IndianaStartup.com » Venture Capital

Raising Venture Capital – How Much Should You Give Up?

Brian Powers — Fri, 15 Apr 2011 13:36:38 +0000

From the title of this post, you are probably assuming it refers to the chunk of your company you will be giving up in exchange for an infusion of capital. You would be right – mostly. In addition to giving up equity, start-up founders also give up some measure of control when they raise venture capital. Therefore, the first part of this post will deal with equity; the second part will deal with control / governance. Keep in mind that what i say below is not necessarily applicable to seed capital or early angel rounds – which I will discuss in a later blog post.

How Much Equity Should You Give Up?

Don't expect a free lunch.

Unfortunately, the answer is not something you will typically have control over. Generally, an investor will give a value to the business based on the net present value of future cash flows, then setting its desired ownership percentage based on its target internal rate of return. A big component to this determination will be the level of risk associated with the investment. So if you want to give up less, you’ll need a good valuation…and you’ll need to minimize risk.

How Much Control Should You Give Up?

Unfortunately, this is someting you will also not have much control over. A venture capiltalist will want board seats. They probably will not require control of the board, but they will likely require supermajority voting provisions on certain issues such as spending capital, raising capital, and selling the business. The venture capital board members will also likely require directors fee and reimburesement for travel expenses. Make sure that the number of seats the investor is entitled to adjusts based on percentage ownership; so as that percentage goes down, so do the number of board seats they are entitled to. Also keep in mind that venture capitalists typically bring very valuable wisdom and exprience to the table – so having them on your board is not necessarily a bad thing.

6 Big Mistakes that Startups Make.

Brian Powers — Thu, 03 Mar 2011 23:00:04 +0000

There is a great post on Venturebeat.com about 6 common legal mistakes startups make. Some of these have been covered elsewhere on this blog – some not. Here is the cliff notes version- check out the post itself for more details:

IP Ownership – make sure it can be transferred to the startup.
Choice of Entity – choose carefully. They recommend a corporation instead of an LLC. I disagree on a certain level, as I have stated before on this blog and my Indiana Law Practice Blog.
Place of Incorporation – they say Delaware. Again, I disagree to an extent (see this post).
Vesting Restrictions – make sure founders stock vest over time, otherwise you run the risk of a founder leaving early on and keeping all of his /her stock.
Securities Law Compliance – beware of not complying when issuing any securities to anyone, no matter who they are.
Legalzoom – avoid like the plague. Hire an attorney!

Raising Venture Capital – A Checklist of Documents.

Brian Powers — Thu, 03 Feb 2011 21:00:00 +0000

Raising venture capital / private equity requires more than just pitching your idea and business plan to a group of people with money to invest – although your pitch is obviously a crucial component. There are lots of documents that will be required, and those documents will usually require the careful scrutiny of a venture capital attorney. Below is a short, but not inclusive, list of what you might expect:

Don't expect a one page agreement.

Venture Capital Term Sheet - These are typically non-binding outlines of the terms of a venture capital deal. Don’t let the “non-binding” portion fool you, though. Terms laid out in a term sheet serve as the basis for all future negotiations, and any attempt to deviate from those terms will not be met kindly during deal negotiations.
Stock Purchase Agreement – This is the definitive agreement setting forth the terms of the venture capital investment, such as the purchase price, the closing date, and the conditions surrounding the issuance of stock – which more likely than not will be preferred stock. There will also be numerous representation and warranty provisions, among other provisions, that will need to be carefully crafted by a venture capital attorney.
An Amendment to the Bylaws – Assuming the company is a corporation and that the VC is conditioning its investment on the receipt of preferred stock (which it likely will), the bylaws of the corporation will need to be amended. This amendment will create a new class of preferred stock and will include anti-dilution provisions. dividend rights, liquidation rights and conversion rights. Some states require a “Certificate of Designation” to accomplish this, rather than an amendment to the bylaws.
Right of First Refusal / Voting Agreement – This agreement will grant the VC a right of first refusal to purchase any shares in the company that come available for sale. It will also likely contain a number of restrictions on the transfer of common stock, as well as tag-along rights allowing the VC to participate in the sale of any common shares. Finally, there will likely be a voting agreement requiring that the common shareholders elect the VC’s nominee(s) to the company’s board of directors.
Consulting Agreement – Often times a VC will require payment of a monthly fee by the company in return for certain management services provided by the VC.

These are just a few of the documents that a company might normally expect to see during the process of raising capital. As always, you should consult an attorney with knowledge of the venture capital process.

What do you think? Anything else to add to the checklist

The Indiana Venture Capital Tax Credit

Brian Powers — Wed, 02 Feb 2011 19:00:00 +0000

Are you raising private capital for your business. If so, you may be able to offer an additional incentive to your investors – a hefty tax credit. The Indiana Venture Capital Tax Credit is a statutory incentive for investors to make investments in early stage Indiana business startups. Investors who provide qualified debt or equity capital to Indiana companies receive a credit against their Indiana income tax liability.

(In case you don’t know, a tax credit is a direct offset of the income tax you owe. In this case, if your tax liability for a given year is $2,000, and you have a tax credit of $1,000, your tax liability is reduced to $1,000. Ding!)

This is a great incentive to offer your investors – assuming they have Indiana income tax liability. If someone has no Indiana tax liability, the Indiana Venture Capital Tax Credit will have little to know value to them.

