you take out the note you’re confident that you’ll have a qualifying follow-on round within 18 months, but many times it takes longer and the note comes due and payable and you’ve already spent the money and can’t raise any more. You’re in default and investors can take your company from you. Most investors don’t want to do that, but why go through the heartburn and stress of facing the potential loss?
Reason 5) Investors have to pay tax on interest they earned but never got
As interest accrues on convertible notes, interest is due. Investors need to pay tax on those notes, even though they didn’t actually get the interest in cash. So, if someone invests $100,000 in an 8% convertible note, they have to pay $2640 in cash to the IRS on that income. Nobody likes paying taxes on money they never got and also, BTW, there is no tax due for equity investments.
Reason 6) You have to come up with a valuation for convertible notes just like equity.
Many people think that using convertible notes lets them “kick the valuation can down the road.” Nothing could be farther from the truth. Every convertible note has a provision called the “valuation cap.” The formula for calculating the valuation cap is as follows:
Valuation Cap = Equity Valuation
This means that when someone invests in a convertible note, they should never have to pay more than what the company is worth today. If the valuation cap were higher than equity valuation, that would mean that note investors would have to pay more than the value of the company. Just because it may convert at a higher valuation some time in the future does not mitigate the risks that the early stage investor has today. In fact, the only way that the higher valuation comes about in the future is that the angel investor puts in the capital early, when risk is highest, so it doesn’t make sense that they should pay more than what the company is worth.
Many companies get confused about this. One company told us that the valuation would be $5 million, but it would be $7 million valuation cap “because it’s going to convert at $12 million some day.” It’s crazy to think that somehow using a convertible note makes a company worth $2 million more than one that uses equity. This kind of thinking makes no sense and hurts the startup community.
Putting valuations on early stage companies is something that is done every day and there’s no magic to it. Seed Funds and Angel Groups have well established valuation methodologies that work well on pre-revenue companies.
Reason 8) Entrepreneurs get diluted with convertible notes
Entrepreneurs should be cautious about the cumulative dilution that paying interest which will be rolled into equity will create. The longer the note goes on, the more startups will be diluted with the interest that they have to pay in the form of equity. It would be better to preserve that equity for future growth. Founders who chose equity over convertible debt don’t have to worry about interest accumulating and diluting their shares.
Reason 9) Equity creates better alignment between investors and founders
When convertible debt is used, there is a misalignment between investors and entrepreneurs. Founders want to use high valuation caps or worse, no valuation caps, and prolong the amount of time before conversion, so that investors get the short end of the stick. Some founders openly state that they want to use convertible debt to preserve their equity. Those are founders that every investor should avoid – not because they want to build a strategy that preserves equity, but that they want to create unfair terms that preserve equity at the expense of investors.
Reason 10) Equity deals have all the terms defined
With a convertible debt deal, the conversion price is negotiated, but all the other terms which are extremely important to the relationship between the founders and investors are left open. This represents a risk to investors and also leaves many matters unsettled. One example is that there are usually terms about board representation which are not found in convertible notes. Investors in early stage companies can offer much more to companies than just a check if they can serve on boards and help move the company along. While there’s nothing to say that companies with convertible notes can’t have boards, in fact many don’t and that’s bad for both investors and entrepreneurs.
With all that being said against convertible notes, they can still be useful for the FFF rounds with friends and family who don’t know how to value a deal and who are investing primarily to support the entrepreneur. Convertible notes can be better than some of the amateurish deals that get put together for early family investors who are often non-accredited that can make follow-on investments difficult or even impossible for the company, thus limiting its chances for success.
Visit www.rockiesventureclub.org to learn more.
It’s a common misconception that angel investing and venture capital is extremely risky.
But when best practices for investing are followed, tax breaks and portfolio returns can consistently outpace even the best mutual funds. If you’re wondering how this can be true – read on!
Angel investing involves capital investments by accredited investors (people with a net worth of $1 million or more excluding the value of their primary residence, or with income of $200,000 or more per year/ $300,000 for a married couple). These investments are in startups, usually with less than $1 million in revenue and less than five years old. These startups have high growth potential and angel investors look to invest in companies that have a believable plan to be able to return 10X their investment or more within five years.
Yes, some of these companies will fail, but let’s compare two investors. The first one, Freddy Frugal, invests all of his money in mutual funds yielding a healthy 8% return. The second one, Andy Angel, invests his money in ten startups. Both investors hold their investments for five years. Let’s look at their returns.
