10 Tips for Succeeding in a Startup Accelerator Program

Article originally published on the SiliconRoundabout on July 4th, 2013

Accelerators come in all different shapes and sizes. With many new Accelerators coming into existence within the last few years, the job of selecting one to join and getting the most out of your chosen accelerator program isn’t always obvious. Some programs, like Seedcamp, cater to high ambition & high growth companies spread across various industries, whereas others focus on specific verticals such as clean energy or healthcare to name a few.

We all have different approaches, but with over 90 companies forming the Seedcamp family we’ve had a chance to see many different industries and what it takes to get those companies to the next level.

Below are Seedcamp’s top tips for succeeding before you enter a accelerator programme:

1) Asses Program Fit – Research what an accelerator’s deal is regarding investment and terms before applying. perhaps your company isn’t ready yet or is too mature for the program you are considering.

2) Do your Due Diligence – Get in touch with founders or mentors that are part of the program, read blog posts from the Accelerator’s team to see what is important for them. This will help you get a better feel for the program but also how the program leaders think.

3) Rehearse your Pitch and prepare to answer questions – Be transparent, confident, and open. If your pitch isn’t ready or you are defensive in your approach, it’ll be a huge red flag.

 Once you enter the program:

4) Be Proactive – Don’t wait for the Accelerator’s team to chase after you, you should chase after them and if you can, be as physically close to the team as possible..

5) Understand your startup is more than just techFinding Product-Market-Fit is crucial at this stage of the game. Don’t focus entirely on tech, embark on a mission to learn and master all the commercial aspects of your startup as well.

6) Attend as many of the curriculum events as possible – They are there to help you. Don’t skip valuable content.

7) Network as much as possible – email all the people you meet and get to know as many of the Accelerator’s mentor base as possible.

8) Build a board of advisors from your networking efforts early. They will be of incredible value

9) Start developing your fundraising strategy after the first week of being in the program

10) Lastly, don’t be afraid to experiment and ask questions – You will have lots of people supporting you. Your mantra should be ‘test test test’ – and that applies to all aspects of your company.

 

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The Basics, Pros & Cons, Points to Consider, and The Modelling of Convertible Notes

note

Special thanks to Dale Huxford from Orrick, Herrington & Sutcliffe LLP for edits and additional legal review.

UPDATED (Nov 11, 2013) – Notes added on: Conversion Triggers section & attached Cap Table in folder updated to v2 to fix some bugs.

The “Convertible Note” gets lots of attention in the blog-o-sphere as an alternative to traditional equity financings; some of this attention is good and some of it bad. Some investors refuse to use them, while others love them as a quick way of getting a company the capital it needs.

Convertible notes are sometimes viewed as a “best of both worlds” compromise from both a company perspective as well as from an investor’s perspective: on the one hand, a note is a loan, so the investor enjoys more downside protection than would an equity holder in the event the company is forced to wind up or dissolve for whatever reason; on the other hand, if the company eventually raises money by selling shares to later investors in a typical early stage financing round, then rather than pay back the outstanding amount in cash, the principal and interest are “converted” into shares of stock in the company (usually at some sort of discount off the price offered to new investors – I’ll discuss that below). In other words, the investor enjoys the downside protection typically associated with debt lenders, but is also positioned to enjoy the upside opportunity typically enjoyed by equity holders.

As with any tool, before you use it effectively, its best to understand the pros and cons of each of its features and how they can be used for your individual circumstances. Fortunately, convertible notes typically have fewer moving pieces than do equity instruments (which explains, in part, why they’re sometimes favoured by early stage companies and investors – the negotiation and documentation for a convertible note round is likely to be far less time-consuming and costly than for an equity round), but before we proceed any further in dissecting this tool, let’s look at the headline basics of a convertible note:

1) Total Amount Raised by the Note – This amount does have a natural limit. Think about it this way… you have an amount ‘outstanding on your cap table’, that will be part of an upcoming round. If a new round in the future isn’t particularly big, having too much money outstanding can create a problem with your convertible note holders taking up too large a portion of that round. Example: a 300K convertible which converts as part of a total 600K seed round would loosely mean that the convertible note holders would have 50% of the round. If the round was supposed to be for 20% of your equity, that means your new investor will only get 10%, an amount that may not excite him that much… and also you only get 50% new money in the door. To limit the extreme cases of this being done, investors usually create a ‘qualified round’ definition within the Note’s terms for conversion (see bullet #5 below) which reduces the likelihood of this amount being disproportionally larger than a new investors amount as part of a new round.

