A Terms Sheet is one of the final documents that will be developed by parties in a corporate transaction - be that capital raising or other deal.
Beyond the Information Memorandum the Terms Sheet summarises the co factors that will make up the deal.
It becomes a focal point of negotiation, and as such also becomes a simple document to instruct lawyers with. If drafted correctly the Terms Sheet will expand into the full legal contract.
For the very organised, the development and presentation of a Terms Sheet is a high credibility tool to gain the attention of the counter party and lead the deal to a conclusion (hopefully positive one).
Sunday, February 22, 2009
Monday, February 16, 2009
Do Option Grants Work ?
There is alot written on options for employees, and generally they can work - but there are also potential issues.
One problem is when the options go deep out of the money / or the Company cannot reach IPO to give the options value. I often call them Jacques Cousteau Options because they are so deep underwater they will never see the surface.
The problem with this situation is that employees who hold such options will often just leave. They have little incentive to stay. So if you have an option plan, and it is not working for whatever reason, don't assume that it does not need to be amended in order to ensure employees don't leave. It will need attention.
One problem is when the options go deep out of the money / or the Company cannot reach IPO to give the options value. I often call them Jacques Cousteau Options because they are so deep underwater they will never see the surface.
The problem with this situation is that employees who hold such options will often just leave. They have little incentive to stay. So if you have an option plan, and it is not working for whatever reason, don't assume that it does not need to be amended in order to ensure employees don't leave. It will need attention.
Friday, February 13, 2009
Don't Give Free Carry If You Can Avoid It
In a recent engagement I was working on I saw a really bad instance of the result of giving a number of people really small amounts of shares in exchange for services, or help. Those small shareholders basically did not give a hoot and were prepared to sell the dominant VC and management down the river when a ridiculous offer came around the corner.
The free carry situation can create the following issues :
- When you have to get any documentation signed, like a shareholders agreement, you will be spending an awful lot of time and legal fees running around getting those little shareholders to sign documents.
- Small shareholders who are given shares don't have the same agenda as Founders and VCs. Simply because their 'pain' in investment is typically low to nothing. So whenever anyone even thinks about selling they are the ones in line first with their hands out.
- You have to communicate with them all. Constantly. And it can be a bit of a pain.
So if you really need to do the free shares thing, or take in small parcels of money, then do it - but just be aware that from a housekeeping perspective it will undoubtedly get messy at some point in time.
Valuation Clawback
An interesting negotiation technique if you are after a high valuation, but the VC does not agree, is to agree to some form of valuation clawback mechanism.
Sounds complicated but it is not. It can be very simple and goes along the following lines :
1. The parties agree to the higher valuation.
2. The parties agree to the typically aggressive financial milestones that accompany (1).
3. If you miss the targets in 2, the VC is issued additional shares on a predetermined formula.
Pretty straightforward approach that has the Investee have to back its numbers in order for the high valuation to hold. In the milestones are missed then the VC benefits as more shares are issued for free, and the effective entry price of the VC lowers (as they now have more shares for the same amount of investment capital).
Thursday, February 12, 2009
Business Plan or Fundraising Tool ?
Are you building a business or just trying to get funding ?
From time to time I have come across individuals who seem to think that a Business Plan is just a tick the box item for gaining venture capital funding. Well the horrible truth is that it is not...... It is meant to be the credible blueprint by which your concept will become commercial reality.
There is a fantastic term which I probably overuse. Originally came from a great Private Equity guy - Rupert Harrington - at Advent Private Capital in Melbourne Australia. I have been fortunate to work with Rupert a couple of times now (www.adventprivatecapital.com.au ).
The term is 'DEFEND'. Can you defend your business plan. Plain and simple. Is it something that if a third party brought it to you - you would invest your own money in ?
If it is just a fundraising document you are going to find it pretty hard to get people to believe the core data, because you probably don't believe it yourself.
So when you are spending your valuable time cooking up your next great idea I encourage you to think at every stage with every key element - can I defend it ? How will I prove that this assumption is credible ? What third party evidence can I bring forward ?
If you can defend it you are on the right track of a business plan. If not - perhaps think about saving yourself a little embarassment by spending more time working through the fundamental assumptions so that it is defendable.
From time to time I have come across individuals who seem to think that a Business Plan is just a tick the box item for gaining venture capital funding. Well the horrible truth is that it is not...... It is meant to be the credible blueprint by which your concept will become commercial reality.
There is a fantastic term which I probably overuse. Originally came from a great Private Equity guy - Rupert Harrington - at Advent Private Capital in Melbourne Australia. I have been fortunate to work with Rupert a couple of times now (www.adventprivatecapital.com.au ).
The term is 'DEFEND'. Can you defend your business plan. Plain and simple. Is it something that if a third party brought it to you - you would invest your own money in ?