Freddy’s returns are 8%, but he must withdraw $2,640 in the first year, and more each year to pay taxes, so the compounding is based on his after tax returns each year. After Freddy pays his taxes, his actual return is less than 5.93%. Not bad, given the relative lower risk of a mutual fund and the liquidity it provides when funds are needed.
|Freddy Frugal – $100,00 at 8% compounding|
|Year||Investment||Returns||Failures||Taxes||Returns After Tax||Portfolio Value After Tax|
|IRR Before Tax||8.83%||$144,524|
|IRR After Tax||5.93%||$129,831|
Andy’s returns are a bit more complicated.
First of all, because Andy is investing in a Colorado company he is eligible for state investment tax credits of 25%. (many other states have similar credit programs) This means that he gets $25,000 back immediately from the state government, so he actually has only $75,000 of his capital at risk. We’ve shown this below by adding the $25,000 cash returned by the state to the value of his portfolio.
Also, Andy’s returns for his portfolio match the HALO report of thousands of Angel investing deals reported, so in the second, third and fourth years one company totally fails each year, resulting in a complete loss of investment and another is liquidated and returns $.50 on the dollar. This results in a tax loss of $15,000 each year which he can take accelerated write offs against ordinary income thanks to IRS Code Section 1244. This results in a cash benefit to Andy each of these years in the form of reduced taxes which we’ve calculated at $4,500 per year.
In the fifth year, the remaining four companies have exits ranging between four and ten times the initial investment amount, resulting in a $295,000 positive cash flow. Because Andy made equity investments in early stage C-Corporate startups and held the investment for five years, he is entitled to a 100% long term capital gains tax exemption thanks to IRS Code Section 1202, so his tax bill for that year is zero.
|Andy Angel – $100,000 in ten startups at $10,000 each|
|Year||Investment||Returns||Failures||Taxes||Returns After Tax||Portfolio Value After Tax|
|IRR Before Tax||31.5%||$333,500|
|IRR After Tax||31.5%||$333,500|
There is a lot of mythology about how many startups fail on average.
So, how risky was Andy’s Investment?
The statistics about how many startups fail on average can be deceiving. Many of those statistics come from the SBA or local Secretaries of State who report failures of hair salons, restaurants and lawn mowing services along with other companies. But, companies that receive venture capital investment have to reach a higher bar than just registering with the state. They need to have gained significant traction and have gone through a lot of due diligence and had to jump the hurdle of convincing dozens of angel investors to write a check. These companies are far less likely to fail than the general population of company formations. In fact, HALO report data shows that about 52% of these companies will return less than $1.00 for each dollar invested. Of that 52%, about 18% will be complete failures. So, we’ve been a little hard on Andy Angel and had him with three total losses and three returns of less than a dollar. On the upside, we’ve also been a bit conservative. About 5% of venture backed startups will return 30X or greater, and there’s a good distribution of returns between 10X and 4X. These winners more than pay for the losers.
Andy’s key to success was that he diversified his portfolio into ten investments. Smart angel investors know the value of spreading out the risk so that the winners can more than offset the losers.
Another point to observe is that we’ve valued Andy’s portfolio at the value of the investment only until the returns came in. Despite that conservative accounting, he barely dipped below his $100,000 investment amount in year four with a portfolio value of $93,500. This means that if the four remaining companies had returned only 1X, his loss would have been limited to $6,500.
But, his returns were a more typical 3X over the portfolio, resulting in a return of $295,000. We can add in the $25,000 state tax credit and his $13,500 in accelerated write-offs from the $45,000 loss, and his net cash return AFTER TAX is $333,500.
Andy was hardly more at risk than Freddy, and yet the internal rate of return on his investment was more than FIVE TIMES GREATER.
So, who is the smarter investor? Freddy Frugal with a 5.93% after tax return or Andy Angel with his 31.8% return and $333,500 in cash after five years? Angel investors have figured out how the system works and have been profiting handsomely from it for some time. Accredited Investors should consider contacting their local angel group, preferably groups that are members of the Angel Capital Association, like Rockies Venture Club, and consider membership so that they can benefit from great deal flow, a community of smart investors, group negotiation and high quality due diligence.
Visit www.rockiesventureclub.org to learn more.
Life Science Investing is Different than Software Tech Angel/VC Deals.
Companies seeking early stage investment in their biotech, life science, medical device or digital healthcare companies face al
l the hurdles that software tech companies face – and then some more. Many of the hurdles have to do with misconceptions that people have about life science investing, and others have to do with the real differences that exist in this market. Companies raising money in the life sciences have to go through all of the things that tech companies do, plus more, in able to successfully raise funding.
