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Venture Capital

Venture Capital 101: The Ultimate Guide To The Term Sheet

Make sure you get guidance from a legal team that is specialised in commercial and start-up law from the start.

Ya-Fan Wong

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The importance of a term sheet in the context of raising funds through venture capital should not be overlooked. If you think of the ongoing relationship between you and the investor as a marriage, then you can think of the term sheet as the antenuptial agreement.

The term sheet is the document that outlines the terms by which an investor (angel or institutional), will make a financial investment in your company. The term sheet is crucial as it usually determines the final deal structure with your investor – it outlines the terms by which your investor will make a financial investment in your company.

Finding an investor can be complex and time consuming. Once you’ve found one with the right strategies and values, you may be tempted to rush through negotiations to access the promised cash injection. There can be serious ramifications if the details of the deal are not negotiated on a level playing field, and this is where the importance of a term sheet comes in.

A term sheet exposes the bare bones of the fundamental commercial terms of the investment. Due to its concise nature, the involved parties are less likely to miss essential details.

The term sheet

The term sheet is intended solely as a summary of terms for discussion and agreement between the parties. Except for the confidentiality provisions, nothing should create any legally binding obligations on the part of the parties until they execute the definitive written agreements, obtain all the corporate and legal approvals, and successfully close the deal by meeting all the conditions precedent.

The advantage of the term sheet in this respect is that it expedites the investment process by outlining the material terms and conditions, and guides legal counsel in the preparation of the proposed final agreements. It also allows you and your investor to get to grips with the terms quickly and provide input from each of your unique perspectives.

Related: The Truth About Venture Capital Funding

What to look out for in a term sheet

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Valuation

Your investor will place a valuation on your start-up company based on, among other things, comparisons to other companies in the marketplace and recent transactions. It is common to set the valuation of the start-up company as a “pre-money” valuation (i.e. the value of the company before the investors in the funding round participate). This is, however, not always the case – so be sure to get clarity on this, as investing pre-money or post-money can make a big difference in the equity stake you are giving away in your company.

If the parties are not in agreement about the valuation of the company, consider making provisions for claw-back provisions in favour of the start-up company or payment by the investor in tranches, which will be determined as and when the company’s audited financial statements indicate its valuation.

Type of shares offered to the investor

You will want to understand the type of shares you are giving away to the investor in return for the investment. Will you be giving the investor ordinary shares or preferred shares? Large investors are often only concerned with two things: Control and economics. As such, investors will often insist on acquiring a separate class of preferred shares which entitles them to fixed returns, the payment of which often takes priority over ordinary share dividends.

Liquidation preference

This is what is used to determine how the money is shared once the liquidity event happens. The preferred shares might have a liquidation preference of 1x the ordinary shares. That means that when the company is sold, the preferred shareholders will be paid first and then the ordinary shareholders.

As a start-up founder, you need to know what you are promising your investor.

Related: Is Venture Capital Right For You?

Employee share ownership

These are shares which are set aside to be issued to employees, advisors and others during the investment round. Having available shares for this purpose is important, as they are needed to bring in new talent. This pool of shares is typically part of the pre-money valuation of the business. You need to understand this concept because these shares can dilute pre-money shareholdings.

Founder vesting

The vesting period for founder shares is ordinarily three to four years. From an investor’s point of view, they want to make sure that you, as the founder and key members of the management team, are locked in and stay invested in the company.

It’s worth noting that many of the vesting provisions are subject to the founder meeting pre-determined performance milestones and continuously adding value to the company. After all, the investor took interest and invested in the venture because they believed in the founder team.

Anti-dilution

This is an important provision to look out for as it protects the investor’s investment if the start-up company raises an additional round of funding at a lower valuation.

Your investor may allude to this in the term sheet and require you to include an anti-dilution clause in the final agreements. Venture capital investors take significant capital risks and they will always seek to minimise their investment risk however they can. It’s important that you understand the effect of anti-dilution clauses on both future capital raisings, as well as your interests generally.

Raising venture capital is a crucial, and often fragile, step in any start-up business’ journey to success. Make sure you get guidance from a legal team that is specialised in commercial and start-up law from the start.

Read next: A Comprehensive List Of Angel Investors That Fund South African Start-Ups

Ya-Fan served his articles at Dommisse Attorneys and was admitted in 2015. He is currently in our Corporate and Commercial division, and is responsible for the firm’s company secretarial unit, offering a value-added service to clients, beyond just the incorporation of a company, to include maintaining of share and director registers and assisting with annual returns.

Venture Capital

Taking A Business Public Can Unlock Its Full Potential

How can business owners continue to create shared value and drive growth beyond the venture capital funding rounds to attract new investors and customers, and unlock the inherent value in their business?

