How Do Venture Capitalists Evaluate Investment Opportunities? | John Colley | Skillshare

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How Do Venture Capitalists Evaluate Investment Opportunities?

teacher avatar John Colley, Digital Entrepreneurship

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Lessons in This Class

14 Lessons (1h 5m)
    • 1. The VC Perspective How do VCs Evaluate Deals

    • 2. What Factors are important to Venture Capitalists?

    • 3. Considering Valuation from the Venture Capitalist’s Perspective

    • 4. How do Investors Value Startups?

    • 5. How Do Investors Value a Series A Investment?

    • 6. How do VCs Evaluate a Market?

    • 7. What do VCs think about your Product or Service?

    • 8. How do VCs evaluate You and Your Management Team?

    • 9. Why is Exit Strategy important to VCs?

    • 10. Why are Barriers to Entry important?

    • 11. How do VCs Evaluate Your Competition

    • 12. What Financial Information is important to VCs

    • 13. What is the typical VC Decision Making Process?

    • 14. Project Evaluate Your Startup

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About This Class



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This course is designed to help you to evaluate your startup/business as a potential investor would look at you.

This is all about putting yourself in the shoes of the VC and discovering how to think like he does. By understanding his perspective, you will greatly improve your ability to present your business to VCs in terms that they understand.  There is a Project at the end of this section to help you implement what you are about to discover here.

What Factors are important to VCs?

If you understand what is important to a Venture Capitalist, it is easier to pitch your deal in terms that he will understand and which will help to make your deal more attractive than other deals that he is looking at.

Considering Valuation from the VC Perspective

Venture Capitalists will certainly approach valuation from a different perspective to you and will end up with (almost certainly) a lower number than you will.  This lecture explains the "rule of thumb" rules you can expect them to apply when considering the value of your company.

How do Investors value a Startup?

At the Seed and Angel stage, valuation of a business with few revenues, no profits which burns cash can be problematic. In this lecture I share a simple formula for arriving at a valuation which can then be discussed and negotiated by both sides.

How do Investors Value a Series A Investment?

When you get to the Series A investment stage, you can use the company's revenues and, if they exist, EBITDA, to arrive at an initial valuation. This lecture outlines the method for doing this.

How do VCs look at your Market?

Market Size is one of the three critical factors that Venture Capital investors will look at closely.  The other two being product and team. This lecture shares their perspective with you and should help you to scope your presentation of your addressable market in their terms.

What do VCs think about your Product or Service?

The product evaluation process is a critical one and Venture Capitalists can expect to complete this due diligence thoroughly.  This lecture explains the steps you may expect them to take and will help you to prepare so that you can meet their expectations.

How do VCs evaluate You and your Management Team?

The evaluation of management is one of the most important parts of the investment process and you can expect that you and your team will be scrutinised in great detail.  This lecture will help you to manage that process by understanding what the VCs are looking for.

Why is Exit Strategy important to VCs?

Venture Capitalists make investments so that they can make money down the line and a strong, highly valued exit is a critical component of that process. They want to know before they go in, how they are going to get out.This lecture sheds some light on the way the Venture Capitalists think about Exit Strategies and therefore how you must think about them too.

Why are Barriers to Entry important?

Barriers to entry are an important factor in both margins and exit strategy and are therefore considered carefully by Venture Capitalists.  In this lecture I explain some of these and why they are important.  You must be able to explain your barriers to entry to prospective investors.

How do VCs consider your Competition?

Venture Capitalists want to invest in market leaders and they therefore evaluate the competitive landscape very carefully.  This lecture explains their approach and why you need to have as good a grip on who your competitors are as they do.

What Financial Information is important to VCs?

Venture Capitalists need to be able to understand the historic and projected financial performance of your company.  They see hundreds of plans and they know what they are looking for.  If you don't provide what they need then you are reducing your chances of getting to that first meeting.  In this lecture I tell you what financial information you need to provide and its a lot easier than you may think.

What is the typical VC Decision Making Process?

Venture Capitalists are continually evaluating deals to ensure that they are investing in the best deals,  You need to understand how they think and the criteria they are evaluating you and your competing entrepreneurs against to ensure that you can position yourself in the best possible position to get an investment.


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Meet Your Teacher

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John Colley

Digital Entrepreneurship


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Here is a little bit about Me...

Cambridge University Graduate

I have a Bachelors and a Masters Degree from Cambridge University in the UK (Magdalene College)

Master of Business Administration

I graduated from Cass Business School in 1992 with an MBA with Distinction and also won the Tallow Chandler's prize for the best Dissertation.

British Army Officer

I spent nine years as a Commissioned British Army Officer, serving in Germany and the UK in the 1980s, retiring as a Captain. I graduated from the Royal Military Academy Sandhurst (Britain's West Point) in 1984.

Investment Banking Career

I have spent over 25 years working as an Investment Banker, advis... See full profile

