Initial meetings, often where you first hear the pitch, are not for deciding whether to invest money in the entrepreneur and their venture, but rather to determine whether you want to meet them again, whether there is potential fit and values alignment, and whether you should invest time in building a relationship with them. The pitch is likely to be brief—in fact, it may take less than ten minutes. The information provided by the entrepreneur may be limited. The intention of the pitch is to give you a first impression and some preliminary information about the entrepreneur and their venture. After hearing them speak, your job is to decide whether to meet them again and gather more information. It’s generally a good idea to keep initial meetings brief—twenty to thirty minutes—so that you don’t invest too much time too early.
What you can expect when you first hear an entrepreneur’s pitch can vary, but to give you an idea, here is a summary of what they might tell you:
A bit about themselves (and their cofounders, if they’re a part of a team)
Something about their product or service (don’t get too hung up on whether you would be their customer; instead, look for them to show you that there are customers for their product or service—that there is demand, or that they are well on their way to validating customer demand)
Some general information about their business—who else is on their team and what their plans are for growing; a summary of their operations, business infrastructure, and systems in anticipation of the next stages of development and growth; and how they plan to grow their business
What they are trying to achieve, and what they need to do so
The information presented in a pitch is introductory and highly summarized. You should focus on whether you are intrigued and interested enough to want to find out more about the opportunity and continue the conversation. It’s like peeling an onion. Spend a small amount of time finding out some key information to decide whether to peel back a layer and delve deeper.
Take the opportunity to ask the entrepreneur questions after their pitch—or during, if the pitch is more conversational. Here are some of the questions you could ask:
Why did you decide to start the business?
What is your vision and mission?
Are you getting any help from advisors or mentors in developing your business? Were you part of an incubator or accelerator program?
Who is using your product or service, and how many people are using it?
Do you have any paying customers? How many, and what is the feedback from them?
What are your next steps in developing and growing your business? What kind of support do you need?
Each time you meet, find out more information, and ask the entrepreneur to update you and demonstrate the progress they have made. Find out what they have achieved in the time that has passed since you last met, what new information they have gathered in the process of building their venture, and what challenges they presently face.
At some point after hearing the pitch, building the relationship, and seeing some progress made, decide whether the investment opportunity is compelling enough to do formal and detailed due diligence (using the integrated investing toolkit). Get references from other people who have invested in the entrepreneurs previously or in their current venture, or who have worked with them previously. Speak with their customers and with people in their supply chain.
Power Poses and Power Pitches
Does the entrepreneur present herself confidently? Is she sitting back and looking disinterested? Are you leaning forward into the conversation in interest or do you have your arms folded? Our body language says a lot about the confidence we have in what we’re talking about and how we present ourselves. The body language of the entrepreneur who’s pitching you can be an indicator of how confident they are in their venture and abilities. Your own body language can signal whether you are interested in or attracted to the opportunity they’re presenting to you.
Recall from Chapter 5 the research by Amy Cuddy, a professor and researcher at Harvard Business School. She studies how non-verbal behavior and snap judgments affect people from the classroom to the boardroom. In her TED Talk, “Your Body Language Shapes Who You Are,” she describes how power poses can affect your stress levels, perception of risk, and mindset. Body language affects our communication and decision making, both of which are critical activities for the entrepreneurs making the pitch and for the investors hearing it. For more insights on body language, communication, and power poses, take a look at her TED Talk.
One-Pagers and Investor Decks
Before you meet an entrepreneur, or maybe as a takeaway after your first meeting with them, you may receive an executive summary about the venture and the investment opportunity. It could be as brief as one page (hence referred to as a “one pager”), or it could be several pages. When the entrepreneur presents their pitch to you, it may be delivered unaccompanied by any materials, or you might see a set of presentation slides—an “investor deck,” or simply a “deck”—from an entrepreneur (usually in a more formal pitch).
A twelve-slide deck might contain some combination of the following information:
Name and elevator pitch (value proposition)
Problem
Solution (value proposition)
Market validation (evidence of potential demand)
Market size
Product (value proposition)
Business model (revenue model)
Market adoption (customer channels)
Competition
Competitive advantages
Team
Investment requirement
If, after meeting an entrepreneur and hearing their pitch, you believe you could work with them and potentially invest in them and their venture, the next step in the investment relationship is to perform thorough due diligence and evaluation. At this stage, you will put the integrated investing toolkit to use to evaluate the entrepreneur, the venture, and the investment opportunity in detail. This includes, but is not limited to, the business model, the team’s capabilities, the competitive environment, the business’s impact, the risk involved, and the financial projections associated with the venture.
