Capital Education video resources

[Marilyn Mrkusich]

So five things that, as the company raising funds, you'll want to make sure in your term

sheet are, firstly, the nature of the investment, so what is it that the investor is going to get

for the investment. Most commonly this will be shares but it could be something different like

a convertible note. The next one is the price or the amount payable for the investment.

You need to be very clear on what they're paying you, for example, the price per share and

when they are paying this amount, are they paying it all up front or one lump sum? or

perhaps in tranches over time? The next one is any conditions to the investment so

important one for actually both parties is to make sure that the investment is conditional on

entry into the formal legal documents, such as the subscription agreement or the

shareholder agreement. You will also need to make sure that it’s very clear what terms of

the term sheet are binding and what terms are not. Another term that is important to include

in your term sheet, are any key agreements as to the shareholders agreement, the

shareholders agreement will be negotiated at a later stage in time, but it can be helpful to

have these discussions now to make sure that you don't lose your investor further down the

track because you're at odds on any particular term to go into the shareholders agreement.

The investor will also want to include a number of things in the term sheet, so five things

that the investor may be looking for include milestones, they may ask the company to

perform at certain tasks or meet certain key indicators by certain dates and insert some sort

of consequence for not reaching those, for example if they are paying their investment

tranches and a certain milestone is not meet, the next tranche of investment may not be

forthcoming. They may also ask for founder commitments from you, so that is a commitment

that you will perhaps stay in your role in the business for a minimum period of time, or that

you will maintain a certain minimum threshold of shareholding to ensure you have some sort

of skin in the game. An investor may also ask for reporting obligations so some sort of

periodic report from the company, as to perhaps the financial status of the company or

where you’re at with product or technology development.

An investor may also ask to include a term on employee share schemes, that is a statement

as to whether there will or will not be an employee share scheme, and what number of

shares will be set aside in the company for employees to take up.

So this brings me to my final general comment about term sheets, generally they are not

binding on the parties, that means one party cannot compel the other party to comply with

what it has agreed to do in the document. Some terms will be binding, for example the

boilerplate, the confidentiality clause, but generally they're not. However, having said that, as

between the parties, they will probably consider the terms ‘as binding’ as the deal being

done, and if you try to change the terms of the deal further down the line this, will probably

be met with resistance.

[Julie Fowler]

So this is going to be a session on term sheets, we have a group of us here to talk through a

term sheet and to discuss it from the investors perspective and from the founder/company's

perspective. So from the investor's perspective we have Damon Crowe from K1W1, Damon

is one of the managers there who has been involved with K1W1 for many years, and K1W1

have been deeply involved in the high-growth tech sector for over 10 years-


[Damon Crowe]

Nearly 20 years.


[Julie Fowler]

Yeah yeah, a long time. Ben O’Brien is the founder and, one of the founders, and CEO of

StretchSense, StretchSense is a company based in Auckland that produces wearable,

stretchable technology that can-


[Ben O’Brien ]

Measure the body.


[Julie Fowler]

Thank you and StretchSense has been through a number of capital raising rounds, five at

the last count so he's well experienced in the process of raising capital and negotiating term

sheets. So for the purposes of this discussion, we have produced a term sheet, it's just an

example term sheet that we put together as a basis to foster some discussion from these

guys. So do download it and look at it as we go through this conversation but please

don't use it as a template, it's not intended as a template. If you want a template you can go

to our websites, Simmonds Stewart, and there are template,term sheets and doc makers

there.


[Julie Fowler]

So we thought we'd kick off today with a bit of a discussion around how you get to the

point of a term sheet, I think that's probably the harder part and Ben thought he might give a

little bit of a chat about that.


[Ben O’Brien]

Okay so you know we're here to talk about term sheets but actually from a founder’s

point pf view, getting to this point is quite a hard road, expect to be rejected, order 50 to 100

times to get there, expect to have to rewrite your business plan for a similar number of times,

actually you go through a process where you're trying to do something but then you're

getting feedback from investors from your customers from your own team as you go and so

things are changing all the time. As a general rule I don't think you should ever negotiate or

try to raise money without getting your company stable, and at least at the break-even

point first, whatever that means to you at that moment, it could mean a salary, it could mean

hitting sales or whatever it is, because the bias for investors is to wait as long as possible

right? If you're a company that's in distress, everything helps the investor to wait because

you may pull out of it, in which case that’s great, that's a risk that doesn't materialise, you

may go down, great, in which case they dodged a bullet, but in all scenarios the price goes

down if you're more stressed. So yeah, get your company into a state that's investment

ready, get it into a stable place and then settle in for a long road of getting rejected over and over and over again and over again. It's kind of what I think.


[Julie Fowler]

Ok so I think what we'll do is we'll start working through the term sheet, so what we have

done is put in a fairly standard term sheet with some provisions which are more founder or

investor friendly. Okay so in the term sheet, the term sheet essentially sets out the key terms

of the transaction as you may have picked up from other sessions. It's really important to

set out in the term sheet those terms, and to ensure that you have agreement with between

the parties in relation to those tombs because once they're in the term sheet, despite the fact

that it says it's non-binding, it's pretty hard to move away from them, so it's a really crucial

document. Right so the term sheet describes the business sets out the parties, now it sets

out the types of shares and the term sheet that we have in front of us that says that

there will be ordinary shares, would that be something you would normally invest on the

basis on?


[Damon Crowe]

It depends on the statement and I think it's important to the statement with the

term sheet with all these terms, it can be investor-friendly and it could be founder-friendly

and it can be fairly neutral terms, and probably at least half of these terms it can be, you

know, one or the other or a mixture of all of that, so when the class of shares, it's really can

relate to the stage of the company, but for this refer we've certainly got a preference towards

a risk-sharing approach which involves more about ‘last in first out’ in which we get more

preferential return on the sale, so if you put your investor money and you get that out

first, generally a fairly benign way of doing that is just one time, so if you put half a million

dollars in, you get half a million dollar back before everyone else. There are other variations

on that, anything more aggressive than that tends to be sort of investor-friendly and almost a

little bit aggressive, now certain groups do prefer participating, preferences which is where

you can get your money and then you're sharing the leftovers, the good thing about

preference shares is they tend to focus the mind on returning investors capital, a lot of

investors are protective of their capital. So we found a really good way to share the risk that

if you do invest at a high-valuation and things don't work out, but there are some residual

value then you tend to share, you give your an investors their money back and then

everyone, if there's anything leftover, you know, the founder can pick up the spoils on that.

So we certainly prefer to invest in preferred shares but depending on the stage of the company, you

know, you can do ordinary shares. It's really a risk-sharing approach for us.


[Julie Fowler]

What would your approach today be, Ben?


[Ben O’Brien]

Umm, I think I kind of agree like 1x preferences, fairly normal and standard, anything more

than that, and especially participating shares are no, that's getting a bit rough. But what you

do have to watch out for, as the founder, is preference stacking. So whatever you agree to at

this point generally subsequent investors are going to get those same terms and those will

stack on top of each other and you can get into a situation where it becomes extremely

difficult for anyone, anyone early, to get money and this can impact the early investors as

well, so this is structured to be like a very very early-stage company looking at this term

sheet. You know, it has things in here which I'll talk about later, like you will have

employment agreements which is ridiculous, that should be done ahead of time. And so one

thing to keep in mind is that, if you're established with your early investors preferences

whatever they are, the later investors will get those and because they may be putting a lot

more money in, and because you may come out of it all with like a mix, not really great but

not really bad, everyone who is early may not get something back because of that. So in

some sense, be very aware that the game, like right now, say I'm negotiating with Damon

directly right now, but a couple of rounds later, we're actually going to be on the same side of

the table dealing with a larger investor, larger company, and so we're kind of establishing the

ground rules for that negotiation now. So just just be careful of that and think forward, and I

guess one other point when you're dealing with investors, it's really helpful if you can

articulate what the capital raising story is going to be. Right here's the eventual exit

that we most likely to target, we think we’re gonna do three rounds to get there, okay

that means this kind of valuation that, kind of valuation that, kind of evaluation that,

kind of valuation, that will then set what deal you should do now and it will set what kind of

terms you want to do now because you can say all we're going to be dealing with like a

nasty PE firm or something here. What can we put down now that makes life better then so I

would just, it's I guess what I'm saying is 1x preference, yes, but just be aware that you're

setting rules for a future game.


