How to start a startup: Fundamentals of attracting investment

Original author: Kirsty Nathoo, Carolynn Levy
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Stanford course CS183B: How to start a startup . Started in 2012 under the leadership of Peter Thiel. In the fall of 2014, a new series of lectures by leading entrepreneurs and experts of Y Combinator took place:


First part of the course

We assume that your company has achieved great success and can easily attract the right amount. However, you must understand that those who throw you money do it for a reason.

First of all, you need to consider the reduction in your share in the company. For example, if you attract two million dollars with a capitalization of six million, then after converting the loan into securities, the initial investors will own 25% of the company’s shares. Plus, investors taking part in the next round may request another 20% of your company’s shares. As a result, at this stage you are already losing 45% of your company.

Do you need it? Maybe it is necessary, because even a small amount with low capitalization is always better than nothing. And if you are satisfied with the proposed conditions, then agree. But know that you need to constantly monitor the progress of the entire process in order to understand what this may lead to in the end.

In addition, you should always choose experienced investors. They have enough money to invest, and they are well aware that investing in startups is risky.

We often come across companies that say: "My uncle or a friend of mine can invest in this business." They, of course, can give five or ten thousand dollars each. However, it is often such investors that cause the most problems, because they might think: “Perhaps I will get my money back. I need a new kitchen. ”

Or: "Investing in startups, it turns out, is not so interesting as they show on TV." They demand their money back, bringing a lot of trouble to the company. Therefore, ask for money from those who have experience and know what they are doing.

Most importantly, do not complicate anything. In the process of attracting financing, use standard documents. Make sure that you work with people who understand what they are getting into, and specify the size of the share that will remain with you as a result.

Carolynn: So, you are starting to attract investment. You know how much your company is worth. You know what documents you need to fill out. It may turn out that you do not understand some of the terms and concepts that your investors use. This is normal, and your task is to find out what they mean.

Do not think that since you agreed on the value of the company, then everything else does not matter. You need to find out what these concepts mean for your company in the long run. At Y Combinator, Kirsty and I constantly hear the founders say: “We did not know what we were signing. We didn’t know what we were agreeing to. ” So your task is to figure it out.



Consider four typical requests from investors. The first is participation in the management of the company. Some investors will ask you to give them a place on the board of directors of your company. This is usually due to the fact that either the investor wants to track what his money is spent on, or he or she believes that he can help you do business.

One must be very careful when including an investor on the board of directors. Most likely, it would be more correct to refuse him. One way or another, make sure that this person can bring real benefits to the company. The availability of financial resources plays a large role, but the presence of an investor who can help develop a strategy and indicate the direction of the company is invaluable. Therefore, approach the choice of investor wisely.

The second is advice. Many can give you advice on work, but only a few can give you really valuable advice. As soon as the investor has invested his money in the company, he or she, in fact, begins to play the role of a consultant, without having any position and, more importantly, without demanding anything in return.

In Y Combinator, we found that every time a certain famous person becomes an investor in a startup, this person almost always asks the company to become its consultant. We have a company that provides personal protection at the request of customers. One well-known basketball player became her investor, and he asked to be appointed as a consultant. In exchange for his services, he demanded a stake in the company.

His “services” were that he just told other professional basketball players about this company who might need a bodyguard. This star has just invested a decent amount in the company. Why not bring real benefits to the company? Why does he need extra reward? If the investor really wants to help you, he will not charge you for it. An investor who asks for an additional block of shares for his services is really just looking for easy benefits.

The third request is the right to a proportional distribution of shares in the company. It consists in preserving its share by purchasing more shares in the future. The application of this right is one way to avoid reducing its share in the company: it decreases every time the company sells more and more shares to other investors.

A simple example: suppose the initial investor acquires a package of preferred shares of the company, and after attracting investments, its share is 3%. The next round of financing is coming. The company turns to the same investor who is interested in proportional distribution and says: “We need more money. We suggest you buy so many shares in the new round to keep your stake in the company at 3%. ”

Investors quite often ask for these rights. They may not do you any harm, but as a founder you must know the principle of operation of these rights. In particular, this is due to the fact that when an investor receives the rights to proportional distribution, trying to avoid reducing their share, the founders may lose an even larger share of the company.

And the last one is providing information about the company. Investors almost always require you to indicate in your contract whether you have the right to receive certain information about your company. Periodically informing your investors about the state of affairs is quite natural.

At YC, we ask companies to inform their investors every month about how their work is progressing, so that they can always turn to them for help when the company needs to establish contacts or hire new employees. Just do not overdo it. If the investor asks you to provide financial statements every month and talk about the progress of the company every week, this is not normal.

Conclusion: if you decide on the method of financing and evaluate the value of the company, this does not mean that everything else is not important. You should be aware of everything related to the financing of your company.

Kirsty: After you have managed to attract financing, you will probably find more zeros on the bank account of the company than you have ever seen in your life.

Further, you begin to actually spend the funds you received. Production costs are the cost of running your business. These include payment for employees, office rent, hosting, as well as the cost of attracting customers.

Costs play a very important role in business, as they are deductible from the tax base and, depending on the income of the company, reduce taxes. On the other hand, non-production costs of the company, which are not included in the tax return, do not allow legally reducing the amount of taxable profit and, accordingly, the taxes themselves.



You can once again look at the situation from the perspective of a large company: if you work at Google, you are unlikely to buy a toothbrush and toothpaste with a company credit card.

Always remember that this money was given to you by investors. They have entrusted you with a large amount and want you to spend it for the good of the company. Do not scatter other people's money. We know several founders who acted dishonestly towards their investors. For example, one founder received money from investors and went to Las Vegas. Judging by his photos on Facebook, he had a good time there. It is clear that now he does not work in the company. This is real theft.

Understanding which costs should be considered manufacturing and which are not is not so easy, especially in the early days when you work 24 hours a day. You can ask yourself this question: “If the investor asked me what I spent his money on and I have to write down all the costs of the items, will some of these items confuse me?” If they are, then most likely you should not attribute these costs to production costs.

Also, do not forget that you have a lot of work, and you basically do not have to think about accounting and financial reporting. However, it is very important to monitor all financial transactions so that your accountant who compiles the tax statements can understand which expenses are related to production and which are not.

In any case, they will need your help as the founder of the company. You can minimize your participation in this process if you keep documents in a safe place where you can easily turn to.

Most importantly, do not leave for Las Vegas with the money of your investors. Spend them wisely.



Announcement:

December 15 from 10.00 to 19.00 in the IIDF City Hall will host the conference "Smart Health".

The purpose of the conference is to tell startups about the needs and plans of the largest market players in new technologies and software products.

The issue of interaction between startups and big business will also be separately discussed.

We invite industry representatives, investors, startups and everyone who is interested in healthcare in Russia.




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