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1. The VC Perspective How do VCs Evaluate Deals: I want to take a look at the investment by veces but looking at it from their perspective. So how do BC's evaluate deals? What you need to do when you are an entrepreneur and you're looking to get VC investment is to put yourself into the shoes off the V. C. U. Need to think like them. You need to evaluate transactions the way they do. And if you can switch that perspective round, then I believe you're gonna have a much better chance of getting investment because you'll actually be presenting or business in a way that they can relate to. And they understand. Now, the main objective off this is to improve your understanding off what is important to be sees when they're looking at deal opportunities. So the first I'm going to start with is the factors that they look at some of the key criteria they look at when evaluating a deal, and then I'm gonna move on on, discuss the whole issue or valuation. How do BC's approach valuation now? Because start ups and syriza and onwards investments are obviously very different businesses or a different stages. Their more developed or less developed on As a consequence, they tend to be valued in a different way, using a different methodology. So I'm gonna explain both of those to you. Then I want to show you how the veces will look at the market you operate in. And this is a critical part because BC's are looking for big markets, hot markets, markets with the opportunity to disrupt on Did you need to understand their perspective? Then we'll talk about how they look at your product or service on why that is important in the criteria you need to be aware off that are important to be sees. Then, of course, they'll turn their attention to you. The map view the entrepreneur and your management team on. Therefore, you need to understand what they're looking for and you've got to. Therefore, when you come to your picture, your presentation in your meetings, you've got to be feeding them that that's of content so that they understand that you are the sort of management team that they want to invest in. Exit strategy is really important. It's it seems perverse. They're trying to work out how they're going to get out before they get in. But that is really part of the key of a successful investment because you can invest in a very good company. But if you can't realize your investment, then clearly you have a problem and the B C's don't want to get stuck there. Why don't BC's worry about barriers to entry? I'm going to tell you they are also very important on how Devi ces evaluate your competition because that's incredibly important as well and how they look at you in the context off the other companies around you with whom you are competing, you need to understand that now the financial information they require is really all about the financial information they require when they first our screening you. I'm not going here into a very great depth about business plans or financial models in there, but there is some key information they do need, and you'll be surprised how easy this to provide it. But you really do not want to miss it out, so you must include it on. The final point is the decision making process. Now again, I'm not taking you through committee meetings and all that sort of thing, but I want you to get a perspective, a holistic view off, how they make decisions because it will effect your business, and it will, in fact, the investment decision they make about you. So this is all about getting the BC's perspective, and if you can walk in their shoes, then you will be putting yourself into a much better position to get investment. As son Su said. Know your enemies and know yourself and you can fight 1000 battles without disaster. So that's it. How to look at deals, how to evaluate deals from the BC's perspective, and that's what we're going to be covering. 2. What Factors are important to Venture Capitalists?: I want to talk to you now about the factors that are important to venture capitalists, because if you understand where they're coming from, you'll do a much better job when you pitch to them. Now, there are basically two schools off venture capitalists. There are those who are looking for certainty safety, a deal that is going to be good, great, but possibly not the amazing deal, this game changing for everybody. And then you've got the guys who just want to invest in the next biggest $1,000,000,000 hit out the park deal. Now, most of those I think, is probably sitting in California s. So if you're looking for an investor in Europe, then you're probably not going to see very many of these. But they're the guys who actually, you know, if they invest in 10 companies and nine go bus providing the 10th makes them a $1,000,000,000 that actually they're probably gonna be pretty happy. So there are these two polarised views on I think you can assume, for the most part, that you're most likely to be talking to the guys who want certainty above the this of the jackpot. The bonanza deal They are, however, very concerned about downside risk, and what they're trying to do is to minimize the risk, minimize the potential downside. Now one of the things they concentrate on to do this is to make sure your business has really traction so that it's got sales it has got customers on. You've proven that you got a product that you can sell in the market. They will also do this, however, through the deal structure, in terms of giving them rights in the deal in terms of the way they structure the equity. So they're always looking to basically get the first cash out and be the last guys to sub suffer any losses on then. Another way they do it is to put together a plan with you to make sure that they're watching you step by step is you achieve milestones along a pretty short term path because if it's 18 months approximately between fundings, then they're gonna want to see a Siris of specific milestones in that 18 month period. And they may well even hold back some of the money that they promised you against you achieving those milestones. So what you have to do is to make sure you have clear answers to all of those three questions. And if it or possible, avoid pivots, particularly in the middle, off a period where you really bean funded. Because if you pivot by, almost by definition, you're throwing attraction out the window and you're starting with a new set of customers, and whatever you do, don't miss your targets. The next thing they're really worried about is exit strategy. Now this could be through an I. P. Erica Meter a trade sale. It could be through a secondary deal. Um, when you talk to them, make it clear that you believe you have a clear exit strategy and it has to be said the most two, most likely either going to be an I p. O or trade sale. If it's gonna be a trade sale, you should have some idea about who the people are, who are going to buy it. And if it's an AIPO, you need to understand what makes a company I potable in terms of its reliability of revenues, the quality of its customers, the quality of the management, its historical track record on make sure that you can articulate that so that they understand that you understand that what's important for an I. P. O. Now the next question is all around, which is most important product, market or team on the simple answer. This is actually all three, but different BC's have different perspectives and different views on gay. If you would've plump for one, I would go for the market. Yes, the team is important, but you can replace the team. The product is important, but actually having a better mousetrap than the next guy isn't necessarily the answer. You've got to be going into a big market where there's lots of potential. At the end of the day. Venture capitalists are people on. What they really want to do is to be smart or to be seen, to be smart and to be successful. They want to make money and they want to make lots of money. So when he's looking at your deal, he's saying to himself, Is this deal such that if it goes wrong, will I get the boot? I am I Am I going out too far on a limb here, so it's gotta be enough within their criteria, that is not seen as an outlier, and he gets the blame if things go wrong equally. He's looking for a deal that sufficiently original and exciting, that it has out potential to be a really winner, and you need to get the point across that you really can be that deal. And he wants to get excited about you on the team and the business and the deal. So you've really got to try and fire him up to work with you. It is, however, all about risk. BC's want to minimize risk in every way possible on They want to try to make sure that whatever happens, they get as much out the deal is possible, and if things go south, they lose as little as possible. So you need to communicate in every way you can when you're talking to them that your deal is a low risk deal. So that is some of the that is. Those are some of the factors that veces find important and you need to start thinking about how they feel on their side of the table because once you can get into their head, it makes your presenting and your pitching off your deal much more sophisticated but also much more convincing. 