Posts by Vladimir Pyrozhenko
This column completes a series of posts targeted at the aspiring and established Ukrainian tech entrepreneurs to help them land funding from angel investors. I’ll also share additional insights from the two experienced business angels – Michael Puzrakov and Murat Abdrakhmanov.
Michael is a Ukrainian tech entrepreneur and a co-founder of Intellias – a leading IT Ukrainian outsourcing company (#10 in DOU Top 50 list) and a founding member and President of Lviv Tech Angels. Murat is a serial Kazakh entrepreneur and active “super-angel” who invested in the top Ukrainian startups like Skyworker, 3DLook, Dmarket, among others.
Today I will address the following:
- What attributes angel investors are looking for in your startup?
- What are angels’ expectations of your pitch deck?
- How to prepare for a meeting and deliver your presentation?
- How to negotiate a startup valuation?
- What are the financing instruments commonplace amongst the Ukrainian angels?
- Other practical considerations in planning interactions with angels:
► What attributes angel investors are looking for in your startup?
After an angel investor is happy with what he/she saw in a pitch deck, comes the time for interviews and due diligence, in the course of which angels scrutinize every aspect of your startup. I will mention just a few focus areas of typical inquiries:
- An MVP (Minimum Viable Product). Times, when angels provided funding after discussing drawings on a napkin in a café, is almost gone;
- Traction: Investors want to see paying and returning customers as expressed in Monthly Recurring Revenue or MRR. Usually, a $5-10K MRR in the last several consecutive months is a convincing indicator for a working business angel. Murat says: “To me, the most important is not the revenue in absolute terms rather its growth rate and stability.”
- Disruptive technology and/or business model that may serve as a powerful source of competitive advantage.
- Competition: Investors hate when a founder confidently states there exists no competition or substitute for what he/she is doing. The chances are that you either haven’t done proper research or the problem you are trying to solve does not exist. Having a direct competition, substitute product (or service), or the “old way of doing things” serves as a good validation of your idea or product.
- Team: Business angels expect a balanced combination of technical and business expertise on the team. Murat comments: “Technical and business expertise are like two wings, and it’s hardly possible to fly with just one. I am not a fan of situations when one or the other expertise is outsourced or hired“.
- Reasonable cap table: Exceptions may apply, but investors (angels and institutional alike) like when there are several – not one – founders on the team, their shares are balanced, or the inequality is justified. Investors also want to see a forward-looking stock option pool reserved for employees. Angels avoid deals with “broken” cap tables – the most significant issue, by far, is too small of an ownership position by the founding team. Post the seed round, if the founding team + employee stock options are less than 50 percent, you are entering dangerous territory.
- Term sheet: The term sheet outlines the essential “conditions” of the deal and is really about two things – control of the company and cash received upon an exit/ liquidity event. If you haven’t bothered to prepare a term sheet, an investor will bring his own. What do you prefer?
- Exit options: The ultimate goal for the majority of angels is to exit 3 to 9 years with a decent multiplier. If you don’t intend to exit fully or partially in a span of a typical startup investment horizon and plan to run your company until retirement, it may discourage angel backers. So, think about your exit strategy well before pitching your project.
► What are angels’ expectations of your pitch deck?
A pitch deck is a short presentation of your startup. There are really no rules on how to structure your pitch, but I’d advise not to invent the wheel and turn to proven recommendations (and commonly accepted pitch structures) like the ones by Guy Kawasaki, Peter Thiel, or Sequoia Capital.
In terms of the storytelling and presentation of facts/ data, Murat recommends avoiding window-dressing in your pitch deck: “I often see pitches where the future is beautiful, and sales forecasts are overly optimistic. As experienced investors, we expect that founders realistically estimate competitive and other risks and do not manipulate data. I am ready to invest in risky projects, but I need to understand those risks and how founders plan to address them. When I do not understand the risks, I would rather back off from the project“.
► How to prepare for a meeting and deliver your presentation?
Michael Puzrakov gives practical recommendations that are coming from his vast experience: “It is kind of obvious, but I’d advise founders to adjust a pitch and the pace of its delivery to the duration of a meeting, do preparatory dry runs to ensure the meeting does not overflow. If founders need to include important details but don’t have time to cover them in a meeting, such sides should be moved below the final slide or in an appendix.
