Category Archives: Term Sheets

Angel Investing – Burn Rate & Cash Runways

Businesswoman presenting her business ideas

One of my favorite First Round Capital Holiday Videos is the the 2014 release – “It’s All About Burn Rate”  set to the tune of Meghan Trainor’s “All About That Bass”.  I sometimes find myself humming that tune when I am reviewing an investment opportunity from an entrepreneur who does not fully appreciate the importance of understanding how burn rate and cash runway can impact the success/failure of their venture. When analyzing the financial structure of an investment opportunity, I try to evaluate both the amount of time the funding will last as well as the milestones/traction that the funding will enable the company to achieve. Will the proposed funding result in:

  • Achieving cash flow “break-even” which allows the company to have some measure of control over their financial destiny?
  • An inflection point of milestones/traction that will position the company to raise another round of funding at more attractive valuation levels?
  • Landing in the “dead zone” – not enough traction to attract the next round of funding and without further funding in need of cutting expenses.

Break-even:

If the current raise enables the company to generate enough recurring revenue to operate on a break-even basis, then the company can continue as an operating entity without having to lay-off staff, reduce marketing outlays or frankly shut the doors and cease operation. The company needs to have a clear understanding of their variable versus fixed costs – what expenditures are mandatory to allow the company to survive versus those that can be reduced or even eliminated for a period of time. Growth may be slower than desired, but may at least provide the company the time to pivot their strategy or hold out for a more attractive funding environment.

Traction reached for next round:

For most of the companies in which I am investing, there will be multiple rounds of financing required before the company is in a position to exit. It is critical to understand what are the milestones/traction that the next investor will require and how does the company plan to achieve these milestones within the runway provided by the current raise? On the expense side, does the company have a strong grasp of the resources required to execute on the plan? Do the assumptions for revenue recognition take into account a realistic sales cycle for the product/service being offered?

The “dead-zone”:

Unfortunately, many companies end up in this position either because they do not raise sufficient capital or do not have the ability to actually execute on the plan that would position them to be attractive to the next investor. I find this oftentimes with companies that utilize convertible notes and end up within sight of the maturity date without enough demonstrated progress. As an investor, I am usually faced with the decision to extend my note, invest more in the company to provide some life support, or hope that there is at least some asset value to be distributed to note holders in the event of liquidation.

Remember as the music states – “It’s All About Burn Rate” 

 

Angel Investing – Ringing in the New Year 2014

??????????????????????????????????????????????????????Yes, it’s that time of year once again when we  think about resolutions for the New Year. In last year’s New Year’s post, I suggested that you think about the composition of your investment portfolio, taking into consideration the amount you want to commit to this sector overall as well as the diversification goals that make the most sense for you.

Here are my three tips for 2014:

Know your co-investors:

If the three most important criteria in real estate are location, location, location, then the top three for angel investing would be alignment, alignment, alignment. Not only is it important for investors and portfolio company CEOs to have alignment in terms of their vision for the company, it is just as critical for the co-investors to be aligned. When the business needs to shift direction, there is a follow-on round required,  or an exit on the table, having conflicting objectives among your co-investors can be quite problematic. The advent of funding platforms has made knowing who else is in the deal somewhat more challenging. Entrepreneurs will oftentimes do some due diligence on potential angels, I would suggest you do the same on potential co-investors.

Get your investment dox in order:

Whether there is a follow-on round contemplated or a potential exit on the table, it is also very important that you know both your rights and your obligations as an investor. Where did you file those stock certificates? Do you have pre-emptive rights? Know your options and obligations before a follow-on round or a potential exit.

Look at the world through the lens of an entrepreneur:

Whether it’s negotiating a term sheet or evaluating a major strategic shift, it is always helpful to put yourself in the other person’s shoes. When I review a term sheet for a potential investment, first I read it as an investor, then I read it as though I am the CEO receiving the term sheet. I also enjoy reading books and blogs directed at entrepreneurs. Here are a few of my picks:

If you have a great resource, let me know in the comment section below!

Have a very Happy New Year!

Angel Investing – Term Sheet Liquidity Provisions

Gold Guys With MoneyIn previous posts, I have described how certain term sheet provisions impact the Economics, Control, and Value Protection in a proposed investment. In this final post on Term Sheets, I will discuss some provisions that impact the Liquidity of the investment. Continue reading

Angel Investing – Term Sheets and Value Protection

Accountant With Giant Golden CalculatorThis is the fourth post on Term Sheets and how they impact returns to investors. In addition to economics and control, term sheets also contain provisions that impact how as investors we can add some level of protection for the value of our investment. Although there are a number of provisions in the term sheet addressing this, the three most important to me are:

Angel Investing – Term Sheet “Control” Provisions

teamwork rowingIn a recent post I discussed the “economic” aspects of a term sheet. In addition to laying out the economics of a proposed transaction, the term sheet also provides a road map to various issues revolving around “control”.  As angels, although we are not involved in the day to day management of our portfolio companies, we need to have a voice in strategic issues that impact our portfolio companies. Typically this “control” is exercised either through: Continue reading

Angel Investing – Term Sheet Economics

RechenschieberIn my last post, I listed four areas that Term Sheets cover. This week, I thought I would focus on some of the “Economic” terms. The terms below apply to Convertible Preferred Stock, although there are clearly other types of securities used to fund early stage companies.  These “economic” terms outline who gets what and cover such concepts as:

Valuation: For a Preferred Stock Offering, this represents the per-share price that you will be paying for the investment as well as the “pre-money” company valuation that this price implies. In addition, the term sheet will typically indicate the “post-money” valuation which includes in the company valuation the new funds being invested. Continue reading

Angel Investing – Term Sheets and Country Western Music!!!

Hank WilliamsProbably one of the things I have found that many of my fellow angel investors enjoy even less than analyzing the financial model of a company they are contemplating investing in (see my last post ) is diving into the Term Sheet. A  term sheet is a document that lays out the key terms of a proposed investment. Once those key terms have been negotiated and the term sheet is executed by both parties, it serves as the basis for drafting the other documents which comprise the legal closing documents in a transaction.

At a recent meeting, one of colleagues made the comment that term sheets are like country western songs – you know those soulful ballads that bemoan the difficult breakup, the secrets never shared, the soulmate you trusted who walked away and left behind a pile of debt……  When you make an angel investment you are not only entering into a financial transaction, you are entering into a relationship with the CEO/founders/management team. If you have been investing in this sector for awhile, it is likely you have made at least one investment that did not turn out as planned!  Another way to think about the term sheet is a kind of “pre-nup” for angel investing. Clearly if you don’t really believe that a particular investment has the potential to be a good partnership over time, you probably shouldn’t make the investment. Continue reading