3. Considering Valuation from the Venture Capitalist’s Perspective: let's consider valuation. Now, from the perspective off the venture capitalist, the one thing you can be absolutely certain is that a V C will value your business lower than you will. Andi. Very simple answer to why this is is that basically he's a buyer and your seller now also, of course, you know pretty well everything or you should know pretty well everything there is to know about your business. And he's coming at it from a perspective where he has to learn about your business. So you have all the information he doesn't have it on. Therefore, he's gonna be more cautious in his approach. Now. One simple way that veces will look at a business is to say, OK, here's a business I'm gonna consider investing in. What do I think the realistic exit valuation is? And let's say it's 100 million. He's then going to say, Well, how risky is this business on? Do you know he'll put a multiple return that he'll expect to get in return for that risk so three times would be low risk five times with the medium risk, 10 times would be high risk sake. But let's say he says. OK, but I want to expect to get a 10 times return from this deal because it Zeke White a risky deal for me to do so. That means that if I divide at the 100 million by 10 I'm going to end up with a post money valuation off 10 million. Now let's say you come to me and you want to raise three million. So if I did that that three million from the 10 million, it means the pre money valuation is going to be $7 million. And that's that's one way to logically scope out in turn, art into science about how there look at the valuation now. There obviously are quite a number of technical details to this. You can expect the analysts to sit down and produce a spreadsheet, and he's going to do lots of cash flow analysis and all the rest of it. So some of the things they're going to look at our you know, what profits on revenues are they going to expect your business to be making in the 3 to 57 year period, whatever it is, when the exit occurs on, then they'll take a look at the sector in the subsector that you're in and say Okay, well, what are the sensible comparative ALS multiples, or revenue and profit? Normally E bit D A, which is earnings before interest, tax depreciation and a depreciation and amortization, Um, and say, Well, is this a relative? Is this a reasonable valuation to be putting on your business at that point of time? There look at other deals in the sector and say, Well, who else is sold? A business which is, at least in the same subsector, is you? What sort of mount multiples of revenues and profits did they go for there? Look at the potential acquirers on say, Well, how acquisitive Army. What's their track record in terms of the prices that they pay for deals? How strategically important is your business going to be to a strategic potential bite at acquirer on this reasons important on two fronts? One of it because if it strategically important, they'll pay more and secondly, if it is strategically important, there'll be more competition for your business, and that will push the price up, however, also except that they will look ahead and say well, if there have to be subsequent rounds of financing, I may well get diluted, and they will have to care to calculate that potential dilution into their investment on their the offer. They're prepared to make you so to summarize. Investors will basically say, for a very lower steel on this is MAWR Private equity return that look for about three times their money. If it's, um, or risky situation, they're looking for five times. And if it's higher risk, they're looking for 10 times. Which is why basically, the earlier the investment, the higher the risk, the higher the multiple expectation and therefore the greater the number. They delude the exit value back in order to get the current valuation that they're prepared to consider on. The other factor to consider is, well, how much of the equity and they're going to get. And let's count this back, because if you give them more than 50% there's not much incentive for you as the management to carry on working. So is it gonna be 40%? Well, that's still pretty high, and that's leaving a lot of head room for subsequent rounds, so maybe it's 30%. Yeah, that sounds like a better figure. Maybe you're gonna have to put an option pool in place. And maybe that 50% 30% becomes 20%. So at the earliest stage, you can always expect angels or veces to be gunning for around 1/3 of the business, sickly up to the A round after the A round in the B rounds of subsequent rounds. That that figure becomes slightly more difficult to be be precise about. But Angel was certainly aim for about 1/3 of the business. So you want to be negotiating in the you know, the 10 to 25% range, if you can, and then see where you end up. But those are, you know, you know, rules of thumb that you can work with. So I hope this helps you to get some idea off how they the B C's, are likely to reverse engineer their valuation from the exit value on the risk they put on the business, measured against how much of the equity they want to get up front, 4. How do Investors Value Startups?: in this video. I want to talk to you about how investors value startups to start with. I want to impress upon you the importance about thinking or valuation as a pie, where your prime concern is to make sure that you get as big a slice as possible. Now the absolute number that evaluation is is put on your business is actually not the key issue. What is really important is how much of the equity do you retain on how much of the equity do you retain through subsequent mountains when you may get diluted? So if you take that mindset than you'll realize that at the end of the day, when the exit happens, it's your slice of the pie that actually gives you your award, the valuations they're achieved on route only part of the factor. Very often, I've seen startup founders get really hung up on valuations, whereas they should be thinking about that at the end. Equity the steak that they will have in the business. So how much is a startup worth? Well, the simple answer That question is probably to start with not very much, which of course makes it very difficult to value. So how do you calculate value? Well, there is a method, and I'm gonna take you through it now. First of all, you need to think how much money your your business needs for the start up phase or the seed face. How much money do you need for the next 18 months? Now, I would stress you shouldn't raise more than you need, because this stage, the money or raising is going to be more expensive than the providing. You haven't up ground than the raise you do next time round. So the valuation today might be a 1,000,000. The next evaluation that next time might be five million. So if you raise you know, a huge amount of money now at one million, the dilution you'll suffer will be commensurately. More so you need to work out how much you need to fulfill your plan. Maybe a small contingency Andres that amount. So let's say we fix the rays at $200,000 that's what you want to raise. So the next question, then, is how much of your company are you going to give away to get this $200,000 in the bank. Are you going to give away 30% of it? You're getting away. 20% of it may be our only gift again and with the way 5% of it. But it's this percentage fact of him with the amount you're raising that actually sets the valuation. So if you raise 200,000 and you're going to give away 30% basically you're saying that your business is valued on a pre money basis at 660,000. If you're giving away 20% then you're valuing it off pre money and a 