Jekyll2024-03-19T00:31:42+00:00https://kruzeconsulting.com/blog/recent_feed/index.xmlShould you cap commissions?2024-03-17T00:00:00+00:002024-03-17T00:00:00+00:00https://kruzeconsulting.com/blog/should-you-cap-commissions<p><img src="/uploads/should-i-cap-commissions-1.jpg" alt="" width="1920" height="1080" /><!--Post Content--></p>
<p>A question we get frequently from startup founders is should they cap commissions for their sales team? The reason they ask this question is because they get the <a href="https://kruzeconsulting.com/3-financial-statements/"><u>financials</u></a> we prepare at Kruze, and they are startled that the VP of Sales or a top salesperson is <a href="https://kruzeconsulting.com/blog/highest-paid-person-startup/"><u>making more money</u></a> than anyone else in the company. And that can be a shock when the <a href="https://kruzeconsulting.com/blog/startup-ceo-salary-report/"><u>CEO</u></a> or COO finds out that another employee is making more than they are. However, capping sales commissions can seriously impact your company’s growth.</p>
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<h2 id="commission-caps-can-backfire">Commission caps can backfire</h2>
<p>While capping commissions may seem cost-effective at first glance, it could actually be less profitable in the long run. Some reasons why include:</p>
<ul>
<li><strong>Caps de-motivate your sales force.</strong> Salespeople tend to be very financially focused. Think about it – if you’re not allowing your sales team to reach their full potential, they don’t have any incentive to keep performing. Once a salesperson reaches the cap, he or she might as well stop there. You want your salespeople to have big commission checks if they’re signing deals. Compensation and sales performance are two sides of the same coin.</li>
<li><strong>Capped commissions let lower-performing salespeople “catch up” to the top performers.</strong> Professional salespeople are very competitive, and that’s exactly what you want. You don’t want someone who’s okay with losing sales to be a salesperson for your startup. Good salespeople aren’t just about the money – closing deals are a way to keep score. And you want to encourage that competitive attitude.</li>
<li><strong>Caps can cause your startup to earn less revenue.</strong> This is related to the first point, but it’s important from a business standpoint. A commission cap will lower your compensation expenses, but it means you’re probably going to earn less <a href="https://kruzeconsulting.com/blog/revenue-visibility/"><u>revenue</u></a> because you’re putting a limit on performance.</li>
<li><strong>Caps encourage salesperson turnover.</strong> For any business, competitive pay is essential for success. Commission caps simply encourage sales staff to explore other opportunities to make more money. There’s a strong relationship between performance and tenure. You risk losing experienced sales reps to competitors that pay more.</li>
</ul>
<p>You want your salespeople to make a lot of money. In fact, it’s a sign of a thriving company if the sales team is very well compensated.</p>
<h2 id="flip-the-script">Flip the script</h2>
<p>An effective alternative to commission caps is the concept of accelerators. So rather than capping, you’re doing the exact opposite. With accelerators, the more a salesperson closes, or a sales team closes in a quarter or a year, they can pick up accelerators, and actually get higher commission levels as they surpass their quotas.</p>
<p>As an example, maybe the sales team gets a 5% commission on all sales they do up to their quotas, but then after they exceed their quotas, they get 8%. That’s a 60% increase on every sale, which will be highly motivating for people on the sales team, so they hit their quotas and then keep going.</p>
<p>So we definitely don’t recommend capping sales commissions. Instead, you should probably look at <a href="https://kruzeconsulting.com/blog/highest-paid-person-startup/"><u>accelerators</u></a>. You’re building a startup. You want to be successful. Paying your salespeople well is going to help you accomplish that.</p>
<p>If you have any other questions on startup accounting or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>. You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dA question we get frequently from startup founders is should they cap commissions for their sales team? The reason they ask this question is because they get the financials we prepare at Kruze, and they are startled that the VP of Sales or a top salesperson is making more money than anyone else in the company. And that can be a shock when the CEO or COO finds out that another employee is making more than they are. However, capping sales commissions can seriously impact your company’s growth. Commission caps can backfire While capping commissions may seem cost-effective at first glance, it could actually be less profitable in the long run. Some reasons why include: Caps de-motivate your sales force. Salespeople tend to be very financially focused. Think about it – if you’re not allowing your sales team to reach their full potential, they don’t have any incentive to keep performing. Once a salesperson reaches the cap, he or she might as well stop there. You want your salespeople to have big commission checks if they’re signing deals. Compensation and sales performance are two sides of the same coin. Capped commissions let lower-performing salespeople “catch up” to the top performers. Professional salespeople are very competitive, and that’s exactly what you want. You don’t want someone who’s okay with losing sales to be a salesperson for your startup. Good salespeople aren’t just about the money – closing deals are a way to keep score. And you want to encourage that competitive