[Damon Crowe]

Yeah you know exactly, in part, having an having an idea of what your financing strategy

might be overtime helps because if you are going to then follow up, to then go and find

professional investor that, you know, fund or so forth that you know what you said here we'll

be mirrored further on, so the more aggressive lease terms are the more aggressive the

following rounds would be. So I think the other thing is you don't just go touching on all the

issues, work really well at the very early stage and the profitable stage so now if someone's

putting in ten thousand dollars to write a business plan, honestly no one's going to ask for

prefs and similarly if you've got a company that's turning over ten million dollars and

profitable, you tend to use ordinary shares, so it's really that risk-sharing in the meantime

where, you know, you're asking for significant amounts, maybe half a million, a million or

more, and where it, on the flip side, there’s virtually no assets in the company, so you know it

is all goodwill and, so just having that capital return through a pref structure just tends to,

in our view, just leaving that whole risk out. Again, good question for lawyers to think, they

can help you know just explain that to make sure it is just that benign one time pref and that

there’s no other things sneaking in there.


[Julie Fowler]

Yeah and I'd said that in our experience, in the investment community in New Zealand the

standard would be 1x non-participating pref. But there are investors like the Australian VCS

are requiring participation rights and other things, preferences on dividends and things,

so you do have to be a bit cautious.


[Julie Fowler]

So the next thing you need to be really clear about in your term sheet is your pre-money

valuation. That is one of the matters that will usually be discussed at length between the

investor and the company.


[Damon Crowe]

Again it's a risk sharing thing, the type of shares and some of the other monetary terms can

you influence that, it tends to be more the stage of the actual business itself so you know

there's various different models, not a DCF or anything at this stage, more of what stages

your prototype or your early release is at, you know, and it tends to be at certain bands so.

We don't like to see people trying to buck the trend, so I thought there is a bit of a trend

especially with prototype and early revenue in companies because you know we we all know

things change pretty quickly and that's pretty hard to justify outside valuations or some sort

of difference to the main so, yeah they do tend to be in a fairly narrow bands, but it is an

important number, but one that is very, probably one of the the last negotiable there in terms

of coming up with a number that works and I guess, it like all negotiations, if both parties are

a little bit unhappy, you've probably struck on the right number.


[Ben O’Brien]

Yeah I think that's a good way to put it. Um, there's a famous saying “you set the price I'll say

at the terms” right? And so valuation is a tricky one because you have to be willing to have

the conversation fairly early in the piece so that you're not completely, you know, at different

levels, because if you are, you get these horribly disappointing conversations when

everyone's is like “ugh, you’re wasting our time", you know, so you got to have it early.

But you should never really anchor to an evaluation until you see what all these terms are

right? Like for example we just talked about participating, preferred, that completely changes

the valuation that you think you can get right? One thing in here that I really dislike is subject to the achievement of milestones which we've kind of skipped over I like to talk about that.

As a founder you should look for levers that grow your value, things that will grow your value

is competitive tension right? Talking to more than one investor will grow your value, having a

viable business will grow your value right, if you're making money or at least break even then

you're going to get a higher valuation, just very simply, being able to articulate benchmarks

so what Damon just said was we know there are certain bands right, so you say okay what

are the bands, what range is the community investing in, and then what can I do to be on the

high side of those bets, you're probably not going to get outside of let’s be realistic but if you

can articulate well yeah these are the hallmarks of companies in this valuation range but we

have this and this and this and this, so we sit here, that's game you can play very very

cleanly. Being willing to walk, you have to be willing to walk because if you're not, you will not

get anywhere near what you want, and yeah I think one other thing which is important to

think about is the actual amount that you raise, is one of the more interesting levers that you

can pull. Um this one here is based on achievement of milestones, which again I don't like

we can talk about it. Yeah let's go back to that, um but but it may be that the valuation you

can command, and the amount of dilution you're prepared to accept mean that you should

be raising less money. It's possible that that's an outcome as well, and that can be a way to

like line up the party so those some of my thoughts.


[Damon Crowe]

Yeah I guess I mean they’re good points and there's a couple of key ones there. I think from

the valuation perspective, if you have got a plan where you’re gonna raise multiple rounds

and if you do go out too high too early-


[Ben O’Brien]

you can stub yourself.


[Damon Crowe]

you miss a milestone or when you miss, even if it's not a formal milestone you’ve just missed

that revenue point that you should be at if you want to be at certain growth metric, not even a

written down milestone, you know, doing a down around or having a flat round can be very

uncomfortable conversation when you go to do that next round. So, again that’s another

reason why there tend to be bands of evaluation, because you know that if you're going to

raise another round then you want to step it up as opposed to see it all over the place

because they're very uncomfortable conversations with existing investors. I think the

amount is an interesting one too, I mean, there's different philosophies on that, at certain

times in the economic cycle, it's pretty much get as much as you can, because you never

know where the next dollar is. If you've got the luxury of being out of pick and choose and

there's not many companies like, in that boat, you can sort of tailor but again it's there is a

focus on how much the founders retain because a lot of lot of investors do back the founders

through multiple rounds, so if you dilute the founder too much, you know, you can then find

that you lose some of those future investors not all investors are like that, but it's just

something to keep in the back of the mind. Raise the right amount to achieve the right

structure within the company, it is a real minefield. We're probably tend towards take more

than less because there's nothing worse than losing a key, sort of, growth metric, but it is

one of those discussions and we have we arrive front of into the first meeting, because what

you said, it’s not a good point-


[Ben O’Brien]

You want to be aligned right.


[Damon Rowe]

Yeah there's no point in investor doing weeks of due diligence to find out there's no deal to

be done, so we try and approach and see whether there is actually a deal in the first

meeting. It is one of those upfront things that you gotta be prepared to answer and have

good answers otherwise you can find yourself slipping down the bottom of the range, so

something to be prepared for.

[Julie Fowler]

In our term sheet we have set the investment amount, in our case 500 thousand is subject to the

achievement of milestones-


[Ben O’Brien]

Shouldn't be.



[Jule Fowler]

No well the way that works is that instead of the 500 thousand being invested in the

company at completion so when you sign the documents, and they satisfy all the conditions.

Instead of the 500 thousand going in at that one point, it's fed in over a period of time subject

to the company achieving specified and agreed milestones. Now clearly there's a risk

there for the company because the milestones might not be achieved.


[Ben O’Brien]

Subject to achieving a milestone, the most toxic thing about that is not risk on the company

or founders, the most toxic thing is that you are guessing today where successful business

plan will be, and that will distort everything because now instead of maximising shareholder

value, instead of growing a good business, the company has to maximise achievement of

milestones which were a guess in a point in time. And that is what makes that just, I actually

think that doesn't benefit the investors either, the investors should get control by having

directors by having regular reporting by being able to like, be part of the conversation the

strategic conversation about where that company's going. What this is to me is, first of all

they don't actually trust the team well enough because they're trying to put in these extra

artificial things. The person who has proposed this term sheet doesn't understand that this is

a, this will destroy the ability to focus on what really creates value for the company. I just I

just don't like it as, if there's really a key milestone that needs to be hit, whatever it is, invest

less, and do another round if that's really a problem. I don't know, I think it can be som place

for a larger company for milestones like if there's an established proven business model and

you're more worried about execution against, that that's it's like hey we want to, this works

we want to do it in Australia or whatever, like if it's that kind of an investment then sure I

could understand that, it makes more sense but for a company like this I just think it destroys

value for everyone because it's the wrong way. Yeah everyone, you know, we have a theory

about how to make value if that changes in an month, we should sit and talk and do that

rather than be like ”‘well no, but the investment sheet said…”.


[Damon Crowe]

There can be a case for sort of one or two milestones, we tend to be, i guess, really prefer

no milestones, or very light milestone so if someone said, you know, I have prototype built

in three months’ time, well then you might say “here's the money to build the prototype”,

when in four months, and then you, get sort of, to the next stage. So I think they've got to be

very achievable, almost founder-friendly milestones.You know, they’re either obvious, so if

someone hasn't built something within four months, then clearly that there's something

terribly wrong.


[Julie Fowler]

I would say that from what we see in the market, milestones have become much less

common than they were meant a few years ago. So I think everyone's, there’s a quite a lot of

alignment between investors and companies on that now.