1,000,000. And if you're giving her a 5% then hey, great! Your valuing your business at four million now, when this this valuation is being negotiated. Of course, there are factors which bounce around to inform to justify ah, higher or lower evaluation. And some of these I put on the screen, the first of which is traction, particularly to B to C B two c business. It's the number of uses, the number of consumers you have, how quickly you've got them, how fast that number is growing on. Do you know what they're paying is is a slightly different issue because you might want to be growing your business very quickly to start with and then then to pay afterwards. How that having a business where you're basically building the users and thinking about the the monetization policy afterwards is not gonna work anymore on a B two. B Business is clearly it's all about the numbers of customers, how quickly you've got them, how fast they're growing. The growth rate over the next 18 months is going to be very important. The Founders reputation. If if you're a founder and you've already set up two or three successful businesses and sold them out, then you're going to get a lot of people wanting to back you. You'll get a much higher valuation to start with, because your track record will make the deal look a lot less risky to the investors. And, of course, the final factor is theater tracked iveness off the sector. You are in because if that sector is really hot, then veces could be a bit like sheep on. They'll be rushing after the the hot deals, wanting to get some participation in a particular space. And if you're in that space at the right time, then your valuation will be higher. So essentially you've got two choices. You can actually go for the highest tiny you can get, get as much money as you can get and go for really fast growth. The problem with that is that come the next round, you're gonna have to go for an even higher valuation and even faster growth. Or you get as I would recommend you get the money you need. You go for a steady, still growing, still reasonably good growth. But you don't set yourself such a high hurdle that after the next valuation round you won't be able to keep sustaining these incredibly high levels off expectation and off growth. So the one last factor that I want to cover with you is to help you understand the importance off the option pool because the option pool is always are put in place before investors make on investment. On this is providing a pot of equity for future employees. On this evaluation, for this comes out of your pot and let me show you the easy way to calculate this and see how it works. Let us say you've put a pre money valuation on your on your business of $8 million and you're going to raise $2 million off new money, which makes $10 million post money valuation. But the investors have said they want a 15% fully diluted option pool. So what you have to do is to look at the post money valuation of 10 million. You have to take 15% off that, which is 1.5 million. So you now know that the post money valuation of the option pool, But then you deduct that 1.5 million from the pre money valuation on. Therefore, the investors put in money at evaluation off 6.5 million on Do you see effectively set those other shares up for free on. That's how you calculate the option pool. And as you can see, that is, diluted your valuation, and therefore you're obviously giving away more equity to the investors than you otherwise would do without the option pool, they're in place, so that is how, particularly at the seed and very early stage angel stage valuations are arrived at in the absence off profits in the presence of negative cash flows. It can be difficult, but that is the generally accepted methodology for evaluate vent for evaluating and valuing startups 5. How Do Investors Value a Series A Investment?: in this lecture, I want to discuss with you how investors value a business at the Siri's, a stage now at Siri's. A. The valuation is really all about traction. Nobody is really gonna be expecting you to be profitable or in the cash generative. But they will certainly expect you to have revenues, which they expect to be growing quite quickly and the speed at which they are growing. And the speed at which you've bean putting on customers will certainly help. It's certainly a factor in arriving at a final valuation, but there's a bit more science to it than that, because what investors want to make sure they do is that they are not paying for some outside off market rates. So what did they do? They go and find listed comparable companies in your sector and subsector. Now, given that you've got the New York Stock Exchange about the London Stock Exchange about NASDAQ, there's really no shortage off businesses they can look at. Ideally, these companies want to be, you know, not stratospherically overvalued. They don't want to necessarily be in different geography, so they there's a certain amount of skill in picking the right group of companies, but you definitely want a group of them. You can find their data in Google Finance or using the U Yahoo analyst pages. So just search for those I want you need to do is once you've identified this group, you need to find for two years historic the most recent two years historic, the revenues and the E bit D. A number on the enterprise value number. Now you can also, if you want to be clever, you can adjust for different year ends because that has an impact. But in essence, what you're trying to do is to get an average for what do these numbers are. So you've got the revenues. You got the idea you got the enterprise value. And so you use those for each of your companies and then divide the enterprise value by the revenues, and that'll give you an enterprise to values ratio. Multiple. Divide the enterprise value by E. B. D. A. And that'll give you a revenues to e but d a multiple and then average those two multiples for the group. Then, once you've done that, do make sure you haven't got any out liars in your group that they're going to distort the number either up or down on bear in mind. If you use the capital asset pricing model, which won't go into here that you were very often apply a discount for private companies. If you look at forecasts, then you can expect the multiples to be lower because obviously there's an element of growth coming into the factors as well. However, if you take these revenues and EBITDA multiples, then take them over to your business and say, Okay, well, my revenues are a $1,000,000 on the average multiple for revenues is 5.6, then that's valuing my business of 5.6 million. And if I'm you know, if if I'm making a bit D a, well, that's great. If I'm not, then that multiple is irrelevant and then do consider the private company discount. But using those two numbers is a straightforward way to get a ballpark valuation for your business on that is the starting point from which you can have a negotiation to take the number either up or to take the number down. But at least you got something scientific, a market based on which to base it on. That is how you look at the valuation for a Siri's A, um, if you're an investor. 6. How do VCs Evaluate a Market?: in this lecture. I want to take a look at how he sees evaluate a market. Now when you are pitching to a VC. As I think I've already said there are three key factors which are team the product on the market and we're going to focus on the market in this particular lecture. The way that the B. C's will come at this is to start off by saying What problem is being solved? So what is the specific product or service that you are going to be offering? And what pain is it addressing on Therefore, and they really has to be a pain here. There really has to be a problem if you can't, if it's just a nice toe, have and there's not a need for this product, then you're already on to a very, very sticky wicket. But the question is, you know what is this pain or problem on? How much need is there for it on? They then say OK, well, we've identified the need. How much do we think people are going to be prepared to pay for this on that obviously begins to give you some sort of quantum for the degree to which people are suffering pain and then they try and say And how many people do we think that are out there who are being who will be prepared to pay for this on the course That gives you an overall market size in that particular market? There is, of course, the whole issue off competition. You