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Archive for the ‘Crowdfunding’ Category

If you’re a company preparing for a financing round in the near future, you should already know what is a Due Diligence (commonly known also as DD). If not, read on. If you do know what Due Diligence is, you might be interested how to do is cost-efficiently.

Wikipedia defines Due Diligence as follows:

Due Diligence is a term used for a number of concepts involving either the performance of an investigation of a business or person prior to signing of a contract, or the performance of an act with a certain standard of care.

Nowadays there are many kinds of Due Diligences, for example Legal, Financial, Technical, Commercial and Environmental. The scope of the Due Diligence will depend on the size and scale of the transaction and the surrounding risks.

We will focus here  on investment-round related Legal Due Diligence, and more specifically on Vendor Due Diligence which is done by the company itself in the preparation phase of the investment round. Due Diligence prepared for an acquisition is in many aspects similar to what we discuss here, but has naturally its own specific issues.

Legal Due Diligence focuses on showing that the future prospects of the company have a secure legal base. For example, it includes information about intellectual property rights (IPR) and customer as well as employee agreements.

Financial Due Diligence focuses on financial issues, and the most important of these usually fall into the categories of earnings, assets, liabilities, cash-flows, net cash or debt and management. In a typical investment round for a early-stage company these (historical) figures are often NOT the ones where the investment is based on.

Commercial Due Diligence is the process of investigating a company and its markets. It typically gathers information concerning published market information as well as information from customers, competitors and other market participants. While Financial Due Diligence is looking at the history, the Commercial Due Diligence is “forward-looking”.

Vendor Due Diligence is a Due Diligence that is made by the company itself. It’s often likely that your investors will make their own Due Diligence, especially if it’s about a larger amount of money. Vendor Due Diligence and a Due Diligence made by the investors are by no means contradictory. And as crowdfunding-style investment rounds are getting more popular, there is an increasing need for quality-evidence to be shown by the company. Vendor Due Diligence is very good for that.

In practise, a Vendor Due Diligence will be done with the help of a Virtual Data Room. It’s an online, secure storage which will help to store and process all the material, whether it is information filled with template or uploaded PDF’s.

By now you must already be thinking that there is no guaranteed quality in the Vendor Due Diligence. You’re right, and wrong as well. When done properly, the Vendor Due Diligence is completed by a verification by an external, independent lawyer. A properly made Vendor Due Diligence together with qualified verification is very valuable tool as part of an investment round.

We at Venture Bonsai have created a standardized and easy-to-use self-service, on-line Vendor Due Diligence process for small and medium-size software/mobile/Internet companies. You can complete it without extensive legal knowledge and have the information verified by your local lawyer. Its main purpose is to guide you through the most important aspects of the Due Diligence. It’s not fully complete, so to say, for that you still need to hire your lawyers. But the reality is that practically no companies looking for funding are doing any kind of Due Diligence so this will both help you to differentiate and find possible holes to be filled. If you’re interested, please get in touch.

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There is also a summary mindmap available (in English) and you can find the book itself here.

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As part of the Venture Bonsai concept, we shot the first five elevator pitches today in Helsinki.

The idea is to make two videos for start-ups looking for funding: one public 100 seconds video and another 5 minutes non-public video which can be shown to potential investors.

To our knowledge, this is the first time elevator pitches are really made professionally.

Same questions were asked from each entrepreneur and if the answer filmed did not go well enough it was shot again. All the aspects of each answer were fine-tuned towards high quality of the message.

The filming itself was done by a professional as will be done the editing.

Looking forward seeing really cool videos next week!

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Last Friday we released some information on our crowdfunding project, now officially named as Venture Bonsai.

Venture Bonsai is a tool for companies (start-ups and others alike) enabling them run a crowdfunding-style financing round successfully.

I’ve covered some of the challenges of the crowdfunding model in my recent blog articles (Part 1 and Part 2). Venture Bonsai is about to solve some of those, if not all, challenges.

The key benefits of using Venture Bonsai are

  • Demystification of the crowdfunding process, and a funding process in general
  • Offers tools and processes to follow the financial regulations
  • Offers tools for acquiring or creating the key documents such as Business Plan, Shareholders’ Agreement and Term Sheet
  • Offers a platform for Vendor Due Diligence (DD), including DD done by certified partners
  • Includes tools for company valuation
  • Includes a “Show Room” for your marketing material
  • Includes “Elevator Pitch on the Video”
  • Includes communication tools required during and after the financing round
  • Tools for escrow account and signature mechanisms

We already have the first companies lined up to use this tool in the piloting phase. Venture Bonsai is also utilizing this model for its own funding process. Please contact us if you’d like to use the upcoming pilot as well.