attitude. Caps can cause your startup to earn less revenue. This is related to the first point, but it’s important from a business standpoint. A commission cap will lower your compensation expenses, but it means you’re probably going to earn less revenue because you’re putting a limit on performance. Caps encourage salesperson turnover. For any business, competitive pay is essential for success. Commission caps simply encourage sales staff to explore other opportunities to make more money. There’s a strong relationship between performance and tenure. You risk losing experienced sales reps to competitors that pay more. You want your salespeople to make a lot of money. In fact, it’s a sign of a thriving company if the sales team is very well compensated. Flip the script An effective alternative to commission caps is the concept of accelerators. So rather than capping, you’re doing the exact opposite. With accelerators, the more a salesperson closes, or a sales team closes in a quarter or a year, they can pick up accelerators, and actually get higher commission levels as they surpass their quotas. As an example, maybe the sales team gets a 5% commission on all sales they do up to their quotas, but then after they exceed their quotas, they get 8%. That’s a 60% increase on every sale, which will be highly motivating for people on the sales team, so they hit their quotas and then keep going. So we definitely don’t recommend capping sales commissions. Instead, you should probably look at accelerators. You’re building a startup. You want to be successful. Paying your salespeople well is going to help you accomplish that. If you have any other questions on startup accounting or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!Should founders accrue payroll before VC funding?2024-03-10T00:00:00+00:002024-03-10T00:00:00+00:00https://kruzeconsulting.com/blog/should-founders-accrue-payroll-before-vc-funding<p><img src="/uploads/should-founders-accrue-payroll-1.jpg" alt="" width="2200" height="1300" /><!--Post Content--></p>
<p>This particular scenario has happened in startups. You’ve started a company. You were used to getting a regular paycheck at your previous job, but right now there’s no money to pay yourself, but hopefully there will when you get funded. And at that point, you feel that you could “reimburse” yourself for all the paychecks you missed.</p>
<p>So you decide to start accruing your hypothetical salary. You basically say, “Hey, I would normally get $10,000 a month, so I’m gonna put $10,000 in the books as a payroll expense. However, that accrual just means you’re creating a liability, and there will be a liability on the balance sheet that says $10,000 per month. That will add up over time.</p>
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<h2 id="accruing-payroll-can-cause-problems">Accruing payroll can cause problems</h2>
<p>There are some problems with this plan. One problem is the amount. While you may think your salary should be $10,000 a month, you haven’t gotten that approved by a VC board <a href="https://kruzeconsulting.com/do-founders-of-startups-that-have-raised-millions-give-themselves-paychecks-if-so-how-much-money-do-they-pay-themselves/"><u>compensation committee</u></a>. It’s a number you picked, not something that was authorized. But there are also other issues.</p>
<h3 id="the-liability-can-discourage-investors">The liability can discourage investors</h3>
<p>A bigger problem is the <a href="https://kruzeconsulting.com/balance-sheet/"><u>liability</u></a> this creates. If you’ve done this, and you’re talking to investors, you have to disclose this payroll liability. If you don’t disclose it, and try to spring on them right before the funding, that’s will be a huge red flag. And your funding could very easily fall apart.</p>
<p>The size of the liability is important here – if you’ve only been doing it for a couple of months, and it’s $10,000 or $20,000, that isn’t as big an issue. But if you’ve accrued $300,000 or $500,000 of payroll, and you’re raising a $2 million <a href="https://kruzeconsulting.com/blog/tip-close-seed-round/"><u>seed round</u></a>, that’s a very big problem for an investor. They aren’t going to want to invest that much money just to see a big chunk of it go out the door right away for work that’s already done. The investors want you to build value and make progress from where you are when they invest in your startup. Essentially, they’re not paying for past performance.</p>
<p>If you disclose this payroll liability after you’ve raised the money, they will probably say no and not let you pay yourself that money. Or maybe they’ll negotiate a much smaller amount, but that will also hurt your <a href="https://kruzeconsulting.com/blog/communicate-with-vcs/"><u>credibility with the investors</u></a>. And credibility is the ultimate currency. You need these people to help you, you need them to introduce you to other investors, or do a bridge round, things like that. So don’t destroy your credibility on this.</p>
<h3 id="the-accrual-can-cause-tax-problems">The accrual can cause tax problems</h3>
<p>Another problem is that it’s “funny money.” You’re making an accounting entry, but you’re not actually paying yourself. Doing this could potentially create <a href="https://kruzeconsulting.com/blog/do-bootstrapped-startups-actually-pay-taxes/"><u>payroll tax</u></a> problems with the IRS and any state agencies. Technically you’re saying this was payroll. Particularly if you run it through your payroll system, which isn’t a good idea either. Identifying this accrual as payroll will trigger payroll taxes, which you should be paying to the IRS and any state agencies where you have <a href="https://kruzeconsulting.com/startup-state-local-taxes/"><u>tax nexus</u></a>. But since you’re not actually taking a salary, you don’t have the cash to pay these taxes. However, the taxing authorities don’t know that. They just know you’re accruing payroll.</p>