If it is just a fundraising document you are going to find it pretty hard to get people to believe the core data, because you probably don't believe it yourself.
So when you are spending your valuable time cooking up your next great idea I encourage you to think at every stage with every key element - can I defend it ? How will I prove that this assumption is credible ? What third party evidence can I bring forward ?
If you can defend it you are on the right track of a business plan. If not - perhaps think about saving yourself a little embarassment by spending more time working through the fundamental assumptions so that it is defendable.
'Group Think'
Grant McCarthy who runs LCC's Singapore operations has a really great term - Group Think. Basically this is a couple of entrepeneurs in a venture that think they are right on an issue - but the rest of the world is wrong. They usually think this right up until the time that their venture is about to collapse...............
Grant and I have actually seen it up close in 2 deals we invested in. Really smart people. Great people to have a beer with. But unable to see clearly as a collaborative the errors that they were making.
One of these deals in particular is a great example. A venture which had IP of only 'timing'. There were competitors in the northern hemisphere but it had the clear jump on the field in Asia. The Founder was a super smart guy and a really nice person. The people he recruited were super smart people. Resume's to die for.
But when they worked together it was as if they were right and the rest of the world was wrong. Unfortunately the venture rather than evolving and improving just was flat simply because the rest of the competitive field was overtaking it. But the management pod just would not accept that they needed to build a business rather than a technological marvel.
Its really disappointing to see. Great people who don't achieve their potential because they can't see the woods for the trees. They convince each other that they are right. Don't take external advice. Perform sub optimally as a result.
Lesson learned : Don't become emotional about your business model. Don't try and convince yourself and others that you are right. This is not about ego, its about building a compelling business proposition.
Grant and I have actually seen it up close in 2 deals we invested in. Really smart people. Great people to have a beer with. But unable to see clearly as a collaborative the errors that they were making.
One of these deals in particular is a great example. A venture which had IP of only 'timing'. There were competitors in the northern hemisphere but it had the clear jump on the field in Asia. The Founder was a super smart guy and a really nice person. The people he recruited were super smart people. Resume's to die for.
But when they worked together it was as if they were right and the rest of the world was wrong. Unfortunately the venture rather than evolving and improving just was flat simply because the rest of the competitive field was overtaking it. But the management pod just would not accept that they needed to build a business rather than a technological marvel.
Its really disappointing to see. Great people who don't achieve their potential because they can't see the woods for the trees. They convince each other that they are right. Don't take external advice. Perform sub optimally as a result.
Lesson learned : Don't become emotional about your business model. Don't try and convince yourself and others that you are right. This is not about ego, its about building a compelling business proposition.
Researching Competitors
Before you spend time constructing the business plan and building that financial model I encourage you to spend as much time finding out what is going on in the marketplace as you can.
Ideas seldomly are unique in this day and age. This is simply the result of too much capital and lots of smart hungry business builders like you.
Too many times I have had someone say - this is unique - only to be very disappointed when the 3 or 4 competitors that they did not know about are pointed out to them.
If all competitors are small and poorly funded then no problem. But if an experienced team or multinational is throwing resources at the same thing that you are - well unless you have an edge (which you may well have) your valuable time might be better spent elsewhere.
So be protective of yourself, and your time - do as much research as you can to establish if you are onto something that is unique.
Ideas seldomly are unique in this day and age. This is simply the result of too much capital and lots of smart hungry business builders like you.
Too many times I have had someone say - this is unique - only to be very disappointed when the 3 or 4 competitors that they did not know about are pointed out to them.
If all competitors are small and poorly funded then no problem. But if an experienced team or multinational is throwing resources at the same thing that you are - well unless you have an edge (which you may well have) your valuable time might be better spent elsewhere.
So be protective of yourself, and your time - do as much research as you can to establish if you are onto something that is unique.
Customer Demand Modelling
This is an easy one, but something I come across all the time.
The entrepreneur that says 'well if we get 1% of the market share this thing will be worth..........' - I am sure you know how it goes.
In building a demand estimate one cannot do enough grass roots research. Building the customer demand proposition from the ground up. An obvious problem with the 'Top Down' approach, besides being lazy, is that as soon as a question is asked at any depth it can lead to those awkward moments because the business promoter has not really thought about it all that much.
Please don't be lured by the false hope that the educated will subscribe to the percentage of market approach. They won't.
Do as much research as you can, including conducting simple surveys of your target customer group. Nothing presents more compellingly than being able to say that you have proprietary research to back your demand estimates / financial model. And that proprietary research can be done quite simply, be that interview, mailouts, telephone canvassing, etc. By doing this grass roots work you will also give yourself the opportunity to really think independently if what you are getting up to is in fact going to be the next big thing - or whether you are simply kidding yourself (don't worry we all do) and your really valuable time is better spent somewhere else.
