How to Get Venture and Angel Funding for Your Tech Startup

1. How to Get
Venture and
Angel Funding
for Your Tech
Startup
#startup
Roger Royse
Th 2/29/24

2. Market Issues
2

3. Valuations down from 2021 highs

4. Exits are down in 2023
4

5. Woman owned company data
5

6. Pitchbook Conclusions
 Deal, fundraising, exit activity and (with exceptions) deal values
were down
 VC Industry is well capitalized
 Advances in AI, life sciences, and clean tech are attracting
significant levels of public and private investment
6

7. Sources of Funding (Non-VC)
7

8. Basic Principles
 Investors are partners
 Stage your financing
 Most funding is dilutive
 Your valuation might have little to do with what you are worth
 Valuation is not your biggest issue
 Avoid early mistakes
 Take cheap money over expensive money
 Common stock is for service providers
 Get a data room
 Do the cleanup ahead of time
8

9. Sources of Funding
 Founders – savings, IRAs, credit cards, mortgage equity
 Debt Financing
 Government Grants
 Friends and Family
 Angels or Seed Investors
 Incubators
 Pitch Competitions
 Institutional (VC or Private Equity)
 Alternative Financing:
o Rewards-Based Crowdfunding
o JOBS Act Crowdfinancing
o ICOs, STOs, IEOs
o Royalty Financing (SEALS)
9

10. Founders
 77% of startups rely on personal savings (and their parents) for their initial funds
10
Source: Wells Fargo/Gallup Small Business Index

11. How Much?
 Angels - $25,000
 Angel Groups - $250k to $750k
 Early-Stage VC - $1.5 M and up ($3m to $5M)
 Later-Stage VC - $10M and up
11

12. The Lead
 Smart Money
 Chemistry
 Commitment
 Deep Pockets
 Network
12

13. Debt Financing
 Bank Debt
 Security
 Personal Guarantees
13

14. Government Grants and Loans
 Free Money from the Government
https://www.usa.gov/grants
https://www.aprise.org/
https://www.sba.gov/funding-programs
SBIR program
STTR grants
14

15. Friends and Family
 38% of startup founders raised money from their
friends and family
 $23,000 was the average amount invested by friends
and family per startup
15

16. Outside Money
 Angels, VCs, crowdfunding, private equity, etc.
 How much to raise?
 Milestones
 Burn rate
 Target runway
 Equity percentage and valuation
16

17. Staged Financings
 Enough to get to next valuation event
 2X
 1 to 2 years
 Up vs Down rounds
17

18. Money to Not Take
 Investor goals
 Cooperation and Accessibility
 Control
 Terms and Valuation
18

19. Angels
19

20. Angels
 Angels
 Angel Groups
 Angel Funds
20

21. Angels
 The Good:
 Connections to VC funding
 Mentorship
 Risk capital
 The Bad:
 Hostage takers
 Whiners
 Demanders
 The Ugly:
 Potential plaintiffs
 Disturbers
21

22. SAFEs and Convertible Notes
 Convertible Notes and SAFEs
 Debt obligations that convert to preferred stock
 Conversion feature – automatic, optional, prepayment
 Valuation Cap
 Sets a maximum valuation at which note will convert
 Discount
 Early investors get a discount to the preferred price
 Change of Ownership
 Investors convert to common or get a multiple on a sale of the company prior
to a priced financing round
 Shadow Preferred
 Pre and Post Money
 MFN
22

23. Convertible Debt
 Short term
 Secured?
 Subordinate?
 Interest
 Fixed repayment
 Discount
 Valuation Caps
23

24. SAFEs
 Simple agreement for future equity
 Pre and Post Money
 Pro Rata Rights
24

25. Effect of Valuation Caps
25
Founders 4,000,000 100% 4,000,000 100%
Stock Pool 0 0% n/a
total 4,000,000 100% 4,000,000 100%
Fully Diluted % Issued
%
Company sells a $1,000,000 SAFE with a $4,000,000 pre money valuation cap
That means that the SAFE will take 20% of the capitalization ($1,000,000/$5.000,000)

26. The UNSAFE
 Valuation Caps + SAFE = Unknown Dilution
Pre–Money – SAFEs take dilution of other SAFEs
Post-Money – SAFEs do not dilute for other SAFEs
https://safegenie.io/ is a tool that helps project pre money SAFE valuation
26

