Eric Gabrys

Trade & Investment Commissioner

california@brusselsinvestexport.com

               

155 Montgomery Street Suite 409

San Francisco CA 94104

M +1 (415) 866 40 22

T    +1 (415) 291 01 30

F    +1 (415) 291 01 25

Skype: bie-siliconvalley

www.brussels-in-usa.com

 

1   Introduction to Venture Capital in the US: Facts and figures

 

There is little doubt that the reason Silicon Valley has become the main hub for innovation in the world lies in its complex ecosystem where VCs and angel investors play a critical role in funding the riskiest asset class that a startup represents. Because of the difference in the American approach to valuing risky investments in startups (even more strikingly so in SV) compared to Europe, it is understandable that Belgian entrepreneurs are tempted by the opportunity to raise venture capital in the US. However, this endeavor does not come without challenges and entrepreneurs will be faced with new risks and constraints.  

Despite its large impact on US economic growth, VC investment is a relatively small business as an asset class.

Venture capitalists invested $59.8 billion in 4,535 deals in 2015, according to the MoneyTree™ Report by PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association). Total investments by angel investors in 2015 were $24.6 billion, a slight increase of 1.9% over 2014, according to the Center for Venture Research at the University of New Hampshire. A total of 71,110 entrepreneurial ventures received angel funding in 2015, a decline of 3.1% over 2014 investments.

The two financing sources target different financing stages: Angels usually take the very early bets (seed funding) and VCs focus on later stage financing for the most part (growth capital). Another difference is that Angel Investors invest their own money while VC firms are professional investors who invest their fund money on behalf of their Limited Partners (L.P.’s).

Venture capitalists invested $59.8 billion in 4,535 deals in 2015, marking the second highest full year total in the last 20 years. In terms of deals over the prior year, this amount of investment reflects a 17.25% increase. Though the average deal size from 2014 to 2015 increased by 5.1%, the deal valuation decreased by 13/1%. Representing a three-year trend in decline in valuations, and indicating that a market correction may be gaining momentum.  Data for angel investments is not yet available for the first two quarters of 2016.

Software (18%), healthcare (16%), biotech (13%), industry/energy (11%), retail (10.6%), and media (9%) companies together received 77.6% of all angel group dollars, according to the Center for Venture Research at University of New Hampshire. California alone makes up over 50% of VC US dollars.

VC investment is not a particularly transparent asset class but the average return on investment is an impressive 0%, reflecting the fact that the vast majority of venture capitalists failed to return the initial investment to their Limited Partners such as a university endowment, pension funds, or large corporations that want to invest some of their capital into startups. The VC firm invests the fund money into promising startups for three or four years and then harvests the returns for the remainder of the fund’s eight to ten-year term in exchange for a fee. The typical V.C. fee structure is “two and twenty”: two per cent of the fund each year as a “management fee” and twenty per cent of the exit profits also referred to as the “carry”.   These are average figures as top notch firms are known to be able to negotiate up to a 30% “carry” while second tier firm partners will be offered less by their LP’s and under stricter conditions.

 

Fig.1 Investments by region – 2015 and 2014

(Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report)

 

San Francisco has definitely defined itself as the epicenter of Silicon Valley by attracting most of all Series A Investments (first round of institutional investors’ money) year-over-year in 2014, 2015; as well, for first two quarters in 2016 has received highest level of funding for all regions with $13.1 billion.

Despite its relatively small size, VC investment has a strong impact on the economy and job growth.  The Kauffman Foundation data shows that fast-growing young firms in the US, while comprising less than 1 %of all companies, generate roughly 10 %of new jobs in any given year.

As reported by Marianne Hudson from the Angel Capital Association, the U.S. Census Bureau and the Ewing Marion Kauffman Foundation in 2009 and 2010 found that businesses that were less than five years old created all of the net new jobs in the United States over the last 25 years. The majority of these jobs came from innovative businesses that grew exponentially, with angel-backed company examples such as Google, Facebook, and Starbucks.