Common Forms of Investment
Up to this point, we have been talking about evaluating the entrepreneur and building the investment relationship. We’ll now move on to a high-level summary of the legal side of things. Legal agreements represent and document the terms and conditions of the relationship, which are legally binding and enforceable. In the investment relationship, they are like a pre-nuptial and marriage contract. Before entering into the investment, get legal and tax advice! Talk to your lawyer about the details of the legal agreements that are required for the specific situation and the investment opportunities you’ll be looking at.
To give you a bit of background on the forms that an investment in a private venture could take, I’m going to cover some of the common structures that are used for investing in equity.
Common Shares
Common shares align you with the entrepreneurs who founded and started the business. Other people who were involved early on in the inception and building of the business may also have common shares. Common shares are the most risky form of investment since there is no pre-specified time when you’ll get your original invested capital back or an investment return. Your investment return is dependent upon the future acquisition of your shares—by a larger company, by the general public through an initial public offering, by other investors, or by the management team or employees of the business. The potential for your shares to be acquired in the future is dependent upon the attractiveness of the business, including the growth in its revenues and profitability, and the impact it has on people.
Convertible Debt
Convertible debt is a type of loan or promissory note with an option to convert into equity shares later after a trigger event. Conversion to equity means the amount of money you invest is converted, at a certain share price ref
erred to as a conversion price, into a purchase of shares of the company.
Valuation and Determining a Share Price
Valuation of private companies is an extensive topic. It makes up a profession of its own and is the subject of many other books. I won’t go into detail about how to value a private company in this book. However, it would be good idea for you to have some understanding of valuation and how it impacts share prices and conversion prices for an investment in a private company.
Arbitrary Share Price
Take, for example, a company with one million shares issued and outstanding and the management and board of the company set an arbitrary share price of $ 0.25 per share. A million shares at $ 0.25 per share means an implied valuation of $ 250,000.
Percentage Ownership and Valuation
More often that not, investment in a private company is referred to by the percentage of equity of the company you own and its valuation. For example, say a company is willing to exchange 10% of its ownership for $ 250,000 of investment. The implied valuation is determined by dividing $ 250,000 by 10% to arrive at a valuation of $ 2.5 million. Over time, as the company raises more investment, your percentage ownership might decrease, which is referred to as dilution. The expectation is that the company is raising more investment and continuing to grow, such that the valuation goes up. As an investor, you want the valuation to go up! Let’s say your ownership has been diluted to 2.5% by other investments into the company after five years, but the valuation of the company has increased to $ 25 million. Your share of the company would now be valued at $ 625,000 (2.5% x $ 25 million). Bear in mind that these are just examples to illustrate what might happen to your percentage ownership and the company’s valuation. Actual outcomes from your investment will be different.
Convertible Debt and Conversion Price
In the case of a convertible debt investment, the amount you invested may be converted to equity at a future date. The share price and valuation concepts mentioned above might be applied, but there are some other features to the convertible debt. The convertible debt may specify a cap on valuation. This is the maximum valuation that your investment will convert at. The convertible debt may also specify a discount on valuation. For example, if you invested $ 100,000, are entitled to a 25% future discount, and the company is valued at $ 1 million in a future financing, your investment would instead convert based on a valuation of $ 750,000. So instead of getting 10% ownership, you would get 13. 3%.
The typical features of convertible debt include the following:
Term of one to two years
Accrues interest at a specified percentage (and is included in the amount that is converted to equity shares later on; the interest is typically not paid out in cash, unless you negotiate otherwise)
Option to convert the amount you invested from a loan to equity shares automatically at the end of the loan term or when a subsequent round of financing is raised by the company
If no valuation or valuation cap is specified in the terms of the convertible debt, option to delay the negotiation about the valuation and price of equity shares until a subsequent round of financing
At the end of the term, if the company hasn’t raised a subsequent round of financing, depending upon the terms of the convertible note, you, the investor, could seek to be repaid in full, keep the loan outstanding, or convert to equity
All of these terms can be negotiated differently depending upon what you, the entrepreneur, and other investors want and agree to.
