US Corporate Law 20 Episodes (9)

A Weird Call From a VC | What the hell is business model, post-investment valuation, term sheet, due diligence?

In the previous lecture, we introduced three common documents for angel investing. After the angel round is the formal venture investment. After you talk to a few investors, the investor you like will send you a Term Sheet (term sheet), but before that, you usually receive such an investment Such a weird phone call.

"Alex, our partners have studied your deal together. In general, your business model is relatively innovative, cash flow and revenue are healthy, and we are very satisfied with your founder and team. Son, we are going to vote 4 million now and press forward P/E of 8 times for your post-money. I will email a Term Sheet to you later. After signing it, we can start DD. "

After I finished speaking, I wanted to smoke myself. I feel like this issue is so papi sauce. But this is indeed a phrase that entrepreneurs hear when they get investment.

If it is the first time that the entrepreneur invests, basically he will be confused after listening to it. So what does the above paragraph in bulk English mean?

1. Partner

The concept is simple enough. Venture capital is all LP (Limited Partner), and the investors inside are called Partners.

2. Deal project

The deal mentioned here is actually a project. Basically, whenever you chat with VC friends, they will say "I'm looking at a project recently". In fact, this sentence is like a lawyer telling you "I'm working on a case recently". For VCs, they call all the startups they're looking at "projects."

3. Business Model

The business model mentioned here is the business model. It sounds like a high-level, like a financial term, in fact, to put it bluntly, it is to ask how your company makes money. VC investment is not to do charity or public welfare, but to make money from your company in the end. Moreover, VC investment does not make small money, but expects a return of more than 10 times. Then a company's business model is obviously the most concerned issue for VCs.

Speaking of which, there is also a phenomenon, that is, Chinese VCs will attach great importance to the business model, and even think that the business model is the decisive factor, even more important than your technology. But VCs in the U.S. tend to put the company's technology at a higher level than the business model.

4. Cash Flow & Revenue

Cash flow here refers to cash flow. Is your Cash Flow flat? The answer to this question is basically no for early-stage startups, and oftentimes for early-stage startups, the answer to this question is often no. And in many cases the VC's investment is their first and only cash flow for a long time.

Then there is the Revenue turnover, which should be regarded as a basic accounting common sense. Cash flow does not necessarily have turnover, and turnover does not necessarily have cash flow. Money borrowed by a company can also count as cash flow, but not turnover. The company sells products on credit, which can be considered turnover, but does not generate cash flow. The turnover can see the overall situation of a company's development, and it also reflects the company's prospects. But the cash flow solves the current problem more. We often say that a company's capital chain is broken, that is, the cash flow is gone. Even if there is a pile of accounts receivable, but cannot pay wages or rent, it will go bankrupt. of.

5. Founder & Team

This is relatively simple. We also said before that the most important thing for investors to start-up companies, especially early-stage projects, is "people, people, people", that is, the team. There are many good ideas, but the real ability to get things done often depends on the people who do them.

6. Post-money valuation

This post-money is actually the abbreviation of post-money valuation, and sometimes even referred to as post. In addition, the corresponding pre-money valuation is pre-financing valuation, referred to as pre-money or pre. In fact, it is the pre-money valuation plus the total investment amount of the investor, which is the post-money valuation. For example, a company is valued at 16 million, then the pre-money valuation is 16 million, the investor invested 4 million, and the post-money valuation of the company after the investment is 20 million. Investors own 4 million out of 20 million, or 20%

7. forward P/E forward price-earnings ratio

This P/E is actually the full name of the Price to Earnings Ratio market price to earnings ratio, or the price-earnings ratio for short. Since it is the ratio of market price to earnings, it can be known that the higher the multiple, the more it shows that the stock price of the company is overvalued. But venture capital buys the future of an enterprise. The reason why VCs are willing to pay such a high price to buy an unprofitable enterprise is to bet on its future. 8-10 times or even 10 times or 20 times the price-earnings ratio is very likely to appear in venture capital. The forward P/E is one of the three common calculation methods for the price-earnings ratio, which means that the company's expected earnings in the next year are used as the denominator. Why do startup company valuations often use the expected earnings in the next year as the denominator? Because often startups are not profitable at all before they get venture capital, and there is no historical data for reference.

8. Term Sheet

The term sheet is often a document of less than 5 pages, short or even 2 pages. However, the amount of information in the book is very large, and the sentences are all professional terms. We will interpret this in detail next. Generally, after signing such a term sheet, the general framework of the investment is set, and the rest is for the lawyers of both parties to refine the framework on the term sheet into a complete legal document.

9. DD (Due Diligence) due diligence

Finally, a term is due diligence due diligence. It sounds like a complicated concept, but it actually means to go through all the legal, financial, taxation and other documents of your startup company from its establishment to the present to see if there are any problems. For a startup company that has received venture capital for the first time, the workload may be small, but the later stage of financing, as the company's development years and operational complexity increase, the workload of due diligence will increase. After the B round, the workload of due diligence will account for more than half of the workload of lawyers in the entire investment.

After listening to the above explanation of these confusing English words, let's go back and listen to the opening paragraph:

"Alexander, some of our partners have studied your project together. Generally speaking, your business model is relatively innovative, with healthy cash flow and turnover. We are also very supportive of your founders and team. Satisfied. In this way, we are now planning to invest $4 million and give you a post-investment valuation of 8 times forward earnings. I will email a term sheet to you later. After signing it, we can start Do your due diligence."

Do you suddenly feel that you understand a lot?

Not at all.

After receiving this call from investors, you will soon receive an email, which is the Term Sheet we just mentioned.

In the next issue, we will talk about the details in the Term Sheet in detail. If today's show is helpful to you, please give me a like, and if you have any related questions, please leave me a message in the comment area.