will not get this market to yourself. You will have to share it with your competition on and going out and saying, Well, actually, there is no competition out. There is probably one of the worst things you can possibly say to any V. C who will just regard you is not being credible and not having done your homework. But you do need to have an understanding of your competition. Are because these are the people you are going to be taking market share from now. If you're in the consumer space, then the market is generally dilemma delineated by looking at the age of the people that their geography and their gender, if you're in the business in the B two B space than its geography. Industrial sectors indeed sometimes subsector and the company size the size off the customers you will be dealing with, so you get us to a starting point there. Now. If you want to take this further, you can go. What in one of two directions. You can actually try to develop a top down analysis of the market, and that is by going to some industry reports like Gardner or Forrester on, then trying to work out from their assessment of a market at what part of it is addressable by you. Alternatively, you could go the other way around and try and go bottom up and say, Well, how many people out there and how much are they going to pay? So you get these twos of conflicting views. The main point is, though, that this whole market analysis exercise is very, very subjective, is fraught with sampling error and estimation era. And it's no more than a a Savigne elaborate guesstimate off the market size. The critical thing here, though, is if it's not very obvious very early on that there is a very large market for your product or service to address, you are going to start to lose the interests off the investor, so you really need to have this thought through. This is how they're going to look at it and you need to be able to address it in their terms. So that is how you evaluate a market from the investor's perspective, and you need to be able to talk in their language. If you're going to convince them that your brilliant product or service is addressing this incredibly badly needed pain for which people will pay a lot of money and there are a lot of them out there to do it, i e. You are addressing a very large market. 7. What do VCs think about your Product or Service?: I want to take a look now at your product or service, looking at it from the perspective off the V C. So how are they going to look at your product or service? Bear in mind that 75% off new product launches fail. So with that as a starting point, the investor the veces will definitely want to see some customers using your product now thes maybe, depending on the stage of your business, thes maybe customers who are dealing with an early stage of your product and early on, maybe an hour for what beater, maybe even having a free product trial. But they will want to see customers using the product to enable them to understand how the customers use the product, the benefits they're getting from it, and then be able to talk to the customers either through an interview process so they can really quiz them and ask them what they're getting from it. Or if they can't do that, then maybe by hearing some customer testimonials were there. Of course, these could be organized by the companies. He didn't quite get the same independence that a VC would like. When you're presenting your product, particularly if it's some sort of software product, Then a product demonstration is really essential, and you must make sure that it works on the day the B C's will be looking for things like how easy it is for you to use the user experience. You know the interaction off off, how the user uses it on the screen, on how easy that is to actually use the software, the speed at which the application works. And they'll also want to look into, you know, competing products to see what else is out there on when they're looking at competing products that I look at the feature set of what your product is offering against what's available in the market from competitors. It's also possible that they'll go to experts and asked them, people, people, particularly people who are expert in that your particular niche and ask them to take a look at your new product and tell them what they think of it. So it's like an independent check. You can expect them to go online to go and see what's being said in Twitter on Quora. Maybe some analysts have published a report about the subsector that you're in, but they'll go to see what they confined online in terms of information with which they can evaluate your product. Then they'll look at your business and the manager, the management team in the business and the production team in the business. And they really want to get a sense for the passion that you have for your product. And what is the understanding that you have about the customer need bear in mind. Very often these products are started because a founder is frustrated that they can't solve a problem, so they go off and solve it by creating a product to do that. So if you have a deep understanding of that knee, then then you're in a very good place to explain that to the investor. And they'll want a sense from your whole organisation about how passionate people are about producing this fantastic product and how great they really think it is because that element off self belief and determination to succeed is going to be a very important subjective factor. When it actually comes to being in the market, competing on and actually having a successful business, they'll inevitably get this slide. Rule out all the spreadsheet out that his days and will want to understand the price at which your products being sold on the gross margin potential now bear in mind. Software, of course, has a very high gross margin on services. Tend to has a much lower gross margin, but they'll want to understand that because once they've got the gross margin, then they can start to look at the fixed, unbearable costs in your business or the SGN A. In a younger company, it's important to spend time really getting underneath the skin off the product. Because although the market is important, don't forget with the third element in this particular triangle, the team you can always change. The team will add to the team later on, but if the product sucks, you're absolutely stuck. So I hope that helps you to get a nun. Durst anding off how veces will look at your product or service, because if you can put yourself in their shoes, then you're going to be very much better equipped to communicate. You're the benefits of your product and service in terms that they can understand 8. How do VCs evaluate You and Your Management Team?: Let's take a look now at how veces evaluate you and your management team. Now it's all well and good finding a great product in a really hot market. But at the end of the day, particularly for younger businesses, it is all about the team. So this is a critical aspect, and you need to get the strengths of you and your team across to the veces. Now the list of characteristics they want to see is probably endless. Andi, I'm suggested a few in the next few slides. Many of these are going to be absent, perhaps in some, um, in some cases. But if they are absent, that will be potentially a red flag for the B. C. So if you as the CEO of the startup, are putting yourself forward, these are the things you need to really be communicating. You must have a strong vision for your company. You must be able to explain. You know what it is. Your company doesn't where you're intending to take it. You must show passion for your product that you are really enthusiastic and you are driven to produce the best possible product that you can hard work goes with the territory, and they will expect to see this. Eso Lots of long golfing weekends are not really on the cards at this stage in the company's history. In terms of this process, maybe in five or 10 years time you'll be able to improve your handicap. You must be able to show a deep understanding off the customer. Need be able to understand the problem, the pain they're suffering. This is why you designed this product. So if you're not feeling and understanding that pain, then nobody else probably is either. On it's absolutely critical. You must be able to hire people well, and they will Look at that your team of the people around you and that will reflect on you . So being able to pick good