<p>So these agencies could come after you for unpaid taxes. And one of the worst things to have as you’re trying to build a startup is have the IRS or a state agency sending you <a href="https://kruzeconsulting.com/blog/payroll-tax-notice/"><u>notices that you owe them payroll taxes</u></a>. The government takes payroll taxes very seriously, because it’s one of their primary sources of revenue. So you could be subject to penalties. You will certainly end up paying your accountant a lot to fix this payroll problem.</p>
<p>It’s possible the IRS or state agencies might never know about this or may not care because actual cash didn’t change hands. But that outcome relies on their interpretation, and it’s a risk you just don’t want to take.</p>
<h2 id="what-can-founders-do-instead">What can founders do instead?</h2>
<p>One option is to request a bonus during your <a href="https://kruzeconsulting.com/blog/what-is-the-right-amount-of-venture-capital-to-raise/"><u>funding round</u></a>. When you’re talking to the investors and the rounds coming together, explain to them, “I haven’t been taking a paycheck and I’m going through my savings. Would you be open to paying me some sort of bonus or let me pay myself a bonus after I close the round? Here’s the dollar amount I’m thinking.” And make sure it’s reasonable so you don’t alienate them.</p>
<p>A lot of investors are okay with that. They know you’ve been scraping by and you built something that they’re investing in. They want you to make good decisions. They don’t want you to be so broke that you’re making poor decisions. Calling it a bonus and asking their permission is very different from accruing a large amount and presenting it as a liability. That liability will have to be paid, and your investors probably won’t want to do that.</p>
<h2 id="carefully-track-any-expenses-you-paid-personally">Carefully track any expenses you paid personally</h2>
<p>Another important thing to do is make sure you track any company expenses that you’re putting on your personal credit card during that time, and get reimbursed for your expenses. And again, you need to make sure these are reasonable. These do have to be disclosed when you’re raising money as well. But often, founders have hosting services and Google apps and other business expenses on their person credit card. As long as those expenses aren’t crazy, it’s a good thing to create an expense report. Make sure it’s documented, make sure you have all your receipts, and make sure you’re audit-ready in case you do get audited someday about these expenses.</p>
<p>Then present that to the investors in the same way you would a bonus. “Hey, here’s what happened. Would you be okay if I reimbursed myself this amount of money?” And most investors will say yes, as long as it’s not too big. And really when you’re raising money, it’s all about having a very honest relationship with your investors.</p>
<h2 id="we-dont-recommend-founders-accruing-payroll">We don’t recommend founders accruing payroll</h2>
<p>The bottom line is that you don’t want to surprise your investors, and you definitely don’t want to alienate them. You don’t want the IRS or state taxing agencies to think you may not be submitting payroll taxes. So accruing payroll isn’t a good idea.</p>
<p>If you have any other questions on startup payroll, startup fundraising, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>. You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dThis particular scenario has happened in startups. You’ve started a company. You were used to getting a regular paycheck at your previous job, but right now there’s no money to pay yourself, but hopefully there will when you get funded. And at that point, you feel that you could “reimburse” yourself for all the paychecks you missed. So you decide to start accruing your hypothetical salary. You basically say, “Hey, I would normally get $10,000 a month, so I’m gonna put $10,000 in the books as a payroll expense. However, that accrual just means you’re creating a liability, and there will be a liability on the balance sheet that says $10,000 per month. That will add up over time. Accruing payroll can cause problems There are some problems with this plan. One problem is the amount. While you may think your salary should be $10,000 a month, you haven’t gotten that approved by a VC board compensation committee. It’s a number you picked, not something that was authorized. But there are also other issues. The liability can discourage investors A bigger problem is the liability this creates. If you’ve done this, and you’re talking to investors, you have to disclose this payroll liability. If you don’t disclose it, and try to spring on them right before the funding, that’s will be a huge red flag. And your funding could very easily fall apart. The size of the liability is important here – if you’ve only been doing it for a couple of months, and it’s $10,000 or $20,000, that isn’t as big an issue. But if you’ve accrued $300,000 or $500,000 of payroll, and you’re raising a $2 million seed round, that’s a very big problem for an investor. They aren’t going to want to invest that much money just to see a big chunk of it go out the door right away for work that’s already done. The investors want you to build value and make progress from where you are when they invest in your startup. Essentially, they’re not paying for past performance. If you disclose this payroll liability after you’ve raised the money, they will probably say no and not let you pay yourself that money. Or maybe they’ll negotiate a much smaller amount, but that will also hurt your credibility with