MassChallenge is the most startup-friendly accelerator on the
planet. No equity and not-for-profit, we are obsessed with
helping entrepreneurs across all industries. We also reward
the highest-impact startups through a competition to win a
portion of several million dollars in equity-free cash awards.
Through our global network of accelerators in Boston, Austin,
Rhode Island, the UK, Israel, Switzerland, and Mexico, and unrivaled
access to our corporate partners, we can have a massive impact driving growth and creating value the world over.
To date, 1,500+ MassChallenge alumni have raised over $3 billion in
investment, generated over $2 billion in revenue, and created over
80,000 jobs.
MassChallenge works with some of the world’s best brands
to help them innovate with startups. Partners in Mexico include: Greenberg Traurig, Fiinlab by Gentera, Promotora Social
Mexico, Nestlé, Cemex, Facebook, Coca-Cola, Microsoft, SURA,
Axtel, Bosch, HDI, INTER, BakerMcKenzie, INADEM, and FONDESO.
Contributors for this publication (MassChallenge Mexico):
Kenny Cuoq
Dulce Kadise
Camila Lecaros
Greenberg Traurig’s advises companies and investors through
virtually all stages of development, from initial business
formation, through angel or venture capital financing, to initial public
offerings and mergers and acquisitions. We understand the needs of
entrepreneurs and their investors, as well as the challenges they
face. Drawing on the firm’s broad platform, the group offers clients a streamlined approach to meeting their diverse legal needs a
single team that can scale up its services as clients’ businesses grow.
Our attorneys regularly advise clients on a host of pressing legal issues,
from corporate and financing transactions, IP protection and software/
IT matters, to labor and employment, compensation, and tax issues.
Contributors for this publication GreenbergTraurig
Arturo Pérez
Gabriel Lozano
Rocío Olea
Raising Capital | An expert guide to fundraising
and investing in startups in Mexico
September 2018
A publication by MassChallenge in collaboration with
Greenberg Traurig
All rights reserved
We truly appreciate the overall support received from
INADEM- Instituto Nacional del Emprendedor for the
completion of this Guide. Your endorsement
of the project greatly enabled the creation and
promotion of this document. With it, we will foster the
advancement of the startup ecosystem for Mexico.
The authors wish to express their admiration for all the
experts, individually listed, that generously donated
their time and knowledge to develop the contents
hereafter. We acknowledge your essential contributions in the making of this document.
If you have any questions or comments
regarding the Guide please contact:
hola@masschallenge.org
Disclaimer
The attorneys at Greenberg Traurig, S.C., which we often
refer to as “GT”, are happy to collaborate in the preparation of the document: “Raising Capital. An expert guide
to fundraising and investing in startups in Mexico”.
Please note that this document provides legal information for educational purposes only. It does not provide
legal advice or business advice. This document is not intended as one between an attorney and client, and will
not create an attorney-client relationship between GT
and the reader.
Likewise, the ethical rules which prevent attorneys
from representing one client adversely to another
client will not apply here, since the readers are not clients.
If the reader decides to proceed with a venture or
idea, GT and MassChallenge strongly encourage the
reader to seek legal counsel from an experienced
and knowledgeable attorney of his or her choice.
Grounded in our comparative understanding of
the Mexican market and expert contributions,
we have prepared a Guide for startups and
investors alike that addresses the most
common and urgent information gaps
in fundraising. Among these are insights
for entrepreneurs, pondering over the
implications of decisions on how you want to
grow, how to fund that growth, who you want
your investors to be, and under which terms.
1. WHY IS THIS DOCUMENT RELEVANT FOR ENTREPENEURS AND INVESTORS? ................. 10
1.1 Expert contributors.
2. THE FUNDRAISING MIND-SET .................................................................................................................... 13
2.1 Fundraise in a timely manner
2.2 Raise only what you need
2.3 Decide which type of financing is right for you
2.4 Understand the implications of preferred stock rights
3. KNOW THE INVESTORS ................................................................................................................................ 17
3.1 Pick your investors
3.2 Insider information on the investors
3.3 Decision-making restrictions on Investment Funds
4. VALUING YOUR STARTUP ............................................................................................................................ 21
4.1 Option 1 Multiples Analysis
4.2 Option 2 Discounted Cash Flow (DCF) Analysis
4.3 When in Mexico
5. THE DIFFERENT INVESTMENT VEHICLES ............................................................................................ 28
5.1 Convertible Notes
5.2 SAFE
5.3 ABACO
5.4 Mexican Early Investment Document
5.5 Equity round
6. THE MEXICAN EARLY INVESTMENT DOCUMENT ............................................................................ 34
6.1 How to use the Mexican Early Investment Document
6.2 Necessary steps
6.3 Differences between the Mexican Early Investment Document and other instruments
7. VALUATION CAP AND DISCOUNT ON CONVERTIBLE INSTRUMENTS .................................... 39
7.1 Valuation Cap
7.2 Discount
7.3 Conversion scenarios
8. AT THE TIME OF THE NEGOTIATION ...................................................................................................... 43
8.1 The Term-sheet
8.2 The Pitch meeting checklist
9. THE PEP TALK ................................................................................................................................... 47
10. ANNEXES .......................................................................................................................................... 49
Annex 1. Extended explanation of “How to identify the most comparable peers
and adjust valuation multiples”
Annex 2. Mexican Early Investment Document - Investment agreement
Annex 3. Valuation cap conversion over time
Annex 4. Term-sheet explanation and analysis
How we gathered the
information for this Guide
WHY IS THIS
DOCUMENT
RELEVANT FOR
ENTREPENEURS AND
INVESTORS?
We understand what you are up against when
fundraising and the high stakes involved.
Entrepreneurs must fund the growth
of their startup. When raising money,
entrepreneurs have a chance to convey the core
needs and promise of their business in a way
that ensures high growth. We know, on the
other hand, investors expect a clear sense of the
capital required, how it will be utilized and
enough tools to quantify the return of the
investment. Time is usually limited when you
have the opportunity to present or listen to a
pitch. You want to glide over presentations.
You want interactions that build trust on the
other party’s capacity and your compatibility
to make business. Everyone should feel at ease.
When fundraising and negotiating terms,
thorough preparation, knowledge of your
numbers, familiarity with instruments and
meticulous decks greatly matter.
They pave the way for smooth relationships
that benefit cooperation. There is indeed an
array of decisions to make before arriving to
these crucial moments and useful steps you
can follow from those who have treaded the
same path.
10
Based on best practices, MassChallenge
and Greenberg Traurig with the support of
INADEM have partnered to assemble an
expert guide to fundraising and startup
investment in Mexico. The Guide is a solid
information ground regarding processes, actors and startup investment instruments available in the country. Alongside, it delivers a
collection of insights from key position players
and offers insider information about venture
business negotiations.
We are sharing with you the expertise of our
knowledgeable network. The information
presented in this Guide is the result of our
conversations with the network that participates in the entrepreneurship ecosystem in
Mexico: attorneys, startups, Venture Capital
firms, accelerators and investors (angel and
institutional). They made available to us their
up-to-date understanding of our market, in order to identify and point out to you: key moments, questions, inputs and factors, to be
addressed and taken into account in the different stages of development of your own
business venture.
PHASE 1
INTERVIEWS
With early stage startup founders
What would you like to know?
With later stage startup founders
What do you wish you knew when you
started?
With Venture capital firms (VCs), investors and attorneys
What areas should be taken into account
when raising capital and negotiating
term-sheets?
PHASE 2
ROUND TABLES
With investors, accelerators and attorneys
to discuss and enrich the first draft of the
Guide
Strategies to raise or invest capital have
faced the challenge of using global standards
under
local
regulation
and
market
conditions. In the process, some of you have
been employing foreign investment instruments for your agreements. These business
terms will eventually become inapplicable under Mexican law and potentially hinder new
financing rounds.
We are presenting and launching for the first
time with this publication, the proposal for a new
Mexican investment vehicle. The Mexican Early
Investment Document is a simplified investment
instrument designed especially for the Mexican market by MassChallenge and Greenberg
Traurig, by adapting elements of the commonly
used instrument SAFE (Simple Agreement for
Future Equity) to Mexican market conditions
and regulation. It is straightforward and easy
to use.
The intended takeaway of the publication
is twofold. We supply entrepreneurs with
decision-making tools and criteria to appraise
your startup, define a fundraising strategy,
anticipate and inform investment decisions.
We are providing legal information for educational purposes only, not as legal advice. We
encourage you to hire an attorney when beginning your venture. Being prepared is always
the best option.
11
Likewise,
by
advancing
understanding
within our entrepreneurial ecosystem we
want to provide investors with confidence
and tools in the investment process. A more
readily prepared generation of startups is on the
rise. The instrument we are launching through
this document, the Mexican Early Investment
Document can help you make investments in
startups in Mexico with more confidence, clarity
and simplicity.
THE FUNDRAISING MIND-SET
Expert Contributions
Venture Capitals
Alejandro Diez Barroso
Managing Partner at DILA Capital
Hernan Fernandez
Managing Partner at Angel Ventures
Alessandro Paganini*
Investment Team at Dalus Capital
Patrick Harmon
Investment Analyst at Dalus Capital
Xavier Ponce de León
Partner at Ideas y Capital
Jonathan Lewy
Managing Partner at Investo
John Farrell
Founder of Acelera
Startups
Juana Barco
Co-founder and Country Manager
México at BackStartup
Victor Rico
Co-founder and CEO Bayonet
Daniel Vogel
Co-founder Bitso
Pablo Estevez Hinojosa
Co-Founder and Head of Sales at
Gus Chat
Juan Carlos Castro
Co-founder at Briq.mx
Simon Borrero
Rafael de Haro
Co-founder & CEO of Rappi
Gabriel Estrada
CEO & Co-founder Vest
Co-founder and Managing Partner at VARIV Capital
Giang Nguyen
Attorneys
Other
Bernardo Tamez Alarcon
Jose Vielma
Isaac Beja
Eric Neguelouart
Founder at LegalMindMX
Lawyer at Promotora Social Mexico
Angel Investor
Equity Research Analyst at Merrill Lynch
Octavio Gutiérrez
García Cano
Director of Entrepreneurial Capital
at INADEM
Jonathan Hanono**
Associate at SHG Corporate Finance
Jose Manuel
Velderrain Sáenz
Raising money, even as an early stage
startup, is your means to an end. So what
is your goal? Fundraising is often wrongly
perceived as an end in itself. You must assess
your business need first, in order to rightly
evaluate the financing options available. Let’s
agree, for most cases, the end goal is for the
startup to grow. Your fundraising strategy shall
be largely determined by the nature of that
end goal.
We want you to have a clear understanding of
the vast implications and advantages of knowing how you want to grow, how to fund that
growth, who you want to partner up with and
under which terms.
Managing partner at Velderrain,
Sáenz & Asociados, S.C.
Investment Team at Dalus Capital
Jimena Rubio
Counsel at Variv
* Drafted and provided input for the sections on DCF and on “How to identify the most comparable peers”.
** Prepared the Model and explanation for the section on “Valuation cap conversion over time”.
12
13
Fundraise in a timely manner
Decide which type of financing is right for you
It is never too soon to plan on your fundraising, the goal and strategy should be defined as
early as possible. As an entrepreneur, you are
always raising money. Investor outreach can
begin even before your startup is ready
to receive funds. You should prevent
waiting until you’re starving for money
before thinking of your next financing round.