people to build a team is a critical characteristic. Be a good communicator, be a be able to get your view across. So when Ugo and give pictures or sales presentations or whatever you need to make sure you do it very well. Organized manner very convincingly. Be able to go out there and share your vision and your your ideas with other people's communications. A critical part of the process. Of course, you can't do everything yourself, so you must be able to delegate tasks and to manage the people around you. They would expect you to be a strategic thinker. This really goes with the vision part, being able to have a vision for your product or service, and you'll need to show that in your communication, your interactions with them. And of course, you need to have good judgment. Now if you want some other characteristics just to keep this list flowing, because, of course you know you are the ideal person, then the presence off a good existing network. The fact that you've got good development industry experience, you should ideally have some start up experience. You must have good technical skills. You should have the ability to sell. They'll expect you to be numerous it and of course, you'll be expected to demonstrate leadership. He suggests some of the things. Of course, you may not have all of these, but the more of these boxes you can take, the better. There is a thing called the C V. Higher on this can be a disaster, and so just watch out that you're not. If you like helping them to fall into that trap by just having some great names on a CV doesn't necessarily mean that you've got all these characteristics. So even if you've got the most wonderfully impressive CV you connects still expect the veces to exercise their subjective judgment about you based on their interactions with you . So you're not going to be able to do this alone just on your CV. Then, of course, they're going to want to look at the rest of your team on. They will expect to see many of these characteristics in your team, although, of course they will expect there to be a lesser level of experience. But they will expect deeper competence clearly in the individuals specific area within the team, whether it's the CFO or the C i o. Or whatever it happens to be. And then, of course, it's a team. They want you to be ableto work well together and to be able to demonstrate that so you know, any any time they see a major blow up between you, they will start to get nervous about the investment they're about to make. Now, one of the BBC's I was talking to recently said that during the process of making an investment, they deliberately set out to stress the management team because they want to see how they handle that stress, so they will ask them for a lot of information very quickly. They'll put them under pressure because they want to see how they're handling that pressure , which I thought was a very interesting insight. At the end of the day. It comes down to passion toe knowledge and to commitment. So if you want to sum it up in three words, those are the three words I would use bear in mind. When you're approaching a B C for money, you are being judged. You are being evaluated. These are some of the criteria that the VECES will have in the back of their minds when they're meeting with you and they're talking to you. So be prepared to be scrutinized because you are a critical component of the investment they want to make 9. Why is Exit Strategy important to VCs?: I want to talk for a few minutes now about the exit strategy, because I want you to understand how veces look at it and why it's so important. So, essentially, what do they mean by exit? Well, it's very simple. It's the realization off their shares, its the sail off their equity interest in the business. But what they're looking for is Theobald iti to do this at a high valuation at a high exit , multiple and ideally in a relatively short period of time. Now the clearly the higher the exit expectation, the higher the evaluation they put on the business at the point of exit, the higher the valuation they will put on your business today because, as we've already seen, that Tual directly linked in terms off multiples. So what are they looking for? Will there start off by taking a look at your business on a standalone basis? So they're going to look to see whether you're in a fast or fast growing market. They want to understand the potential your business has to grow from the position it's at now to the point of exit. If you've got market leadership or close to it then that's a big tick in the box, and I'll see that very positively. They're want to understand from you what your competitive advantages are. Why is your business, your product or service better than that off the competition? Then they will want to look at you from a financial perspective and understand your profit margins. What is your gross margin on your product? What is the ability for it to improve over time as you scale the business up, which of a often happens, then they'll want to understand what the barriers to entry are. What are your unique selling propositions? What patents or technology do you have that make your business a unique? These are things which is going to be very difficult for your competitors to copy without acquiring you. So it's things which they will not be able to do organically. And then, of course, as we've already seen, they're going to look very closely at management quality. The next phase is to look at potential acquirers, so it's saying who is out there who might actually make this exit happen. So they're gonna look to see how many potential acquirers there are in the market. And how acquisitive are they? How active have they? Bean? And, of course, crunch base is a great source of information for this. They'll want to understand why they would want to acquire you. You know what will be the strategic logic for it? Maybe they're going to get some unique technology. Maybe it's going to be some form of access to a new bunch of customers or a new sector of the market. Whatever it is, they'll need to understand how you fit with your potential acquirer. Then they'll want to understand how that business is likely to value U on. You can work on the basis that if a public company wants to make an acquisition, which is gonna be earnings enhancing, it has to make an acquisition on evaluation multiple, which is lower than it currently exists itself. Therefore, you can take the company's valuation multiple to be a ceiling. Having said that very often for strategic rationalism because they can see synergy benefits , they can see extra one plus one equals five often acquisitions and made it a higher multiple. But then the initial impact is diluted, and it only becomes a creative further down the line. If there is a limited number of AIPO candidate off acquisition candidates, then they'll want to know. Are you going to be a company that they can bring to the market? Are you going to be able to do an I P O on? Then finally, they will look at the geographic fit between your business on those off your potential acquirer universe. Now, just a another quick word on I pose. If there's a limited number off acquirers out there, it's not a disaster. But it does mean that the case for you, you know, doing an eye. Pierre will be stronger and will have to be stronger. Will have to stand up so they will want to be able to see. That's the case, which is why I've included in a previous lecture this access this NASDAQ listing documents so you can see what it's all about. Bear in mind. When they're making this evaluation, information is going to be limited. They will be able to see who's acquisitive. They will be able to Suze potentially a fit. But of course, we're talking about an event which is going to happen in 3 to 5 years time presumably on therefore making forecasts of what your business is going to be like, what their business is going to be like. What the market opportunity is gonna be like in that time period in the future is going to be quite difficult. However, the exit strategy is a critical critical component off the evaluation off your business at BC's will take it very seriously. They will have to explain to their colleagues how they think they're going to get out of this investment and therefore you need to understand and be able to explain it to them. 10. Why are Barriers to Entry important?: I want to take a look now at why barriers to entry are important. If you're not familiar with barriers to