We’ll be on a roadshow for Venture Bonsai as follows: London March 1st & 2nd, Silicon Valley March 4th to 8th. Please contact us if you’d like to learn more (as an entrepreneur, as an private/angel investor or as a partner).

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Last week week we discussed the first five items of the following list, this week we cover rest of them.

  1. How do I find the potential investors?
  2. Which regulation applies and what can I actually do?
  3. How do I get the investors’ attention?
  4. How to deal with all the required documents?
  5. How can I negotiate all the terms with so many investors?
  6. What about company valuation?
  7. What is Due Diligence and why do I need it?
  8. How on earth do I get all the papers signed by a large number (say, 90) of investors all over Europe?
  9. How can I securely communicate with all those potential investors without answering the same questions over and over again?
  10. How to take advantage of a large number of investors, after I got them?

6. What About Company Valuation?

Company valuation is always a tough call. There is no real truth available for this, but typically (we entrepreneurs) over-estimate the value and the potential investors under-value the company as they want to “get a good deal”. So what would be fair price for a share issue?

The easiest way to set the price is just decide a value that you think would be acceptable for the investors. It makes sense to ask around your friends and other entrepreneurs as well as to compare the valuation to other similar companies. The challenge is, however, that typically the values of financing rounds are confidential and there is no good way to do good market research. A good way to know if you are in the right range is also just asking some potential investors. Even though their opinion may be biased, they are after all “your customers” and you get the feeling if you’d be able to sell your product ie. the shares to them.

You could also use the Dutch Auction model which Google used in its IPO offering. The Dutch Auction is a type of auction where the auctioneer begins with a high asking price which is lowered until some participant is willing to accept the auctioneer’s price, or a predetermined reserve price (the seller’s minimum acceptable price) is reached. The winning participant pays the last announced price.

If you want to use even more exotic and different model you can also use the Vickrey Auction model. This is a type of sealed-bid auction, where bidders submit written bids without knowing the bid of the other people in the auction. The highest bidder wins, but the price paid is the second-highest bid.

The Dutch Auction and Vickrey Auction models may turn out to be interesting due to the relative fairness of the valuation but they do require software tools in order to manage the process properly.

7. What Is Due Diligence (DD) And Why Do I Need It?

Wikipedia defines Due Diligence as “a term used for a number of concepts involving either the performance of an investigation of a business or person prior to signing of a contract, or the performance of an act with a certain standard of care.”

Concerning fund raising with crowdfunding model there is a need for “vendor due diligence” meaning basically a Due Diligence carried out at the expense of the company. This is necessary (among other things) in order (1) to find and correct any matter potentially decreasing investors’ interest in company, (2) systematically documenting anything that positively increases investors’ interest such as Intellectual Property Rights (IPR) and (3) having a third party opinion on issues such as “is this technology working or could it work” and “are all financial and legal matters as they should”.

Those objectives can be achieved by

  1. Company itself documenting and listing certain issues
  2. Having a third party doing the Technical Due Diligence (sometimes this is not relevant)
  3. Having a third party doing the Legal Due Diligence (this is often the most important one) and includes for example checking the balance sheet, accounting reports and the IPR
  4. Having a third party doing the Financial Due Diligence (as this concerning the issues such as market and future development, may be the most difficult one)

There are no really standardized ways of doing the DD and this typically means that there are quite many different ways of performing this. It also means that it is good business for lawyers and other parties. However, there are efforts already (among others our GrowthOS project) solving this problem. Standardized Due Diligence, when successful, means an easier way to analyze company as an investment target (good for the investors) and more affordable way of performing one or more Due Diligences (good for the entrepreneurs).

8. How On Earth Do I Get All The Papers Signed By A Large Number (Say, 90) Of Investors All Over Europe?

Let’s imagine that your company has successfully completed all the above mentioned steps. You have 90 investors agreeing to invest certain amount of money in your company, with the specific terms agreed. The remaining challenge would be printing 90 copies of each document and having all signing those papers. Sounds like a lot of work…

This is luckily not necessary.

You can either structure the documents so that each party can just “join” the agreement (consult your lawyer on this) or use some other method. This “other method” means processes currently being developed several parties, enabling signing documents with legal binding with electronic means.

9. How Can I Securely Communicate With All Those Potential Investors Without Answering The Same Questions Over And Over Again?

Email is not really good means of communication for secure discussion. You have a need (and in a way, an obligation) to answer to the questions asked by the potential investors as part of a funding round. You also have to share same information with all parties, keeping them equal as required by the law. At the minimum, you may want to set up a secure discussion board for all the participants and keep all discussions there.