Raising
equity,
for
example,
involves
thorough due diligence from funds and takes
between four (4) and five (5) months on
average in Mexico. It is not possible to close an
equity round in one month. In fact, finding
yourself in that situation could mean having to
settle for very bad terms to satisfy the hurry.
There are two ways to finance a startup: through equity (capital investment) or through
debt. When a startup receives an investment through equity, it usually gives away shares
of the company. Debt instead, is a loan that should be paid depending on the terms
agreed upon, including an interest rate. Equity financing is the most expensive way to finance the startup, as it requires a long-term commitment and a relationship with an
investor.
Raise only what you need
One common misjudgment is that you should
raise as much money as possible, as early as
possible. This is a misconception, incorrect for
several reasons. The first one is dilution. The earlier you raise and the more you raise at an early
stage, the more equity you will need to give up
as a founder. At an early stage, investors will ask
for a higher amount of equity for the same investment ticket than at a later stage, to reward
them for investing at a riskier stage. While you
might have to give away 10% of your company to raise USD200k after you’ve proven your
business model, you would have had to give
away 20% for the same amount a year before.
14
Our advice is:
Raise, but only what you need,
especially at an early stage. Raising
too little may not be worth the legal
fees and time involved and raising
too much can imply a bad trade-off
because of the dilution involved.
Startups can access different forms of equity financing at every stage of their
development
Seed Stage
Growth
Scale
Startups have an idea,
they are evaluating the
opportunity, and starting
the business
Startups have begun
operating, they are improving
their business model, and
already have clients
and suppliers.
During this stage, startups
begin to leverage the market’s
potential and build the
structure to support growth.
The business is well
established, and new business
lines are emerging.
Size of
investment
(USD)
<100k
100k - 500k
500K - $5 MM
>5 M
Investors
Personal assets,
friends or family
Angel investors
or seed stage
Venture
Capital Funds
Venture Capital
Funds
Private equity
Types of
investment
First funding
Seed Capital
Series A or
Series B
Growth or
expansion capital
Stage
Founders who have already given up a large
portion of their startup at early rounds will
find themselves with little equity after several rounds of financing, hampering greatly the
founding team’s economic incentive to grow
the company, and turning off investors. One
leading angel investor in Mexico says that entrepreneurs should walk away from any deal
that requires giving away more than 25-30%
of their startup when starting. A good indication of ‘what you need’ is the amount of
capital necessary to achieve the milestones
that will allow you to raise the next round.
For example, if you’re raising money pre-series A and think that achieving 100,000 users will allow you to raise a Series A, then
raise enough today so that you can get to
the 100,000th user and raise your Series A.
Conceptualization
15
Understand the implications of preferred stock rights
If investors use a convertible instrument to
invest in a company they can expect to receive
equity of the company as preferred stock. In
other jurisdictions preferred stock is defined
under the law, in Mexico it is not. However,
it is generally understood as shares having
special rights compared to common stock.
Parties can negotiate the type of “preferences” granted by preferred stock. For example,
preferred stock may grant its holders with: a
liquidation preference (an investment protection provision), veto or qualified voting attributes (e.g. a super majority vote of the preferred stock is necessary to approve the sale
of the company), or special dividend or
redemption rights.
16
KNOW THE
INVESTORS
Fundraising is a game of two players: the
startup and the investors. Once you know
what your growth objectives, financing
needs and options are, you then need to
focus on choosing and getting to know
your potential investors. Especially important, is how you interest them in your project.
17
Pick your investors
Part of developing a fundraising strategy goes through filtering your businesses’ potential
investors. They must be a match for your venture. Once you have selected your financing
sources, develop a strategy to approach them.
Develop a strategy to approach investors
when raising money
Select those investors with whom
there is a likely match for your
product or service.
NARROW
DOWN
THE LIST
The power of an introduction should
not be underestimated.
A startup is more likely to get
attention if it is referred by
someone known by the investor
or the fund.
Referrals may come from a
portfolio company of that VC or
by other entrepreneurs whom
that VC or investor respects.
UNDERSTAND
HOW TO REACH
THE INVESTORS
AND WHO THE
DESICIONDECISION
MAKERS ARE
FIND A WAY
TO STAY IN
THE INVESTOR’S
RADAR
18
Aspects to consider:
Geography
Stage
Industry
Investments in the startup’s
competitors
Availability of funds
Even if your startup is not ready to
receive funds yet, many investors and funds
recommend meeting early. They highlight the
importance of beginning a relationship early on. This will allow you to build trust and
get advice. To do this, in-person meetings
and a strong and simple narrative are key.
Insider information on
The Investors
Economic and power dynamics
Investors have restrictions of their own.
Their decisions are limited by a set of
variables. This means a good investment
for one investor might not be good for
another. Understanding their economic and
power dynamics is helpful when deciding who
to approach and crafting a fundraising strategy.
Qualitative interests
Below are some points we have heard from
Investors, about what they like to find in startups:
Having co-founders (two to three, or
more). A lot of funds and angel investors are
reticent to fund single founders. Starting a
company is an enormous challenge, generally thought to be easier to tackle as a team.
One technical co-founder. Especially for
tech-heavy startups, having a technical
co-founder is often reassuring to investors.
An established Founder’s Agreement. A
clear agreement between founders on a number of key issues, such as equity breakdown
and potential scenarios (for example a
founder leaving).
300% dedication from co-founders.
All founders should be 100% dedicated to the startup and not involved in other businesses or professional activities.
A story/passion based venture. The most
successful entrepreneurs start a company out
of frustration, with the goal to solve a problem they have faced and are passionate about.
Engineering a coherent and convincing story
to pitch to investors is more impactful than
a well-designed PowerPoint presentation.
DECISION MAKING
1. Investors will request the
startup’s model, valuation
rationale and financials.
3. Depending on the exit
potential, Investors will
determine how much
equity in the company will
allow them to achieve their
required return. Return
expectations vary from fund
to fund.
2. Based on those inputs,
Investors will come up with
their own expectations and
determine how much your
company can be worth at
exit.
4. Investors will determine
what ticket size would buy
them the necessary equity
in the company (taking into
account future dilution),
and decide whether they
can afford the investment
ticket considering their fund
size.
19
Decision-making restrictions on
Investment Funds
Investment Funds’ decisions are limited by a
set of variables, one of which is its Limited Partners Agreement (LPA). Limited Partners are
the investors in Venture Capital funds. An LPA
sets out the terms framing the VC’s operation,
such as compensation for the VC and investment limitations. For example, a fund might be
restricted by its LPs to only invest in Healthcare
deals in Mexico. The consequence is that even
if you offer a hot deal, not every fund will be in
a position to invest. This should be taken into
consideration when establishing which funds
are worth approaching and which are not.
We recommend you inquire in advance about
specific terms, of where a fund can invest. For
example, INADEM has a specific age range
for entrepreneurs and invests only in startups
based in Mexico. Some LPs are focused on certain industries (i.e. FinTech, financial inclusion,
etc.), others invest only in certain markets (i.e.
base of the pyramid). In general, we recommend
you raise the question early in the process to
make sure none of these restrictions are present
20
VALUING YOUR STARTUP
Valuing a company is more of an art than an
exact science. Startup valuations are especially tought given the unpredictability of future
success and growth. Eventually, the amount
agreed on will be closely intertwined with other factors, such as how much equity you are
willing to give away and the stage you are at.
Other unquantifiable factors such as the entrepreneur’s business trajectory - Is it your first
company? Have you sold a company in the past?
type of experience- can impact a valuation.
Although there is no formula to value an early stage startup, we will touch
on two popular valuation techniques:
-Discounted Cash Flow (DCF) Analysis
-Multiples Analysis
21
Valuation technique
Two popular valuation techniques
Option 1 Multiples Analysis
Step 1. Identify the most comparable peers
Identify the most comparable peers, both
public and private.
How to identify the most comparable peers
and adjust valuation multiples
Foreign startups, often U.S. ones, can be an
adequate comparative starting point. However, given that the characteristics of each
country differ, it is necessary to adjust foreign
values to Mexican standards. You are able to
do this by considering the following variables:
Option 1
Better suited for early
stage startups
Multiples Analysis
A calculation based on an
analysis of the
average Enterprise
Values and the financial and
operating figures of the most
comparable peers
Option 2
For later stage startups (Series B and above) with predictable cash flows
Discounted Cash Flow (DCF)
Analysis
An estimate of the value of a company based on the present
value of its future cash flows
Country risk. The risk given to a specific country by estimating the difference (the spread)
in yield of the 10-year government bond for
the US and the other country.
Regulatory risk. Regulations that can affect
the startup’s operations and growth.
Political risk. Potential political threats that
can affect the growth of the business.
Market size. The addressable market for your
company.
Market maturity. Is your market mature
enough to accept your product (awareness
and access) vis-à-vis the comparable market.
Security risks. Is there more risk for the operation of the business due to location or any
other security related issues.
22
Exchange rate risk. Volatility of the exchange
rate that might affect the financial situation of
the company.
Company size. How a company relates to a
comparable in terms of revenue or expected
value.
Public company comparables. One proxy for
discount rates can be achieved by using the
discount between public companies in the US
and Mexico as a reference for your startup.
Company growth rate. Differences in growth
rates should be taken into account and adjusted accordingly.
Access to capital & VC industry
maturity. More mature markets provide a context where raising capital for startups is comparably easier, translating into higher multiples.
Exit probability. Countries with more developed capital markets see far more IPOs and
acquisition of startups. Therefore, comparable
multiples should be adjusted downwards accordingly.
Gross/Net Margins. One should take the
gross and net margins of a comparable company into consideration, reducing the comparable multiple if the comparable company has
higher margins.
23
Debt situation. The value of the company is likely to be adjusted downwards if the debt is deemed significant.
**You can find detailed explanations of
each variable in ANNEX 1 of this Guide.**
Step 2. Find their current Enterprise Values
For comparable peers, use online resources
such as financial news articles and public companies’ Annual Reports to find their current
Enterprise Values or the pre-money valuations
(“EV”) at which precedent transactions (such
as M&As/ IPOs/financing rounds) occurred.
The Enterprise Value can be thought of as
the theoretical takeover price if the company were to be bought. In the event of such a
buyout, an acquirer would generally have to
take on the company’s debt, but would be
able to make use of the company’s excess
cash. Thus, in simple terms, we can think of
the EV of a firm as its equity market value,
plus all its debt, minus the excess cash it has.
Note: In the case of private transactions, such as a peer company’s financing round, the valuation at which this occurred may not always be disclosed.
24
Step 3. Generate financial and operating
multiples for the company’s peers
As in the previous step, it is necessary to
search the web to obtain both financial and
operating figures for the company’s peers, in order to generate the multiples described below.
Financial Multiples. The most commonly
used financial multiple is the EV / Revenues.
Most investors will rely on this multiple to
get an approximation of the company’s valuation. EV / EBITDA is also used, albeit less
so, given that positive EBITDA figures are
seldom seen among early-stage startups.
When calculating the multiple for each peer,
it is necessary to use the Yearly Revenue or
EBITDA figure, corresponding to the same
time period as the EV that was obtained.
Operating Multiples. The type of operating figures used to calculate these multiples will vary depending on the industry in
question. They are essentially the most relevant operating metrics for the sector. For a
Lending Company, operating multiples may
be, for example, the total amount of loans
issued or the number of approved loans;
whereas for a blog or a web-platform, they
may be the number of registered users or
the monthly unique users visiting the portal.