 

 

2   Funding process in the US: A Silicon Valley prospective

 

Generally VCs are not interested in seed funding while business angels primarily focus on seed funding.  One of the most relevant criteria used to differentiate VCs is the size of their current fund.  Their investment must return a significant part of the fund in order to be considered in their deal flow.  When the rate of success in VC funding is less than 50%, a VC will only bet on a company that can return a significant part of their current fund.   Other criteria to select your VCs should include:

  • industry focus
  • network and contacts -  VCs are often referred to as recruiters on steroids which is not a bad thing in a very competitive environment where people assets will be key to your success
  • personal chemistry with the VC partner who will sit on your board

Seed funding from Angel investors, as well as from the three Fs (friends, family, and fools), is usually tapped into in order to complement your own funding. Unlike in Belgium, you must be considered as an accredited investor (you own over 1 M liquid assets or your disposable income is over 200k/year, see more on http://www.sec.gov/answers/accred.htm) to be able to invest in startups as an individual.   Very wealthy individuals - usually successful former entrepreneurs - act more like micro VCs by making angel investment their full time job.  Shark Tank, a very popular ABC prime time show, has been epitomizing this type of angel investor.   
 
A typical start-up in the Silicon Valley/SF will undergo the following steps of funding:

  • Your own money together with money from 3Fs (Fools, Friends and Family); entrepreneurs should expect investors to ask about the skin they have in the game.
  • Angel investing from accredited investors or seed money from accelerators or incubators.  Seed funding typically ranges from 150k to 1.5M USD. Seed funding is generally focused on evaluating soft skills like the founder’s team expertise and experience, together with the potential market for the proposed solution or product. 
  • VC investment (1 to 4M USD deals), called Series A, as well as follow-up rounds:  Series B, C, D, etc. The amount raised can be up to and even over 1 Billion as we saw in Uber’s series E.  Not all companies will make it through all these stages. Series A and above will primarily focus on facts and the founder’s ability to execute.  Series A funding often creates the feeling of a funding crunch among entrepreneurs; this is referred to by investors as the “valley of death” for a startup, as this particular funding round reflects on the founder’s ability to execute or properly pivot to gain significant market traction at a time when additional funding will require data and proper execution to be justified.

 

 

Fig.2 Typical funding process

VCs expect to get to an exit through an IPO or more likely via an acquisition within 5-7 years of their initial investment.  There is a recent trend for startups to remain private by tapping additional funding from private equity funds.  It remains to be seen if this becomes a more permanent trend or just the sign of a bubble in the mobile/social media software industry.

Over 140 companies have soared to a $1 billion valuation or higher, based on funding.   These startups are commonly referred to as “Unicorns”, a term coined by VC Aileen Lee in his TechCrunch post in November 2013.  See techcrunch.com/2013/11/02/welcome-to-the-unicorn-club

As indicated earlier, 71,000 companies were funded by Angel Investors in 2015 while less than 4,600 received funding from VCs during the same year.  Seed funding remains an extremely risky investment and most startups fail.  However, a few successful ventures create so much value that the average IRR for diversified angel investment is estimated to be between 20% and 30% according to the ACA/Kauffmann foundation.

 

 

3   VC Incubators

 

Incubator programs are another means of accessing funding for your startup, and more and more of those founded in Silicon Valley welcome international startups into their programs. The programs are designed to be collaborative and highly selective, with the ultimate goal of helping start-ups succeed by providing (1) access to a pool of funders usually at the angel, seed, or Series A level (2) business education and mentorship (3) access to a business-tech network (4) access to peer networks.

 

  • Successful incubators in the San Francisco Bay Area

 

Founders Space

http://www.foundersspace.com/

Dedicated to helping exceptional entrepreneurs grow their startups, get funded and go global. According to Forbes Magazine, is the #1 incubator for startups coming from all over the world to Silicon Valley.

 

 

Y Combinator

https://www.ycombinator.com/

Provides seed funding for startups in return for small takes in the startup companies. Notable alumni include AirBnB, Dropbox, Stripe, Optimizely, Mixpanel, Docker, Reddit, Instacart

 

Plug & Play Tech Center

http://plugandplaytechcenter.com/

A global innovation platform, to connect startups to corporations and invest in over 100 companies every year. The have 22 locations across the world. Notable alumni include PayPal, Dropbox, SoundHound, Lending Club.