[Ben O’Brien]

This valuation is calculated on a fully diluted basis, so for the viewers at home what that

means is that any options or things that aren't actually shares but where someone has a

right to shares, are calculated as if they were shares. And then if you jump over to the ESOP

section it says an ESOP plan will be established by the company prior to completion. So one

of the traps here especially for the founders is that the dilution from the ESOP can come out

of your shareholding and not the investors’ shareholding, and so… Now that might be okay

but it should be extremely clear and, like, where that's coming and what happens. Because

otherwise what can happen as you get into this weird situation where the founders are being

diluted by the ESOP and they’re the ones running the company, the investors aren't and so

post-investment, the incentives for the founders are to not use the ESOP, that that can be a

point of risk here. So I'm just I'm kind of flagging it, it doesn't it's not like, it doesn't kill a deal

but you have to be really clear that this game around when an ESOP is provisioned for, can

often, if it, especially if it happens before an investment round is completed, it can be a point

of divergence, and that one groups’ incentivised one way and the others the other way. So

having that really clear and explicit and it if you are being diluted more than investors then

guess what, the price can go up a little bit right? Because that's, you know, in the overall

negotiation, one person's wearing more risk there, so, just want to be-


[Damon Rowe]

You know I think ideally because there is a schedule here for a cap table and generally, just

about all term sheets we sign were aparting to a- yeah that's already been fleshed out. So

50 entrepreneur and the investor [20:50]. Knowing exactly whether it's a 10% ESOP, 5% or

20%. It all depends on the reason for the company what the company is going to need down

the track as to whether it’s between 1 or 20% ESOP, but generally for early-stage it might be

for the five to ten. But that's clearly mapped out.


[Ben O’Brien]

Yeah that's the key point, as if it's not clearly mapped out, what happens is everyone gets

to the line and then they suddenly say “Oh wait”’, and suddenly someone has to lose value

and… yes as long as it's going to be clearly mapped out that's the point.


[Julie Fowler]

It's really important the investor a company understand the cap table from the outset and are

a really clear on what's in there. Because that sets the valuation price per share, and clearly

the dilutionary effect of any ESOP that’s agreed. And there have been a gazillion examples

of the cap table instead of being the first thing discussed, being the thing that's discussed

just before you sign the documents which is a position I'm in right now with a deal.


[Ben O’Brien]

Yeah and that is a problem.


[Julie Fowler]

Yeah it is, it's surprising people don't focus on it until the last minute even though it's been

circulated a gazillion times.


[Ben O’Brien]

I think there’s one other point with cap tables, always be able to work in terms of price per

share and as a founder you need to know how to do a cap table and it's actually more

complicated than you think but once you get it right it's very straight forward. And that should

never be something that investors are providing to you. Also not only should they not provide

it, you should have your own cap table and know the state of your company, but also that's

kind of how you scenario plan for the different investment outcomes right, you need to be

able to calculate well if we've raised as much money at this valuation and then these things

happen this is what will happen, then we'll get this much money on exit and now get that

much money. You need to be able to do all that scenario planning because that is the the

playing field for the negotiation so, learn how a cap table works really really closely and be

very comfortable with that conversation before you start negotiating.


[Damon Crowe]

Yeah make sure you have that discussion many about ESOP because some investors

are, you know how they do think there are only very key staff, other investors are quite

happy for even the secretary also, you know, or the doormantp have some shares so

it is something that needs to be discussed up front.


[Julie Fowler]

Yeah, the other reason for making sure you retain and manage your own cap table is

because your investors will have their cap table as well or usually they do. it’s so that you

can do a check because if there are discrepancies between those those two cap tables, you

need to figure out why that is and, you know, there are occasions when it's the investors that

is wrong and so everyone needs to know they're on the same table, and you don't want to be

relying on theirs if you don't have yours to check against.


[Ben O’Brien]

And actually, I agree on the rounding method, one of the like, you will, like no one thinks

about it, but as the size of your rounds, so rounding for round,as the size of the amount of

money you're raising goes up, then the influence of the number of decimal points of your

calculations become more and more important. At the beginning doesn't really matter but

after a while you find out that you need four or five decimal points and there are still like

ten shares here or ten share there, or all so many dollars here, so many dollars there and it

can be really frustrating when you're right up against the line and you suddenly find out okay

wait a second, we've got 80 bucks of shares that we don't know how to allocate and these

these deals are incredibly structured. So everyone signs it like a thousand times, it’s like

usually three or four different sets of documents and the definitive agreements. Everyone's

signing everywhere, so to just arbitrarily give someone extra shares is not easy to do you

just can't do that. And so being clear about just the mathematical precision of your

calculations up front, is actually something that's really important.


[Damon Crowe]

But just on ESOP, so I mean I can just see my little bit in terms of your math, I mean one of

the things we found with ESOP is, generally once you've decided on the numbers it's pretty

much a lawyers game after that.


[Julie Fowler]

So the next provision in the term sheet that can come up is a founder lock-up and what

a found a lock-up is a restriction on the founders from selling their shares for a period of

time. And I can explain what that's about but I guess I’ll leave guys to talk about it. So

Damon, is it something you look for.


[Damon Crowe]

Yeah generally I mean there's a few terms here that kind of go together and this is one of

them. You know founder lock-up, obviously with early-stage investor, you're backing the

person, so the last thing you want them is to bail on you. So if they're selling out you want to

be selling at the same time. Yeah really founders shouldn't be selling until the company's

profitable, really it’s a high-level rule of thumb. Even then, you know, you still would ask

questions as to why founders are selling, although there is a, if the company, if we founder,

when give or takes five or ten years for company to become profitable it's not unreasonable

for a founders who want to make some money off the table at that stage. But certainly the

early-stage where they, you know, company is quite young and you're really backing

someone's word on that they can, you know, finish a prototype and launch product can get

some early revenues, you really hold the reliant on them so if they're selling then that's a real

red flag. So it could, it’s quite a reasonable provision for an early-stage company.


[Ben O’Brien]

Yeah I think I generally agree, although maybe tweak some of the numbers a little bit and

add some more exit clauses would be my thinking. So it's three years, in mean in one sense

no one should be able to sell shares without a special majority anyway so telling a founder

they can't sell shares when no one can transact anyway in some sense is superfluous. I've

seen more commonly provisions like if a founder quits operationally, there maybe some kind

of share penalty which I'm not, try not to have it but that's often where it goes.


[Damon Rowe]

That’s the next one.


[Julie Fowler]

no no, that’s a separate one, I didn’t include in because I do think it's so draconian.

So what Ben is talking about there is if a founder ceases to work in the business, so what

we were just discussing is not selling your shares, but if a founder resigns, what should

happen there, and in some circumstances and investors will ask for, will require that those

shares be boughtl back from the founder and sometimes a punitive discount.


[Ben O’Brien]

Yeah or nothing, so yes I guess that's my point is like, I agree with Damon that you back

the horse, back the jockey not the horse, back the jockey not the horse. But share sales

themselves are generally so controlled like, I'm surely there are vetoes that the investors will

have to block anything, they'll need to be a special majority, like you, there are be so many

layers of protection around share sales for a company like this. This is not a publicly traded

company all right, that generally doesn't come up so-


[Damon Crowe]

it doesn't get triggered.


[Ben O’Brien]

It doesn't, it'll never get triggered, there's no scenario that gets triggered, so the more

relevant scenario that will come up will be people will say well ok that's fine, but what if you

stop working for the company and you just wanted to come silent and so I think in that

provision, when that comes up I'd like to have some provisions for sickness or disablement

or like you know force majeure act of God, whatever you want to call it. That's important

because you know it could be that your, you know, partner gets very very sick and it's totally

outside of your control and that's just life, and so I don't think that the investors should be

protected from common risks outside of your control, they should be protected from you

saying you'll do something and then just getting cold feet. That's where I think the protection

should come in.



[Julie Fowler]

So another provision that's in the term sheet is founder vesting. Founder vesting as a

provision which means that despite the fact a founder might, may own say 40% of the

company at the time the investor comes in, if that founder ceases to work in the business

within a specified period, often two or three years, the company has the right to buy back

some of those shares so that the founder may end up holding only 10% of the shares in the

company because his shares have been bought back, because he ceased to work in the company.