Graeme Wellsted

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In the context of entrepreneurship, a great deal of emphasis is placed on the start-up phase of a business. But what happens beyond that?

Going public

Listing on a stock exchange is often the best way for a business to realise the next phase of its growth ambitions and create opportunities for shareholder and investor diversification.

Listing a company provides a more effective tool to access capital and enhance liquidity than private equity markets, as there is a much larger investor base to tap. Importantly, this pool will also include institutional investors, such as pension and investment funds, most of which are mandated to only invest in listed entities.

Reasons to list

Raised capital can be used to fund expansion or research and development, or meet other capital requirements for acquisitions. Listing creates exit opportunities for founders, shareholders and early-stage investors, and helps to spread the risk of ownership. Other growth opportunities become accessible as lenders can more accurately determine a company’s market value to determine loan-to-asset ratios.

Valuations for potential mergers or acquisitions are more objective. In this regard, a share issuance can be offered as a suitable exchange of value, rather than using cash to make a purchase or acquisition. Listing a business boosts its credibility and brand equity, which is beneficial from a customer perspective.

It helps to attract and retain the best talent from an employee perspective through the implementation of an employee share incentive scheme.

Related: What should I know about a Public Company before registering one?

Achieve consensus

But before a business lists, it is important to consider the commercial benefits and, consequently, if this is an appropriate next step. In this regard, the leadership team must first review the strategy and agree on where the business is in its lifecycle, and where it is going. For any business to be successful, the shared beliefs and purpose of its leadership team must align and there must be consensus among shareholders that the time is right to list.

Consider the trade-offs

Once this point is reached, consider the implications of taking a private company public. Firstly, business owners must understand that they are effectively giving up control of their company. They must also acknowledge that the transition from a private to public company can be difficult, with increased compliance and transparency.

Listing on a stock exchange also raises the public profile of the company. This includes greater oversight from external stakeholders, with strict reporting and disclosure requirements required by the exchange and regulators. These aspects are mandatory to ensure greater transparency, which translates into greater protection for investors.

Meeting compliance requirements

Arriving at this decision therefore requires a thorough due diligence process. This entails meeting financial reporting and minimum regulatory compliance requirements, which have potential cost and administrative implications that can prove challenging, particularly for smaller businesses.

However, it’s imperative to meet these requirements, as this ensures the business will stand up to market scrutiny and that the entity delivers exactly what it promises to investors. It also ensures the business meets the exchange’s corporate governance requirements, complies with the Companies Act, and operates in line with industry best practices.

Related: Public Private Partnerships Can Work For Entrepreneurs

Demonstrate value

This due diligence process is also vital if a company hopes to adequately demonstrate value to investors in the open market. This will help listing advisors and sponsors, whose job it is to market your company to potential investors, to more accurately determine if there is appetite for your business.

Institutional and retail investors will use this information to interrogate the business’s value proposition to ascertain the potential for growth following a listing, and determine whether the business model will deliver adequate and sustained returns over the medium to long term.

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Venture Capital

Need Funding For Your Vision? Give ‘Tasteful Persistence’ A Try

Zuko Tisani’s Legazy is a company that plans six international immersions for mainly start-ups, executives and members of the public. He has managed to grow his business from floundering for funding, to attracting large corporate investors. Here’s how your business can follow suit.

Diana Albertyn

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Legazy was launched with the aim of playing a leading role in the South African digital economy by stimulating the trade on African innovation. Legazy is well on its way to increasing the success rate of entrepreneurs through exposure to market access, partners, media and investors. “Before we were consumers and bystanders of industry 4.0,” says founder Zuko Tisani.

“We work with large corporates and Government, speaking their language by understanding what is important to them and not promoting what we think is important,” Zuko explains.

“Our narrative is tailored to fit the specific corporate we speak to. A lot of companies make the mistake of shooting in the dark and send a generic proposal to as many people as possible.

“We also realised the return on investment for content was huge. We are well documented visually and with the corporates that sponsor our projects it makes it easier to get funding because we can tell a unique story, a big story and an emotive one that goes hand-in-hand with our proposal and separates us from others.”

Related: Attention Black Entrepreneurs: Start-Up Funding From Government Grants & Funds

Zuko offers these top tips for start-up funding success:

How do you get people to care enough about your idea to invest?

1. Be very clear about how assisting you benefits them

Human nature is selfish. Win-win is not enough. Think more 51% to 49% — give more than you get. How is your sponsor going to be the winner of the day by supporting you? Always bring it back to the bottom-line. Whether it’s tax benefits, market exposure or adding value to their supply chain, be careful not to oversell because it can close an opportunity before it even opens. Do your homework to find gaps to fulfil or to enhance existing projects. Once you have emailed a specific request, lay out end-to-end how you will use the money and how it will benefit them.