entry as a business concept, then you definitely want to take a look at the work off Michael Porter when he talks about sustainable competitive advantage. But essentially, what you're talking about is the factors in your business, which make it difficult for your competitors to compete with you. You can do things that they cannot do, and they cannot easily replicate. And of course, the more barriers you have on, the more competitive you can be against you from your competition, the higher prices you can charge and therefore the better margins you have. And, of course, if your competitors can't replicate what you're doing, then hey, guess what they might have to require you on. Then we're back looking at exit strategies. But let's focus on this thief First barrier to entry Really wanted look, look at is what is called a network. Effects on this essentially can be summarized by saying that the value off your business to existing customers increases when you get a new customer. Now, the most obvious example of this is the fax machine. If you bought the fact effects machine and you were the only person you had one, you wouldn't be able to fax a fax to anybody else because there wouldn't be another receiving facts out there on the more fax machines that other people by, the more useful your fax machine is to you, because the more people you can send faxes to and that's network effects, then intellectual property is important now. This is not always covered by patterns, because if you apply for a patent, you very often have to explain North a lot about what you're doing in order to make clear that your particular piece of intellectual property is unique. So very often power. Intellectual property is not protected by patents but is still valuable because it is difficult to replicate on a classic example of this is a very nice, complicated piece of software or some form off Internet platform or whatever, something that's difficult for somebody else to go and build. Now, many barriers to entry only really kick in at scale. On the larger, your business is very often the mawr beneficial. These barriers are so when you look at a business today. You may think that some of these are not really very applicable to the business, but you need to think about where the business is going to be in 3 to 5 years time and therefore the potential that that it has to develop the strength of these barriers over time. Let's look at some or are very obvious barriers to entry that people can have. The first of these is data. If, in the course of your business you collect a lot of information and a lot of data, which you can use in your business, that is not easily replicable by your competitors. High switching costs are when basically, for the user, it means it's either difficult or expensive to switch from you to a competitors, or it's just downright inconvenient. But if it's very easy for a count customer to go from you to another customer, then actually that has got low switching costs, and therefore that's a weakness. So the more not necessarily difficult, but the more expensive or the mawr. A customer is going to be reluctant to switch from where you are to another platform, then the better it is. So if you look at Facebook and linked in the benefits you have from being on Facebook and not replicated by linked in therefore this. You know, it's an awfully, awfully difficult to take what you've got on Facebook moving across the Lincoln and get the same benefits because the different people on there you got different information. You've already put an awful lot of content up onto Facebook. These are all high switching costs. Know how is we've covered in terms of intellectual property. But it goes beyond that. It's about a business process. It's about understanding how you run your businesses, about the processes inside your business that make your business difficult to replicate on that experience. And that expertise has value. And if it's not easily replicable by a competitive than it's good, company's brand clearly is a ah function of scale. A very small company is difficult to have a very strong brand. A very large companies going toe potentially have a stronger brand. Of course, you can get very small niches hougan niche companies that can develop very valuable brands even though the company itself is not particularly large. But certainly brand is a benefit. A and it can be a barrier to entry. People will buy a particular company's product because off that brand and then finally scale in itself can be a barrier to entry. It's very difficult to compete with somebody who's very large because their costs will be so much or their cost efficiencies would be so much greater than that of the smaller company on. Therefore, they weren't The smaller company won't be able to be so competitive on price on customer service and therefore scale itself can be a really benefit. So those are some of the barriers to entry and that this is why veces like to see them because the more barriers they can see, then the higher the margins on basically potentially the higher the exit valuation as well . 11. How do VCs Evaluate Your Competition: in this video I want to discuss with you how bc's evaluate your competition. The main point is that veces really want to invest in market leaders if they can, because market leaders command premium valuations Now, clearly at an early stage, it's difficult to establish whether or not your market leader, because you're obviously not going to be a markedly that as things start. But if they come to the conclusion that they believe you have real potential for market leadership, then they're gonna be interested in your business. Well, how do they look at market leadership in simple terms for established businesses? They're gonna look at the companies with whom you compete and look at their revenues, and that'll give you an idea off who's got the biggest share of the pie. But clearly, if you're an early stage business, you need to look at other things because the revenues are probably not going to be a great indicator. You can look at Internet traffic is one. Of course, you can look at the quality of the product and its its characteristics, and how it compares to the other competition competitive products in the market. You can look at the amount of capital raise, you could look at the quality off the partners and the customers within the business. And, of course, you could look at the ability, the quality of the management team and their assessment. The BC's assessment that this management team can out execute the competitors in the market . This is a highly subjective area, as you can see, but it's clearly one that's very important, and they spend quite a lot of time in it. When they've got some sort of hierarchy, they will rank these competitors, and then they will want to discuss these with you. They'll also take some external soundings. I'll probably talk within their own networks that may or even talk to other players in the market. If there's a major competitors somebody like Google or Microsoft who's a direct head to head competitors, they may be a little bit cautious because they're not gonna be able to outspend them equally. If you can come up with a solution that something like Google is gonna have to buy clearly . Ghouls, highly acquisitive, got very deep pockets, so that sort of balances out. It is a very good thing, so you need to be aware that the B C's will expect you to have a good grasp off the competitors in your market, and you will be expected to be able to discuss this hierarchy with them and to explain exactly where you think your position now and why you believe you can rise to market leadership. Whatever you do, do not fall into the trap off saying we have no competitors. One of the obvious statements that what if there are no competitors, there's no market. It is generally taken by BC's that if you say you have no competition, that actually what it means is you don't really know who your competition is on. That is not a good thing. The other thing you must bear in mind is that your assessment of the competition has to be consistent with your evaluation. Off the market size, the two obviously have to tie in together, so that is a quick summary off how veces look at your competition. It's important that you develop a sophisticated picture off who your competition is on, how you're going to out compete them because remember, the B C's are looking for potential market leaders 12. What Financial