[Ben O’Brien]

I think I’ll just add that, so from a founder point of view one thing you want to be really

careful of here is that, like Damon said we're backing the founder so they shouldn't leave

and that’s fair enough which is why you're going to have to agree to something like this,

okay. The problem is, there are other scenarios that can leave to an untenable employment

situation, right, which the investors can cause. So for example, the investor might change

like maybe I really like Damon he's a fantastic guy I've known for ten years and I I'd like

to back him as an investor, but then he gets sick, someone else from his fund replaces him

and that person just sucks, they want way too much information, they meddle with the

business, they come in they talk to the the management team and bypass the CEO. That

person sucks. And at that point the founder is now in a situation where their business is

being destroyed by the actions of the investor right, whether directly or indirectly and they

may want to say like, you know what I threaten to quit unless you change your behavior. And then

something like this can come and bite you really really hard because the investor who is not

Damon, not the person you had the relationship with, can say “Ah you know what, take it”, so it's-



[Damon Crowe]

At the moment, there’s ways to deal with this is in the detail on someone because I mean

this is a fairly general clause, and it's one where you should have a certain, first draft of the

term sheet. It's really something that needs to be discussed, because you know certainly

over a period of 36 months, you would expect something like this to be very unusual.

So in the full document that this leads to you can actually add some exceptions where

there's a change in control or you can have where it's usually monthly vesting, you can't

have a cliff where everyone, you get the shares after 18 months in, if a certain action occurs.

So this is a very general clause for what could end up being quite a detailed clause with the

number of exceptions. Something that just needs to be discussed upfront but just to be, I

think, to be aware that it is becoming fairly standard that a large block of unpaid shares

are often being expected to be put up, be put at risk.


[Ben O’Brien]

And I think, to the founders I think that's okay, but like Damon said, you need to be

thinking okay what if it goes wrong not because the fact, because that, this is to protect the

investors, if the founder does something wrong but from a founder’s point of view, you

should be thinking well I intend to stay in this for a very long time it's gonna take you ten

years so this is okay but you should be thinking what if it goes wrong because of the

investors’ point of view, and if, from the investor point of view and if you put-


[Damon Crowe]

That's where you’re going to do your homework to them. And there's sometimes after the

founder to make sure that you know if you're getting a fund or investor on board, and that

you know, if you've satisfy yourself with a long-term investors.




[Ben O’Brien]

Definitely definitely.


[Damon Crowe]

You know there are fly-by-nighters, but you know, again that's up to the founder to really

make sure you're not being backed by a fly-by-nighter, someone who isn’t for the long term.

Again, that’s a negotiating point.



[Julie Fowler]

So another point that will be in the term sheet is an expaniation of the fact that, before the

company issues new shares, it will need to offer those shares to the existing shareholders,

specifically the investors. Completely standards you don't have to worry about that. I don’t

think we need to discuss it. The point that can be discussed, and can be slightly contentious,

is whether investors have the right to oversubscribe, which means not only do they get the

right to subscribe for their pro rata allocation of the next round, but they also get to say “Oh

and in fact, I want to take more of it”. Now this can be an issue for a company because they

might want to take a new investor on board because that person has connections they want,

or usually connections, industry knowledge, something like that. And so if your existing

shareholders take the round or take more than their pro rata allocation of the round, it

limits their ability to take on that strategic key investor. And so it can be a point to be

discussed. What's your, K1W1’s view on those situations Damon?


[Damon Crowe]

Again, that's probably my main discussion point and it depends on the stage of the

company. I mean if you, if it's a large capital raising and, you know, you've identified the

need for a specific strategic investor or you want an institutional investor then you

know you're gonna sit around the table before you go and talk to those of that

second round and say well you know, we need an investor on board they're

probably going to want two-thirds of the round so I get key, the key existing

shareholders around the table and say well this is what we think, you know.

So there are the formal rights and then there are the sort of informal discussions, you as

a shareholder, says to what the strategy is. And sometimes it can be a bit hard to

marry the two up, and you’re sometimes stuck with historical. Where you think the

company might be going in one direction, and they might want to bring on you a new

investor and the terms make that difficult. Now in one of the areas we find that is if you have

to go through a pre emption round before you go and talk to a new investor, that's you know

that can be quite difficult, because strictly speaking you should offer, I mean you don't even

know what the new investor is going to want. So that's that's where you've got to get the

board and founders, have got to get the existing shareholders around the table and make

sure you're all on the same capital-raising strategy. But yeah, I mean just for us in

particularly and I know a lot of funds, your pre-emptive right is up to your pro rata, it’s one of

those things you never give up, you know, you want to be able to follow your winners. The

over-subscription ones are a bit in a gray area that you sort of need to sit down with all

involved at that point in time. It's nice to have but it's probably that base pro rata that you’re

really concerned about but, and sometimes you know if you can, if you don't really want to

over-subscribe, sometimes you’d have to put your hand up so we'll leave the next round. So

again it's a real discussion point but it can be, if it's poorly worded and you've got some, and

this is where you got some shareholders are out of the loop, you know, that's where it can

get difficult and that's where it sometimes up to the entrepreneur and the board to bring all

the shareholders along with them and communication can be key, because there's nothing

worse than finding out a company needs money and you haven't very from them for 12

months, whereas if you're getting regular updates and you're on board with strategy,

obviously that's a lot easier to discussion as well so. It can be a difficult one, legally putting

that down as to what, you know, strategically the company might need, can actually can

sometimes be a little bit different.


[Jule Fowler]

Yeah I think it’s, I’ll let you respond too Ben, but in practice you're absolutely right.

Regardless of what we put down in the legal documents when you're doing a follow-on

round, companies should always be speaking to their existing shareholders and investors to

get a sense of whether they are interested in investing, and before you start embarking on

the legal processes to give the round away.


[Ben O’Brien]

Yeah I agree, communication, this is kind of pointless in some sense because the investors

will have vetoes on investment, they'll have, you'll need a special majority and they’ll have

need to have being part of the planning process anyway, so for you to get to the end stages

of some capital raise and then have a clause like this block it, it's just inconceivable because

there's three other ways they can block it. You'll have had to have talked anyway so it's kind

of, its kind of, not to mention every single time you do an new round, at least in the early

stages you're pretty much gonna throw away your whole company documents and start

again from scratch, it's just like, sometimes twice within the same negotiation, like it can it

just, you'll be amazed so things like this, I just wouldn't worry about as few of the founder

you just have to communicate, you have to keep your investors along for the ride and

basically if an evasive doesn't want you to do in your deal, it's not gonna happen because

they'll block it every way they can and if they want you to do a deal why would they do that

and would want to use something like this. It’s just not, it's not super relevant I think.


[Damon Crowe]

Well it's where it becomes relevant, I think it’s a bit difficult to discuss is, is it in a distress

stage, so if if the company hasn't performed and you put some of the entrepreneur's and

some of the the investors want to restart but to restart you have to sometimes reset the

valuation, that's where these terms can become quite difficult because you know, they do

entitle the existing shareholders to certain rights and if you're wanting to, sort of, issue

shares, let’s say at half the previous round that's when it's, these become quite difficult but

you know best thing to try and avoid. Coming up with a sensible valuation and achieve your

growth targets these things, as you say, just gets thrown out the window.


[Julie Fowler]

So next thing which will be really standard in any term sheet is anti-dilution protection. What

that means is exactly on point, if the company raises capital at a valuation which is lower

than the existing round or the last round, then the investors in the last round get a top-up of

their shares to compensate them for that and the magic in this is what formula will be applied

to calculate the number of shares that the existing investors, how many shares the existing

investors get for a top-up. And I am NOT going to go into the math on this and I don’t think

we want to do that, Ben might want to-


[Ben O’Brien]

I kind of do-


[Damon Crowe]

This is the middle of the road one.


[Julie Fowler]

- weighted average rather than than narrow which is what I put there but-


[Ben O’Brien]

Sorry I guess one point here, and yes you're gonna have some anti-dilution protection that's

just table stakes, that's okay, but in my experience most people sign these documents don't

understand what those words mean, at all, and to actually understand it you need to use

numerical analysis so it's actually like early-stage university mathematics to work out what actually-


[Damon Crowe]

It can be, if you're concerned about it though, if you're doing cap table. it's actually not that

hard to whack an example calculation-


[Ben O’Brien]

Yeah exactly which is exactly where I was gonna go with it, so make sure that yo understand

what it is and build a calculator, just do it.


[Damon Crowe]

It’s first year math really, it’s not complex math.


[Ben O’Brien]

Yeah exactly, but if you are, so if you're an engineering or mathematical background, great

but if you are in some field that doesn't have mathematical training just you know what this

means, you will have to do this to some extent. But you know what it means and have a

work example so that you actually like know what the details are and how how it plays out.