As in the case of financial multiples, it
will be necessary to obtain the operating figure corresponding to the same
time period as the EV, to then insert it in
the formula: = [EV / Operating Metric]
Step 4. Apply the average financial and
operating multiples to the company´s figures
Calculate the average Financial and Operating
Multiples for your company’s peers and apply
these to the company’s financial and operating
figures. These will provide a rather approximate
estimate of what an appropriate valuation for
the company should be. It is not an exact calculation. Moreover, individual risk and growth
potential considerations will come into play in
determining the value of any specific company.
Valuation Multiples Example
Average Peer Multiples
Avg. EV/Revenues: 3.1x
Avg. EV/Registered Users: 8.5x
Company X Figures
Last Twelve Months Revenues: $650,000 Registered
Users: 350,000
Company X Implied Valuation
Applying Avg. Financial Multiple: ~$2m [3.1*650,000]
Applying Avg. Operating Multiple: ~$3m [8.5*350,000]
Valuation Conclusion
A reasonable pre-money valuation
could be in the $2-3 mm region
A similar calculation to the one above could
be talked through with the company’s potential investors. An appropriate valuation for the company should be within the
ranges determined jointly with investors.
25
Valuation technique
Option 2 Discounted Cash Flow DCF Analysis is not suitable for early
stage startups
(DCF) Analysis
The DCF is a valuation methodology that accounts for all future cash flows of a company
and discounts them back to present value by
applying a discount factor. The discount factor
applied in a DCF is typically determined with the
use of the Capital Asset Pricing Model (CAPM).
The CAPM takes into account a number of factors, including the risk-free rate, risk premium,
and the illiquidity risk of a private company,
among others. This discount rate applied in the
DCF will be equivalent to the required rate of
return of the investor (assuming the company
has no debt) and will tend to be higher for private companies than for publicly traded ones.
There is a lot of material freely available online
if one wishes to dig deeper into this methodology. However, it should be cautioned that this
valuation methodology only becomes relevant and appropriate when valuing later stage
companies with predictable cash flows. As explained below, this is not a suitable methodology for valuing early stage startups: the earlier
the startup, the more both investors and entrepreneurs should refrain from utilizing DCF
as a method to determine a company’s value.
26
Why? Key DCF variables such as forecast free
cash flows (FCFs) and the applicable discount
rate are big unknowns, “finger-in-the-air” inputs at a company’s early stage. The quality of
the output valuation of a DCF is only as good
as the inputs one plugs in. You may have heard
the expression “JIJO”, standing for “Junk In,
Junk Out”. If you use unreliable inputs in a DCF
model, the output will be just as unreliable.
One must solely apply DCF as a method of
valuation once cash flows are highly predictable. This will only really be the case for late
stage startups with a history of financial results that can be extrapolated into future years.
For early stage startups, in terms
of finding the right valuation for a
company, comparable multiples are
almost always the way to go. This
technique is in line with the market
and what other investors/acquirors
have been willing to pay for similar
companies.
When in Mexico
Mexican funds rely on financial models more
than U.S. ones Why do they? The reason for
this has to do with the return investors can
expect in Mexico vs. in the United States. In
the US, it is not unrealistic for startups to tap
into the billion-dollar valuations. Conversely, a 50-million-dollar exit would be considered a winner investment for an investor in
Mexico. In each country, for two funds of the
same size, the Mexican one has to be way
more careful about the valuation the startup
can potentially exit at and how much equity it needs in order for its investment to be
deemed ‘successful’.
Example:
Two USD 5M funds (one U.S., one Mexican) are looking to make investments with
the potential to return their entire fund.
They each invest in one startup locally.
The U.S. Investor. Their startup becomes a
unicorn and exits at USD 1 Billion. It doesn’t
matter whether the U.S. fund owns 5% or 10%
of the startup: it would still receive multiple
times the value of its fund. In fact, it would
only require for it to own 0.5% equity in the
startup to return its entire fund (USD 5M).
The MX Investor. Their startup exits at USD
50M, a winner exit for Mexico. Owning 10%
or 5% would make all the difference between returning the entire fund or just
half the fund. Actually, any equity below
10% would fail to return the Mexican fund.
Implication. Since valuation expectations differ between the U.S. and Mexico, a Mexican
fund will be pickier about the valuation it enters at and how much equity it is receiving.
Analyzing the business model and assessing
different financial scenarios thus become essential in picking the right investment in Mexico. Furthermore, the Mexican fund will procure building a portfolio where several of the
companies are expected to be successful.
Mexican startups cannot aspire to
Silicon Valley valuations
Whilst being so close to Silicon Valley (California), it is not necessarily justified for Mexican startups to aspire to Silicon Valley valuations. A valuation of your startup under
the terms and conditions of the strongest
startup ecosystem in the world is not suitable. The bulk of the answer to ‘why’ lays in
the maturity of the Venture Capital industry in Mexico as compared to the US. Silicon
Valley has ‘closed’ many startup cycles, with
successful entrepreneurs turning into Angels
and fueling the ecosystem with good advice
and capital; former startups becoming major tech players with acquiring power (thus
boosting startup exits – and valuations); and
VC firms showing high returns throughout
various profitable funds thanks to large exits – making VC investments a trusted asset
class for investors. That is, while in Mexico
VCs remain a nascent industry, too young to
show a strong track record of exits and where
entrepreneurs do not enjoy the industry
foundations that Silicon Valley allows for yet.
Convertible Notes
THE DIFFERENT INVESTMENT
VEHICLES
Whether you are using equity or debt
financing, choosing an adequate investment vehicle is key, as it will define the
characteristics of the relation between the
investor and the startup. There are several
investment vehicles available for startups. Next, we will provide you with a short
overview of the most relevant ones for the
Mexican market, including a new investment vehicle proposed by MassChallenge
and Greenberg Traurig: the Mexican Early
Investment Document.
28
Convertible notes or convertible loans are a
commonly used mechanism in early stage financing. Essentially, and to put it simply, convertible notes are loans given to a company
by early stage investors (often angel investors or early stage VC funds), which shall convert into equity once certain conditions are
met (primarily an equity-priced round – often
times defined as “Qualified Financing”). As
any other loan, convertible notes charge an
interest rate over the principal amount, which
will accrue during the life of the loan but will
not need to be paid until the maturity date.
It is also possible for the note to include:
-A pre-fixed percentage of equity at which the
note shall convert.
Notes issued at different moments to different
investors will likely have different economic
conditions. In addition to the economic terms of
the note, entrepreneurs should also look at any
control or protective provisions required by the
investor, liquidation preference provisions, conversion mechanisms and the impact the note
shall have to their cap table upon conversion.
To compensate for the risks taken on by
the early investors under a convertible
note, often times convertible notes include:
-A discount over the subscription price to be
paid by future investors under a subsequent
equity-priced round (ranging from 10% to 30%).
-A price cap or ceiling to the subscription
price upon which the convertible note investors shall convert its loan into equity.
-Or both, a discount and a price cap, in which
case the convertible note investors would typically have the right to choose from either of them.
29
Safe
Abaco
As an alternative to convertible notes and
because some investors prefer to avoid
having to deal with interest calculations
and maturity dates, early stage funding
can also be documented through a standard form of agreement named SAFE.
Because SAFE is an instrument developed
to be used by companies incorporated in the
U.S. and to cover U.S. transactions, certain
Mexican investors decided to create a standard form of agreement that could be used
for Mexican companies raising early stage financing. ABACO is a standardized form of
agreement, in Spanish, useful to document
early stage financings and the agreement to
turn the investment into company equity.
The SAFE instrument is standardized. There are a few alternatives to
choose from when drafting it. The
alternatives will depend on the terms
agreed between the investor and the
startup (i.e. a cap with no discount
vs. a cap with discount and so forth).
Essentially this agreement is a contractual
commitment to acquire future equity from a
company, under a pre-agreed set of terms and
conditions. SAFE gives investors the opportunity to turn their investment into equity once
certain conditions are met (similar to those conditions described above for convertible notes).
Find additional information on SAFE at
https://www.ycombinator.com/documents/
30
Companies from other Latin-American jurisdictions with Roman law
based legal system may find
ABACO useful. ABACO is a good
model when you consider drafting
an agreement to document early
stage financing.
For additional information on ABACO go to
http://dinerojoven.com/avalancha/ABACO.pdf
Mexican Early
Investment Document
MassChallenge and Greenberg Traurig are proposing a new investment vehicle that includes the characteristics
of a SAFE adapted to the Mexican law,
explained in detail in the next section.
This instrument was built to simplify the
current instruments available in Mexico and
make the investment process friendlier for
early-stage entrepreneurs. The Mexican
Early Investment Document can be modified to adapt the different conversion scenarios depending on the pre-agreed terms.
The Mexican Early Investment
Document is a contractual commitment to acquire future equity from a company under a preagreed set of terms and conditions.
Equity round
The alternatives discussed above (Convertible Notes, SAFE, ABACO, Mexican Early
Investment Document) are simply mechanisms through which the investors would
become partners and share the ownership
of the company with the founders. Ownership of a company is represented by the
equity issued to its shareholders and hence,
founders may also raise capital by simply issuing and selling shares to new investors.
Most of the times, investors would seek to receive preferred shares (shares ranking senior
to or having additional rights than Common
Stock) out of their investment. The stage of
the company, the bargaining power, and the
company valuation, among other factors,
would affect the amount of money the founder may raise and the conditions agreed upon
with the investors during an equity round.
Depending on the stage of the startup, it may
be difficult to value the company. This is due
to uncertainty, lack of sales, or the absence of
positive EBITDA (Earnings before interests,
taxes, depreciation and amortization). Startups in a conceptualization or seed stage will
normally tend to postpone their valuation
through the use of specific investment instruments: Convertible Notes, SAFE, ABACO,
or the Mexican Early Investment Document.
31
The effect of accounting & tax
regulations in Mexico on investment
vehicles
There are recommended investment instruments depending
on how clear the startup valuation is:
Instruments to use
Type of
Financing
Equity
Round
Equity
SAFE
Converts
to Equity
32
No Valuation
Clear Valuation
Recommended
Recommended
ABACO
Converts
to Equity
Convertible
Note
Converts to
Equity
orDebt
Recommended
Mexican Early
Investment
Document
Converts
to Equity
Recommended
Recommended
Each investment vehicle will have its accounting and tax implications. If the investment is
documented as debt, the investor will receive
an interest income. The investor will acquire
tax obligations due to interest income, including tax withholding and VAT (in many cases).
The taxes will be triggered at the conversion.
On the other hand, the startup will have a taxable income every year due to the annual adjustment inflation calculation. In addition, the
startup will have to recognize the investment as
a liability and not as equity. The startup’s financial statements may be negatively influenced
and this could result in a technical bankruptcy.
In accordance with Mexican accounting principles*, contribution for a future capital increase
or investments for future equity should be
recognized as a liability in Mexico, unless they
comply with the guidelines to be considered
as equity.
In order for investments to be treated as equity and not as debt, avoid use of foreign
investment instruments or traditional investments instruments documented as convertible notes that have not been adapted
to accounting and tax regulations in Mexico.
*Principles as regulated in the Normas de Información Financiera, issued by the Consejo Mexicano de Normas de Información Financiera (2018).
33
THE MEXICAN EARLY INVESTMENT
DOCUMENT
The Mexican Early Investment Document is a
contractual commitment to acquire future equity from a company under a pre-agreed set of
terms and conditions.
This instrument is intended for use by investors
with a high tolerance for risk: savvy investors
understanding the risks and opportunities in
early stage investments made at high-growth
companies. As in many other high-risk/return
opportunities, investors should have a basic
understanding of the industry, the company and the lack of liquidity of its investment.