Information is important to VCs: in this video. I want to talk to you about the financial information that is important to veces on. What I'm looking at here is the initial financial information that you need to provide to them when you send them a summary or maybe even a pitch deck or something like that. Before you've had your meeting, what information do they need in order to evaluate your business quickly and come to a conclusion as to whether or not this is a business they want to take a look at now they have a very clear idea of what they're looking for. They look at hundreds of plans all the time on their certain characteristics in the financials that they will want to see. And it really is in your interests if you're gonna build, trust and build a relationship with them to provide them with the information they want up front. And it's not, as you will see very difficult to do. They will want to see both historic and forecast information. The historic information enables them to show what you have delivered or what the business has actually delivered. Clearly, in an early stage business, there may not be much information, but nevertheless, whatever you've got from Day zero, put it in then. The other thing to say is, if you can put a forecast going out than basically forecast, probably aren't worth much after two years. But if you take it out five years, you might give them an idea of really way ambitions on way or projections are, although obviously it's based on a lot off assumptions you will only need at this stage to provide profit and loss account information. You will not need to provide balance sheet information, and nor will they expect to see detail cat for information that can all come later. So what do they want to see? Well, they want to see the revenues the headline sales number on, then the gross profits where they want to go to see what the gross margin is on your product. Then they want to know what the total expenses are, and if you're going to split them out, then split them out into sales and marketing are in R and D. I put in are in a but it R and D and other general and administrative expenses. Jenna then show the prophet the operating profit line on. Also, you should put in the little line that shows what the revenue growth rate is, so it makes it easy for them. They don't have to calculate it, and that's pretty well all you need to give them. So that is the headline financial information they expect to see. Not a lot, but it is important to put it in on. It's if you don't put it in the B. C's will simply wonder why you haven't included it. 13. What is the typical VC Decision Making Process?: I want to talk to you a little bit now about the BC decision making process. You need to be aware that it can take between six, even nine months to raise capital, so you need to start preparing to do this long before you really need to do it. Definitely, um, allow more time than you would expect on whatever you do. Do not run out off cash because investors can sense desperation when they see it, and they will club you in terms of the valuation. They will make it very expensive because they'll see a real opportunity even assuming that they then want to do an investment. So you have a number of stages on. I'm not going to go through the whole detailed mechanics of it, but basically you can look at it in terms of preterm sheet and post term sheet. And in the pre term sheet phase, really, it's all about getting to know that the company having meetings, obtaining information during analysis and evaluating whether it's really a deal the BC wants to do on, then it'll go through probably a couple of committee approvals and initial approval and then a pre term sheet sign off approval once the term sheet has agreed. And ever get this cinnamon negotiation involved in that, then they will go into due diligence and documentation on again MAWR committee approvals prior to signing off on investing in the business. If you look at it from a different perspective and from the BC's PERSPECTIVE, they have really four stages to their whole deal making process, sourcing deals, learning about them, making investments and then exiting Andi, you can expect them to have a an extensive network for their deal sourcing activities. Andi can look at I said 2 to 400 companies a year here, But, I mean, I've heard of five or 600 companies coming across people's desks. So you've got to realize that you know you're in a lot of competition to get their attention. They'll then initially screen and eliminate, really is quite a spot suitable and try and get that down to no more than maybe 40 to 80 companies a year. So already there's a very high attrition rate on when they get a an opportunity across their desk, they're going to go through it very quickly, and if it doesn't tick enough boxes. It's out, it's off the table and they won't want to look at it. Then they'll go through a pre Linley due diligence phase without actually spend some time how you look at the business they won't spend probably any money on. They'll probably eliminate again another 50%. But go forward with maybe 20 to 40 companies at a deeper level of due diligence, which might involve a certain amount of expenditure. Then they will end up with 10 to 20 companies. Andi. Then they get a term sheet out, so they're only getting a term sheet out for 10 to 20 having seen maybe 4 500 companies. Then off those 5 to 10 they will invest. So they're basically getting term sheets out, but investing maybe in about half of those so they could still fall off the table. Then they'll monitor support. Follow on, and then they'll go through the exit. Management pays, and they'll focus on getting their money back from their winners, expecting attrition rate of maybe 10 or 20% of complete failures. So you can see from their point of view it is a process. It is a system and you have to keep yourself at the top of the pile all the way through. Now I've put a little checklist in with this, which is all about deal flow management, and it's some of the criteria that they're continually evaluating your business on the other deals they're looking at against each other to try to make sure that they're investing in the best possible deals. So take a look at that checklist and try to make sure that when you're talking to them, you are front of mind and at the top of the list for us, many of those characteristics as possible. So that's it. A bit more depth and understanding about the VC decision making process. I hope you find that helpful. Definitely work on your presentation and your relationship with your BC to make sure that you tick the boxes that need to be ticked 14. Project Evaluate Your Startup: Now I have a little project for you. I want you to do an evaluation off your own. Start up off your own business when I provided you with is a checklist off investment criteria. There's both a PdF and a spreadsheet on. What I want you to do is to look at these criteria on try and think first of all, like a B C, and score yourself either winner in a range of 1 to 5 on those criteria but thinking as if you were V. C. But looking at your business, then I want you to try and reverse it and see if you look at any of these aspects differently. If you're looking at it just from the entrepreneur from your own perspective. And if you want to make it really interesting, try and find somebody you know who's independent of your business, but who knows enough about it that they might be able to give you a view? Maybe it's an adviser. Maybe it's somebody who it may be a non executive director or something like that, or somebody who does know you on what you're doing and get an independent assessment from them and see how they score. Then I want you to compare the scores. Compare these results on. Ask yourself, what have you learned about your strengths and weaknesses about your business? Where are the gaps you are gonna have to fill? What action do you need to take before you'd look at approaching a V C or an angel or any other investor to get investment into your business? So that's the project. It's a screening. If you like off lots of key criteria. I think they're 48 different criteria there, under a range of different headings. Go and take a look on. Do the evaluation on your business, but try to put yourself in the mind of the V C and then try and do it on your own. From your own perspective, Andi would be very interesting to see what comes up, and I'd be interested to hear the results