the investors. And credibility is the ultimate currency. You need these people to help you, you need them to introduce you to other investors, or do a bridge round, things like that. So don’t destroy your credibility on this. The accrual can cause tax problems Another problem is that it’s “funny money.” You’re making an accounting entry, but you’re not actually paying yourself. Doing this could potentially create payroll tax problems with the IRS and any state agencies. Technically you’re saying this was payroll. Particularly if you run it through your payroll system, which isn’t a good idea either. Identifying this accrual as payroll will trigger payroll taxes, which you should be paying to the IRS and any state agencies where you have tax nexus. But since you’re not actually taking a salary, you don’t have the cash to pay these taxes. However, the taxing authorities don’t know that. They just know you’re accruing payroll. So these agencies could come after you for unpaid taxes. And one of the worst things to have as you’re trying to build a startup is have the IRS or a state agency sending you notices that you owe them payroll taxes. The government takes payroll taxes very seriously, because it’s one of their primary sources of revenue. So you could be subject to penalties. You will certainly end up paying your accountant a lot to fix this payroll problem. It’s possible the IRS or state agencies might never know about this or may not care because actual cash didn’t change hands. But that outcome relies on their interpretation, and it’s a risk you just don’t want to take. What can founders do instead? One option is to request a bonus during your funding round. When you’re talking to the investors and the rounds coming together, explain to them, “I haven’t been taking a paycheck and I’m going through my savings. Would you be open to paying me some sort of bonus or let me pay myself a bonus after I close the round? Here’s the dollar amount I’m thinking.” And make sure it’s reasonable so you don’t alienate them. A lot of investors are okay with that. They know you’ve been scraping by and you built something that they’re investing in. They want you to make good decisions. They don’t want you to be so broke that you’re making poor decisions. Calling it a bonus and asking their permission is very different from accruing a large amount and presenting it as a liability. That liability will have to be paid, and your investors probably won’t want to do that. Carefully track any expenses you paid personally Another important thing to do is make sure you track any company expenses that you’re putting on your personal credit card during that time, and get reimbursed for your expenses. And again, you need to make sure these are reasonable. These do have to be disclosed when you’re raising money as well. But often, founders have hosting services and Google apps and other business expenses on their person credit card. As long as those expenses aren’t crazy, it’s a good thing to create an expense report. Make sure it’s documented, make sure you have all your receipts, and make sure you’re audit-ready in case you do get audited someday about these expenses. Then present that to the investors in the same way you would a bonus. “Hey, here’s what happened. Would you be okay if I reimbursed myself this amount of money?” And most investors will say yes, as long as it’s not too big. And really when you’re raising money, it’s all about having a very honest relationship with your investors. We don’t recommend founders accruing payroll The bottom line is that you don’t want to surprise your investors, and you definitely don’t want to alienate them. You don’t want the IRS or state taxing agencies to think you may not be submitting payroll taxes. So accruing payroll isn’t a good idea. If you have any other questions on startup payroll, startup fundraising, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!What are SG&A expenses?2024-03-03T00:00:00+00:002024-03-03T00:00:00+00:00https://kruzeconsulting.com/blog/what-are-sg-a-expenses<p><img src="/uploads/what-are-sga-expenses-1.jpg" alt="" width="1920" height="1080" /><!--Post Content--></p>
<p>Founders will hear the term “SG&A expenses” thrown around in board meetings a lot. SG&A stands for <a href="https://kruzeconsulting.com/income-statement/"><u>selling, general, and administrative expenses</u></a>. One way to think of SG&A expenses is that it’s the cost of running your company.</p>
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<p>Some people refer to this as “overhead,” but that term has become somewhat synonymous with “unnecessary.” Sometimes CEOs and founders will be told they need to cut “overhead” but that phrase makes it seem like overhead expenses are unimportant. And that’s not necessarily true – one example is <a href="https://kruzeconsulting.com/startup-accounting/"><u>accounting</u></a>. That gets captured in SG&A expenses, but accounting is a crucial business function. You need to understand your finances and you want to remain <a href="https://kruzeconsulting.com/do-vcs-and-angels-really-care-about-gaap-compliant-financials/"><u>compliant</u></a> with taxes and regulations. We work with companies every day who need help fixing their accounting.</p>
<h2 id="whats-included-in-sga-expenses">What’s included in SG&A expenses?</h2>
<p>Selling, general, and administrative expenses essentially refer to the non-production costs of a startup. These expenses are not directly attributable to the production of your product. The direct costs associated with producing your product are called the cost of goods sold (COGS), and don’t fall into SG&A expenses. Let’s look at each part of SG&A.</p>
<h3 id="selling-expenses">Selling expenses</h3>
<p>Your sales expenses include a lot of different elements, such as:</p>