Preferred Shares
Preferred shares are a type of equity share that gives an investor a percentage ownership in a private company. Unlike holders of common shares, the holders of these shares get preferential rights, which may include the following:
Deciding who is on the board of directors of the company
Voting rights, meaning they have greater influence over decisions made at the shareholder level of the company
Dividend preference, meaning dividends owed to them get paid out before those to common shareholders
Liquidation preference, meaning that in the event the company is sold, they will get paid back before common shareholders
Other rights including, but not limited to, influencing how the company is managed, how management and staff are paid, and how shares can be sold or transferred
Other New Forms of Investment
Simple Agreement for Future Equity
In December 2013, Y Combinator, a company that provides seed funding for startups and helps accelerate their development by focusing on helping the founders make desirable products, launched a new form of financing they referred to as a “simple agreement for future equity,” or SAFE for short. While it is increasingly being adopted by investors in Silicon Valley, it is still not widely used across the US , Canada, and in other locations. I mention it here in case you come across it. Common shares, convertible debt, and preferred shares are still the most typical and common forms of investment that you’ll encounter.
SAFE is a form of convertible equity and has the following features:
A SAFE is a form of equity financing and is not debt; like shares, a SAFE does not have a maturity date.
A SAFE does not accrue interest. The investment returns on a SAFE are dependent upon the future success and valuation of the company.
Revenue-Based Financing
Revenue-based financing is a financing structure where a company promises to pay a percentage of its future revenues to an investor in exchange for capital investment. The total amount that is paid back to an investor is based on a multiple of the initial capital investment. A number of early-stage venture funds and accelerators—including Seattle-based Lighter Capital and Fledge, and Vancouver, Canada-based TIMIA Capital—offer revenue-based financing. It is an increasingly attractive structure for impact-based businesses as there is less need for company founders to exit their venture through an acquisition in order to provide their investors with a return. Revenue-based financing enables founders to stay with their business long-term whilst providing investment returns through a structured, methodical buy back of shares or payback of capital over time.
Investing with other people gives you access to their experience and access to more information about investment opportunities. But it is not just information about the ventures you want; you also want to gather information about the entrepreneurs you might be investing in. A key part to building an investment relationship is putting in the time to get to know an entrepreneur. Once you find some entrepreneurs and investment opportunities that you are interested in pursuing, applying the techniques from the integrated investing toolkit and from integrated decision making will help you decide whether to go move forward. Understand the different forms of investments that are possible, and seek advice from your lawyer and financial advisor about any legal agreements and investment terms you’re considering entering into before signing on the dotted line.
Honing your integrated investing skills requires practice. I encourage you to continue to refer to the resources in this book as you start to meet other investors and entrepreneurs building meaningful, purposeful businesses of the future.
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1 In the UK , the relevant statutory instrument is the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, accessed April 8, 2016, http://www.legislation.gov.uk/uksi/2005 / 1529 /pdfs/uksi_20051529_en.pdf .
2 In some cases, non-accredited investors who are sophisticated, experienced, and knowledgeable enough to evaluate the risks and rewards of a private investment opportunity are permitted to invest. Do consult a lawyer to understand the details of the securities law and applicable exemptions.
3 Robert Wiltbank, PhD and Warren Boeker, PhD, “Returns to Angel Investors in Groups” (Ewing Marion Kauffman Foundation, 2007), accessed April 8, 2016, http://sites.kauffman.org/pdf/angel_groups_111207.pdf . The 538 angels included in a study by the Kauffman Foundation enjoyed 2.6 X returns over the life of their investme
nts. For deals on which collective due diligence totaled less than twenty hours, returns were only 1.1 X . But deals on which angels put in over forty hours of due diligence (the top quartile) returned 7.1 X to those investors.
4 “BetterInvesting Investment Clubs,” BetterInvesting, accessed April 8, 2016, http://www.betterinvesting.org/Public/Clubs/default.htm .
5 For the most up-to-date information on securities laws and regulations, visit the US Securities and Exchange Commission website at www.sec.gov .
6 A fund is a legal entity for the purposes of pooling or aggregating capital from investors. Typical legal entity structures for funds are a corporation limited by shares or a limited partnership. There is always a fund manager managing the capital in the fund and the business affairs of the fund. It could be an individual or a team of people or a fund management company. Contrast this with angel investors, who are individuals investing their own money directly into companies and managing their own capital.
7 “Invest,” SolarShare, accessed April 9, 2016, http://www.solarbonds.ca/invest/invest .
8 “About Us,” ImpactSpace, accessed April 9, 2016, http://impactspace.com/about .
9 “Ventures for Good Startups,” AngelList, accessed April 9, 2016, https://angel.co/ventures-for-good .
10 “About Us,” National Crowdfunding Association of Canada, accessed April 9, 2016, http://ncfacanada.org/about-us/ .
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