 

US Market Access Center (USMAC)

http://www.usmarketaccess.com/

Provides international tech companies with fast and successful access to the US and global markets via Silicon Valley

 

 

500 Startups

http://500.co/

A leading global venture capital seed fund and startup acclerartor. Manages $200 million in assests and invests in ,300+ technology start-ups. Notable alumni include RealtyShares, Dollar Beard Club, Twilio, CreditKarma, SendGrid

 

RocketSpace

http://www.rocketspace.com/

A technology campus located in San Francisco. Since 2011, has been helping tech entrepreneurs, startups and corporate professionals bring the future to market. The company offers services to its members including programming, consulting, events, and office-as-a-service, which together create the perfect ecosystem and community for innovation to thrive. Notable alumni include Uber, Spotify, Hootsuite, Practice Fusion, and Weebly

 

The Batchery

http://batchery.io/

The Batchery is a Berkeley-based global incubator for seed stage startups ready to go from idea to launch at lightning speed. We are a community of 50 veteran investors and advisors ready to provide you with ideas, insights, and networks. We are the global gateway to Silicon Valley, with the best in office space, tools, and partnerships for entrepreneurs in the Bay Area, around the US, and internationally.

 

 

 

The Runway

http://www.runway.is/

Runway is an incubator and co-working space, home to high-caliber startups located in the Twitter building in downtown San Francisco. With over a dozen partnerships with Fortune 2000 brands and an international network of cutting-edge startups, Runway is the home of innovation.

Discount Code: TEDxSF

 

 

 

Blackbox

http://blackbox.vc/about/blackbox/

Bring motivated founders with great ideas from every corner of the world to Silicon Valley to learn from and connect with successful entrepreneurs, experienced venture capitalists and other resources to accelerate their global expansion.

 

 

 

GSV Labs

http://gsvlabs.com/

Empowering entrepreneurs and partners to accelerate global innovation

 

 

4   Tools & term sheets

 

In the early life stages of a startup in Silicon Valley, investment is usually made via convertible promissory notes.  A convertible promissory note is a financial instrument in a form of a discounted debt that will be automatically converted into convertible preferred stock at the next (qualifying) financing round.  This is a great tool to avoid lengthy discussions about the startup valuation and to keep the financing accessible and low-cost.  You can easily find examples of a convertible promissory note sheet on the web (e.g. www.startuplawblog.com/wp-content/uploads/2012/07/Term-Sheet-Seattle-Angel.pdf ) or in the enclosed appendix A.

Business angel funding often relies on a lead investor who will bring a group of investors with him (together with their respective market expertise).  You can find a list of such key business angels on www.businessinsider.com/sv-angel-50-2012-7?op=1 .

In addition to traditional ways of funding, Crowdfunding should certainly be considered as a new funding source and is particularly relevant for startups active in a B-to-C product or service.  It can also help finalize a financing round for any startup (e.g. to finalize the last 20% of the round). We always recommend entrepreneurs to be listed on platforms such as gust (gust.com), AngelList (angel.co), Dreamfunded (dreamfunded.com), Kickstarter (kickstarter.com), GoFundMe (gofundme.com), or Circleup (circleup.com) even before actually looking for funding as this can be a great tool to meet with mentors, advisors, and of course as an alternative new funding source.  Thanks to Title II of the JOBS Act, accredited investors can now invest small amounts directly into startups or indirectly via syndicates (a few hundred or thousand, much less than the typical minimum of 25k for a traditional angel investment).  This is also a great tool to promote your startup to potential investors.  As Tim Draper, a long-time VC in the valley, stated, “…equity crowdfunding gives entrepreneurs access to a new group of investors who might be great assets to their business. I welcome investing in crowdfunded companies. It means that a company has a large number of promoters before I even invest.” From the investor point of view, these are great tools to reach diversification, which is critical for long–term success in angel investment.

 

5   Equity Crowdfunding

 

Investing in the US has traditionally been heavily concentrated in Fortune 500 Companies through the regulated Wall Street Stock Exchanges, yet half of jobs and economic output in the US is from startups and small businesses. As a reaction to this need, crowdfunding platforms began to spring up, leveraging the Internet and social media to provide project or venture funding with no equity exchange. Global crowdfunding raised $34.4 billion in 2015, and could surpass venture capital funding in 2016[1].