Life Science companies should consider attending the RVC/CBSA BioScience HyperAccelerator to help them through the process. We guarantee participants will be amazed with the quality and usefulness of this unique content that can be found nowhere else!
What BioScience Companies Need to Know
Time-Lines – there are a lot of investors who think that all life science deals take ten years or more because of the huge regulatory hurdles that have to be overcome, and that the capital requirements could be in the hundreds of millions before the company gets to an exit. These investors are missing out on lots of great opportunities. What they don’t realize is that companies rarely move all the way down the regulatory pathway before achieving exits if they’re developing a novel drug, for example. Usually the hurdle is Phase 1 Clinical Trials before a company is acquired, so the pathway can actually be shorter than for some tech investments. Also, many companies are working on repurposing existing drugs for new uses. In this case, all they need to prove is efficacy for the new use which can be a relatively short process. Devices, in contrast to drugs, can achieve FDA approval in just months in some case.
FDA Regulatory Risk – many investors who don’t understand the biotech space have heard horror stories about the capricious, costly and time consuming process of FDA approvals. While these fears are not totally unfounded, most companies pass through the process in a relatively short time and at low cost. We budget about $50,000 and six months for a 510K approval process in some cases. Angel investors have special opportunities to invest in pre-FDA approved companies because valuations typically double or triple after FDA approval, resulting in good returns for investors.
Liquidity Events (Exits) are more obvious for many biotech, medical and life science companies because there is a clear playing field with companies that are regularly acquiring companies as a part of their innovation strategies. There are enough players that companies who are intentional about crafting the best exit can create a situation with multiple bidders to result in the highest exit valuation. Even if the exit pathway seems clear to founders, their presentations should include a clear description of their exit strategy in order to bring the most investors on board.
Intellectual Property is Critical – while most tech and software companies have dropped patent filing altogether, IP is the core to creating value in the life science and medical space. Granted patents are always best, but at least having patents pending with a strong defensive strategy is critical for success. Companies will also need to be able to demonstrate that they’re not infringing on the patents of others. We’ve seen companies who we’ve found to be infringing on patents which made them uninvestable. This is something that companies should research well and be able to demonstrate instead of doing a lot of work, only to have investors find that the project is dead on arrival after several years of effort.
Team Considerations – tech companies often suffer because they have a bunch of coders who’ve been working for years to come up with a product, but they don’t anyone on marketing, finance, or business strategy. Life Sciences can have these problems when they’re staffed with teams of smart PhDs who don’t have the experience or track record to be able to raise funds, transform from a research organization to a marketing organization, or to understand value creation for acquirers. Make sure your company has the appropriate finance and marketing team members on board before raising money.
Market Fluctuations – it seems like biotech is always way up or way down and the current market position may influence investors’ desire to jump on-board with these companies. Founders should be prepared to talk about trends in the industry and why their company will be providing value that either transcends the current market situations, or that the investment cycle is expected to be long enough to stretch beyond any current market challenges.
Marketing Strategies for life science companies are going to be significantly different than for tech or other physical product companies. Some life science companies build an expensive and time consuming strategy that involves hiring and training a sales force who then try to forge relationships with doctors and hospitals in competition with some of the largest and well funded companies in the world. If the company survives that process and gets to an exit, then the first thing that the acquiring company is going to do is to fire all those salespeople and add the company’s product line to their own and get their own sales people up to speed on marketing it. So, life science companies should think about how they add value to their acquirers. Is their value primarily the product itself, the team, the market share, the sales organization, research under way, or something else? Make sure that you’re not pouring resources into something that won’t create value for your acquirers. With that being said, companies will need to establish a market presence in order to validate that the product is of interest to customers and will be a success in the market. This benchmark may be achieved with as few as one thousand sales. These can be achieved through forging partnerships with sales organizations rather than starting from scratch.
Valuation for life science companies seems to have a significant spread which may be caused by inexperience on the founders’ side, or by the uncertainties in the market. Companies that want to raise funds quickly should price their shares competitively with other startups and keep in mind that not every startup ends up with a five hundred million dollar exit.
Life Science founders have a lot of opportunity in front of them if they understand their market and how to take advantage of it. Founders should be prepared to dispel myths and to focus on the clear strategy they have for product development, regulatory strategy, marketing and exit. These will lead to most investor interest and fastest pathway to funding. Life science and medical investments currently comprise about 30% of venture capital investment which shows that investors recognize the opportunities that this space brings. Founders and investors alike should have a clear understanding of the differences between life science and software/technology investments and how to take advantage of them.