<ul>
<li>Sales wages, salaries, and commissions along with payroll taxes and benefits</li>
<li>Packing and shipping product</li>
<li>Marketing, advertising, and promotion</li>
<li>Travel, meals, and lodging for staff to sales calls, events like trade shows, and client meetings</li>
</ul>
<h3 id="general-expenses">General expenses</h3>
<p>General expenses are incurred by your startup regardless of the industry or the products/services you produce. General expenses can include:</p>
<ul>
<li>Rent for office space that can’t be attributed to your production process</li>
<li>Utilities, including electricity, water, or sewer expenses, which aren’t part of your manufacturing process</li>
<li>Office equipment like computers, servers, printers, or telephones that aren’t part of production</li>
<li>Office supplies that are used for administrative functions</li>
<li>Insurance</li>
</ul>
<h3 id="administrative-expenses">Administrative expenses</h3>
<p>These expenses are the costs involved in having administrative personnel, both internal or external if the company outsources any functions. These costs can include:</p>
<ul>
<li>Accounting payroll or fees for outsourcing</li>
<li>Information technology payroll or fees for outsourcing</li>
<li>Human resources personnel</li>
<li>Legal counsel</li>
<li>Any consulting fees</li>
</ul>
<h2 id="sga-costs-cover-a-lot-of-essential-functions">SG&A costs cover a lot of essential functions</h2>
<p>Managing your SG&A expenses is critical for your startup’s profitability, but you need to be careful. Cutting SG&A costs can give your profits a quick boost, but that could be at the expenses of your long-term profitability. So cutting marketing and advertising costs could improve your bottom line in the short term, but you could be losing sales further down the road. Not hiring a professional accountant could cost you later if you don’t get the right tax credits, like the <a href="https://kruzeconsulting.com/research-and-development-tax-credit-us/"><u>R&D tax credit</u></a>, or if you end up paying fines and penalties because you’re not paying the right <a href="https://kruzeconsulting.com/startup-state-local-taxes/"><u>taxes in states where you do business</u></a>. Not hiring an attorney to review legal contracts could mean you’re not getting the best deal.</p>
<p>If you’re struggling with profitability, there may be something structurally wrong with your business model. You should look at all the elements of your company, and not focus on a narrow area. It’s easy to slip into a mindset of emphasizing sales, or research and development, or product manufacturing, and short-change SG&A expenses.</p>
<p>That doesn’t mean overspend on SG&A. You should approach SG&A expenses as an investment, because it can be a competitive advantage. Without these functions, your company may never take off. So invest wisely, and get the right bang for your buck so you can actually run your business.</p>
<p>As an aside, if you’re trying to get a quick read on your startup’s profitability, you can take your sales revenue, subtract the cost of goods sold, and you’ll get gross profit. Subtract SG&A expenses from gross profit, and you’ll get your operating income. That’s a good process to know, and investors look closely at operating income.</p>
<p>If you have any other questions on SG&A expenses, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>. You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dFounders will hear the term “SG&A expenses” thrown around in board meetings a lot. SG&A stands for selling, general, and administrative expenses. One way to think of SG&A expenses is that it’s the cost of running your company. Some people refer to this as “overhead,” but that term has become somewhat synonymous with “unnecessary.” Sometimes CEOs and founders will be told they need to cut “overhead” but that phrase makes it seem like overhead expenses are unimportant. And that’s not necessarily true – one example is accounting. That gets captured in SG&A expenses, but accounting is a crucial business function. You need to understand your finances and you want to remain compliant with taxes and regulations. We work with companies every day who need help fixing their accounting. What’s included in SG&A expenses? Selling, general, and administrative expenses essentially refer to the non-production costs of a startup. These expenses are not directly attributable to the production of your product. The direct costs associated with producing your product are called the cost of goods sold (COGS), and don’t fall into SG&A expenses. Let’s look at each part of SG&A. Selling expenses Your sales expenses include a lot of different elements, such as: Sales wages, salaries, and commissions along with payroll taxes and benefits Packing and shipping product Marketing, advertising, and promotion Travel, meals, and lodging for staff to sales calls, events like trade shows, and client meetings General expenses General expenses are incurred by your startup regardless of the industry or the products/services you produce. General expenses can include: Rent for office space that can’t be attributed to your production process Utilities, including electricity, water, or sewer expenses, which aren’t part of your manufacturing process Office equipment like computers, servers, printers, or telephones that aren’t part of production Office supplies that are used for administrative functions Insurance Administrative expenses These expenses are the costs involved in having administrative personnel, both internal or external if the company outsources any functions. These costs can include: Accounting payroll or fees for outsourcing Information technology payroll or fees for outsourcing Human resources personnel Legal counsel Any