2) Discount Percentage – Simply put, if shares are worth $1 a 20% discount percentage would mean that an investor would get the shares for 80 cents. For cases where the next round’s valuation is below your convertible note holder’s cap as set in point #3 below, a discount factor will yield the convertible note holder a marginally cheaper price for having taken a risk on you. Typically this discount percentage is likely to be between around 15-25%. Another Example: a round closes at 3M. Your cap is at 5m. Your convertible note holders have a 20% discount, so they get to convert into the next round at a valuation of 2.4M.

3) Limit On Company Valuation At Conversion (the so-called “Valuation Cap”) – In order to calculate the number of shares into which the outstanding balance on a convertible note will convert, you must know the price at which the next round’s equity securities are being sold. Price per share, as you may or may not know, is calculated by taking the company’s pre-money valuation (negotiated at the time of the equity financing between the company and the investors) and dividing that number by the total number of outstanding shares in the company (the company’s “fully diluted capital”). Recall, however, that convertible notes are typically entered into in anticipation of an equity financing round – thus, at the time a convertible note is issued, no one knows what the negotiated pre-money valuation will be if/when the company undertakes an equity financing. Consequently, no one knows exactly what the price per share will be at the time the notes are issued. This creates uncertainty and is a cause for some investor anxiety, particularly for those investors concerned that that the number of shares into which their note may convert may be insignificant relative to the other shareholders, particularly in the event the pre-money valuation at the time of conversion is especially high.

The valuation ‘cap’ is intended to ease investor concerns by placing a maximum pre-money valuation on the company at the time of conversion. with the use of a cap, an investor can effectively set the minimum amount of equity an investor is willing to own as part of having participated in your convertible note round. For example, if you have a 200K note on a valuation 5m cap, then the worst case scenario for that convertible note holder, would be 4% equity after the new round is over. A typical valuation cap for very early-stage companies will be around $4m – $6m, with most companies at the Series A level settling on $10m valuation caps or more. For more statistics on caps and other components of a convertible note, I have included a link at the bottom of this post to an article with additional stats.

One thing to note, is that in the USA, there is a rising prevalence of uncapped notes. Clearly this is a founder friendly outcome, and if possible, always nice to get. The flip-side, is that for the investor, the may feel a bit ‘unprotected’ in the case of where the company does exceedingly well and thus their amount converts to a much smaller percentage than originally hoped.

4) The Interest Rate on a Note – A convertible note is a form of debt, or loan. As such, it usually accumulates interest, usually between 4-8% between the point when you sign it and when it converts. This amount is usually converted as part of overall amount at the next round. For example, if you have an annual interest rate of 8% and you have a Loan Note of 100, then you’d convert 108 after a year.

Note: In the US, it’s highly advisable to include an interest rate, even if it’s simply a nominal amount equal to the applicable federal rate (most recently at less than 1%), b/c if not, then any amount that could have been earned via interest is taxed to the company as gain. So it’s not really an option to exclude it in the USA. In the UK, you don’t necessarily need to include it should you wish to omit it.

5) Conversion Triggers – The point of a convertible note is for it to convert at some point in the future, not for it to stay outstanding indefinitely. As such, it will likely have a series of triggers for conversion. One I mentioned earlier is the next ‘qualified round’. Basically this means that the round is big enough to accommodate the amount in the note (without washing out new investors) and also is the type of round that is typical for the next step in the company’s growth and will give the note holders the types of rights they’d expect for their shares once converted from loan to equity. Another conversion trigger is an expiration maturity date, whereby the note holder typically can either ask for their money back (although this rarely happens) or basically seek to convert the outstanding amount at that point. There are more types of conversion triggers that note-makers can add to a note, but these are the basic ones. Update: upon a change of control event in the future and before the convertible is converted, investors can sometimes ask for a multiple of their loan back as payment in lieu of converting to ordinary shares prior to the completion of the change of control event. You can see some examples of this in the wording of the attached examples later in this post.

