[MUSIC] Hi, everybody. When you are financed by venture capital, you enter into a long-term relationship. Why? Because the venture capitalist accepts to hold a very illiquid asset for a long period. The quid pro quo is that the VC wants to be on the top of a constant stream of information. He also wants that the company delivers on its commitments. This relationship is structured by a series of milestones, the business plan, an agreement on the enterprise value, a term sheet. This is a recap of all the terms and conditions attached to the investment. Due diligent operations are subsequently performed. When they are completed, the company and the financiers sign a shareholder's pact. Each financing step requires a specific business plan. A Series C plan is much more detailed than the document originally seen by business angels. The company is now aware of its competition, its markets and its products. Its management team is identified. There is a track record on the business and the use of the proceeds of the previous financing rounds. Let's now discuss the basic details of the business plan, with a focus on the seed-financing round. The purpose of the business plan is to help you to introduce yourself in a sharp and focused way. Financiers invest in a minuscule proportion of the companies they see, perhaps less than 1%, and, by the way, a recommendation will be tremendously helpful. The business plan is a critical part of the filtration process. The business plan adds to the credibility of your idea. You have done your homework. You know your competition and the key numbers of your business. The business plan has to answer key questions. Is your business scalable? Are there barriers to entry? What are your competitive advantages? What is your products? What is the value of proposition brought to the client? You also want to demonstrate the relevance of your offer for the market, either because you already experienced some kind of client validation or because you are able to find credible analogies with existing situations. The business plan adds to the credibility of your team. You introduce the key people of the management team, inter alia their experience and why this experience is relevant to the venture. You give details on the personal investment of each individual to the company, you have skin in the game. The business plan gives a view of the key numbers and development milestones. What is your business model, the structure of your revenues? Describe your marketing and sales plan. What are the costs and margins? Describe your investment plan. How long can the company operate before the next capital raise? 18 to 20 months runway is the expected answer. Elaborate on the risk. The business plan addresses the investment opportunity. The financier should be in a position to figure out her potential capital gain or at least find a reason not to rule out your request. Help her with a value creation plan, established thanks to credible growth plans and projections on the returns on investments. Your set of hypotheses must be serious and consistent. Let's now consider the delicate issue of valuation. The real issue is not the value per se, but the share of capital that will be transferred to the financiers against the required amount of money. The outcome does not stand from a unique scientific method. In practice, two sets of methodology can be used. First one is the DCF method. DCF for discounted cash flows. The enterprise value is the discounted sum of all the cash flows generated by the firm after the date of investment. You will look at this in detail in an exercise, but remember at this point that the result depends on parameters, which are very difficult to estimate. Such as cash flows generated within a predictable timeframe as per the business plan, a notional terminal growth rate beyond this horizon, an actualization rate which is contingent to the risk borne by the venture, the cost of capital, also known as WAC. The result would be adjusted to take into account the illiquidity of the investment and potential alternative scenarios. The method seems rigorous and scientific, but you must know that the result is extremely sensitive to the chosen parameters. Also note that the value created beyond the horizon of visibility, called the terminal value, may be as high as two-thirds of the total value. The second method is a comparable approach. The DCF method is not satisfactory, when the venture is immature and does not generate cash flows. The financiers then look for similar companies for which an indisputable valuation exists, such as stock price or last funding round. We will consider turnover of multiples relative to real transactions on similar companies by same sector, margins, growth rates, etc. The end game is to produce counterpoints and negotiate. When the discussion is about start ups, the calculation can be very simplistic. We look for the investments required within 18 to 24 months. This amount will be assumed to be worth 20 to 30% of the whole company. This will provide the valuation. Is this valuation reasonable? The decision of the VC will depend upon the answer to the question. Let's listen to what Jeff Clavier has to say on this issue. >> And then in terms of just the valuation, the pre-money valuation. >> The question. >> That's the question. A lot of entrepreneurs aren't familiar. Some of them know, of course, but, especially the seasoned ones. But, at this time, it's probably better than last year. So what are we looking at in terms of the- >> It's always a tricky question to answer, because it really depends on the opportunity, the track record of the team and so on and so forth, but I will say this. We look at an initial dilution, so the percentage of ownership that will take in this initial round to be anywhere from 20 to 30%. So if you look at, let's say a million dollar investment. They will come out in at $2.5 to 3 million, pre-money, which is sort of the mor standard, but it depends. >> You've just crossed a very important line. VCs have validated your business plan and you agreed on a valuation. You are now going to negotiate a term sheet. What is it about? Note that the term sheet is not the final agreement. Factual information must been checked in a due diligence process. After this, you will sign the definitive agreement, the shareholder's pact. What are the essential clauses contained in the term sheet? First, good governance clauses. It is about size and composition of the Board of Directors. Rights granted to specific categories of shareholders, such as special voting rights. How to deal with special events, such as the sale of the company, a merger, capital increase, preemption rights, management of the employees, stock option pool. Second, closest relative to the value of the company, the price, obviously. But also all the rules which protect the value at rooted to the financiers, anti-dilutive clauses, the rights are clauses and jargon. These are provisions, which issue bonus shares when there is a down round, i.e., a subsequent financing at the lower price per share. In the same vein, a preferential subsequent right in case of financing round to come, or rights to priority payments, if the company is sold. Or rights to sell at the same terms as management, should they decide to sell their holding. This is called a drag along provision. Let's now move to due diligence. The term sheet is an asymmetric agreement. Financiers can pull out if the due diligence process uncovers weaknesses in your business. Make sure that financiers are determined to invest. The purpose of the due diligence process is to find reasons not to invest. Its scope is the facts, turnover, audit book, etc., commitments taken by the company, staff arrangements, your declarations, and in particular what you have not necessarily declared. For instance, litigation or a rising conflict with a client. Due diligence is a very heavy process, make sure that you'll not experience unpleasant surprises before you sign the term sheet. Finally, let's have a look at the shareholders' agreement. Due diligence may lead to the the renegotiation of a number of provisions of the term sheet. When the process is completed, you will sign a binding agreement with the assistance of your lawyers. You are now engaged in a new journey. The next step may be the IPO of your company. We will look at this in the next section of this course. Goodbye. [MUSIC]