consulting fees SG&A costs cover a lot of essential functions Managing your SG&A expenses is critical for your startup’s profitability, but you need to be careful. Cutting SG&A costs can give your profits a quick boost, but that could be at the expenses of your long-term profitability. So cutting marketing and advertising costs could improve your bottom line in the short term, but you could be losing sales further down the road. Not hiring a professional accountant could cost you later if you don’t get the right tax credits, like the R&D tax credit, or if you end up paying fines and penalties because you’re not paying the right taxes in states where you do business. Not hiring an attorney to review legal contracts could mean you’re not getting the best deal. If you’re struggling with profitability, there may be something structurally wrong with your business model. You should look at all the elements of your company, and not focus on a narrow area. It’s easy to slip into a mindset of emphasizing sales, or research and development, or product manufacturing, and short-change SG&A expenses. That doesn’t mean overspend on SG&A. You should approach SG&A expenses as an investment, because it can be a competitive advantage. Without these functions, your company may never take off. So invest wisely, and get the right bang for your buck so you can actually run your business. As an aside, if you’re trying to get a quick read on your startup’s profitability, you can take your sales revenue, subtract the cost of goods sold, and you’ll get gross profit. Subtract SG&A expenses from gross profit, and you’ll get your operating income. That’s a good process to know, and investors look closely at operating income. If you have any other questions on SG&A expenses, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!What is Founder Preferred Stock?2024-02-25T00:00:00+00:002024-02-25T00:00:00+00:00https://kruzeconsulting.com/blog/what-is-founder-preferred-stock<p><img src="/uploads/founder-preferred-stock-2.jpg" alt="" width="2200" height="1300" /><br /><!--Post Content--></p>
<p>Founder preferred stock is a pretty new thing in the startup game. Historically, founders would always get <a href="https://kruzeconsulting.com/startup-finance/"><u>common stock</u></a>, usually in the form of founder shares that they received early on. By getting their common stock so early, founders could lock in capital gains and all of the increases in value. However, a new phenomenon has developed in the form of founder preferred stock.</p>
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<p>Some founders are now getting roughly 10%, 15%, or 20% of their normal common allocation in founder preferred stock. This is a special class of stock that converts to <a href="https://kruzeconsulting.com/preferred-stock/"><u>preferred stock</u></a> when the founders sell it to investors during a future round of financing. Founder preferred stock must be fully vested when granted, and it’s not subject to repurchase or forfeiture if the founder leaves the company. </p>
<h2 id="lowering-a-founders-tax-bill">Lowering a Founder’s Tax Bill</h2>
<p>Founder preferred stock can also provide a lower tax bill in some instances. When a founder sells common stock for a price that’s higher than its fair market value, the difference between the two could be deemed compensation to the founder (who was granted the shares by the company), and therefore be taxed at ordinary income rates. Founder preferred stock automatically converts into shares of preferred stock when it’s sold to an investor in connection with a new financing round without involving the company at all. In theory,* this avoids the “compensation” argument, and may allow any profits the founder makes on the sale to be considered capital gains, which are taxed at lower rates than income.</p>
<p>Founder preferred stock was developed by the law firms who structure this kind of thing. The idea is, if you give founders, say, 20% preferred stock, when they sell some of those shares to venture capitalists down the line, both the founders and the venture capitalists are happy because the founders can sell those preferred shares at the higher preferred price, and the VCs can acquire preferred stock rather than common.</p>
<p><strong>*NOTE:</strong> We would like to make clear that this is by no means official tax advice! We are only discussing a current trend in the startup world. You need to work with your legal counsel regarding founder preferred stock.</p>
<h2 id="preferred-stock-is-more-valuable">Preferred Stock Is More Valuable</h2>
<p>Preferred stock is always more valuable than common stock. For example, common stock might be 30 cents a share and preferred stock would be $1. This is because preferred stock includes liquidation preferences and other rights. Therefore, founders are able to sell their portion of preferred stock in a <a href="https://kruzeconsulting.com/blog/what-is-a-secondary-stock-transaction/"><u>secondary sale</u></a> at a higher price. </p>
<p>It’s consistent with the rest of the preferred share class, meaning there’s less risk. As always, there’s still some risk, but there’s less of a risk that ordinary income tax rates would be applied. It’s more likely that <a href="https://www.irs.gov/taxtopics/tc409#:~:text=Capital%20Gain%20Tax%20Rates,than%2015%25%20for%20most%20individuals."><u>capital gains tax</u></a> rates will be applied instead.</p>
<h2 id="the-downsides-of-founder-preferred-stock">The Downsides of Founder Preferred Stock</h2>
<p>There are a couple of downsides to founder preferred stock:</p>
<ul>