Important to note that investors are not looking for a great shiny presentation – they are looking for a great startup. So, if the presentation is not perfectly coherent – that’s fine; it is not important to me. Pitching is an interactive process, and an investor will be able to recognize a great startup, even if the presentation is not perfectly structured or presented.“
► How to negotiate a startup valuation?
In my career, I’ve seen pre-revenue startup valuations between $100 thousand and $30 million. “Pricing” startups are more an art than a science, but, as a founder, you should get familiar with the popular valuation techniques and prepare to justify your valuation requests. There are many articles and even books written on this subject. As a rule of thumb, for an “average” $0-5K MMR startup (if there is such a thing), you’d give up to 15% of the equity in the first round at $1-2M valuation. This is a very rough approach. In reality, it depends on dozens of factors, like the uniqueness of your idea/ product, management experience, the size of the opportunity, barriers to entry, industry comparables, and exit opportunities others. For example, the valuation can reach the mentioned $30 million or more if your invention helps tap into a huge addressable market and has an approved patent.
To put things into perspective, a famous US-based Y Combinator invests $120,000 for 7% equity in its companies valuing their “graduates” at a little over $1.7 million on a pre-money basis.
Here are some tips to prepare for a valuation discussion with an angel:
- Know your business: Be ready to defend your next twelve months revenue forecast to have an informative revenue multiple-based valuation discussion;
- Understand your peers: Research your industry peers and their fundings rounds to compare their revenue, its growth rate, and valuation to that of yours. If your company plans to do business in the US and you are based in Ukraine, be prepared that you will be heavily discounted relative to your US-based peers;
- Have a realistic plan: Articulate clearly how you are going to hit your sales numbers in year one by detailing your roadmap, conversion rates, business model description, etc.;
- Plan your next funding round: Have answers about the timelines, tentative round size, and valuation of your next fundraising milestone.
►What are the financing instruments commonplace amongst the Ukrainian angels?
Here is a non-exhaustive list of financing instruments presented in the order of descending interest among our angle backers:
- Straight equity: In straight equity deals you give up a part of the equity in exchange for cash and/or other benefits;
- Deferred equity: Deferred equity instruments include SAFEs and convertible notes. Angel investors are not huge fans of those because they may not give clarity on the valuation of your startup. Thus, an investor is kept in suspense on the equity stake he/she will eventually get (since conversion to equity takes place at the next “priced” round).
Other instruments include various forms of debt with covenants and other non-standard equity deals, but they are not popular and common.
► Other practical considerations in planning interactions with angels:
- Worries about NDA (Non-disclosure agreements): Business angels typically do not sign NDAs. I’d not waste time asking for that. Your worries that an angel will steal your idea are quite ungrounded. Instead, I’d recommend taking simple and common precautions to research the angle you are planning to approach to uncover any affiliation with your competitors or adversaries. I personally met investors who attended startup conferences like Web Summit to source ideals and created copycats of a successful business model in their home country;
- Lead investor: Angels may ask about your lead investor. A lead investor is a fund, individual, or group of investors leading the round by putting in the most money, leading the due diligence procedures, structuring the deal, etc. If you do not have a lead investor – that may be fine, but assuming you already have soft or hard commitments from other investors, make sure you mention that. Such commitments show that someone else believes in your startup and voted for it with their dollars.
- Personal liking and trust: To some extent, an angel’s decision to invest may well depend on his/her personal liking of a founding team, CEO’s charisma, transparency, and work ethic. Showing to meetings on time and prepared, projecting confidence, being upfront about business risks will go a long way towards getting funded. Michael notes: “The biggest mistake a founder can make is deceiving or openly lying to investors. By doing so, a founder can damage his/her reputation for a long time or forever.” On the same subject, Murat mentions: “It’s critical to build trust between an investor and founders that does not happen overnight and builds through several interactions and open dialogues.”
Back in 2012, I did not realize that landing angel investing is a marathon that requires stamina and knowledge of the “rules of the game.” This article is only a scratch of the surface, and each founder should take it through the prism of her/ her own circumstances. Still, I do hope my experience and well as that of Michael Puzrakov and Murat Abdrakhmanov will help Ukrainian founders get funded and create a plethora of new generation of Ukrainian companies.
Prepared with love for the Ukrainian tech community.
Vladimir Pyrozhenko, Founding Partner at Very Good Advisors (VGA)