All companies raising capital should be well versed not only in the specifics of their industry, but should also prepare solid strategies and complete the following steps before starting their fund-raising activities.
Ten Steps for LifeScience Companies to Prepare for Venture Capital
- Exit Strategy Canvas – identify comparable transactions in the market for both dollar amount and multiples of revenue. Identify early, mid and late stage values the company presents to acquirers. Identify who the acquirers are at each stage of the company’s development.
- Business Model Canvas – this is the core business strategy document that allows a company to understand their unique value proposition, their customer, the channels used to reach customers, core metrics, partners, and how they spend and make money. This one-pager is key to understanding the key concepts behind any company.
- Strategic Plan – Not your grandpa’s strategic plan, but a two-page document that provides a roadmap from where the company is today through its growth. This is the difference between success and failure during Q&A with investors and for the company overall! Research shows that companies with written strategic plans outperform those without plans by 65%.
- Go to Market Plan – people take this for granted when they’re heads-down in the science or tech development, but this is the key risk companies face – getting customers to actually buy the product. Without a strong go to market plan, you’re out of luck with investors who are always concerned about this key risk.
- Proforma – you need more than a great idea to raise money, you’ll need to model out your use of funds, needs for capital, revenues and expenses. A good detailed proforma that is well researched and validated is a must for planning your business and for determining your capital needs and valuation.
- Finance Plan – you need to know how much to raise now (this is harder than you think) as well as your future raises between now an exit. You’ll need to know this to help model your cumulative dilution and to understand what the major milestones are that you’ll need to achieve at each level of funding.
- Valuation – let’s make this simple. You can’t raise money without knowing your valuation, regardless of whether you’re using equity or convertible debt. Go through five valuation models and play them off of eachother to have a defensible position when it comes time for negotiation.
- Term Sheet – this is the key document used in negotiating the deal. Make sure that you’ve got a term sheet in your pocket before you meet with investors so you have a solid understanding of the key terms and how they’re used in venture deals.
- Executive Summary – When investors ask for information, they’ll want a two-page executive summary and pitch deck. The executive summary has all the core elements of your company in a concise format that investors can use to determine their interest in moving forward.
- Pitch Deck – when you get in front of investors you’ll need a pitch deck to present your information. Get this done professionally so that you can communicate effectively in a highly competitive capital market.
Life science companies can get templates, education and mentor assistance in creating all of these in a two-day BioScience HyperAccelerator hosted by Rockies Venture Club and the Colorado BioScience Association. The two day workshop is $995.00 per company and includes a one-year membership in the Rockies Venture Club for the primary participant and a free subscription to the IdeaJam platform to help companies securely get feedback and input on their Provisional Patent Application. Companies using the IdeaJam platform can file patent applications in a fraction of the time and cost of using patent attorneys.
Apply to Join the BioScience HyperAccelerator here ===> https://rockiesventureclub.wildapricot.org/event-2614776
The Next Session is August 29-30th in Denver. Apply by August 22 for preferred admission.
After the first angel or VC funding round closes and the checks are cashed, most startups go through a transformation, like from a caterpillar to a butterfly, that makes them fundamentally different than a pre-funding company. CEOs who fail to realize the changes that need to happen will end up facing challenges they did not expect.
Here are a few changes that need to take place after funding:
Create a budget.
No – not your proforma with all the optimistic sales projections – this should be a budget with numbers you can commit to. Many companies feel like having a million dollars in the bank is an unlimited blank check to buy fancy new furniture or hire a dozen new employees. But all those things drain cash faster than you think and having a written plan for minimizing your burn rate and maximizing the runway to your next raise (or hitting break-even) is going to be an important part of your success. Running out of cash before you hit the milestones needed for the next raise is a death sentence for your startup.
Update the Professionals that Serve Your Business.
If you’ve had your Aunt Bertha doing your books, it’s probably time to upgrade to a CPA who can provide you with the advice you need to keep from making mistakes. A CPA is going to be important once you need audits as well. Your legal team should now include several different legal specialties including securities, Patent and IP, and general business and contracts. You probably got your legal house cleaned up in order to get funding and now is the time to get the right people on board to keep it that way. Bankers, insurance, and other advisors are all going to be able to scale with you as you grow.
Communicate with Investors.
Investors notice when you stop calling them after the check has cleared. This is a bad thing for founders – especially those who are going to need to raise another round. Future investors will contact first round investors during diligence and a good relationship is important – even more so if you hope to have follow-on rounds from your first funders. Monthly reports including good and bad news, financials and metrics updates are a minimum. It’s better to stay on top of the investor relationship and by communicating frequently, investors are more on-board with what’s happening. Use a platform like Reportedly.co that allows you to see who has opened your messages and also allows investors to comment and offer help when needed.