I guess that's that's my key thing, because I remember when we first saw one of these one

of early rounds, and everyone around the table was just like well you know that's standard

and they said but what does it, what does it mean, and they said well it's standard that's

what it means, and so you go away and you do the calculations and then you know. So just

don’t just sign up to something that you don't know what it means, never sign a document

with a term you don't understand. I think that's the point.


[Julie Fowler]

And also it is key because there are different calculations, there are different standard

calculation method,s and you may be told one is standard but there are some more

favorable for the founders and companies than others and so that's really key to understand

that as well.


[Julie Fowler]

In any term sheet, you will generally see the maximum number of directors. That's because

it's sort of ties in with a representation that the investor has and the number of voices at the

table. And it's common I would have to say that that number is set at five or six. Do you

have any views or preferences as to the number of directors.


[Damon Crowe]

Practically versus the document, so I mean practically for a very early-stage company that's

just building a prototype, you want two or three. But you might have a provision for up to five

as the company grows, I mean for a company that's just engineering and beavering away,

you just want them to have their head down, bum up and not be overly, having keep

multitude of directors. As obviously as sales grow and the complexity of the business

grows, you clearly want different skill sets and bigger board, but the number is, what works

best for the stage. I think the only, one of the keys is balancing things up, you know, ideally

you want to, say, if it's five you want two invests, two founders and maybe an independent,

you kind of want a balance, you don't want sort of a board stacked all in favor of one group

or the other. So it's got a lot of it's really about finding the balance and then finding the right

number for the practical stage, but the documents often, you’d want document a

decent-sized board with the right balance and then whether that's fully filled out or not is

dependent on the stage of the company.


[Ben O’Brien]

Yeah I kind of agree, the thing that was most glaring to me here is the only person with the

right to appoint a director is the investor, and that that feels wrong to me I think the founders

should be able to have a couple of seats on the board that they they can appoint. But

ultimately, you know, they set the company up that’s their. One thing to be aware of,

directorships really interesting because they sit right at the heart of legal obligations

to shareholders and the outside world, liability for things that the company does wrong, you

know, like tax or health and safety or whatever. Then there's control of the company and

what happens, what strategy and where it goes, setting the culture, and also you know as

a founder you signed up to do a company often because you not just have a vision about

some cool product, but you actually want to learn and you want to grow and you want to

become you know skilled. And so directorships are also about the founders becoming skilled

and learning and getting to work with interesting people and so that ball of different

obligations often pulls in different directions, very very often and then it changes through

time because in the beginning, you know, beavering away on a prototype is different to

scaling international sales, these are different things so you'll have different skill sets that

you require. And so it's one of the most interesting spaces for, I guess, thrashing out that

equilibrium between all those different things, but I would certainly say yeah there should be

a balance. At least, kind of, one person from each stage of investment should be

represented there somehow, represent different blocks of shareholders even though you

actually have an obligation to all shareholders, that's the other interesting thing right? You

get theoretically all the directors represent all the shareholders, and in practice directors will

represent shareholders block, and may even have legal obligations to those shareholder

blocks. It gets very interesting but yeah, I agree a balance is what you would look for.


[Damon Crowe]

And often you see sort of thresholds, so you know founders or investors have got certain

percentages they are entitled to, and that's just a good way for especially if any investor

sells out and you know you can have the same, as long as they hold 10%, because that way

if they end up with just one share, you don’t have a go at one share and entitlement to the

board. But yeah again it's just, and really, a negotiating point of and trying to balance it out

for what works.


[Ben O’Brien]

Yep, and I would say just thinking back to all these terms linked together, so thinking back to

the lock-in period founders, I would definitely tide that to having a directorship and the ability

to appoint directors.


[Damon Crowe]

Founders are prepared to pay fees, yeah I mean not exorbitant fees but I think you know,

there are obligations on directors now as you say for the health and safety legislation that

yes, but it’s very, it's unreasonable to expect directors to do this out of the goodness of their

heart unless they are, so you know, major shareholder, they might do it for some options or

something but you got to be prepared to pay a reasonable amount, not above the odds but

you know as you said it's becoming more onerous on directors. So if you want the right

person, you do have to remunerate them in some form or the other.


[Ben O’Brien]

No I just straight-up agree with that I think, probably the only area is settingrules and norms

like a remuneration committee or something so that it's transparent. The risk there is

that the directors pay themselves and then it's not really to the founders, it’s more to the

shareholders and the shareholders turn around and say oh wait I want wasn't fair and

reasonable, so the directors just have to have a really clear and transparent basis for

getting paid. And on a practical basis, when that goes up and down having good

documentation about what value you got for the company is important but yeah I agree.


[Jule Fowler]

Okay so then approval rights, in your term sheet they will be some matters which need to be

approved by the investors generally the mechanism for that is that it needs to be approved

by the investor director. That’s just more pragmatic, it's easier logistically to get that

approval sorted out. And there's a whole list of things and usually they're not contentious,

there are material transactions that the company might undertake and the investor director

needs to be across those. I think the most contentious one in my view, and jumping ahead

slightly is whether an investor director needs to approve the issue shares. You know I

think I know what you're gonna say here but, might be different from my view.


[Ben O’Brien]

What do you think I’m going to say?


[Julie Fowler]

WellI think you gonna say they have to do.


[Ben O’Brien]

Yeah I yeah, that’s what I was gonna say, you’re good. Yeah, I kind of think, there's a

minimal amount, like if as over time you've had multiple rounds and someone

only has a small percentage of the company now and they haven't participated in

subsequent rounds and I think that could go away potentially or get aggravated in block. But

yeah I, every time we've ever done a deal the investors have demanded this and I, kind

of, it seemed reasonable to me. I guess maybe just quickly give my high-level thougt on this,

these vetoes are generally not contentious. One thing that tends to happen though is they

don't capture the evolution of the company, so like with a 250,000 or 50,000 or whatever. If

you're in a growth company or a declining company, in both scenarios these numbers don't

really make sense. If you're on the rocks, directors are probably going to approve every

dolla,r this is where it's gonna go right, like every dollar. And they're gonna, you're gonna

have like weekly solvency meetings when times are tough and you're gonna have really

close relationship between the CFO and everybody. When times are good and you

have to move really fast then these thresholds become really stupid, arbitrary, and the focus

is on moving quickly and so encapsulating the authority at a single number, it's almost

completely random if it's going to be appropriate or not or holding you back.





[Julie Fowler]

Yeah well also my view is that, in a high-growth company which is relying on capital raising

to grow, it does seem a little bit dangerous to put that growth in jeopardy because your

investor, existing investor has to approve it. The investor comes in knowing that it's a

high-growth company which will grow by future capital raises and investors do have

protections through the anti-dilutes, through the pro-rata pre-emption processes.


[Ben O’Brien]

Sorry but what if it’s -


[Julie Fowler]

No, we’ve had this discussion before.


[Julie Fowler]

But I do know that in practise, it’s a really hard one to win and I would say the majority of

cases the directors do get this veto right over new share issues, but in theory I don't

think they need it or should have it. But interested in your view Damon.


[Damon Crowe]

It's one of those ones that some people like it some people don't. As long as we

have our pre-emptive right and then we tend to be reasonably neutral on this one. Because

we do have, our policy is generally to - we are long-term investors, so we invest over

multiple rounds, so we tend to be more worried about some of the other provisions.

I think I guess when these things get triggered is when you start to worry, you know, if there

is some disagreement by the investor not wanting to invest, to issue shares or an investor

director, then you start to ask questions as to why you're not working with the entrepreneur

on that.


[Julie Fowler]

So one of the other terms in the term sheet will be a list of conditions precedent and these

are measures which will usually be in any term sheet, and these are measures which need

to be sorted out before the investment can complete. Often these things are sorted out

before, even the long form documents are entered into and don't necessarily make their way

into the long form documents and they're almost like a checklist of things that need to be

tidied up. Did anyone have any comments on any of these?


[Ben O’Brien]

So yeah, there are some terms in here which, as far as I'm concerned, just basic hygiene

things that you should have done in your company immediately, so entering to employment

agreements. any non-compete provisions, assignment of IP, like these are fine to have in

this term sheet, I have no problem with them being part of the checklist but seriously if you

have a company you haven't got IP assign from all the people working on it, you're in deeper

trouble because you own nothing actually, at that point. And people can extract extremely

onerous terms - just to get back what you've paid to do so yeah looking at this just just have

that stuff sorted out immediately, if you haven't already got employment agreements and IP

assignment, just go sort it out like now, forget about raising money just go sort it out. That's

my advice.