2. Be persistent not pestering

Sending mails to busy stakeholders without response is a norm — try to find other stakeholders, who are more junior and would also have an interest in your project, to assist. Tasteful persistence is mostly rewarded — be delicate but direct in what you want; keep demonstrating you can add value and deserve the sponsorship.

3. Make the vision big and the ask small

It’s important to gain and build trust so take what you are given and build on that.

Related: Government Funding And Grants For Small Businesses

What steps can your start-up apply when approaching corporates for funding?

1. New is hard to sell and often has tentative buyers in the beginning

However, it’s worse to enter an over-saturated market where differentiation is difficult to see. A lot of entrepreneurs focus on the complete market and say things such as, ‘It’s a $10 billion industry’. Can you skew your value proposition to make a buyer believe it’s unique? And can you capture an upcoming market such as Generation Z (the coming economically empowered generation) in your offering?

2. Paper trails

If you are looking at partnering with a corporate find out where they have put their money before, and what it took for the start-up to gain access to those funds. Also look at the companies similar to yours that are succeeding — where is the money in your sector? This will also inform where you will be wasting your time.

3. It’s all seasonal

Keep a tight watch on when budgets are allocated. A lot of companies will inform you that they’re not in a good position to allocate money. Find a non-financial resource that you can be offered and leverage their partnership to gain financial support with another sponsor.

4. Know the lay of the land

The winner is the one who has the most information. If you are trying to tap into being a supplier for a corporate, know the decision-makers; know the key influencers. Your business is reliant on relationships.

As connection with anyone becomes easier, it’s easier to create solid relationships with decision-makers who can help your business with a signature. But always ensure your proposal offers the greatest value and that you do not only know the decision-maker, but everyone else who is part of supporting the sponsorship.

Read next: A Comprehensive List Of Angel Investors That Fund South African Start-Ups

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Venture Capital

If You Have A Great Business Idea, Who Ya Gonna Call? Hint: Not A VC

As customer development expert Bob Dorf advises, “For as long as humanly possible, avoid investors as best you can.”

Andrew Broadbent

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If you have the next billion dollar start-up business idea that is going to change, even revolutionise, an industry, what is your next step? Should you:

Say you’re an experienced entrepreneur who has already thought about all the important metrics for starting a business.

Those metrics might include:

  • Barriers to entry for rivals
  • Initial start-up costs
  • The regulatory environment
  • Questions as to whether/how to patent your idea

Once you’ve got the answers to these questions, how do you start?

Here’s a tip: The first step is not to think about money. Instead, next time you find yourself ruminating over a particular idea, first validate audience demand.

Related: Is Venture Capital Right For You?

Why it’s important to think about your audience as your first step

Raising VC money has been all the rage and hype for the last decade or so.  And, with so many up-and-coming start-ups getting funding each month, people may think venture capital is the obvious path to take.

I’ve often seen people on Quora saying, I have this great business idea; how should I approach potential investors? Whom can I speak with about my idea?

One of the answers to that question, which was upvoted, caught my eye. That commentor wrote, “Talk to your ‘potential’ consumers or your target audience.” Potential consumers, the writer pointed out, will help you:

  • Understand your idea better
  • Find mistakes and areas of improvement
  • Evaluate customer interest and willingness to pay
  • Understand market potential and size
  • Understand the buyer persona better.

All these things will help you at later stages, the writer continued, in reference to fund-raising and shaping your business.

Why you shouldn’t talk to a venture capitalist first

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VCs can be useful and smart. If you run in entrepreneurial circles – like networks and conferences – you may find it useful to talk to VCs because they’ve probably already entertained 20 different businesses pitches before your idea arrived this morning. Undoubtedly, too, VCs are in a position to offer a diverse perspective.

So, if you get the chance to meet one, talk to him or her without an agenda. Your only goal is to learn something new.

In fact, you can get amazing insights, such as marketing practices going on around you, what’s working and what’s not; operational nightmares, expansion difficulties, hiring disasters.

A great VC will have an interesting story or two on practically every single facet of business, including starting, scaling and managing a startup. Even more important will be the fact that a VC investor can help you get the pulse of market/investor sentiments.

Yet, despite these positive attributes, VCs are not your first call. In fact, I would not recommend at all that you  talk to a VC at the outset about your nascent business idea – and not because the VC will steal your precious concept or  not fund your “idea” since it’s just that – an idea.

When you have a proven concept that is based on actual numbers rather than projections, it may then be time to talk to VC investors. But before that point, first talk to your potential consumers and get some traction.

This article was originally posted here on Entrepreneur.com.

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