The entrepreneur that says 'well if we get 1% of the market share this thing will be worth..........' - I am sure you know how it goes.
In building a demand estimate one cannot do enough grass roots research. Building the customer demand proposition from the ground up. An obvious problem with the 'Top Down' approach, besides being lazy, is that as soon as a question is asked at any depth it can lead to those awkward moments because the business promoter has not really thought about it all that much.
Please don't be lured by the false hope that the educated will subscribe to the percentage of market approach. They won't.
Do as much research as you can, including conducting simple surveys of your target customer group. Nothing presents more compellingly than being able to say that you have proprietary research to back your demand estimates / financial model. And that proprietary research can be done quite simply, be that interview, mailouts, telephone canvassing, etc. By doing this grass roots work you will also give yourself the opportunity to really think independently if what you are getting up to is in fact going to be the next big thing - or whether you are simply kidding yourself (don't worry we all do) and your really valuable time is better spent somewhere else.
Early Stage Valuation
This is a real toughie. How do you value a business in its early stage of development ? Unfortunately the answer is not what everyone might want to hear.
The accepted approaches to valuation, such as asset value, Discounted Cashflow, Comparable Analysis, Break Up Value, etc simply do not really apply. Generally because the risk associated with the early stage of the venture is so high that mature valuation tools provide little more than fodder for academic argument.
I have even heard one venture capitalist suggest that there should be a dollar amount entered for every engineer in a software firm, and the same amount substracted for each MBA graduate in the same firm..........
My personal recommendation is for hte budding entrepeneur to fund the investment themselves, along with family and friends, until it is at least a visible commercial proposition. By this I mean there is something more to show than scribbling on the back of a coaster. Beond htre 'angel round'.
At this stage the valuation argument takes on a little bit more relevance as the project has taken its first young steps towards success. To argue value I believe you should ensure that you have specific knowledge of the sucessful and failed businesses that are similar to yours. Particularly the later - as VCs will always research failures and bring these up with you. So be prepared.
At the end of the day the early stage valuation, in my experience, tends to be a justification styled process where a VC that really likes a business plan will be more flexible in approach to value than if they are only luke warm. And the level of interest can often be driven by previous successes or failures - so in preparation of the business model and the valuation argument consider trying to enlist the assistance of someone who has done it all before - and with whom the VCs will gain comfort.
Comfort = lower risk. Lower risk means you will be better placed to argue value.
The accepted approaches to valuation, such as asset value, Discounted Cashflow, Comparable Analysis, Break Up Value, etc simply do not really apply. Generally because the risk associated with the early stage of the venture is so high that mature valuation tools provide little more than fodder for academic argument.
I have even heard one venture capitalist suggest that there should be a dollar amount entered for every engineer in a software firm, and the same amount substracted for each MBA graduate in the same firm..........
My personal recommendation is for hte budding entrepeneur to fund the investment themselves, along with family and friends, until it is at least a visible commercial proposition. By this I mean there is something more to show than scribbling on the back of a coaster. Beond htre 'angel round'.
At this stage the valuation argument takes on a little bit more relevance as the project has taken its first young steps towards success. To argue value I believe you should ensure that you have specific knowledge of the sucessful and failed businesses that are similar to yours. Particularly the later - as VCs will always research failures and bring these up with you. So be prepared.
At the end of the day the early stage valuation, in my experience, tends to be a justification styled process where a VC that really likes a business plan will be more flexible in approach to value than if they are only luke warm. And the level of interest can often be driven by previous successes or failures - so in preparation of the business model and the valuation argument consider trying to enlist the assistance of someone who has done it all before - and with whom the VCs will gain comfort.
Comfort = lower risk. Lower risk means you will be better placed to argue value.
Thinking Independently
One of hte most common problems I have encountered with budding entrepeneurs is their inability to be flexible in their thinking. That is it is a 'their way or the highway' approach to the development of a business concept. Unfortunately investors don't really warm to this sort of approach.
Constructive observation should be filtered into the thinking of every business person. In developing my own Firm I have learned so much from making mistakes, backing the wrong people and ideas and making numerous other mistakes. Although the strategy has always ben there, the ability to execute has been held back at times by simple mistakes.
Today I counsel with as many people whom I respect in business as I can. I have learned to think independently about all issues, and to be flexible in business planning.
Constructive observation should be filtered into the thinking of every business person. In developing my own Firm I have learned so much from making mistakes, backing the wrong people and ideas and making numerous other mistakes. Although the strategy has always ben there, the ability to execute has been held back at times by simple mistakes.
Today I counsel with as many people whom I respect in business as I can. I have learned to think independently about all issues, and to be flexible in business planning.
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