[Damon Crowe]

you know, the investors have a lot on their plate and if sometimes you know, things drag on

they're looking for an excuse to not, you know, mess up, so you know. The more

easier you make some of these things, the more preparation done, they easier to get to get

these signed and get the money in the bank and get on the way, so good hygiene.


[Julie Fowler]

So in a term sheet too, it will often describe broadly the type of warranties that you'll need to

give in the long-form documents, and the long-form documents you'll need to give pages of

warranties, usually in the term sheet they'll just be either a one paragraph description or

maybe down to three or four paragraphs. Did you have any comments on that?


[Ben O’Brien]

Yeah you can see because I’ve drawn a box around it, it's a trick. Just be really careful, you

have to be prepared to stand behind what you say like that's a very cool point, you can't be

lying you have to be prepared to stand behind what you say, but warranties are extremely

serious and you've got to make sure that they're not fairly onerous, so just this here it says

“all information provided to the investor, exclusing forecasts and other forward looking

information is true and complete in all material respects”, that to me a little strong. Like first

of all, all information I'd like it to be all written information, it gets really grey when you've

had many many conversations you've sat down over beers and talked, they may have talked

to your employees, to other people, like the spread of all information is large and

uncontrollable, so at the very least get it in writing, and the investors should be asking for

stuff in writing anyway. Like okay that sounds great give me the business plan, give me this

give me the analysis of IP, give me your framework of operate, whatever it is. So at the very

least that - and generally I would look for best of knowledge and belief there as well. Again

some, depending if it's really core to the business, sometimes it's just your risk and you

have to be prepared to take it, so but just be aware very easy to slip into overreach where

you’re warranting things that you just don't know or you can't warrant or you haven't

been able to control. So I'm not saying yes or no there, I'm just sort of saying be really

careful, warranties are very serious, you do have to stand behind your word but make sure

it's really word, make sure it's not accidentally additional informations coming in.


[Julie Fowler]

Absolutely agree, warranties are really important parts of that, a lot of documents, we should

really be careful with them. Despite what you say in your warranties, you do have an

underlying obligation under the financial markets conduct that- not to be misleading or

deceptive. So regardless what you put in your documents, you can you can't be misleading

or deceptive which you know I'm sure no one would be but that's the threshold.


[Julie Fowler]

So it's really important to know that most of the terms we've been discussing, believe it or

not, are not binding until you sign your long-form documents. But there are a couple of terms

which will be binding in your term sheet, and those are usually your exclusivity, if there is

one, and confidentiality, and they'll always be usually a confidentiality provision that's not

contentious. Other than just being a wee bit aware of that because you need to be able to

talk about your term sheet to your poten- to your shareholders and potentially to other

investors so you need to make sure it accommodates that. But more importantly, exclusivity

now exclusivity means that you can't talk to any other person about your capital raise. So

you're bound to only negotiate them with your investor or investors who signed up to term

sheet in respect of this capital raise. And there are different views as to whether that's

appropriate or not. Ben-


[Ben O’Brien]

Yeah I think this is straight-up a power term in some sense because if-if you negotiate an

exclusivity with an investor, then if- so let’s assume different scenarios. Let's say that you

want to do a deal and things are looking good, then the investor can use exclusivity to stop

you getting other offers on the table, and can use it to wait a bit to see if the company gets,

you know, needs the money a bit more. I'm not saying that’s something someone will

explicitly set out to do it but it is an underlying dynamic. If things aren't going well and you're

under exclusivity and you're not likely to get a deal but they kind of want to think about and

sit on it, and you want to say no this is not good, I'm moving on. This can stop you from

doing that, very very truly, and just generally, generally you want to have different options on

the table and and there'll be periods of time like for example where you give a whole bunch

of DD information, investor goes away for a few weeks. That's a good time to be building a

plan B a Plan C as the entrepreneur, in case the DD comes back bad. So generally I don't

think you should turn exclusivity if you can avoid it. Sometimes you can’t, sometimes it's a

power term, sometimes the investor will just say “no this is my offer, I don't want to put all my

time and effort into this deal have you've walked at the last moment and waste all my

precious time”, you know, all the rest of it and so- but this is very much it’s a- it's a

very much carving out the pie term - there's not a lot of ways to make the pie bigger. It's a

straight-up zero-sum game. So I say no, but you may have to live with it but try to avoid it if

you can.


[Damon Crowe]

This depends on the, sort of stage, and state of a company really, I mean. Some investors

get worried about it, ours are a bit more relaxed and again it depends on how much is

being syndicated, what the lead is doing, you know, how much work they have to do, it's not

one that you- It is quite common so just yeah.


[Ben O’Brien]

Yeah it is common yeah.


[Damon Crowe]

Understand why you’re signing it away if you are, is really the main point.


[Julie Fowler]

And in this term sheet we’re talking about, we've provided for 90 days which I do think is a

long long period. You probably wouldn't want to go beyond 60 and if you were going to sign

up for 30, would be, because you do want to incentivise everybody to act quickly.


[Ben O’Brien]

Preparing a DD library is a lot of work. It's weeks and weeks and weeks of work you

know getting all material contracts, getting all the finances, getting that all these business

plans and things getting like just everything they have, customer databases, whatever it is

that's required, getting that DD library it's really important. You've got it in a form, before you

sign this, have it ready before you sign this, have everything you need good to go. You

should have that as company hygiene anyway but the reality is it will take time and effort.

Because during the DD, you don't want- time kills deals, you don't want it to take time, you

don't want people coming with questions and like a week or so later you get it to them, that

would kill your deal. Also you look unprofessional.


[Damon Crowe]

I mean a lot of these- a lot of these terms haven't changed. They've evolved, you know

there's a lot of resource on the internet, Simmons Stewart has got templates by the

Angel Associations, you got templates, VCs putting our templates now. You know it's not

hard to, you know, find this information they're prepared.


[Julie Fowler]

And I guess my final point is, despite Ben’s comment earlier, don’t be scared to see

your lawyer about this, hopefully this has flagged that there are some nuances

in term sheets which might- some provisions which may, on their face, which may look

pretty bland, actually do have some quite serious implications to you, so it is important to

have a chat with your lawyer before you sign them.


[Julie Fowler]

So the term street discussion we're having today is based on an equity capital race which

means you're issuing shares. Another common way for early-stage companies to raise

money is on the back of a convertible note, and what that means is the investor provides

money to the company, basically on the basis of a loan, but the intention is not that that loan

is repaid the intention is that it converts to shares at the time of the company's next capital

raise. And the benefit for the investor in that process is that when it converts, it converts at a

discount to the valuation that you receive or that you negotiate at your next capital raising

round. That can be really helpful because you can enter into the convertible note without

having to get into all of the detail about investor rights, director appointment rights and things

like that. It's really just a commercial get-money-into-the-company kind of deal, but there

are some downsides to that.


[Damon Crowe]

You know, I think the downsides are you- you're kicking those terms down the road, so

sometimes, investors like to know what they're getting up front so say, you go through the

process- it's actually not that much more onerous to get shareholders agreement and

issue shares when the company's office in New Zealand, very easy to deal with. So we

find that the downsides mainly of of convertible note is the uncertainty, you know sometimes

you do want to just know what, you know, what terms your on, what you’re putting in a

certain amount of money in and what you're gonna get at the end of that, you know the worst

is some of the unkept convertible notes, because you really don't know where you're gonna

end up at the end of the day. And so you know, you want to know- you don't try to estimate

what your returns might be in at the end-down the track and, that’s probably the worst. The

uncertainty and also the-pushing a problem on to another day, probably the main concerns

for us with convertible notes. When I say do use in certain situations but- and flexibility can

sometimes be useful but sometimes you want certainty.


[Ben O’Brien]

As a founder, you-to minimize cost and to maximize your negotiating flexibility, you should

become, like just make the investment and legally upskilling yourself over all of this. So that

when you use the lawyers it's a “Hey Julie I have this opinion what do you think” and then

she can say “yes, no, push harder Ben, you're being a wimp”, whatever or “oh yeah

we'll deal with that” but, and then that massively reduces your costs and it just makes you a

much more competent negotiator.