10. How To Take Advantage Of A Large Number Of Investors, After I Got Them?

This may be the coolest advantage you’ll get, potentially benefiting you more than just the money. You know  how the investors always emphasize how they have connections to help your startup. In some cases that may be true, yes. However, the likelihood that you get quite a lift for your business from the large number of investors, is higher. What this means is that as the number of crowdfunding investors (in your company) grows, the likelyhood that they can help you to get more lead, customers and revenue, grows equally. Each of the investors has a motivation (ownership) to help you.

What would be the best way of managing this communication? As an entrepreneur you don’t want to spend all your time with those questions that have no value. Here you may not want to treat all the shareholders equally (meaning: communicate with all of them equally much concerning business). Similar discussion forum as was used during the investment round may be useful, but may also not be adequate.

If you are facing these challenges, and would like to use a leading edge service to solve them, please get in touch. We are currently working on a solution that would help you on this.

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Crowdfunding is gaining some momentum as a potential investment vehicle for startups. As the traditional Angel Investors and Venture Capitalists have become more careful on the early stage investments and number of investments has dropped dramatically, there is a need for new methods.

But how do you actually run a crowdfunding investment round? There are no tools currently available for this so it may seem like a lot of work. And it is. This means it’s just another challenge to be solved.

The issues you have to consider and solve when running a crowdfunding round (or any investment round):

  1. How do I find the potential investors?
  2. Which regulation applies and what can I actually do?
  3. How do I get the investors’ attention?
  4. How to deal with all the required documents?
  5. How can I negotiate all the terms with so many investors?
  6. What about company valuation?
  7. What is Due Diligence and why do I need it?
  8. How on earth do I get all the papers signed by a large number (say, 90) of investors all over Europe?
  9. How can I securely communicate with all those potential investors without answering the same questions over and over again?
  10. How to take advantage of a large number of investors, after I got them?

1. How Do I Find Potential Investors?

In most cases you need to find all the interested investors yourself! You can also use some of the crowdfunding initiatives, such as GrowthOS and Vestify, to find those people, but it can take some time before these are the quickest way. You can also consider making a deal with a large bank and make a underwriting deal with them. In any case you have to keep in mind the regulative limits set by the financial authorities of your country, such as SEC, European Union and national laws.

2. Which Regulation Applies And What Can I Actually Do?

This depends where your company is based and where your investor candidates are. Regulation is largely unified with the European Union (excluding UK), USA has its own regulation as is the case with for example Japan and Australia. Due to the legal reasons and as I am not a lawyer, you should consult your lawyer if you are unsure about this.

3. How Do I Get the Investors’ Attention?

If your service or product is on the market and if you’re lucky, they’ll contact you. It’s always the best if you can get yourself and your offering visible so that the potential investors call you (and you don’t call them).

However, if you are really early stage company, or there is nothing in public yet, or if you just are not famous (yet) then you need other tools. One thing we are piloting next month is producing professional-grade “elevator pitches on video”. One of the videos is 100 seconds long and is meant to be public, including publishing it in Youtube. The other video is 5 minutes long and can contain “more confidential information”. The purpose of the videos is simply to get more attention of potential investors and get them in touch with you. We have developed a special “format” with pre-determined questions  related to startups and funding to speed up the process. Both shooting the ideo and editing it is done by the professionals, ensuring high quality and nice feeling.

You should, one way or another, have your own “Show Room” with all the videos, screencasts and other material you want to use for showing what you do.

4. How To Deal With All The Required Documents?

In order to raise money you need in minimum

  • Business Plan (with an excellent Executive Summary)
  • Share Issue Offer, including the Term Sheet
  • Shareholders’ Agreement

There are many guides on how to write a business plan so we don’t cover it here. Concerning the Offer and Term Sheet, you may want to take advantage of services such as The Funded (only for entrepreneurs) or consult your lawyer (again:-). Shareholders’ Agreement is discussed in the next chapter.

5. How Can I Negotiate All The Terms With So Many Investors?

The thing is, you don’t (negotiate with all of them). You must have such versions of the key documents such as the Shareholders’ Agreement that it is acceptable for all the parties without further negotiation. It’s “take it or leave it” kind of thing. An if it is not acceptable by the investors, they may “leave it”.

Luckily there are number of initiatives taking place in this field. There are for example already few “Standardized Shareholder’s Agreement” templated downloadable for free. You can always customize these with your own lawyer, but the key thing to keep in mind is that it has to be acceptable by both the investors and yourself.

Next week: Challenges 6 through 10!

PS. I’ll be in London and the Bay Area early March, please contact me if you’d like to discuss crowdfunding (as an entrepreneur or as an investor)

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