Raising your First Cheque and Decoding Term Sheets
Founders have a tough task ahead of them as they set out to raise their first round of funding. I, Sanjay Mehta, founder and partner at 100X.VC will give you some guidelines detailing how to go about the same. This would also shed light on iSAFE notes and term sheets.
100X.VC is an institutional fund that aims to support founders by nurturing their ideas and helping them navigate the crucial seed stage. 100X.VC believes in simplifying funding so that founders gain the knowledge to carry it out efficiently. To do so, founders should initially work on and articulate the following questions about their start-ups.
What is the reason for your company's existence?
Mission: Stating the problem that you plan to solve with your idea
Value proposition: The solution you offer to consumers
Elevator pitch: Your ask from investors for your idea
These elements should give investors an idea of why your business needs to exist in today's world. Entrepreneurs are believed to have the mindset to commit to their plan by overcoming all obstacles, coupled with irrational perseverance. This should reflect in your mission, value proposition, and pitch to investors.
Where could your company be?
This section talks about your idea's potential, its place in a consumers lives, and your expectations.
Potential market size: The total market size that is affected by the problem you wish to solve.
Addressable opportunity: The share of the total market you expect to impact with your idea.
Positioning and Segmentation: How you group and target consumers in the market.
Why will consumers want your product?
Your product could be world-class, but consumers should buy it for it to be successful. It could be classified as a painkiller, which means it would sell on its own due to dire need, or a vitamin, which consumers feel the need to have. Either way, you need to first define the space in which your product falls for consumers. Non-linear growth projections for your business idea and a plan to achieve the same would also excite investors.
What investors are looking for is an entrepreneurial mindset. Entrepreneurs build wealth, not income. Thus, including a huge share of funding for the founders' income could be a red flag. It is expected that, as a founder, your main aim is to grow the business and direct incoming funds for the same rather than for you personally. A reasonable amount for your income can be stated without an issue.
Why is this the right time to start this business?
Timing is crucial for start-ups, and external factors that determine your start-up's existence need to be evaluated diligently.
Economic impetus: Better ways to do things which enabled your idea to grow.
Enabling technology: Evolved technological support which fuels a trajectory of innovation.
Cultural importance: The rising significance of cultural or social factors.
Where are you now?
Metrics: Get clarity on numbers and financials. Define the metrics most relevant to your growth.
Capital: A clear idea about the investment required and how it would contribute to the future of your start-up would help investors know where you stand.
Team: Identify the competencies and gaps in your current team and articulate the points you might need to work on.
Why isn't everyone working on it?
Investors usually ask this question to know what sets you apart from other players or other similar ideas.
Competition: Who are other players in your space?
Unfair advantage: What sets you apart from the competitors mentioned above?
Disruption: What change can your idea bring?
What will you do better?
Having listed your competitors, you need to be sure of what would set you apart from them.
It can be in either of the following three domains:
Execution: On-ground implementation of similar ideas can set you apart
Delivery: Actual product/service features and elements can be your USP
GTM: Your business model and go-to-market strategy's robustness can be the reason investors would be attracted to your concept.
100X.VC Investment Thesis
Founding team: The combined skills, knowledge, and experience of the founders.
Market size opportunity: The potential of the idea
Business model strength: The robustness of your strategy
Unfair advantage: What sets you apart
Returns: Conviction of minimum 20x returns
These are the five elements that 100X.VC scrutinizes before committing. 100X.VC works as an operator VC that helps founders achieve their goals, build networks, and raise capital for future funding rounds as well. To gauge how your investors perceive you, start thinking from an investor's mindset towards your idea.
Questions and doubts show interest in your idea. They are usually around what investors might have perceived to be your weak link. For example, questions about expected growth can mean the investors are trying to determine scalability. While it usually takes about seven meetings to close a deal, you must calibrate and re-articulate your pitch after each meeting according to the questions you were asked to prepare a more persuasive pitch in your next meeting. What is a term sheet?
A term sheet is a letter of intent. It is a starting point, and the investor's focus and attention on the deal are at its max point when it is being signed. While it does not include the promise to invest, it consists of the deal's key terms between VCs and the start-up.
Pre-money: The company valuation before the investment round
Post-money: The company valuation after the investment round
Both mean different things based on your contract since your equity stake also changes correspondingly. It is better to clarify with the founders which one you refer to when you touch upon valuation. Investment Documents
One of the following is used to raise the first stake for start-ups:
SHA: Shareholder Agreement
This is a clause usually used to guarantee returns to the VC in case the start-up undergoes a less-than-desirable event such as a merger. Typically, at the seed stage, the liquidation preference is 1X, and it usually increases in further rounds.
Drag-Along: These rights enable the investors to force the founder to join in the sale of the company
Tag-Along: These rights ensure that investors' shares are also taken into account during the sale.
Anti-Dilution Rights: These protect investors if the company raises additional financing at a lower valuation than in the previous financing round.
These rights exist to safeguard the VC from future unprecedented less-than-favorable outcomes for your start-up.
The iSAFE(India Safe Agreement for Future Equity) Note is a reliable instrument to carry out your investments. By agreeing to this, you defer your valuations to a future priced round, when the company would be more mature than it is currently.
Some of the key elements of iSAFE are as follows:
Not a debt instrument since the start-up is at a very early stage
It is a CCPS (compulsorily convertible preference shares) instrument.
No valuation requirement.
No board seat.
Very few consent rights/reserved matters.
No reservations on ESOP shares coming exclusively from founder's shares.
No voting rights to investors.
No forced employment terms with founders.
No forced exit rights on founders or the company.
No enforced opinion in founders' remuneration.
No commitment and non-compete clause.
In all the above points, iSAFE is different from standard terms. 100X.VC uses iSAFE extensively. Through this agreement, the investors stay on in a consulting role without interfering with start-up founders. Rather than enforced rules, differences can be resolved by consensus after discussing the issue through this process.
Pitching to Investors
Every sentence of the pitch is essential as it forms an impression upon the investors. The best way to create a memorable pitch is by supporting all statements with numbers and impact, which investors can easily understand. Founders need to remember that their goal is not to close the deal but rather to get the next meeting. Investors can't commit on the same day.
At 100X.VC, investors are looking for founders with a believable dream and evidence which convinces them how they will achieve the same.
Why start-ups do not get funded
VC is the right option only for businesses with a huge value return at the end since investors are not interested otherwise, even if you have a strong, robust business.
Many businesses focus a lot on the product and do not convert the product to business before pitching.
Lack of focus on how to use the capital that they ask from the investors.
Advice from wrong people. Founders need to listen to experienced people with similar journeys, yet remember that every journey and business is different.