[Susse Reynolds]

Valuation and valuing startups is a really spicy topic and it's not one that you are going to

find any definitive answers on, and in a fairly gnarly sense, it really does come down to what

your investors are willing to pay; and every investor is different, and every market for

startups is a little bit different. So the New Zealand market, we still have a bit of a reputation

for our deals being relatively reasonably priced and you will see all sorts of different methods

of evaluation the venture capital method, the Dave Berkus method. Google valuing the

startup companies and you'll find all manner of tips and tricks for valuing your company, but

it will fundamentally still come down to what investors are willing to pay. And in that sense

right now right here, in this little spiel that I'm about to give you will date probably within the

next 12 months, but in New Zealand, if you are straight out of the chocks and you don't

have any customers yet, and you are raising your first round of angel funding, and if you're

going straight in at it, and you haven't raised a pre-seed or a seed round or any friends and

family, most startups are valued between sort of 750 thousand to sort of two million or so.

But what you want to keep in mind and the most important aspect for me when you're

valuing the company is understanding what your capital strategy is, understanding how

much money you're going to need to raise to get your company to a point where somebody

might buy you, where that M&A or that trade sale happens. And so for me that's about

making sure that you retain as much equity as you can through to that trade sale point and

ideally, at that point you will still have 30% equity in your company. And on the Angel

Association website we have a bunch of templates and spreadsheets that you can plug the

various figures into to figure out, you know, what impact that has on you because

you may well be part of a co-founding team, in which case there are other dynamics that you

need to take into account. But hopefully that gives you a bit of a sense the market for

startups in New Zealand at the moment if you're right out of the gates, your valuation is

going to be somewhere between 750,000 and 1.5 to 2 million.

[David Beard]

So typically people would look at venture capital investment after they've achieved some sort

of prior capital round, typically with an angel capital round. So we look at late-stage

businesses, typically businesses that have product already developed, you'll have some

customers that have come on board and you started to make some early revenue. In some

cases especially when it's a high-tech company and you might be developing some deep

deep IP businesses, then we may look at you a little bit earlier, but that's typically what we

look to at early-stage companies. So for us, why would a venture capital firm invest in a

company? We look at probably three main things and I'd call it compelling team, compelling

product-market fit, and a compelling investment. And if we break those down, we would sort

of say a compelling team for us is a team with founders who have deep knowledge in their

space that they've provided a solution for. They've got a really open and stron

communication style they're able to present complex ideas and very simple fashions and

also that they're able to negotiate and understand commerce really well, and generally

people that we can build trust with and know that when we make a large investment that

they're people that will feel confident, that we can build alignment and move forward with.

In terms of the product-market fit, what we like to see is a solution which sold, we call

it a genuine need. We separate it and look at it as some companies produce a product which

is a nice-to-have and we like to invest in need-to-have. So it's up to a lot of the companies to

define what that need-to-have is, but that's all part of that compelling list and we take a very

strong view as whether that can be sold and needs to be solved or whether the company,

your customer may in fact have a number of alternatives of which you may be one of those.

We actually look at products that are unique they have some innovation. We use the term

innovation moat which means essentially that it's not easy to replicate or copy. In today's

world there are thousands of companies, all producing lots of solutions and with large pools

of capital, it's it's often very easy to replicate. So we'd like to see a little bit of secret sauce in

what your product does, and so anybody who can just go into your screens or your

website or your solution and say hey I can do that, that becomes a little bit difficult for us.

What we also like to see in product-market fit, like I say, we're a later-stage investor is

companies that understand who their customer is and how they can sell to them.

Typically these days, especially with the internet it's easy to put up some Google ads and

just say we get a number of customers come onboard from our Google ads, but that

doesn't quite get it from our point of view, it gets you some initial traction, what we're really

keen is to understand why do those customers come to you, what is it about your product

specifically that helps their business go forward and creates value for them. The last thing

that we're interested in is typically, ‘Is it a good investment?’ ‘What is a compelling

investment?’, and key to that really is what we call the Total Addressable Market which is

‘TAM’, so the total addressable market is really about where your product can be sold. And

for us generally we're saying that's a global market rather than specifically just New Zealand.

And the opportunity is, if not in the billions of dollars then at least in the hundreds of millions

of dollars that your product can sell into.

[Adam Clark]

So I've been on that on the side of both raising capital for a range of early-stage companies

and also investing in then several early-stage companies as well, typically with within

software and ideally within the Saas space. Key things that everyone says they're looking for

I guess, you know an A market and an A team, and I think those things are super important,

but I always find, you know, when I tend to be investing early I go one of two ways. Either I'm

going to be all-in with my time and so I'm looking for a really compatible team that I can work

with the, founding group particularly, the CEO and the senior executives, because I'm gonna

invest materially of my time, get alongside that team and help them execute. And so that,

you know, that team potentially becomes even more important than the immediate market

that they're looking at. Other times, I will simply follow someone else into an investment

and when I'm doing that, I'm not putting much time into it, I will look at the market and the

space and I'll look at the individual that I'm following and I've probably worked with them and

and know them very very well. So I’ve been involved in raising capital both as a founder,

raising capital from investors, as a board member who might have already invested in the

company and looking for a subsequent round, and then as as an investor, both a lead

investor and a follow-on investor. And I think in in all cases, what you're trying to do is find

the people that create a really good dynamic between a willing buyer and a willing seller

ultimately like anything really here you're selling yourself, you're selling your vision, you're

selling the team, the market opportunity, and an opportunity for an early stage

investor to participate in that journey. And so finding the right fit is really really important

whether you're the investor or the investee. You know I'm often I'm often a lead investor I

tend to either work incredibly closely with the founding team lead an investment and

then and then invite others to participate or others follow, or I do the opposite where I see

that somebody oh no and respect very well has invested into a company and I'll

follow them without doing too much due diligence and really trust their judgment. The team

and being compatible and actually wanting and enjoying working with that team and

on that project is probably the most important thing to me. You know, I've made

some mistakes in the past where I've got super excited about the product and

super excited about the market and super excited about the impact that we might

have, but just not really been compatible with with the founding team or the CEO

that might be in place and that's no reflection on them that's not necessary reflection on me

it's just a compatibility thing, and so you know particularly if you're working with a

lead investor, you've got to take that lens as the founding team as well, that lead investor

albeit an earlier stage investor, an individual like me or be at a professional investor coming

in from from one of the funds you really want to make sure that that's somebody you want to

spend a heck of a lot of time with. The key thing that I look for is the depth of passion that

exists and the vision for the business, and the depth of thought that's come from the

founding team. I'm less worried about whether, you know, the go-to-market component is

precisely right or this is how we're going to deal with privacy and security, it's that they've

thought about the key themes that will need to exist, the key streams of work that will need

to exist in order to pursue the vision and they've got some reasonable thoughts around that

and they’ve organised themselves around it. Because a lot of founding teams aren’t going to

have all the answers they're, you know, if you're doing this for the first time there’s lots of

learning and, you know, your investor group, your advisory group, your board and the people

you employ will help to actually solve for those things. And so when I look at a

business plan in, whatever form you get it, you know it's, I'm happy if it's

a series of bullet points, provided that it demonstrates that you guys have got a

good depth of thinking.

[Caroline Quay]

So today I'm going to talk about the key things that all investors look for. Its high-level

requirements that investors look for when companies come to pitch to them for investments.

Investors also need to understand your product and your services and how it's been

received externally, market validation effectively.

Investors also need to hear about risk, they're also looking for companies with

global ambitions that can scale globally. By far the most important thing are the

values of the company. You need to talk about the “why”, why you decided to pursue

this idea, innovation, product or services. You need to take investors with you in

your journey and tell them the story why you're passionate about this, why you

care about this, why now is a good time for your idea, and why investors should

care as well. Talk about what problem you're trying to solve here and also

talk about how your idea, your company, your product or services is going to

change society or a segment of society. The other thing that is really really

key is external validation. When I talk about external validation, I'm talking

about market validation, customers, users. If you've got market feedback or

customer feedback it is really useful for you to be able to show that to

investors and explain that to investors. And also in terms of market

feedback, if you have a list of prospective customers or customers who

are willing to talk to investors about not just your product but the value of

your product to them as customers, that is hugely hugely valuable. More priceless

would be if you are able to actually have paying customers ready when you're

talking to investors. We also look for scalability in ideas, product, services and companies.