Balance Growth and Resources.
You’ve been pitching your $100 million top line you expect in five years, but now it’s time to match your resources to your growth targets. Grow too slowly and you’ll never raise another round (so you’d better hit break-even) and grow too fast and you’ll run out of cash before you hit the benchmarks for Series A and then game-over. Perfect balance is what you need for venture success.
Update your Exit Strategy (Goals and Contacts)
During your pitch everyone wanted to acquire you, but now it’s time to start executing on your Exit Strategy. You should include the update in every board meeting and monthly update. Start making contacts with those companies for whom you create value early on. If they don’t know who you are, you’re not going to get the multiple offers you need for that 5X multiple you were lusting after.
Ok, you think you’re growing too fast to waste time on shit like metrics. Fine – go ahead and be mediocre. The best companies are crystal clear on what success looks like, how to measure it and what their goals are. Without metrics, your team is mis-aligned, your investors are in the dark, and really – you haven’t got a clue about where you’re going. You don’t have time not to do this.
It’s not set in stone, but without a roadmap you’re bound to get nowhere fast. Companies without at least a lightweight two pager plan find themselves going through expensive pivots left and right to try to figure out what they could have done in the first place with a good planning process. BTW, statistics say that after three pivots you’re out.
Change from Tech Culture to Sales Culture.
So far, success has looked like getting your MVP launched. You are three founders and a dog coding away in a basement somewhere, but now you need to change gears and become a sales and marketing company with a tech foundation. Too many companies can’t get out of their tech roots and they keep on coding, but never figure out how to sell. Break out of your comfort zone and start selling.
You’re on the clock now and capital is the most powerful accelerator out there. You’ve got to code fast, sell fast, grow fast. Companies that think they can continue on their old pace don’t get venture capital. It’s a race against the clock with ROI multiples of 10X in five years, 25X in seven, there’s no time to waste and the slow starters won’t ever get to Series A.
Investors are your partners.
Now that the deal has closed, and all the negotiations are done, it’s time to tap into your investor base for help, connections and advice. Keep them in the loop and engage them – they’re worth a lot more than just capital.
Post funding transformation is hard and unnatural for most founders. Pay attention to your successful peers and remember that getting rounds of funding are not what this is all about – work towards creating a great, meaningful company with huge value for your exit partners!
Peter Adams is the Managing Director of the Rockies Venture Fund, Executive Director of Rockies Venture Club and Co-Author of Venture Capital for Dummies, John Wiley & Sons, August 2013. Available at Amazon.com, Barnes and Noble and your local bookstore.
Women make up the fastest growing community of angel investors and it’s changing the face of Angel Capital for the better.
Angel groups like Rockies Venture Club have been beating national averages for investing in women and minority led companies with 54% of our portfolio consisting of women and minority led companies vs a national average of just 14%. But in order to balance the ecosystem it’s important not just to invest in women led companies, but to engage women angels who can help mentor startups and who can gain experience serving on the board of directors of some of the startups they invest in, thus paving the way for increasing the number of women on corporate boards at all levels.
Research shows that companies with women on boards out perform those with no or few women. Companies wit
h the highest percentages of women on their boards outperform their less diverse peers by 66%. We have certainly seen these trends in our portfolio companies and are committed to developing further diversity in our community.
We have launched the RVC Women’s Investors Network (WIN), led by Barbara Bauer. The network has had several well-attended events that focus on angel education and making connections. The group is based on four principles that play on women’s strengths:
Engagement: Programs that allow people to work together and share wisdom of crowds to make good decisions and great investments.
Give Back: WIN members have years of business experience and they want to be more than just a check – they like to mentor and coach up and coming companies.
Act From Knowledge: Women like to understand the landscape before they jump in and invest. No more “fake it until you make it” – that can cost thousands for new angel investors!
Education: Classes, workshops and “get to know an angel” events provide deep venture capital knowledge to get WIN members up and going quickly and confidently.
If you’re interested in engaging with the group, volunteering, or just learning more, consider attending the WIN Luncheon at the Angel Capital Summit, Tuesday March 21 on the DU Campus.
Click HERE to register
If you’re interested in learning more about Angel Investing and Venture Capital, you should definitely attend the full Angel Capital Summit. Tuesday-Wednesday March 21-22 in Denver.
Click HERE for more information and to sign up.
Want to learn more about Rockies Venture Club? Check us out at www.rockiesventureclub.org
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