27. Pre and Post Money Valuation Caps
27
Founders 4,000,000 100% 4,000,000 100%
Stock Pool 0 0% n/a
total 4,000,000 100% 4,000,000 100%
Fully Diluted % Issued
%
Company sells a $1,000,000 SAFE with a $4,000,000 pre money valuation cap
That means that the SAFE will take 20% of the capitalization ($1,000,000/$5.000,000)

28. Series Seed Stock
 Watered down preferred stock
 Justifies low common stock price
28

29. SAFE and Conv Debt Traps
 Post Money SAFEs
 Valuation caps and excessive dilution
 Securities law violations
 Cap Tables
29

30. Venture Capital
30

31. “Avoid venture capital unless you absolutely need it.” Randy
Komisar, venture capitalist*
*Straight Talk For Startups
31

32. Should You Take Venture Capital?
 Must give up Equity
 No near-term cash flow
 Risky
 Illiquid
 Can the business scale?
 Explosive growth
 Huge market
32

33. Which VC should I approach?
 Thematic Investors bet on their thesis of what is next
 Domain Investors focus on an industry that they know well
 Quant Investors focus on data
 People Investors bet on the jockey, not the horse
 Tech investors bet on the horse
33

34. Venture Capital Economics 2/20 Formula
 2% management fee on committed capital
 20% carried interest
 7-to-10-year terms
 LPS want 2 1/2 to 3 times investment return
 VC fund must earn 3 to 4 times investment to return that amount
34

35. Venture Capital Economics – Expected
Performance
 50% lose money
 20% – 30% are singles or doubles
 The rest must be home runs (10X to 100X)
35

36. General VC Fit
 Large potential market
 First Mover or first to market advantage
 Long term scale over short term profits
 Not able to service debt
 Traction!
36

37. Venture Capital Economics –
Management
 Venture capital will participate in management
 Board seats
 Board Observer
 Management rights letter (for VCOC exemption)
 Seven-to-ten-year term (and longer)
 Precludes small investments
 Board meetings
 Management
37

38. Venture Capital Metrics
 Team
 Domain expertise
 Technical co-founders
 Technology or product
 Solve problems, address pain points
 Customer validation
 Market size
 Must be a huge market
38

39. Picking a VC
 Reputation
 Likelihood of closing
 Stage of fund
 Size of fund
 How much dry powder?
 Is there a fund 2, fund 3 etc.?
 Are they litigious?
 Deal with decision makers
39

40. Entrepreneur VC Fit
 Network
 Temperament
 Advice
 See the published email from the CEO of CircleUp to an investor
at for an example of a VC/Founder relationship that did not work
out
40

41. Company VC fit
 Capital intensive business?
 Follow on funding?
 Time to exit
41

42. Series A is the New Series B
 Series Seed
 Pre-Seed
 Series A-1, A-2
42

43. Types of Funds
 Micro VC – angels with other people’s money
 Seed Stage Fund – early, first institutional money
 Mid Stage – B and beyond
 Late Stage
43

44. Syndicates
 Lead or Co Lead and followers
 Party rounds
44

45. Other Parties
 Lawyers
 CPA
 Banker/Broker/Finders
 Mentors and Advisors
45

46. Strategic Venture Capital
 Can you pivot?
 Will it affect customers?
 Follow on investors
 Change in management
 Strategic agreements
 Confidentiality
 ROFR, right of first look, right of first offer
 Strategic objectives
 Less operational involvement
46

47. Positioning for Outside
Capital
47

48. Structuring for Capital
 Business Model
 Choice of Law
 Choice of Entity
 Cap Table
 Vesting
 Debt
48

49. VC Considerations
1. QSBS
2. VC’s LPA will not allow investment in a passthrough
1. Tax exempt investors want to avoid UBTI
2. Foreign investors want to avoid ECI
3. VC wants to be able to manage losses
1. No K-1’s showing losses
49

50. Term Sheets
 Valuation
50

51. Participation
 Participating preferred stock returns its investment and then
shares pro rata in proceeds of a sale
 Non-participating convertible preferred stock either gets a return of
its investment or its pro rata share of proceeds
 Participation may be capped at a multiple of the investment
 Conversion to common – auto-conversion and majority vote
51

52. Dividends
 Preferred will have a dividend preference.
 A cumulative dividend on preferred shares must be paid before
any other dividends on common.
 If the company can't pay out a cumulative dividend in a year, the
amount is carried forward.
 Common in private equity deals, not in venture
 Non-cumulative is only paid when as and if declared.
52

53. Liquidation Preference
 Who gets paid first and how much?
53

54. Example of Liquidation Preference
 1X Nonparticipating convertible preferred
 $1,000,000 invested for 10%
 Ex 1: Exit (sale) of company for $5,000,00
 Ex 2: Sale for $20,000,000
54