In order to become a qualified Indiana businesses for purposes of the Venture Capital Tax Credit, Indiana businesses must go through a certification process by submitting an application to the the Indiana Economic Development Corporation. Additionally, after a taxpayer makes the investment, the taxpayer must submit proof of investment to the IEDC from which the IEDC shall issue the taxpayer a letter indicating that the taxpayer is entitled to a tax credit.

The maximum amount of tax credits available to investors in a qualified Indiana business equals the lesser of either (a) the total amount of qualified investment capital provided to the qualified Indiana business in the calendar year, multiplied by 20%; or (b) $500,000.

If you trying, or intend to try, to raise capital, make sure you explore this option.

If you have had experience using this tax credit, either as company raising capital or an investor, please share your thoughts in the comments!

Is equity financing right for your small business?

Brian Powers — Thu, 24 Jun 2010 03:13:04 +0000

Bank of America has a website called Small Business Online Community, the mission of which is to “create a thriving online community that empowers people in building a successful business.” A few weeks ago, a gentlemen called me, after reading some of my posts on IndianaStartup.com and interviewed me regarding the raising capital and potentially giving up control in the process. The article, which you can find in its entirety here, is pretty good, and give some interesting perspectives (other than just mine).

Here are some excerpts quoting yours truly:

Still, Indiana business attorney Brian Powers, who also runs the blog http://Indianastartup.com, points out that such a power-sharing arrangement can work-it just depends upon the individual circumstances of the parties involved. “Investor control is not necessarily a bad thing, especially if you have a young business that will be gaining partners that have greater industry expertise and business connections than you do,” he explains. But if a business owner can’t take an emotionally detached look at his company’s real long-term needs, he or she might be better served by bringing in a third party to help facilitate offers and find the best match. “That’s what I often do,” Powers explains. “I end up helping companies through the process of figuring out that what they’re usually being offered is a pretty good tradeoff for the money.”

What helps Powers assess what is or isn’t a pretty good tradeoff is the fact that he’s been on the other side of the table. “In 1998, I was part of a dot-com startup company that raised $1 million in capital through an equity round,” he explains. “Back then, though, we got ridiculous valuations and didn’t have to give up control to get it. Those days are long gone now.” For a short primer on these valuations and their role in determining equity investment, check out Powers’ blog: http://indianastartup.com/business-funding/raising-venture-capital/raising-venture-capital-how-much-should-you-give-up/.)

Good News for Start-ups – Venture Capital Investments on the Upswing!

Brian Powers — Thu, 06 Aug 2009 16:20:15 +0000

ChubbyBrain.com, a fascinating site who’s mission is to democratize startup and investor information to make it more widely available, recently published its Q2 2009 Venture Capital report – and the results are very encouraging if you are a start-up in the market to raise venture capital. Overall, the report shows a 61% uptick in investment capital flowing from VCs to entrepreneurs compared to the prior quarter. Some highlights from the report include:

Total deal value in Q2 of 2009 was $5.329 billion – up from $3.314 billion on Q2 2009.
VC’s are investing across a wide geographic base – including Indiana.
Venture Capital IS available for early stage companies – in fact – 35% of the deals in the report consitsed of seed funding or Series A rounds.
Healthcare investments were – well – healthy. Healthcare investments made up 37% of the deals in the report.

You can read the entire blog post here, or check out a PDF of the entire report below.

Startups: Venture Capital is Back! (startupprofessionals.com)
Do You Really Even Need VC? (cloudave.com)
Venture Capitalist Activity Up 61% in Q2 2009. Is the Worst Over? (myventurepad.com)
Where Entrepreneurs Can Still Find Private Capital (businessweek.com)

Indiana Cutting Budget for 21st Century Research and Technology Fund

Brian Powers — Wed, 22 Jul 2009 12:00:53 +0000

According to the website for the 21st Century Research and Technology Fund:

The 21 Fund provides financial support to highly innovative Indiana-based companies, thereby helping these firms make the transitional leap from general research and development to product development while also creating high-wage, high-skill, high-tech Indiana jobs and diversifying the state’s economy.

The site also says:

The 21 Fund seeks technology-based companies conducting business in Indiana and provides financial support to make the transitional leap from research to product development. By supporting high-tech companies during this crucial stage, the 21 Fund encourages entrepreneurial success and keeps Indiana’s most promising technologies in Indiana, leading to the creation of the high tech, high-paying jobs of tomorrow. The 21 Fund does not focus on a particular technology or application area in selecting awards. This allows Indiana’s strengths to identify themselves through successful completion of the 21 Fund’s rigorous review process. Avoiding pre-selection of technology focus areas ensures that the 21 Fund plays an unbiased central role in diversifying the State’s economy, a goal outlined in the 21 Fund’s legislation.

Sounds great, right? Encouraging tech companies to start-up in Indiana, as well as stay here, has always been a minor challenge when compared to the tech start-up hotbeds around the country. The 21 fund was supposed to be part of the solution to that problem. Unfortunately, on July 1st, the budget for the 21 fund was cut by $35 million over the next two years. David Castor, who’s Business and Culture Blog I subscribe to (and link to from the homepage of this site), sums up my feelings on this news:

This is an extremely short sighted move. It has a negative impact on both attracting and promoting growth for emerging technology businesses – businesses which have proven to be high growth and high profit. Promoting the success of these businesses leads to an increase in jobs, increase in average incomes, increase in consumer spending, and increase to tax dollars back to the state. That is economic improvement.

It is odd that in the year of economic stimulus dollars being granted to the state to boost infrastructure and economy, our state takes a position to decrease funding to businesses that truly impact economic improvement.

Short sighted indeed. If anyone out there has some insight on this decision, or an opinion one way or another, please chime in below with a comment.