Startup Financing: Questions and Answers From A Recent MIT Panel

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Startup Financing: Questions and Answers From A Recent MIT Panel

 

This past week, I was on a panel discussion at MIT on the topic of raising funding for an early stage startup.
 
Also on the panel was Michael Greeley from IDG Ventures.  Michael was representing the VC perspective whereas I was there speaking primarily from an angel perspective (and alternative sources of capital like friends, family and fools).
 
Here are some of the questions that came up in the panel.  Since I didn't take notes during the panel myself, this is my best recollection from the two hour session.  Please note that this is not legal advice and if you are raising funding, you should consult counsel on all legal matters.
 
1.  If I raise capital from friends and family, do they have to be accredited investors?
 
Generally, yes.  Though there are ways for pool together interests from non-accredited investors, it's usually not advisable as it can get tricky and complicated.
 
2.  To raise VC funding, do I need to have a complete management team assembled?
 
Not necessarily.  Many VCs do not mind considering startups that have an incomplete management team.  Some will actually see gaps in the management team as a positive as that is an area that they can help with and bring value to the startup.
 
3.  How do I negotiate the highest pre-money value for my startup?
 
Entrepreneurs are often overly obsesssed with the pre-money valuation of their startups.  Though this is an important factor in the negotiations, it is by no means the only one.  Often, non-valuation factors like corporate governance, control and preference issues end up being much more important than the valuation.  Entrepreneurs should look at the deal as a whole and understand the details.
 
4.  Do investors read business plans?
 
For the most part, no.  A great business plan will not guarantee funding (or for that matter, even a meeting).  If you find the crafting of the business plan helpful, then you should do it.  But, investors do not generally require a detailed, written business plan. 
 
5.  Do I need to have formed a legal entity before approaching investors?
 
It's not required for investors prior to approaching them for funding, but is often a good idea because it is relatively simple and inexpensive to do. 
 
6.  How do VCs value companies?
 
This is an imperfect science.  A common approach is that VCs will determine what the company could be worth at the time of an exit (IPO or acquisition).  They then work backwards from there, determining what percentage of equity they need to own to generate the desired returns for their limited partners.  Of course, they apply this approach across a portfolio of investments expecting that a small percentage will generate significant returns.
 
7.  How do I find angel investors for my startup?
 
There's no single answer to this.  In major markets like Boston and San Francisco, many angel investors are members of angel groups.  These groups pool together expertise and resources in order to make better investment decisions.  Of course, there are also private investors acting independently.  Generally, you'll want to find investors that have a background in the particular idea you are pursuing -- or, an affinity for it.  Angel investors often invest for reasons beyond just pure financial return.  One common reason is to stay involved in the entrepreneurial process and help entrepreneurs build great companies. 
 
8.  How do I pick the "right" VC?
 
There are a number of considerations.  First, you should verify that the VC makes investment in the stage and type of company you are building.  Also, it is important to remember that you are not just picking a firm, you are picking a partner within that firm.  Ideally, you'll find a partner that has made similar investments in the past and has knowledge of your market. 
 
If you have any other questions, leave a comment and I'll do my best to answer.  Please remember that I'm not a VC, and don't play one on TV.  For content that is much better than this, I strongly recommend Ask The VC by Brad Feld.  It's a great source for information on the VC industry and the process of raising money.
 
 

Posted by Dharmesh Shah on Fri, Apr 13, 2007

COMMENTS

The advice I always give, to the question of how you pick the "right" VC, is to consider more than just the financial terms of the deal (and yes, to understand those, you need to look at much more than the pre-money valuation). And you need to consider more than whether the partner you'll be working with has made similar investments in the past, and has knowledge of your market. Those are helpful -- can be VERY helpful -- but I don't see them as definitive. Consider as well how much value the partner has brought to the companies they've invested in previously. While they're doing their "due diligence" on you, you should do some of your own on them. Did they bring in critically needed senior team members? Did they play a major part in formulating the "go to market" strategy? Did they bring great investors to the table to build the syndicate, or as follow-on investors? And so on.

posted on Friday, April 13, 2007 at 12:01 PM by Geoff Mamlet


This is generally good advice. But, I disagree with MIT's position on question 2: I believe you DO need to have the complete management team to get your startup company's product to market before you take financing. I learned this the hard way. Here's why: (1) the kind of people you might be able to hire post-money -- those who are looking for startup-executive positions-- tend to be rapacious thugs. I know, I know, YOUR company is different. YOUR idea is good enough to attract really great executive talent to round out your team. Folks, get real: maybe your idea isn't quite that great! And the downside of hiring a rapacious thug is very great. Ask me about kids' college tuition charged to company credit cards by executives put in by investors. Ask me about hired executives deciding on their own that their salaries should be grossed up for income taxes. (2) Executive searches are distracting, time-consuming, and expensive. (3) Most importantly, the ability to attract good executive talent is a great way for you, the founders, to validate the quality of your idea. If you can't find good executive talent, maybe you should rethink putting five good years of your life into the deal.

posted on Friday, April 13, 2007 at 12:10 PM by Oliver Jones


On the question of "How do I negotiate the highest pre-money value for my startup?": Let me plug my own Venture Hacks: http://venturehacks.com Our first series of articles describes how to negotiate a great Series A investment.

posted on Friday, April 13, 2007 at 1:46 PM by Nivi


Dharmesh, what's the definition of an "accredited investor"? How do I know if my friends and family qualify?

posted on Friday, April 13, 2007 at 3:35 PM by Ryan


Ryan: http://www.sec.gov/answers/accred.htm For most people you either have to make > $200K/yr or be worth > $1M.

posted on Saturday, April 14, 2007 at 4:20 AM by Devin


I've heard horror stories from companies about getting signatures from all the A round investors in order to close the C round. There can be a real disadvantage to having many friends-n-family investors, "accredited" or otherwise, in early rounds, especially if the company runs into trouble and needs a down round to keep going. It's hard enough to explain stuff like "participating preferred" shares to your employees, never mind your mother. I think a good rule of thumb for A-round friends and family investors is to refuse them unless you can't make the company happen at all without them. Don't bring family members in to do them a favor--believe me, you probably aren't actually doing any favors. After you hit it big, you can always give people gifts of cash or marketable securities.

posted on Saturday, April 14, 2007 at 12:44 PM by Oliver Jones


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