Some of the advantages of this investment
document include: simplicity, compliance with
the Mexican law (can be used by SAPIs), fairness for investors and startups, and easy usage.
You can find a format Investment Agreement
for the Mexican Early Investment Document in
ANNEX 2 of this Guide.
34
How to use the Mexican Early Investment
Document
As mentioned repeatedly in this document, the Mexican Early Investment Document is an instrument for investors to fund
startups at an early stage, where their investment rather than considered a debt instrument may be characterized as a capital contribution for accounting purposes.
In order to comply with the applicable Mexican
accounting principles (Normas de Información
Financiera, issued by the Consejo Mexicano de
Normas de Información Financiera), the execution of the Mexican Early Investment Document should be preceded by the execution
of a corporate resolution, whereby the shareholders of the startup agree on the following:
Necessary steps
Investment documents such as convertible
notes used in other jurisdictions, which are
characterized as debt of the company receiving the investment, trigger certain obligations
for both startups receiving the investment
as well as for their investors. These will be
shown in further detail below. In an effort to
simplify this kind of investment transactions,
the Mexican Early Investment Document has
been drafted to meet the requirements of
our jurisdiction. It is structured to create a
future capital increase in the startup. Nonetheless, each issuer should confirm accounting and tax treatment with their counsel.
An agreement that such funds shall go towards a future capital increase
The number of shares to be issued for a conversion event (at this point, this will have to
be an estimate since certainty as to the exact
number of shares will come at the moment of
conversion)
Funds invested in the startup shall not accrue interest
Considering such amount is not reimbursable, they shall be recognized in the entity’s
functional currency.
35
Necessary steps and implications of the use
of the Mexican Early Investment Document
Topic
Steps to
Follow
Signature of
the Document
Execute a shareholder’s
meeting (unanimous
vote is highly
recommended)
immediately prior to
the execution of the
New Mexican
Mexican
Early Investment
Investment
Document, whereby
shareholders of the
startup approve the
transaction.
Year on Year
Conversion
No action necessary
from a legal
standpoint.
Differences between the Mexican Early
Investment Document and other
instruments
If the company uses a promissory note or a traditional convertible note, it should charge interests at market value and, in most cases, also
VAT, since investors are considered as creditors
to the company. At the moment of conversion,
interests accrued under a convertible note are
considered to be paid by the company (even
when no cash payment is actually made). Thus,
the company should receive an invoice complying with tax requirements from the investor
and make the corresponding tax withholdings.
For example, in Mexico, interests paid to foreign tax residents must be withheld at the
payment date or when interests are due and
payable, whichever date is earlier. Therefore, in practice, withholding must be made:
1) when the debt is converted into shares,
since this is deemed as if an interest payment
was made, or
2) when interests are payable. Therefore, even
if the company does not effectively make any
cash interest payment or is not going to make
any interest payment on the due date to the
investor, it must, at least, pay the withholding
tax attributable to the interest payment to the
tax authorities.
Accounting
threatment
treatment
for the
entrepreneur
Future Capital
Increase
Future Capital
Increase
Capital
Capital
Accounting
threatment
treatment
for the
investor
Future Capital
Increase
Future Capital
Increase
Capital
Capital
Another drawback is the fiscal impact that
may generate to the company. By recording this investment as a debt instrument,
the company may have non-accounting
tax revenue due to the annual inflation adjustment which, basically, is the debt average multiplied by the inflation for the year.
Debt instruments may create additional
responsibilities for the investors who are tax
residents in Mexico. Among others, having to
register in the Federal Taxpayer Registration
as a recipient of payment of interests and filing provisional payments. Likewise, money
laundering prevention obligations could be
triggered, since loans, carried out on a regular basis, may be considered a vulnerable activity under the anti-money laundering law.
Issues related with tax compliance,
money laundering and other obligations should be reviewed carefully on
a case-by-case basis.
Contributions for future increases in capital,
which do not comply with the requirements set
by the Mexican Financial Reporting Standards
to be booked as capital instruments, shall be
deemed as liabilities. Traditional models or
foreign models simply translated, but not conformed to the Mexican regulation, usually do not
incorporate all the elements necessary to consider these investments as capital instruments.
37
The Mexican Early Investment Document seeks to avoid some of the problems
described above, by considering in a comprehensive manner, the commercial, tax and
anti-laundering laws, as well as the financial
reporting standards that apply locally. This Investment Document was conceived in consideration of Mexican laws and not as a translation of a foreign-law governed document only.
Finally, duly note that the draft annexed to
this Guide is a general sample form intended to cover basic investment needs. It should
be expected, that investors want to negotiate additional clauses to meet their particular needs. Usually, these clauses will call
for certain coventants whereby the startups
commit to implement or meet certain standards and best practices (i.e. anti-corruption,
data privacy, environmental, safety, etc.).
38
VALUATION CAP
AND DISCOUNT
ON CONVERTIBLE
INSTRUMENTS
All the investment vehicles presented up to
now, except for the Equity Round, are convertible instruments. They are a form of
short-term debt that converts into equity.
This means they will need to define caps and
discounts as part of the negotiation process.
39
Valuation Cap
The risk of an overinflated cap
A Valuation Cap is one of the variables applicable to convertible instruments, namely Convertible Notes, SAFE, Mexican Early Investment
Document, ABACO, etc. It defines the maximum valuation at which the investor will convert their investment amount. It also sets the
‘worst case scenario’ an investor can expect
in terms of converting his or her investment.
Simply put, if an investor invests 1M through a
SAFE at a 10M valuation cap, they know that
in the case of an equity round they will receive
at least 1/10=10% of the startup pre-money.
Negotiating a high cap might seem beneficial for a founder because it means less dilution: receiving 1M pesos at a negotiated
20M cap (1/20=5%) seems to indicate that
the entrepreneur is getting twice as less diluted as if he had negotiated a 10M cap
(1/10=10%). However, inflated valuation caps
eventually get rectified in later rounds, when
dealing with more sophisticated investors.
You should include a valuation cap for protection and to reward:
Valuation cap for protection. A valuation cap
acts as a protection mechanism for the investor. It serves to avoid the scenario where a
startup’s valuation skyrockets in a subsequent
round. For example, if an Angel investor invests
USD 100k at early stage without cap and a
startup’s pre-money valuation at Series A turns
out to be USD 10M, the investor’s capital would
end up turning into just 1% of the company.
Valuation Cap to reward. Scenarios such as
the above are also inconsistent with the idea
that early-stage investors should be rewarded for investing at a riskier stage, especially
if it’s partly due to their capital that the startup managed to achieve a great valuation.
You will find an explanation on how a Valuation Cap converts over time in ANNEX 3.
40
Risk 1. Dilution
The first result of an overinflated cap is that
the founder ends up more diluted than expected (the opposite effect to the one intended). Example: a startup receives USD 1M
through a SAFE at a USD 20M cap and 20%
discount, expecting to leave the investor with
1/20=5% of the equity. It then proceeds to raise
a Series A at a valuation of USD 10M (down
round), effectively letting the investor convert
their 1M at a valuation of (1-20%)*10M=8M,
giving the early stage investor 1/8=12.5% of
the company, instead of the 5% expected.
Risk 2. Investor and founder turn off
The second result of an overinflated cap is
to turn off both future potential investors
and founders. It sends a message to investors that you misinterpreted your potential
value and can leave early investors with unjustifiably high stakes in the startup. For the
founders, down rounds can leave founders
with such a small stake in their own company that the financial incentive to take
the startup forward becomes questionable.
Risk 3. Bottom line
Overinflated valuation caps put a lot of pressure on founders, to reach for overinflated valuations as further rounds unfold. It is better to
set a reasonable valuation, keep a sensible share
of the startup and gradually go up in valuation.
Discount
A Discount allows the investor to convert at
the price of shares sold in a subsequent equity
round, but at a discount previously agreed by
the investor and the company. The discount is
considered a reward to an investor that came in
early to the company and assumed a considerably higher amount of risk. In consideration of
the higher risk taken on, the investor would be
allowed to purchase (convert) his/her shares at
the same price offered at the conversion event
(priced round) minus the agreed discount.
Conversion scenarios
Depending on the cap and discount that
you established, there are different scenarios that can take place when the investment vehicles are converted to equity.
Convertible instruments which include both valuation caps and
discounts (such as the SAFE and
the Mexican Early Investment Document), will generally benefit the
investor by using the conversion
trigger that grants them the largest
number of shares.
Scenarios 1, 2 and 3 are detonated by a conversion event:
Scenario 1. Conversion event where
pre-money valuation is below valuation
cap
In this scenario, the pre-money valuation would
yield a price per share that is below the price
per share yielded by the Valuation Cap. The
lower the price per share, the greater the shares
the investor will receive upon conversion.
Here, there are two possible outcomes depending if the note includes only a valuation cap or
a valuation cap and a discount. In either case,
as explained above, the investor would choose
the conversion mechanism giving him/her the
greater number of shares. Given the case only
a valuation cap is present and that such cap
is higher than the pre-money valuation, the
investor would not use the valuation cap for
the conversion of his/her shares. In contrast,
when there is a cap and a discount present,
because the use of the cap is irrelevant when
the pre-money valuation is lower than the cap,
the investor would choose to use the discount
provision to set the price for his conversion
shares at a discount compared to the price
of the shares sold in the new equity round.
41
Scenario 2. Conversion event where
Series A pre-money valuation is equal
to valuation cap
Scenario 3. Conversion event where
Series A pre-money valuation is above
valuation cap
In this scenario, Series A pre-money valuation
yields the same price per share as the price
per share yielded by the Valuation Cap. Here,
if the note includes a discount provision, because the cap is irrelevant, the investor would
choose to use the discount provision to set
the price for his conversion shares at a discount compared to the price of the shares
sold in the new equity round. Should no discount be present, the conversion shares would
be calculated using the pre-money valuation.
In this scenario, Series A pre-money valuation
yields a higher price per share than the price
per share yielded by the Valuation Cap. Here,
should the note include a discount provision,
then the investor’s decision would depend on
the discount rate and the valuation cap. In other words, the investor would determine which
of these options would prove more beneficial to determine the price per share. If the
note does not include a discount provision,
the investor would calculate the number of
conversion share through the Valuation Cap.
Most common conversion events:
Equity Financing. The next equity round
in the company, in which the company receives gross proceeds in an amount
agreed by the investor and the company.
Liquidity Event. This is a broad term, used
to include (1) a change of control in more
than 50% of the company’s equity, (2) sale
or disposition of substantially all the of
the company’s assets, (3) liquidation, dissolution or winding up of the company’s
business, or (4) an initial public offering.
Optional Conversion. This conversion event includes the possibility of converting the note to
equity simply by reaching an optional conversion date (similar to a maturity date) in which the
investor may choose to convert his or her note.
42
AT THE TIME OF
THE NEGOTIATION
Things to take into account when you negotiate your relation and terms with the investors.
43
The Term-sheet
The Pitch meeting checklist
In the long run, term sheets determine your
relation with the investor. They are the prenup agreement, if one may borrow the term,
between investor and entrepreneur. Likewise, what you are aiming for in this “business marriage” is to have No Surprises.
Similarly, a badly negotiated term-sheet can
affect subsequent investment rounds, as it
may scare away more sophisticated investors.
In order to arrive to your investor meeting prepared, make sure to check the following points:
Term-sheets cover a set of conditions, beyond valuation, instruments and conversion.