Again, these are the headline terms of a convertible note, and not representative of all the terms. However, for early discussions with potential investors, you’ll rarely have to talk about anything more than 1-4. Beyond that, you usually start having to involve lawyers (or experienced deal drafters) to help you finalise the document.

Now that we’ve reviewed the basics of a Convertible Note, take a look at a recent report that has statistics of what common terms have been given to Valley based companies. If you are not in the Valley, you will likely have a different set of averages, so be mindful of that.

http://www.siliconlegal.com/reports/seed-financing-report-2010-2012

Now, let’s look at the headline pros and cons of using a convertible note.

Pros –

  • Typically less involved and less paperwork than equity rounds; can cut down on time and legal fees
  • Investors enjoy downside protection as debtholders during the earliest stages of the company when company is at critical growth stages
  • Company can defer the negotiations surrounding valuation until later in the company’s lifecycle (i.e. for very early stage companies at the earliest stages of planning and preparation, valuations can be more difficult to define)
  • At conversion, note holders typically receive discounts or valuation caps on converting balance, thereby rewarding the earliest investors appropriately for their early investment in the company but without causing valuation issues for the company

Cons –

  • If a convertible note is made to be too large, it can negatively impact your next round because it’ll convert to a disproportionally large portion of your next round, effectively crowding-out your next round’s potential investors from having the equity stake they may desire.
  • If a convertible note’s cap is made too low, in order to accommodate a larger round later, the Founders may need to take the additional dilution that would happen if they exceeded the convertible’s cap.
  • Because a convertible note can be made to be quite versatile, sometimes investors can add clauses in there that have greater implications down the road, such as being able to take up more of a future round than the actual amount they’ve put in, for example.
  • If not careful, you can accumulate various too much convertible debt which may burden you at a conversion point
  • Doesn’t give your investors (in the UK) SEIS tax relief, thus making it less attractive than an equity round. There may be some workarounds, but generally SEIS and Convertible notes are not seen as compatible.
  • Notes give convertible note holders the investor rights of future investors (say in a future Series A Preferred Shares), which may include more rights than those they would take for the amount of money they put in had they simply done an equity deal on Ordinary Shares with you today.
  • If the convertible note automatically converts at the next equity raise (i.e. the investor has no choice), investors may wind up being forced to convert into securities shares despite not being happy with the terms of the equity financing. The note holders may unfortunately have less influence in negotiating the terms of the equity financing, which partially explains why some investors are reluctant to invest with convertible notes.
  • Finally, while convertible notes allow the company to defer the valuation conversation until a later time (see discussion under “Pros” above), any inclusion of a conversion cap will raise a similar conversation, which defeats some of the purpose for why companies and investors alike originally favoured the convertible note as a quick-and-easy financing solution to begin with.

Now let’s explore a few more core concepts in detail.

Seniority – A convertible note is a form of debt or loan. Although its not too common to hear about investors asking for their money back, they in fact, do have that right… additionally, one of the privileges that having the Note act like debt is that it acts senior to equity in the case of a liquidation. What this means in practice, is that Loan holders will get their money back first.

Subscription Rights – Some investors like to have more equity than their invested amount would likely yield them upon conversion. So one thing to look out for is how much they want to take up of the next round as part of having been in the convertible note. Example: An investor gives you 50K, which converts at your next round of 1m on 2m Pre at 1.6% -> next to nothing for the convertible investor. However, that investor had a Subscription Right for up to 30% of the new round, so that allows him to participate on the 1m round with up to 300K thus affording him a larger ‘seat at the table’ in excess of the 1.6% he would just have without this right.

To conclude and to provide you with some practical examples, in the following Google Drive Folder I have added an excel sheet with an example cap table as well as UK & USA termsheet templates from Orrick* that are uberly simple, for review purposes only (they may not be fit for what you need, but give you an idea). A comment on the example cap table – it isn’t designed to be ‘fully realistic’ per se, as in, your cap table will likely not look like this in terms of founders and shareholders and number of rounds before a convertible comes in, but it serves well for you to play with the variables that make up a convertible note so you can see how they affect your fully-diluted stake after a round.

I hope this helps you decide what the best options may be for you. As usual, please give me feedback on all these materials as with software, there are likely bugs somewhere!!  Thanks in advance!