<li><strong>Unbalances liquidation preferences.</strong> Founder preferred stock can affect the<a href="https://kruzeconsulting.com/liquidation-preference/"><u>liquidation preferences</u></a> for the company. Liquidation preferences are supposed to mirror however much the investors put in. If they put in five or ten million dollars, they get the first five or ten million dollars out. When founders are gifted or receive preferred shares, they are not really putting money in there, so it throws the liquidation preferences off balance.</li>
<li><strong>Affects board voting.</strong> Founder preferred stock could also potentially change a vote on the basis of a share class or something like that. Investors often negotiate certain voting rights or protective provisions for specific company actions or transactions. For example, there are some governance situations where VCs will say, “Hey, you can’t sell the company unless all of the <a href="https://kruzeconsulting.com/what-kind-of-financial-data-should-a-company-prepare-when-seeking-series-a-venture-capital-funding/"><u>series A</u></a> or all of the series B approve it. We as a share class want to be able to vote on this.” Founder preferred stock can affect these voting rights.</li>
</ul>
<p>So there’s a lot of mechanisms at work here, but the basic logic is that preferred stock is there to protect the founder from paying ordinary income tax rates. Instead, they pay capital gains tax rates and it’s a benefit for them. Naturally, the VCs get preferred stock.</p>
<h2 id="talk-to-your-law-firm-about-founder-preferred-stock">Talk To Your Law Firm About Founder Preferred Stock</h2>
<p>If you want to know more abouts the ins and outs of founder preferred stock, you should talk to your law firm. Your law firm will need to structure founder preferred shares, and you need to do it early when you form a company.</p>
<p>You also have to remember that founder preferred stock is not a guarantee. The <a href="https://www.irs.gov/"><u>IRS</u></a> is very much capable of looking at this kind of stuff, seeing what’s happening, and potentially questioning it when you have most of your shares in common stock. They are within their bounds to say it is “against the spirit of the deal” or the spirit of founder stock. If they do, they could make you pay ordinary income taxes.</p>
<p>We’d like to reiterate Kruze is not making any recommendations or vouching for founder preferred stock. If you’re interested in this mechanism, you need research it thoroughly and talk to your legal counsel.</p>
<p>If you have any other questions on other startup related trends, valuations, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dFounder preferred stock is a pretty new thing in the startup game. Historically, founders would always get common stock, usually in the form of founder shares that they received early on. By getting their common stock so early, founders could lock in capital gains and all of the increases in value. However, a new phenomenon has developed in the form of founder preferred stock. Some founders are now getting roughly 10%, 15%, or 20% of their normal common allocation in founder preferred stock. This is a special class of stock that converts to preferred stock when the founders sell it to investors during a future round of financing. Founder preferred stock must be fully vested when granted, and it’s not subject to repurchase or forfeiture if the founder leaves the company. Lowering a Founder’s Tax Bill Founder preferred stock can also provide a lower tax bill in some instances. When a founder sells common stock for a price that’s higher than its fair market value, the difference between the two could be deemed compensation to the founder (who was granted the shares by the company), and therefore be taxed at ordinary income rates. Founder preferred stock automatically converts into shares of preferred stock when it’s sold to an investor in connection with a new financing round without involving the company at all. In theory,* this avoids the “compensation” argument, and may allow any profits the founder makes on the sale to be considered capital gains, which are taxed at lower rates than income. Founder preferred stock was developed by the law firms who structure this kind of thing. The idea is, if you give founders, say, 20% preferred stock, when they sell some of those shares to venture capitalists down the line, both the founders and the venture capitalists are happy because the founders can sell those preferred shares at the higher preferred price, and the VCs can acquire preferred stock rather than common. *NOTE: We would like to make clear that this is by no means official tax advice! We are only discussing a current trend in the startup world. You need to work with your legal counsel regarding founder preferred stock. Preferred Stock Is More Valuable Preferred stock is always more valuable than common stock. For example, common stock might be 30 cents a share and preferred stock would be $1. This is because preferred stock includes liquidation preferences and other rights. Therefore, founders are able to sell their portion of preferred stock in a secondary sale at a higher price. It’s consistent with the rest of the preferred share class, meaning there’s less risk. As always, there’s still some risk, but there’s less of a risk that ordinary income tax rates would be applied. It’s more likely that capital gains tax rates will be applied instead. The Downsides of Founder Preferred Stock There are a couple of downsides to founder preferred stock: Unbalances liquidation preferences. Founder preferred stock can affect theliquidation preferences for the company. Liquidation preferences are supposed to mirror however much the investors put in. If they put in five or ten million dollars, they get the first five or ten million dollars out. When founders are gifted or receive preferred shares, they are not really putting money in there, so it throws the liquidation preferences