They encompass the complete structure you
will negotiate at the time of signing: the price,
what happens in the event of liquidation, how
should the board of Directors be integrated,
among many more. Most important to the
investor party is the term-sheets’ definition
of its entitlements: which powers does the
startup grant to the investor. The term-sheet
clauses determine whether the investor can 1)
make decisions within the company 2) have
veto power over certain startup decisions or
the structure of how they are going to invest.
You will find the different types of clauses
that can be included on a term-sheet with
the long-term consequences of some of
them, explained in ANNEX 4 of this Guide.
44
Time
Clarify how much time you will have to
pitch and for Q&A. Some investors may
only have 30 minutes to dedicate to the
meeting whereas in other occasions they
may have an hour or more. You will have to
be flexible and accommodate their availability in terms of the number of slides
in your deck, the detail you go into, and
the speed at which you go through your
presentation. Always have a presentation
as visual support to guide the discussion.
Problem/Solution & Business Model
Be very clear in explaining at the onset
of your discussion what the problem is
that you are tackling and what your business does to satisfy a specific market
need. You know your business like the
back of your hand and it is easy to rush
this part and lose your audience. It may
be the first time the investors hear of a
similar startup to yours, so ensure you
explain what it is that you do as clearly as you possibly can. Your explanation
should be so clear and straightforward
that even a 10-year-old could understand it. Also, do not forget to lay out
your Business Model comprehensively,
in order to explain how you are able to
effectively capture value in the market.
Key Operating Metrics, Financial
history & projections
Present your business’ key operating
metrics and financial figures both in
terms of historical achievements and
future projections. This is essential for
the investor to understand the kind of
traction you have had to date and to
be able to quantify the potential return
of his or her investment into the future.
Market
Present the size and growth of your addressable market. An investor will want
to know the size of the market to understand if there is sufficient space for you
to grow at a scale that will provide attractive returns for his or her investment. An
investor will also want to understand if
you are within a growing and expanding
industry that will make way and support
your growth path, as opposed to being in
a dying industry. Investors want to invest
in the industries of tomorrow, not to enter a market in decline. Do not engage in
such uphill battles in terms of fundraising.
Team
Give an overview of the team focusing on
the funding team’s complementary skills.
Emphasize what makes you the right
people to nail the execution of your idea
and to keep on growing in the market.
Competition/Differentiators
Give a snapshot of the competitive market
highlighting what sets you apart from the
competition. Be sure to answer: What are
your competitive advantages? Why will
the market favour your service/product
vs. that of competitors? Do the competitors validate what you are doing in other
markets and could they be likely acquirers
of your business sometime in the future?
Funding & Ownership
Be prepared to discuss your previous
funding and what your current ownership cap table looks like. Investors
will want to confirm you have a large
enough stake to keep you and other co-founders motivated in the future (despite dilution of future rounds).
Ask & Uses
Remember to conclude your pitch
with a call to action that clearly explains the capital you require and how
you will utilize this to fund your growth.
Spell-check
Last but not least, remember to spell
check your deck and have peers proof
read the presentation. It can be very
distracting to go through a deck scattered will errors and it would not speak
highly of your diligence and attention.
CAC:LTV, Cohorts & Unit Economics
Calculate your CAC:LTV (Acquisition
Cost of Clients: Lifetime value) ratio
and have these items very well understood for your business, as this is bound
to come up in the discussion. Cohorts
are important for an investor to understand the stickiness of your product: Is
churn an issue? Do users get addicted
to your product/service or do they use
it sporadically or quickly forget about
it? Answering these questions is key for
an investor to understand the long-term
sustainability and growth of your startup. You should also be able to provide
a clear breakdown of the unit economics of your company. An investor will
be interested to find out if you are simply
burning money or if you are extracting
healthy margins from each transaction.
46
THE PEP TALK
We believe in your potential. These are
our last words of wisdom for whenever, in the process of raising money, you
look for a match and negotiate terms.
47
Have a story.
Define previously how much of your
startup you are willing to give away, have
a fundraising strategy, and understand
what you are committing to. Rely for these
answers on investment vehicles.
Always have a presentation as
visual support to guide
the discussion.
Read the fine print.
48
1
2
3
4
5
6
7
8
Investors want to enter/invest
in the industries of tomorrow.
Prepare – know your numbers,
the financials, unit economics,
and key indicators.
Understand which investors fit
your startup best, who will add
value at the current stage that
you are in.
ANNEX 1
Show that you have the right
team to execute your vision:
a mix of energy, passion and
knowledge.
We are available. Let us know what we can do for you
MassChallenge Mexico and Greenberg Traurig team
49
Annex 1.
Extended explanation of “How to identify the
most comparable peers and adjust valuation
multiples”
Country risk. The country risk can be adjusted by calculating the difference (the
spread) in yield of the 10-year government bond for the comparing country and
Mexico (e.g., 2.5% for the United States vs
6.8% for Mexico). This variable can reflect
the difference in risk for both countries.
Regulatory risk. Is regulation for your industry much tighter than that of the startup you’re comparing yourself to? Tighter regulation can translate into limited
growth potential, thus affecting valuation.
Political risk. Is your business at risk because of potential political decisions?
Example. You’re in the business of exporting cars to the United States (US) and the
US is putting into question the NAFTA.
Market
size.
Does
the
company
you’re comparing yourself to have access to a considerably bigger market?
Market maturity. Is the comparable company operating in a country with a stronger awareness of your industry and a better access to the product than in Mexico?
Example. A larger portion of the US population knows about Fintech solutions and is also
more likely to try new Fintech products there.
50
Security risks. Does your business have a higher security risk where you operate as compared
to where the comparable company operates?
Example. A consumer goods startup in Tijuana
is exposed to a higher risk of theft than one in
Houston.
Exchange rate risk. Does your startup get
revenues from countries where the exchange
rate is more volatile than the countries where the
comparable company gets its revenues from?
Example.
Your
revenue
sources
are
spread across Latin America vs. European countries for the comparable company.
Company size. How big/small is the comparable company compared to yours?
Example. If a comparable company has an EV
/ Revenue multiple of 30 (i.e. its EV is equal
to 30 times its revenues) and your company only has $1000 of revenues, it’s wrong
to think it should be valued at $30,000.
Public company comparables. The discount
rates between public companies in the US and
Mexico can be used as a reference for your
startup.
Example. A startup in the convenience goods
sector could analyse the EV / Revenues multiples of 2 public convenience stores like 7-Eleven in the US and Farmacias Guadalajara in
Mexico and see how discounted that multiple
is for the
Mexican company compared to the US one.
Then, it could take the EV / Revenues multiple of a similar startup in the US and apply the discount it extracted from the public sector companies to determine what
its EV / Revenues multiple should be.
Company growth rate. It is important to take
into account the growth rate of comparables.
Example. If the company you are looking to
use as a comparable has been growing at three
digits each quarter for the past few years,
and your company’s growth is only scraping
the double-digit rates, you will likely have to
account for this by cutting the comparable
multiple. Likewise, if you are using a more mature company as a comparable, with a slower growth rate, you may want to use that to
your advantage, given that investors/acquirers will likely be inclined to pay a higher price
for a faster growing business that can yield
better future returns. However, there is also a
balancing out effect from the lower business
failure risk that a more mature company can
provide.
Access to capital & VC industry maturity. Markets such as Silicon Valley provide a context
where raising capital for startups is comparably easier than for example in Latin America. This means that multiples will generally
be higher for Silicon Valley companies that
have access to a more-readily-available capital source. This kind of context reduces potential fundraising struggles and increases
the companies’ access to capital, which is
what fuels growth. Also, a more mature VC
market with a higher number of funds competing for quality deals increases multiples,
as funds compete on valuations to win the
more attractive investment opportunities.
Exit probability. The US market sees far
more IPOs and acquisitions of startups than
the Latin American market. An investor may
therefore perceive better opportunities to
monetise his investment some years down
the line, and thus be willing to pay a higher
multiple. US comparable multiples should
therefore be adjusted downwards accordingly.
Gross/Net Margins. The gross and net margins of a comparable company should be taken into consideration. The comparable multiple should be reduced if the company has
higher margins than yours, and vice-versa.
Debt situation. Remember to take your company’s overall debt situation into account.
After establishing your pre-money valuation
using comparable multiples, investors may
likely reduce this by the value of your company’s debt if the debt is deemed significant.
51
Annex 2.
Mexican Early Investment Document Investment agreement
INVESTMENT AGREEMENT
This INVESTMENT AGREEMENT (the “Agreement”) is made as of [*], by and among [*],
(the “Company”), a [*] duly incorporated in
accordance with the laws of [*], and represented herein by [*], and [*] (the “Investor”)
a [*] duly incorporated in accordance with
the laws of [*], represented herein by [*];
RECITALS
The parties hereby individually state,
through their attorney-in-fact, the following:
ANNEX 2
a) The execution of this Agreement on behalf
of their principals and the fulfillment of their
corresponding obligations, as well as the consummation of all transactions and acts included
in this Agreement, have been duly authorized
by taking all necessary corporate measures.
b) The attorney-in-fact for each party has
sufficient powers of attorney to enter into
this Agreement on behalf of its corresponding principal, same which as of this date have
not been revoked or modified in any way.
c)
id
to,
This Agreement constitutes a valobligation
of
each
party
hereenforceable pursuant to its terms.
d) It wishes to enter into this Agreement in
the terms and conditions specified here in.
52
e) In order to provide the Company with additional resources to conduct its business,
the Investor is willing to provide certain
consideration to the Company at the Closing,
referred to herein as the Investment Amount
(as such term is defined below), as a contribution for a future capital increase. In consideration of the foregoing recitals, and the representations, covenants and conditions set forth
below, the parties agree on the following:
CLAUSES
Clause 1. Definitions.
“Preferred Stock” means (i) series “[*]”
shares of the Company’s Capital Stock, or
(ii) any other newly issued series of shares of
the Company’s Capital Stock, that rank senior to the most favorable series of currently issued shares of the Company, in connection with economic, voting or other rights.
“Capital Stock” means the shares representing
the capital stock of the Company, represented
by any series of shares, regardless of whether
such series of shares grant its holders a right
to vote.
“Company
Capitalization”
means
the
sum, as of immediately prior to the Equity
Financing, of: (1) all shares of Capital Stock
issued and outstanding, assuming exercise
or conversion of all outstanding vested and
unvested options, warrants and other convertible securities, but excluding (A) this
Agreement or any other instrument containing future right to shares of Capital Stock entered for the purpose of funding the Company’s business operations, and (B) convertible
promissory notes; and (2) all shares of Capital
Stock reserved and available for future grant
under any equity incentive or similar plan of
the Company, and/or any equity incentive
or similar plan to be created or increased
in connection with the Equity Financing.
“Closing” has the meaning set forth in Clause
3 hereof.
whichever calculation results in a greater
number of shares of Preferred Stock.
“Liquidity Capitalization” means the number,
as of immediately prior to a Liquidity Event,
of shares of Capital Stock outstanding, assuming exercise or conversion of all outstanding vested and unvested options, warrants
and other convertible securities, but excluding: (i) shares of Capital Stock reserved and
available for future grant under any equity
incentive or similar plan; (ii) this Agreement or
any other instrument containing future right
to shares of Capital Stock entered for the purpose of funding the Company’s business operations; and (iii) convertible promissory notes.
“Optional Conversion Date” means the date
that is [*] months after Closing.
“Discount Price” means the price per share of
the Capital Stock of the Company sold in the
Equity Financing multiplied by the Discount
Rate.