 

Given the funding and investing potential here, entrepreneurs and early-stage investors took an interest in this approach as a means to: (1) validate a product or service in the market (2) provide a new pool of capital for entrepreneurs (3) make early-stage investing more accessible to non-accredited investors.  Policymakers within the Venture Capital and Entrepreneur Community began lobbying Washington D.C. to allow crowdfunding as a means to raise funds in exchange for equity to unaccredited investors. On May 16, 2016 the US Securities and Exchange Commission (SEC) adopted Regulation Crowdfunding, i.e. Title III of JOBS Act

 

Under this regulation, early stage startups and small businesses are able to raise up to $1 million through investments as low as $100 per person.

 

All Provisions on the Regulation Crowdfunding can be found here: https://www.sec.gov/rules/final/2015/33-9974.pdf.  A summary of intentions and helpful context on Regulation Crowdfunding can be found in this SEC Press Release from Q42015: https://www.sec.gov/news/pressrelease/2015-249.html

 

 

6   Challenges & tools to overcome them

 

Most investors and VC funds will invest in companies with (at least part of) a management team based in the US and in companies incorporated in the US (often in Delaware because of its legal framework), hence it is a real challenge to attract US investment into your Belgium based startup and very few funds invest in foreign based companies.  A decision to tap into US venture capital must be mature as it will have numerous consequences on the company operations and prospects. In order to attract investor attention, you will be asked to pitch your ideas and provide an investor deck (PowerPoint presentation) in addition to your business plan and executive summary (typically a 2-page document). Your investor deck (presentation for investors) should include the following slides: Your mission/vision, problem/solution, market/opportunity, market strategy, technology, your competition, your finances, the funding requirements, milestones and a presentation of the management team.

Your differentiators (or unfair competitive advantages as we like to call them in SV) and initial market traction are also key information to your prospective investors. 

  • BI&E San Francisco can provide you with an investor deck template upon request.

One of the most common fears among European entrepreneurs is having their idea stolen when pitching about their new endeavor.  It is important to stress the fact that most Business Angels/VCs are more focused on your ability to execute your plans than on how great your idea is. Still, Belgian entrepreneurs often come to the Valley being very cautious that their idea might be stolen/copied; this is usually an unfounded fear.   The probability of someone else having the exact same idea as you is close to 100%; the execution (strength of the team, results, ability to pivot, etc.) is what matters most to your success and to your investors; as Derek Sivers stated on http://sivers.org/multiply, “the most brilliant idea with no execution is worth $20; the most brilliant idea takes great execution to be worth $20,000,000”. 

 
We cannot stress enough the fact that Business Angels and VCs are looking for companies with a very high potential market.  The hard reality for entrepreneurs (and their investors) is that most startups fail (over 50% or more depending on the study).  As an investor, you need big hits in the exit of some companies in order to cover the losses experienced in a majority of your investments and to make a decent return on your funds. This can only happen if your market is big enough to return a multiple of your initial investment. Keep in mind that, from an investor point of view,  this is one of the most risky asset classes and most expect an average of 20% to 30% ROI in return of taking these huge early risks. If investor expectations and risk perception vary along the business cycle, it is always preferable to indicate the largest addressable market for your products/services.  A large and fast expanding market is indeed a key factor in VCs and Business Angels decision process. Entrepreneurs should also have an idea about exit strategies for their initial investors while keeping in mind that investors are only a mean to a goal; Investors move away quickly from deals if they feel that the entrepreneur considers his company a lifestyle company. 

 

Venture money is certainly an expensive source of financing for entrepreneurs but remains a key component of the SV eco-system’s success along with universities, service providers, government, customers and… you, the entrepreneur.

 

 

 

 

 

 

 

 

 

 

7   Bibliography & useful resources

 

Angel Investing by David S. Rose - An interesting view on seed funding from the business angel prospective

Venture deals by Brad Feld and Jason Mendelson - It explains in full detail the financing process for an entrepreneur in the US.  

Terms sheet and valuations by Alex Wilmerding - A line by line look at the intricacies of Term Sheets & Valuations

Mastering the VC Game by Jeffrey Bussgang - Its blurb says it all : A venture Capital insider reveals how to get from start-up to IPO on your terms

http://www.angelcapitalassociation.org/ A reliable source of information about angel investment and useful, practical information can be found in their knowledge center for prospective entrepreneurs

https://www.pwcmoneytree.com/  The MoneyTree™ Report is a quarterly study of venture capital investment activity in the United States

https://paulcollege.unh.edu/research/center-venture-research/cvr-analysis-reports  University of New Hampshire Center for Venture Research

 

Publications for investors