Not only a scalability about the product being able to be sold outside of New Zealand, but

when we talk about scalability we are also looking for founders and teams with global

ambition. You need to be able to pitch your product not just how it actually is placed in the

New Zealand market or the local market segment. New Zealand is great because it's a small

country and it's great for you to use it as a test market, however investors are looking for

companies that can scale and that will scale. The next thing that is hugely important is

people. Investors invest in people, as much as when you're pitching to investor your product,

services, innovation company or your idea, and you are trying to convince investors that

your company, your product, your idea, your service is worth investing over others, to a large

extent you are also pitching yourself and your team and why you are worth investing above

others. Let us now address risks. Risk is not a scary word for early-stage investors,

early-stage investors take risks, but what you need to demonstrate to the investors is

that you understand the risk of your business, your idea, your product, or your services, and

that you have a an ability to actually mitigate that risk with a plan. Again, be open be

transparent don't be afraid and don't hide your risks, because investors already have

identified it. What they're looking for and what would impress investors is that you have

thought about the risk and you have got a plan to overcome those risks and address those

risks.

[Robbie Paul]

So I'm Robbie from Icehouse Ventures, we're an investment group that's been investing in

Kiwi startups since 2003. We've invested in a 182 companies and put a 115 million into

those companies since then. So we're early-stage investors, what does that mean, we invest

anywhere from say a quarter of a million dollars into ideas, pitch decks and founding teams

to one and a half million dollars into companies that have product built and revenue offshore.

where do we fit in, we're often happy to be the first check in, we don't need to follow anybody

else, nor do we syndicate, and we are not VCs that bring tens of millions of dollars to growth

companies. Some of those exists here, many invest from offshore into New Zealand

companies. So in terms of the capital food chain we talk about founders bringing their own

capital or bringing friends and family in, we can fill that next gap from 250 to sort of one and

a half million, and from there venture funds can invest tens of millions of dollars into a small

number of growth companies.

And I'm here to talk about the things that investors look for.

The first one I want to start with is unique insights or perspectives, so that is founders that

are exploiting opportunities or industries that they know because they've been part of them

or they've observed them closely. A great local example of that is the team at Avertana,

those guys came out of LanzaTech which used the intellectual property strategy to extract

waste from value at steel mills, they've done a similar thing targeting the solid waste stream

at steel mills.

So the next one that's pretty obvious is that investors like backing experienced

entrepreneurs and teams that have been there, they tend to know the path that they need to

go on, they know how to hire, they know how to raise money, they know how to move into

new markets and all of those things serve them well when they're trying to exploit a new

opportunity or or build a new company. So an example of an experienced entrepreneur in

the New Zealand context would be Mike Carden. He and his brother built an HR software

company back about ten years ago called Sonar6, they raised money, took that in the United

States, grew it and sold it. Mike and his brother have come back and have started a second

HR software company called Joyous. So not only do they know the industry that they're

moving into and the competitors and the landscape, but they know how to build

software businesses from New Zealand and take them to the world.

The third thing that we're looking for is startups and companies that are building businesses

that are moving into large and durable markets. So what do we mean by that? We mean

businesses that are targeting large industries globally or large customer bases globally.

So a great local example is Sunfed Meats that’s creating plant-based protein. They're not

only targeting an industry and a niche that's growing very quickly around the world as

evidenced by the growth of those types of products on supermarket shelves, but they're

creating a product that consumers on every continent could purchase the.

Fourth thing that we like to look for is capital efficiency or what we say is the ability for

founders and companies to make massive strides with limited resource. Going well or

going poorly companies always need more capital and to get more capital they need to hit

milestones efficiently and effectively. The way that translates into startups is often companies

that have founders that can build the product or service and deliver the product or service

that they're planning to sell. It is not often resource-efficient to have to outsource the

development of product or intellectual property to a third party. We also love to see

breakthrough technology, what does that mean? That means science or innovation or tech

that is literally world-leading. PowerbyProxi is a great example, they came out of the

University of Auckland where they had spent years developing the intellectual property

around wireless power transfer. They became a global leader and outpaced and out hustled

and out delivered many organisations that were better resourced but didn't have the same

intellectual grunt.

[Justin Wilcox]

So the first thing you need to know about investors is that they don’t wanna pay for your rent,

they don’t wanna pay for your grocery bills, they don’t wanna pay for your Netflix

subscription. What they wanna pay for is a machine that they can put one dollar in and get at

least ten dollars back.

So if you want investors’ attention, if you want their confidence, if you want their money, you

need to prove to them that you’ve built that machine, and the best way to do that is to find

product-market fit and prove it to your investors. So to do that, think about it in just two steps:

Step 1, go identify problems that your target customers are actively trying to solve. The way

you do that? Through customer interviews.

Once you’ve proven that people are actively trying to solve a problem that you wanna solve,

then you just need to experiment and iterate on a solution to that problem, find a business

model that is financially sustainable and that will create a 10x return on an investment for

your investors. If you do those two things, interview your customers and then run

experiments to prove that you can solve their problem in a financially sustainable way, you

will not only get the interest and excitement of your investors, you will probably get their cheques.

[Darrin Grafton]

So our first company was Interactive Technologies and we founded that, myself

and Bob Shaw with the cofounders of that business. And we started off building

travel technology for the Australasian market, and by chance, meet up with Andrew

Bagnal, l and at that time he set a challenge for us to look whether we

could actually globalised our technology through his group. And in around six

weeks, we built the first prototype of that technology and launched that and

demonstrated that to him. And so our first investment round was with somebody

within our trade industry. He invested, it was quite a small amount back then but

was quite big for us as a start-up and the leverage that we then gained from

that was that led us through to being included in the public float of the Gulliver's Travels group. That was in 2004, and in 2007 when just before the GFC was heading, we set up

Serko. Serko was basically founded by myself and Bob and 26 of the core team that we had

with us in the first company. And Serko was set up with some very strong mission and we

wanted to really control dates and time really importantly with what we were

trying to do, so the milestones were absolutely key. Sne of the things that we

said about was that we wanted to either look at a trade sale or an exit strategy

within seven years of the business and we formulated a very controlled plan

about how to actually get there, in fact, we listed our business on the same day

that we founded our company, seven years later. That's how focused we are on dates.

Another thing that we're really focused on is around cash management and we do

these plans out two years and we always imagine a worst-case scenario, and we sort of run

these models through and if anytime that cash could drop down below a certain

level we go and raise money. Now it's quite different been on the public market, on the public

markets you can raise money quite quickly as long as the story and the models actually align

and, in fact, you can complete the task in around two to three weeks.Sso today we've raised

around 90 million out of the market, so in 2014 we listed off on the inside NZX, raised 22

million their process took six months, it involved around 2 million of cost and it involved

accountants lawyers and financial advisers, media and everything through to the whole

listing process. Once we've done that, around 2 years later we then raised another 8

million to build a new product, we actually completed that process and just

over three weeks so we're able to go through a lot tighter process and

complete that very very quickly. We then last year in September, raised another 15

million and were able to execute that again within about a four- week timeframe

from start to finish, and then this year we have just completed a 45 million

dollar raise that was a little bit more complex and with this one we actually

had the largest player in the world in our space being booking.com investing alongside us.

Your strategy and your mission has to be very clear and able to be communicated if you're

not communicating that to your investors or your potential shareholders then no one

understands the story for you to be able to buy what for them to buy shares.

So for us looking where we are today and we raised 45 million, we had 30… Our

model told us that if there was a GFC in the next two years we could burn 35 million of cash,

and so we've raised 45 million plus the money that we already had in the bank mean that we

were well protected and could execute our strategy which was the most important thing.

So you formulating the right board is absolutely key to driving your vision so if you have a

board member that is not aligned as I found to the overall strategy of your company it's

gonna make it really complex to execute.

So in our case, we had Simon Botherway who had established and chaired the FMA

so he was the highest person and governance, so being an entrepreneur

you're sitting over here and governance is over to the left, so running really

hard over here wanting to burn cash and having the model of governance that

drives that back was absolutely key from a board perspective. And then we had

Claudia Batten who thinks like us but was a marketing expert and we weren't

marketing experts we were tech experts, so having that part of our board gave us

that absolute depth as well. So key parts of having this overall board composition

attracts the investment, so having Simon Botherway, who was actually an investor

and analyst himself, has given credibility across New Zealand and Australia and the

business and what we've actually been able to achieve and he attracts natural funds coming

into there, so sometimes establishing the right board can actually make raising

capital a lot easier.