“Agreement” has the meaning set forth the in
the preamble hereof.
“Investment Amount” has the meaning set
forth in Clause 2 hereof.
“Control” means the authority to direct the
management and policies of Person, directly or indirectly, whether by holding securities or membership interests with a
right to vote, by contract or otherwise.
“Public Offering” means (i) the closing of an
offer to the general public of the Company’s
Capital Stock, pursuant to a registration statement filed pursuant to the Ley del Mercado de
Valores and authorized by the Comisión Nacional Bancaria y de Valores; or (ii) the closing of
an initial coin offering, or any other analogous
offering whereby the Company raises funds
by investors in any jurisdiction, in exchange
for cypto-currency or any other analogous asset or currency using blockchain technology.
“Financial Statements” shall mean an income statement, balance sheet, statement
of stockholders’ equity, and/or a statement
of cash flows, in each case as of the end of
[(i) each of the first three (3) fiscal quarters
and (ii) each fiscal year of the Company.]1
“Liquidity Event” means a Corporate Transaction or a Public Offering.
“Discount Rate” is [100 minus the discount]%.
54
“Equity Financing” shall mean the next sale
(or series of related sales) by the Company of
its Capital Stock following the date of Closing
from which the Company receives gross proceeds of not less than $[*] ([*]).
“Investor” has the meaning set forth in the
preamble hereof.
“Mexico” means the United States of Mexico.
“Person” means any individual or legal entity,
trust, joint venture, partnership or company,
governmental authority, or any other entity of
any kind, with or without its own legal capacity
“Conversion Price” means the either: (i)
the Cap Price or (ii) the Discount Price,
“Liquidity Price” means the price per share
equal to the Valuation Cap divided by the Liquidity Capitalization.
“Cap Price” means the price per share equal
to the Valuation Cap divided by the Company
Capitalization.
“Company” has the meaning set forth in the
preamble hereof.
“Corporate Transaction” means (i) the closing
of the transfer (whether by merger, consolidation or otherwise) in a transaction or series
of related transactions in connection with the
Company’s Capital Stock to Person or group
of Persons if, after such closing, such Person or
group of Persons Controls more than 50% of
the outstanding Capital Stock of the Company; (ii) any reorganization, merger or consolidation of the Company, other than a transaction or series of related transactions in which
the holders of the Capital Stock of the Company outstanding immediately prior to such
transaction or series of related transactions
retain, immediately after such transaction or
series of related transactions, retain Control of
the Company or such other surviving or resulting entity; (iii) a sale, lease or other disposition
of all or substantially all of the assets of the
Company; or (iv) the liquidation, dissolution or
winding up of the Company; provided, however, that a transaction shall not constitute a
Corporate Transaction if its sole purpose is
to change the state of the Company’s incorporation or to create a holding company that
will be owned in substantially the same proportions by the Persons who held the Company’s Capital Stock immediately prior to such
transaction. Notwithstanding the prior sentence, the sale of Capital Stock in a bona fide
financing transaction shall not be deemed a
“Corporate Transaction”.
“Valuation Cap” is $[*].
Clause 2. Investment in the Company.
2.1. Investment Amount. Subject to the conditions described herein, the Investor agrees to
invest in the Company the amount of $[*] ([*])
(the “Investment Amount”). The Investment
Amount shall be documented by the Company as a [contribution for a future capital increase or an investment for future equity]2,
as applicable, in accordance with Mexican accounting principles, as regulated in the Normas de Información Financiera, issued by the
Consejo Mexicano de Normas de Información
Financiera, A.C. or any other accounting principle which may substitute such principles.
2.2. Closing. The closing of the investment in
the Company (the “Closing”) in return for the
Investment Amount paid by the Investor, shall
take place via the exchange of documents and
signatures on the date hereof. The Execution
of this Agreement shall constitute a written acknowledgement of the receipt and sufficiency
of the Investment Amount by the Company.
Clause 3. Conversion of Investment Amount.
3.1. Equity Financing. Upon the closing of an
Equity Financing, the Investment Amount will
be automatically converted into a number of
shares of the Company’s Capital Stock equal
to the Investment Amount divided by the Conversion Price. At least fifteen (15) business days
prior to the closing of any Equity Financing,
the Company shall notify the Investor in writing of the terms under which the Capital Stock
of the Company will be sold in such financing.
The shares delivered to Investor pursuant to
the conversion of the Investment Amount shall
have rights and obligations at least as favorable
as the most favorable rights and obligations
granted to any other series of shares issued by
the Company as a result of the Equity Financing.
3.2. Liquidity Event. If there is a Liquidity
Event prior to the conversion of the Investment
Amount pursuant to Clauses 3.1 or 3.3, the Investment Amount shall be converted into that
number of shares of the Capital Stock of the
Company, equal to the Investment Amount divided by the Liquidity Price. At least ten (10)
days prior to the closing of the Liquidity Event,
the Company shall notify the Investor in writing of the terms of such Liquidity Event. The
shares delivered to Investor pursuant to the
conversion of the Investment Amount shall be
shares of the Preferred Stock of the Company.
3.3. Optional Conversion. Unless earlier converted to shares of the Company’s Capital Stock
pursuant to Sections 3.1 or 3.2, at the Investor’s
election at any time on or after the Optional
Conversion Date, the Investment Amount shall
be converted into that number of Conversion
Shares equal to the Investment Amount divided
by the Conversion Price, in the understanding
that for purposes of this Clause, the Cap Price
shall be considered as the Conversion Price.
3.4 Mechanics of Conversion. As promptly as
practicable after the conversion of the Investment Amount but no later than fifteen (15) calendar days thereafter, the Company, at its expense, will deliver to the Investor a certificate
or certificates representing the corresponding
shares of Capital Stock (títulos definitivos de
acciones) duly issued in favor of the Investor.
Furthermore, as promptly as practicable after
the conversion of the Investment Amount but
no later than ten (10) calendar days thereafter, the Company shall (i) cause the Investor to
be registered as a holder of its corresponding
shares of Capital Stock of the Company in its
Stock Ledger (Libro de Registro de Acciones)
and in all corporate books and records of the
Company, and shall deliver satisfactory evidence thereof to the Investor, and (ii) file with
the National Registry of Foreign Investments
(Registro Nacional de Inversiones Extranjeras)
the corresponding report as a result of the
conversion of the Investment Amount into
capital stock of the Company, if applicable.
Clause 4. Repayment.3
Repayment
of Investment Amount in cash cannot be made by the Company without
the prior written consent of the Investor.
Any amounts payable hereunder in cash or in
kind, as applicable, shall be paid free of any
deduction or withholding required to be made
from such payments by any law or regulation,
Any amounts payable hereunder in cash or in
kind, as applicable, shall be paid free of any
deduction or withholding required to be made
from such payments by any law or regulation,
whether in Mexico or in any other applicable
jurisdiction, or in any other political subdivision or tax authority. In case the Company is
forced to make any deduction or withholding
from any amounts payable hereunder by the
Company to Investor for tax matters or any
other reason, the Company will pay Investor an additional amount in order to ensure
that Investor receives the amounts it would
have in fact received if such withholding had
not taken place. The Company shall demonstrate to the Investor’s satisfaction, in a term
no longer than 5 (five) business days follow
convenient in order for the Investor to be
able to claim the payment of such taxes in
accordance with the applicable laws and international treaties to avoid double taxation.
The Company undertakes the obligation to
hold the Investor harmless from any liability which may occur as a result of payment
of the taxes referred to in the previous paragraph, and will have the obligation to reimburse the Investor, in immediately available
funds, any amount the Investor may have paid.
The obligations of the Company that derive
from this Clause shall be in force during the
whole prescription term for taxes in connection
hereto, regardless that the Investment Amount
is fully paid before the end of such term.
Clause 5. Representations.
The Company hereby states under oath that the following statements are, to this date, true and cor
rect, and recognizes and accepts that the
Investor enters into this Agreement based
on the truthfulness of such representations:
5.1 Incorporation and Existence. The Company
is a corporation duly incorporated and existing in accordance with the laws of Mexico, and
is registered at the Public Registry of Commerce (Registro Público de Comercio) of its
corporate address, and that it is not subject to
any procedure regarding liquidation, dissolution, bankruptcy or suspension of activities, or
any other that may prevent it from performing
its businesses in a continuous or normal way.
5.2 Absence of Non-Compliance. Entering
into this Agreement and fulfilling the obligations derived from it, will not create a situation
of non-compliance with any law or corporate
provision by the Company, or of any stipulation contained in any contract, agreement or
instrument of which the Company is a part of
directly or indirectly, nor will it result in the creation of liens, burdens, fines or penalties on the
rights and assets of the Company, and it will
not implicate any modifications, rescissions,
suspensions or terminations of any authorization, permit or any other rights acquired by
the Company. Entering into this Agreement
does not breach any contractual or unilateral
provisions of which the Company is a part of,
and therefore no additional authorization from
any Person is required prior the date hereof.
5.3 Intellectual Property and Data Privacy. The
Company (i) is the sole and exclusive owner,
or has the valid right or license to use, and,
to the extent that it does any of the following, to develop, make, have made, offer for
sale, sell, import, copy, modify, create derivative works of, distribute, license, and dispose
of all intellectual property relating to, used
in, or held by the Company (such intellectual property being hereinafter collectively referred to as the “Company IP Rights”); and
(ii) complied in all material respects with the
Company’s, published privacy policies and internal privacy policies and guidelines, related
contractual obligations with customers and
end users and all applicable laws relating to
data privacy, data protection and data security, including without limitation the Mexican
Data Privacy Law (Ley Federal de Protección
de Datos Personales en Posesión de los Particulares) and its rules, directives and guidelines.
Other than the Company IP Rights, neither the
Company, nor its current shareholders hold or
own any other intellectual property of any kind,
including any intellectual property that is similar
to the Company IP Rights. Company IP Rights
are sufficient to conduct the business of the
Company, and Company has not transferred,
assigned, exclusively licensed or otherwise
conveyed to any subsidiary or affiliate, or to
any third party any of the Company IP Rights
necessary to the business of the Company.
To the knowledge of the Company and its
current shareholders, there has been no loss,
damage or unauthorized access, use, modification or other misuse of any such information by the Company or any of its current shareholders, officers, consultants or
independent contractors, and no third person (including any governmental authority) has made any such claim or commenced
any action in connection with the foregoing.
5.4 Cap Table. The capital stock of the Company is currently owned by the individuals and/
or entities, and in the proportions set forth in
the document attached hereto, identified as
Exhibit “A”. The Company further represents
that the current shareholders have duly authorized the execution of this Agreement,
and all current shareholders have undertaken
to carry out all actions necessary or convenient in order to satisfy the Company’s obligations in connection with this Agreement,
including without limitation the conversion of
the Investment Amount, as provided herein.
5.5 Truthfulness of Information and Absence of
Material Adverse Effects. All information and
documents delivered by the Company to the Investor is the entire information and documents
available to the Company, and it is truthful,
valid, correct and complete. The Company has not omitted any relevant information
that may have an adverse effect on the operations of the Company that (i) if known by
the Investor may have caused it not to enter into this Agreement, or (ii) could prevent
the Company from operating in the ordinary
course of its business, as it has been doing
leading up the execution of this Agreement.
Clause 6. Additional Agreements.