55. Board Representation
 Size of board
 Founder-friendly boards
 Role of the Board
 Observers
 Indemnification
 Insurance
55

56. Board Rights
 Indemnification
 D&O Insurance
 Right to designate
56

57. Protective Provisions
 Class vote or majority vote
 Delaware law
 Separate vote for later investors
 Do the interests of different investors diverge?
57

58. Protective Provisions
58
Standard:
 Right to veto or block certain corporate
actions
 Sale of the company
 Amendment to the company’s certificate or
bylaws so as to adversely alter or change the
rights of preferred stock
 Increase or decrease in the number of
authorized shares of preferred or common
 Authorization or issuance of equity security
having a preference over, or being on a parity
with, preferred stock
 Redemption of shares of preferred stock or
common stock
 Declaration or payment of dividends
 Change in the authorized number of directors
of the company
Other:
 Hiring, firing or change in the compensation
of officers
 Any transaction with any director, executive
or employee of the company
 Incurrence of indebtedness in excess of
$[____]
 Change in the principal business of the
company or the entering into any new line of
business
 Any purchase of a material amount of assets
of another entity
 Option plan increase

59. Information Rights
 Financial statements and other information
 Thresholds
59

60. Registration Rights
 Requires a company to list the shares publicly so that
the investor can sell
 Demand rights
 Piggyback rights
 S-3 rights
60

61. Common Restrictions: Co-Sale
Rights, ROFR, Drag Along
 Co Sale and Tag-Along Rights – right to participate in a sale
 Right of First Refusal – right of company (first) and investors
(second) to require shares to be offered to each of them before a
third-party sale
 Drag Along – right to force shareholders to sell in an exit
 Board, common and preferred approvals
 Small shareholder carveout
61

62. Founder Vesting
 Term, milestones, commencement
 Acceleration
 Single and double triggers
 Fire the Founder
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63. Pro Rata Rights
 Right to maintain, right to participate
 Major investors
 Limited by amount of money company wants to raise
63

64. Option Plan
 Increased pre money
 409A valuations
 Extended exercise periods for NSOs
64

65. Redemption Rights
 Feature of Preferred Stock
 Right to put stock to company, usually after a period of time and
over time
 Is effectively a right to force a sale of the company
65

66. Anti-Dilution
 Broad-based weighted average
 Narrow-based weighted average
 Full ratchet
66

67. Exclusivity
 No-shop
 30 to 60 days
67

68. Nonbinding
 30 day no-shop
 Confidentiality
 Is it really nonbinding?
68

69. Planning for Later Rounds
 Overly favorable terms
 Valuation planning and down rounds
 Reverse splits
 Cap table management
 Fire the CEO
69

70. Troubled Company Terms
 Forced conversion to common
 Full ratchet
 Uncapped participating preferred
 Insider rounds
 Low valuations
 Down rounds
 Trigger anti dilution protection unless waived
 Pay to play
 Requires existing investors to invest on a pro rata basis in
subsequent rounds or they lose preferential rights (anti-dilution,
liquidation preferences, voting rights)
70

71. Successful Exits
 IPO
 Sale or Acquisition
71

72. Unsuccessful Exits
 Zombie Companies
 In re Trados Inc. Shareholder Litigation
 Bankruptcy or Insolvency Reorganizations
 Fire Sales
 Management carveouts
 Fiduciary duties: shareholders, optionees, preferred and
creditors?
72

73. Other Unsuccessful Exit Issues
 Tax Liability
 Personal Liability
 Tax
 Employment
 Fiduciary Claims
 Securities Law Claims
 Contractual
 Pierce the veil and creditor claims
 Serial Entrepreneurs and failed companies
73

74. Bibliography of Essential Reading
 10,000 Startups: Legal Strategies for Startup Success, Roger Royse
 Dead on Arrival: How to Avoid the Legal Mistakes that Could Kill Your
Startup, Roger Royse
 Straight Talk For Startups, Randy Komisar and Jantoon Reigersman
 The Startup Checklist, David S. Rose
 Angel, Jason Calcanis
 Venture Deals, Feld and Mendelson
 The Startup Game, William Draper
 Secrets of Sand Hill Road, Scott Kupor
 How to be the Startup Hero, Tim Draper
 Make Elephants Fly, Steve Hoffman
 Getting to Wow, Bill Reichert
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77. © 2023 Haynes and Boone, LLP