*Regarding the Convertible Note Documents, a disclaimer from Orrick: The linked documents have been prepared for informational purposes, and are not intended to (a) constitute legal advice (b) create an attorney-client relationship, or (c) be advertising or a solicitation of any type.  Each situation is highly fact specific and requires a knowledge of both state and federal laws, and anyone electing to use some or all of the forms should, prior to doing so, seek legal advice from a licensed attorney in the relevant jurisdictions with respect to their specific circumstances.  Orrick expressly disclaims any and all liability with respect to actions or omissions based on the forms linked to or referenced in this post, and assumes no responsibility for any consequences of use or misuse of the documents.

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Additional Notes on Early-Stage Startup Valuation

English: Diagram of the typical financing cycl...
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In my recent post on how an early-stage investor values a startup, I talk about how market comparables were the closest guide to how early-stage investors value a startup vs. any other methodology. However, I feel like I left one question unaddressed. Namely, why are there valuation discrepancies for comparable companies across the world (more specifically at investment stage rather than exit stage)?

The answer has to do with liquidity of deals, the localized risks for investors, and the supply of investors.

As I mentioned in my last post, there are various factors that can come into how an investor values a startup, but using market comparables from deals done in the USA doesn’t always incorporate all the risks that are prevalent in the specific geography where the company and investor in question operates. Furthermore, the availability of capital in any geography will also affect how an investor gauges his own risk/reward ratio when pricing deals.

I’m going to talk about this point abstractly and without incorporating the argument of the global nature of internet-based businesses (they do have some localization risk still, but less so). So, for example, startup exits for investors in certain developing economies will happen less often than say, in Silicon Valley. This has to do not only with the number of companies coming out of the country, but the universe of potential buyers for these companies in that geography.

This affects that risk an investor takes, as he is less likely to get that 10x that I mentioned in my previous post. Therefore an investor seeks a ‘discount’ to take on a deal in order to have a portfolio of deals where there is the possibility that one will be able to exit in spite of whatever market conditions exist locally. Add to that the fact that the investor may be one of very few investors, and therefore can command this discount more forcefully than if more competition existed (once enough investors exist, market pricing becomes more stable and in parity with other larger markets).

Think of it this way… If you’ve been on tourist holidays to resorts abroad, you’ll have noticed that things that are generally cheap(er) back home are notably more expensive at the resort store. This higher cost is due not only because of the transport cost to the resort, but also the cost of holding them there in inventory without knowing if anyone traveling to the resort will buy them. If the seller doesn’t include a higher premium on these items, he will not break even considering the high scrap-age risk he must take on inventory not-bought, and if there aren’t any other stores around, the store doesn’t have to compete on price either, but can continue to seek profit under the circumstances.

So, the point of this post is only to highlight why in certain parts of the world financing can be more difficult to get, but also why it can be priced differently than equivalent deals elsewhere.

 

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The UK Startup Visa – Driving future economic growth

Immigration
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I’m extremely excited with the good work the UK government is achieving in approving the new Startup Visa program.

In summary, three types of visa applicants will benefit from this new program:

Investors who invest £5 million will be allowed to settle here after 3 years, and those investing £10 million or more will be allowed to settle after 2 years. This compares with the current minimum 5-year requirement.”

and,

Entrepreneurs who create “10 jobs or turn over £5 million in a 3-year period.” Additionally, “the standard investment threshold for an entrepreneur to qualify for a Tier 1 visa will remain at £200,000, but the government will allow high-potential businesses to come to the UK with £50,000 in funding from a reputable organisation. And entrepreneurs will be allowed to enter the UK with their business partners as long as they have access to joint funds. Additionally, a new type of visitor visa will be created for prospective entrepreneurs. They will be allowed to enter the UK so that they can secure funding and make arrangements for starting their business before they transfer to a full Tier 1 (Entrepreneur) visa while they are here.”

and lastly,

An Exceptional Talent visa (limited to 1000). “This innovative new route for exceptionally talented migrants will be limited to 1,000 visas per year. It is for those who have already been recognised or have the potential to be recognised as leaders in the fields of science, arts and humanities.” The limit to 1,000 of these is the only downer in the new reforms… hopefully this will change with time as the process to evaluate credible candidates is streamlined (currently this is set for review after 12 months).

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