6.1 Information Rights. To the extent that the
Company prepares Financial Statements, the
Company shall deliver to the Investor such Financial Statements upon request, as soon as
practicable, but in any event within thirty (30)
days after the end of each of the first three
(3) quarters of each fiscal year of the Company and within ninety (90) days after the end
of each fiscal year of the Company. Such Financial Statements shall be in reasonable detail and prepared on a consistent basis. Additionally, regardless of whether the Company
prepares Financial Statements, the Company
shall deliver to the Investor such information
relating to the financial condition, business or
corporate affairs of the Company as the Investor may from time to time reasonably request.
Notwithstanding anything to the contrary in
this Clause 6.1, the Company shall not be obligated under this Clause 6.1 to provide information that (x) it deems in good faith to be a
trade secret or highly confidential information
or (y) the disclosure of which would adversely affect the attorney-client privilege between
the Company and its counsel; and the Investor
agrees to maintain the confidentiality of all of
the information provided to the Investor under
this Clause 6.1 and agrees not to use such information other than for a purpose reasonably
related to the Investor’s investment in the
Company.
Clause 7. Assignment. The Company may
not assign or otherwise transfer its rights
or obligations under this Agreement without the prior written consent of the Investor.
The Investor may authorize the assignment
of rights and obligations of the Investor to
any of its affiliates or subsidiaries, or otherwise transfer its rights or obligations under
this Agreement to its affiliates or subsidiaries without the consent of the Company.
Clause 8. Amendments. This Agreement
may only be amended by written consent
between the Investor and the Company.
Clause 9. Notices. All notices, requirements
and other communications to any of the
parts of this Agreement, shall be in writing
and such notices shall be deemed received
if they are delivered personally or by overnight courier with confirmation of receipt,
to the addresses of each party listed in the
signature sheet of the present Agreement.
Unless any of the parties gives written notice
of a change in address, or the person designated to receive such notices, judicial and extrajudicial proceedings which take place at the
addresses indicated in the signature pages of
this Agreement will have full force and effect.
Clause 10. Expenses. Each party shall be
responsible for the expenses incurred
in connection with the drafting, negotiation, and execution of this Agreement.
Clause 11. Entire Agreement. This Agreement
contains the entire agreement and full under
standing between the parties relating to the
matters referred to herein.
Clause 12. Language. The parties agree that
this Agreement is executed in English and in
Spanish, and agree and acknowledge that to
the extent of any conflict between the terms
and conditions of the English and Spanish
versions, the Spanish version shall prevail.
Clause 13. Governing Law; Jurisdiction. For
everything related to the interpretation of,
compliance with and execution of this Agreement, the parties expressly submit to the
applicable laws of Mexico and to the juris
diction of the competent courts located in
diction of the competent courts located in
[Mexico City], and waive any other jurisdiction to which they may now or in the future
be entitled to by reason of their address.
[INTENTIONALLY BLANK. SIGNATURE
PAGES FOLLOW.]
En vista de lo anterior, las partes celebran
el presente Contrato de Inversión en la fecha establecida en el proemio del presente.
INVESTOR
[*]
_____________________
By:
Position:
ANNEX 3
THE COMPANY
[*]
_____________________
By:
Position:
60
61
Annex 3.
Valuation cap conversion over time
We include an example below, to explain how a Valuation Cap converts over time. The process is
explained in chronological order.
Pre-Series A
Investors
Inflection Point*
Future value of
Instrument**
% of ownership
inflection point***
Valuation after
discount****
Grandma
823,529
126,403
18.06%
3,825,000
Fund A
5,000,000
1,000,000
25.00%
3,600,000
**Please refer to the spreadsheet that accompanies this document for more detail of the calculations.**
Step 1. Startup foundation
First, the co-founders created the startup. At this point there were no investors and there was
no valuation of the company.
Type
Co-founders
Common Stock
Ownership
100%
Step 2. Pre-series A investment
1. The co-founders raised a USD 100,000 convertible note from their grandma (700,000 Cap,
interest rate 8%, discount 15%)
2. They also raised a USD 1MM SAFE from Fund A (4MM Cap and 20% discount)
Pre-Series A
Investors
Grandma
Fund A
Investment
Convertible
Note
SAFE
Investment
Date
01 /Jan/ 10
N/A
Note amount
(USD)
100,000
1,000,000
Cap
(USD)
700,000
4,000,000
Discount
15%
20%
Interest
Rate
8%
N/A
Premoney Valuation
Years
(Maturity)
$4,500,000
Investors
Pre-money Equity
Breakdown
Pre-money
Convertible %
Pre-money Convertible
Co-founders
100%
54.16%
$2,437,410
Grandma
0
18.06%*
$812,590
Fund A
0
27.78%*
$1,250,000
TOTAL
100%
100%
$4,500,000
3
N/A
Step 3.1. Conversion upon Series A
It is time to value the company in order to raise a Series A Investment. At this point the Convertible
Note and the SAFE will become Equity. However, the question is how much equity for each one:
1. Grandma: If the company is worth more than $823,530, then Grandma will own 18.06%
of the company, since 823,530 -15% discount = 700K USD which is equal to Grandma’s Cap. Any valuation below $823,530 will give Grandma more equity (>18.06%).
2. Fund A: If the company is worth more than $5MM, then Fund A will own a 25%
of the company, this is because 5MM -20% discount = 4MM USD which is equal to
Fund A´s Cap. Any valuation below $5MM will give Fund A more equity (>25%).
62
* Cap / (1-discount)
** Including interest
*** Future value / Cap
****Premoney Valuation*(1-discount)
* If Valuation after Discount is larger than the Cap, the Pre-money
Convertible Percentage is calculated as Future Value / Cap.
Otherwise, it is Future Value / Valuation after Discount
63
Step 3.2. Series A investment
After determining the pre-money valuation and thus the equity that corresponds to each of the
pre-money investors, three new investors invest USD 5.5MM on the company. Now we can calculate
the post-money valuation. The post-money valuation is Pre-Money Valuation + Series A Investment
(4.5MM + 5.5MM = 10MM). The original investors are diluted in their correspondent percentage.
Series A Investment Date
Series A Investors
Fund B
$1,000,000
$2,000,000
Andreseen Horrowitz
$2,500,000
Total Investment Amount
$5,500,000
Post-money Valuation
64
Investors
Post-money equity breakdown
Post-money equity breakdown
Cofounders
24.4%*
$2,437, 410
Grandma
8.1%*
$812,590
Fund A
12.5%*
$1,250,000
Fund B
10.0%**
$1,000,000
Benchmark Ventures
20.0%**
$2,000,000
Andreseen Horrowitz
25.0%**
$2,500,000
TOTAL
100%
$10,000,000
01 /Jan/ 2013
Amount
Benchmark Ventures
Equity breakdown (Series A)
* (Pre-money Valuation/Post-money Valuation)* Pre-money
Conversion Percentage
** Investment Amount/Post-money valuation
Step 4. Debt
Between Series A and Series B, they acquired debt for 2MM.
When the Series B starts, the company is worth 18MM, but has 2MM in debt. Therefore EV –
Debt = Equity Shareholders which is 18MM-2MM=16MM. This means we will valuate the company
in 16MM for Series B.
$10,000,000
Type
Note Amount (USD)
Debt
2,000,000
Pre-Series B Valuation
$18,000,000
65
Step 5. Series B
Three new hedge funds invest 6MM in Series B. Now we have 6MM + 16MM corresponding to
the company's pre-money shareholders value. The company's post-money shareholders’ value
at this point is 22MM + 2MM debt = Enterprise Value (EV) 24MM. However the dilution for each
investor should only be calculated with the equity shareholders´ data. Debt should not be used
to make this calculation.
Series B Investment Date
66
Series B Investors
Amount
Hedge Fund 1
$1,000,000
Hedge Fund 2
$2,000,000
Hedge Fund 3
$3,000,000
Total Investment amount
$6,000,000
Pre-Series B Valuation
$18,000,000
- Debt
$2,000,000
Pre-money shareholders value
$16,000,000
+ Series B Investment
$6,000,000
Post-money shareholders value
$22,000,000
Equity breakdown (Series B)
Investors
Post-money equity breakdown
Post-money equity breakdown
Cofounders
18%*
$3,899,856.70
Grandma
6%*
$1,300,143.30
Fund A
9%*
$2,000,000.00
Fund B
7%**
$1,600,000.00
Benchmark Ventures
15%*
$3,200,000.00
Andreseen Horrowitz
18%*
$4,000,000
Hedge Fund 1
5%**
$1,000,000
Hegde Fund 2
9%**
$2,000,000
Hedge Fund 3
14%**
$3,000,000
TOTAL
100%
$22,000,000
01 /Jan/ 2016
* (Pre-money Shareholders Value/Post-money Shareholders
Value)*Post-money Series A Equity Breakdown
** Investment Amount/Post-money Shareholders Value
67
Annex 4.
Term-sheet explanation and analysis
There are some terms that make sense in early stage startups that make no sense in later stages. This is why it is so important to understand the meaning of the different clauses that may be
seen in a term-sheet when negotiating with investors.
The explanations and examples presented below are simply an indication about what should be
expected and the impact to the company. Nonetheless, several factors such as the size of the round
and the stage of the company, among others, may justify a departure from these standard terms.
Price
Option Pool
Example
ANNEX 4
Explanation An option pool is the percentage of equity a company sets aside for its employees.
This allows companies to incentivize employees to work their
hardest by aligning the interests of the company with their own interests.
Investors almost always include the option pool in the pre-money valuation. Doing this makes a VC’s valuation of your company seem higher than it actually is.
For example, assume a company is presented with the following terms:
a $1M investment at a pre-money valuation of $4M, including an option pool equal to 20% of the post-money valuation.
20% of the post-money valuation is $1M.
This means out of the
pre-money valuation of $4M, $1M is dedicated to creating an
employee option.
Thus, the effective pre-money valuation is $3M.
Analysis
68
“Upon the Closing of the financing, 15.0% of the fully diluted capital stock of the
Company (on an as-converted to Common Stock basis) will be reserved for future grants pursuant to the Company’s unallocated employee option pool (for
purposes of clarity, which number will equal XXXXX shares of Common Stock).”
Generally, option pools aren’t part of the term-sheet during a seed
round. During a Series A round they might be included in the term- sheet.
Investors rarely will agree to not include the option pool in the
pre-money valuation.
Thus, it’s not worth trying to negotiate with investors to move this option pool to the post-money valuation.
However, if the option pool is 15 – 20%, it’s worth negotiating down to a lower option pool.
Ultimately, it’s just very important to realize that a large option pool
will make an investor’s valuation seem higher than it actually is.
Liquidation Event
Conditional Funding
Example
“In the event that the Company meets the conditions set forth on Exhibit A as of
no later than XXXX, then the conversion price at which the investor’s shares of
preferred stock convert into common stock will be adjusted concurrently such
that it reflects a higher agreed upon pre-money valuation, equal to $XXXX.”
Explanation Investors will sometimes include certain conditions that must be met or
milestones you have to hit in order to get part of your money or equity.
In some cases investors will say they will give you a certain amount of equity
back if you hit a specific milestone. For example, they might try to get 50% of
the company initially and then give you 20% back if you meet a certain goal.
Examples of milestones include: passing a certain number of users or revenue,
getting investors to commit a certain amount of funding, or closing a certain important partnership.
Analysis
While investors in Mexico commonly include conditions or milestones in their term-sheets, you should do your best to avoid these.
Conditions force you to focus on very specific things that might not be good
for the long-term interest of the business. Furthermore, startups sometimes struggle before doing well, so these conditions give investors the
power to pull out too quickly without giving you the time you need to succeed.
Participation
Example
“The proceeds of any liquidation, dissolution, or winding up of the Company will
be paid as follows: “Thereafter the Series X Preferred participates with the Common Stock pro rata on an as-converted basis”.
Explanation Participation details describe what occurs after the preferred stockholders get
the money from their liquidation preference. There are three different types (detailed below). To make things clear, let´s assume an investor invested $1M for 20%
equity of a company and had a 1x liquidation preference. Non-Participating. The
investor does not receive anything after getting their liquidation preference. For
example, if the company were to be acquired for $2M, the investor would receive
$1M and the remaining $1M would be split proportionally among all of the common shareholders.
Fully Participating. The investor gets part of the remaining money, equal to their
ownership percentage. In this case the investor would receive a total of $1.2M.
They would get $1M from their 1x liquidation preference and then 20% of the remaining $1M. Capped Participating. The investor gets part of the remaining
money, but only up to a certain overall multiple.
Analysis
A Non- Participating term should be negotiated. In the worst-case scenario, the
founder should agree to capped participation, and should carefully consider the
implication of agreeing to fully participating. As mentioned before, this is especially important as it will set a precedent for future investors.
Preferred Shares
Example
“The securities sold in this financing will be Series X Preferred Stock (the “Series X
Preferred”), and will be entitled to the rights and privileges set forth in this Term
Sheet”.
Explanation Investors generally are issued preferred shares, as opposed to founders and employees who are issued common shares. Preferred stockholders get certain privileges. These include protective provisions (explained later) and the priority to get
money before any of the common stockholders do.
Analysis
70
This is normal and should be expected.
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Board of Directors
Liquidation Preference
Example
“The proceeds of any liquidation, dissolution, or winding up of the Company will
be paid as follows: First pay one times the applicable Original Purchase Price
(as adjusted for stock splits, stock dividends, recapitalizations, and etc.), plus declared and unpaid dividends on each share of Series X Preferred (the “Liquidation
Preference”).
Explanation Liquidation preference is usually a multiple of the investor’s initial investment,
such as 1x, 1.5x or 2x. This multiple dictates how much money the investor gets
before common stockholders receive their money. Preference exists to protect
investors from “downside risk”. It helps investors if the company does not have a
very profitable acquisition. For example, assume an investor invested $1M originally and soon the company is acquired for $2M. If the liquidation preference is 1x,
the investor would receive $1M before anyone else gets anything. If the liquidation
preference is 2x, then the investor would receive the $2M.
Analysis
72
A 1x liquidation preference should be negotiated. 1x is very common in the US,
but often-Mexican investors will try to negotiate a higher liquidation preference.
This is especially important because the terms the founders agree to
here will likely set a precedent for future investors. Even though giving away a generous liquidation multiple in a seed round may not seem
like a big deal, investors in their Series A, Series B, and so on will likely ask for the same or better terms than those agreed on in the seed round.
Board Set
Example
“At the Closing, the Board shall comprise [______] members consisting of
(i) [name] as the representative designated by [____], as the lead Investor; (ii) [name] as the representative designated by the remaining Investors;
(iii) [name] as the representative designated by the Founders; (iv) the person
then serving as the Chief Executive Officer of the Company; and (v) [___] person(s) who are not employed by the Company and who are mutually acceptable
[to the Founders and Investors][to the other directors].”
Explanation Investors will often ask for a seat on your board of directors. Doing so will
put them in a position to oversee and have control over your company.
Analysis
It is common for the lead investor of a Series A round or a later round to
get a board seat. In most circumstances, you should negotiate strongly against giving up a board seat during a seed round unless special circumstances suggest you should consider otherwise (e.g. a Fintech company giving a board seat to the former governor of Banco de Mexico).
When
thinking
about
adding
someone
to
your
board,
you
should
think
very
carefully
about
two
things:
1) Value to your company. Do you want this person to have significant power over your company? Are they someone you trust to make
good decisions for your company?
Do you want to work with them?
It’s vital that you trust them, as they will have the power to vote to replace you.
2)
Implications
for
voting
power.
How
will
adding
this
person to your board impact your company’s control over the board?
It’s normal for earlier stage companies to have a board comprised of one investor, two founders, and potentially one other outside person. You want
to try to maintain majority control over the board for as long as you can.
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Additional Powers Granted to Investor
Protective Provisions
Pro Rata Rights
Example
“In the event the Company proposes to offer equity securities to any person (excluding Exempted Securities), each stockholder of the Company will have the
right to purchase their pro rata portion of such equity securities. Each such stockholder will have twenty (20) calendar days after delivery of a notice from the
Company describing such offering to elect to purchase their pro rata portion.
Any such equity securities not purchased by a stockholder may be reallocated
among the other stockholders.”
Example
Explanation Pro rata rights give the investor the option to invest in a future
round
to
maintain
their
percentage
of
the
company.
For example, let’s say that today an investor invests $1M in your company
at a $5M post-money valuation. This means they own 20% of your company.
If in one year, your company decides to raise a second round of
$4M from other investors at a $16M post-money valuation, then
the initial investor’s ownership is diluted by 25% (4M / 16M).
Pro rata rights exist so investors can avoid this dilution. In the scenario above, the initial investor could exercise his or her pro rata rights and invest an amount equal to 20% of the second round (keep in mind, this
is 20% of the round, not the valuation), which would be $800,000.
By doing this, the initial investor would own 20% of the new shares being created for the second round, and thus would still own 20% of the overall company.
Analysis
74
Pro rata rights are very standard and you should keep them in your termsheet. In fact, it’s in your best interest for your investors to have pro rata rights,
as it aligns your interests with those of your investors: as your company continues to grow in value, your earlier investors are able to maintain their stakes.
If a Mexican company is receiving the investment you should check
with your own counsel because certain corporate entities would
mandatorily grant this right to any investor (i.e. there is no need
to
negotiate
something
already
afforded
under
applicable
law).
“For so long as any shares of the Series X Preferred remain outstanding, the vote or
written consent of the Requisite Holders, voting together as a single class on an asif converted basis, will be necessary for the Company to take the following actions:
(i) amend, alter, or repeal any provision of the Certificate of Incorporation or Bylaws of the Company;
(ii) change the authorized number of shares of Series X Preferred or Common Stock;
(iii) authorize, designate or issue, whether by reclassification or otherwise, any new
class or series of stock or any other equity or debt securities convertible into equity securities of the Company ranking on parity with or senior to the Series Seed
Preferred in right of redemption, liquidation preference, voting or dividends or any
increase in the authorized or designated number of any such new class or series;
(iv) redeem or repurchase with respect to Common Stock (excluding
shares repurchased upon termination of an employee or consultant pursuant to a restricted share purchase agreement or right of first refusal);
(v) enter into any agreement regarding an asset transfer of more than
$XXXXXX, license of intellectual property out of the ordinary course of business, acquisition of the stock or assets of another entity or a Liquidation Event;
(vi) borrow, loan or guarantee an amount in excess of $XXXXX;
(vii) consummate any interested party transaction;
(ix) hire, fire, or change the compensation of the Company’s executive officers;
(x) change the principal business of the Company, enter new lines of business, or
exit the current line of business;
(xi) declare or pay any dividend; or
(xii) any voluntary dissolution or liquidation of the Company.”
Explanation Protective provisions are the veto powers you give to your investor. They require you
to get your investor’s approval before doing things such as taking on debt over a certain amount of money, amending your company’s bylaws or selling your company.
Analysis
The sample protective provisions above are standard and are generally acceptable to investors and founders. The investors will want to ensure their ability to
control company actions that could impact their investment, while the founders
and the company will prefer to retain the power to operate the company freely.
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Right of First Refusal
Drag Along
Example
“Each current and future holder of Common Stock will be required to enter into
an agreement providing that in the event a majority of the stockholders have
approved an acquisition of the Company—whether by merger, consolidation,
sale of assets, sale of stock or otherwise—such holder will grant any consents or
approvals reasonably determined by the Board to be necessary in order to
approve or participate in the acquisition of the Company subject to customary
limitations.”
Explanation In the event that over X% of shareholders (generally X is equal to or greater than
50) agree to a sale of the company, all other shareholders must agree to the sale.
The objective is to prevent a situation in which a few shareholders are able to stop
an acquisition from happening. For example, let’s say that the Drag Along clause
dictates that if over 50% of the shareholders are in favor of a sale, then everyone
else must agree to it. If an acquisition is proposed and 60% of shareholders support it, even if the other 40% are strongly opposed to it, the company can still go
through with the acquisition.
Analysis
This is completely normal and fair for investors.
Tag Along
Example
Example
Right of First Refusal. At any time, and subject to the terms and conditions specified in this Section [XX], each Stockholder shall have a right of first refusal if
any other Stockholder (the “Offering Stockholder”) receives an offer from a Third
Party that the Offering Stockholder desires to accept to purchase all or any portion of the shares owned by the Offering Stockholder (the “Offered Shares”).
Explanation Under this clause a stockholder has the contractual obligation to offer to sell its
equity to the other holders, or sometimes back to the company, after receiving a
bona fide offer from a third party to buy that equity stake. The offer to the other
stockholders must typically be made on substantially the same terms as those
offered by the third party.
Analysis
This contractual provision covers the circumstances in which a shareholder (often
a Founder or Key Management) wants to sell any of its shares to a third party.
This provision would require the seller to give the company first, and then the
investors, a notice of a proposed sale and grant the company/investors a right
of first refusal to purchase their shares. It is common for this provision to be
present and accompanied by the co-sale right provision (tag-along) and for both
to operate successively (i.e. if the investor does not exercise its ROFR then it
would still have the right to “tag” its shares to the proposed sale to a third party).
If at any time, a Stockholder who (together with its Affiliates) holds no less than
[51]% of the outstanding Common Stock of the Company (the “Selling Stockholder”) proposes to sell any shares of its Common Stock to an Independent Third Party
(the “Proposed Transferee”) and the Selling Stockholder cannot or has not elected
to exercise its drag-along rights set forth in Section [XX], each other Stockholder
(each, a “Tag-along Stockholder”) shall be permitted to participate in such sale
(a “Tag-along Sale”) on the terms and conditions set forth in this Section [XXX].
Explanation In a situation where majority shareholders sell their shares, the tag along provision allows minority shareholders to “tag along” and sell their shares at the same
terms.
Analysis
76
This is also known as or referred to as a co-sale right. This provision is often also
used to restrict or condition sale of the Founder’s stock to a third party unless investors are given a first refusal right to purchase the stock or to participate in such
stock sale on a pro-rata basis. This is customary and a provision many investors
would expect to have in any financing.
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Do’s
Dont’s
Practice giving your pitch presentation, and
review your company materials with several
different people.
Don’t accept the first term-sheet you’re given.
Know your company’s financial details, market potential, and preferred financing numbers.
Conduct reference checks by chatting with
existing portfolio companies of investors who
are being considered.
Hire a top lawyer. Even though it’s costly it
will pay off in the long-term.
Do’s & Dont’s
Don’t only focus on the valuation and amount
of money an investor is offering. The other
terms and the quality of the investor are just
as important.
Cold calls are often not an effective way to
approach a VC.
Don’t get caught up in fundraising and leave
your business unattended.
Keep in mind that later investors will often
ask for terms that are the same or better than
the terms you give earlier investors.
Read as much as you can about each term
online and research what their implications are
for your company.
Decide which top terms matter the most to
your company and focus your negotiation on
these terms.
Be prepared for tough questions related to
your IP protection, legal barriers, competitive
advantages, and investor’s rights granted to
prior investors.
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