off balance. Affects board voting. Founder preferred stock could also potentially change a vote on the basis of a share class or something like that. Investors often negotiate certain voting rights or protective provisions for specific company actions or transactions. For example, there are some governance situations where VCs will say, “Hey, you can’t sell the company unless all of the series A or all of the series B approve it. We as a share class want to be able to vote on this.” Founder preferred stock can affect these voting rights. So there’s a lot of mechanisms at work here, but the basic logic is that preferred stock is there to protect the founder from paying ordinary income tax rates. Instead, they pay capital gains tax rates and it’s a benefit for them. Naturally, the VCs get preferred stock. Talk To Your Law Firm About Founder Preferred Stock If you want to know more abouts the ins and outs of founder preferred stock, you should talk to your law firm. Your law firm will need to structure founder preferred shares, and you need to do it early when you form a company. You also have to remember that founder preferred stock is not a guarantee. The IRS is very much capable of looking at this kind of stuff, seeing what’s happening, and potentially questioning it when you have most of your shares in common stock. They are within their bounds to say it is “against the spirit of the deal” or the spirit of founder stock. If they do, they could make you pay ordinary income taxes. We’d like to reiterate Kruze is not making any recommendations or vouching for founder preferred stock. If you’re interested in this mechanism, you need research it thoroughly and talk to your legal counsel. If you have any other questions on other startup related trends, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!What Are Capital Expenditures for Startups?2024-02-18T00:00:00+00:002024-02-18T00:00:00+00:00https://kruzeconsulting.com/blog/what-are-capital-expenditures-for-startups<p><img src="/uploads/what-are-capital-expenditures-capex-1.jpg" alt="" width="1920" height="1080" /><!--Post Content--></p>
<p>Capital expenditures, otherwise known as CAPEX, are mentioned in startup board meetings all the time. It’s definitely a fundamental term to understand when dealing with startup accounting.</p>
<h2 id="capital-expenditures-depend-on-your-startup-industry">Capital Expenditures Depend On Your Startup Industry</h2>
<p>The importance of your capital expenditures depends a little bit on the type of startup you are running. For example, if you’re a manufacturing or cleantech company, which involves heavy, physical equipment, CAPEX is your number one ingredient in the business. </p>
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<h2 id="capex-are-investments">CAPEX are Investments</h2>
<p>At a high level, capital expenditures are investments that a startup makes in things like:</p>
<ul>
<li>Fixed assets</li>
<li>Property</li>
<li>Equipment</li>
<li>Computers/Physical Technology</li>
<li>Furniture</li>
<li>And, often, software can be CAPEX too</li>
</ul>
<p>These are big investments. Whether your startup is building robots, or working in cleantech that’s capturing CO2 from the environment, you’re going have to have a building in which to house your machines and, obviously, you’re going to have the machines and all of the parts that go into them. These are all capital expenditures.</p>
<h2 id="capital-expenditures-on-the-balance-sheet">Capital Expenditures on the Balance Sheet</h2>
<p>Now, capital expenditures are interesting in the <a href="https://kruzeconsulting.com/startup-accounting/"><u>accounting</u></a> world because they get treated slightly differently from regular operating expenses. Operating expenses are things such as:</p>
<ul>
<li>Employee salaries</li>
<li>Food/Catering</li>
<li>Hotels</li>
<li>Travel</li>
</ul>
<p>If capital expenditures are over $2500, they are actually “capitalized” on the balance sheet. This means they are put in an asset count on your <a href="https://kruzeconsulting.com/balance-sheet/"><u>balance sheet</u></a> and you recognize the expense. You <a href="https://kruzeconsulting.com/ebitda/"><u>amortize or depreciate</u></a> those fixed assets over time. The length of time you depreciate those fixed assets depends on what they are and what the <a href="https://www.irs.gov/"><u>IRS</u></a>’s guidance is.</p>
<p>Usually that’s about two to five years. It’s the kind of thing that gets washed out on your tax return and, often, there’s some adjusted journal entries at the end of the year to make sure that the amortization/depreciation schedules match your <a href="https://kruzeconsulting.com/how-much-does-a-startup-tax-return-cost/"><u>tax returns</u></a>.</p>
<p>So when you make capital expenditures they will be reflected on your balance sheet as an asset, and that asset’s going to be reduced every year by the annual depreciation and amortization that’s applicable to that asset.</p>
<h2 id="capex-on-the-cash-flow-statement">CAPEX on the Cash Flow Statement</h2>
<p>As well as being on the balance sheet, CAPEX is also reflected on your <a href="https://kruzeconsulting.com/cash-flow-statement/"><u>cash flow statement</u></a> as it falls under investing activities. The structure of the cash flow statement will generally go as follows:</p>
<ol>
<li>The first group to appear on a cash flow statement will be operating activities. These are usually things like your net income.</li>
<li>Then there will be some add-backs, like working capital.</li>
<li>Next will be other kinds of balance sheet accounts that may fluctuate to get to your cash flow provided from operating activities.</li>
<li>Finally you’ll have investing activities, which is what capital expenditures fall under. Again, you’ll see those big cash outflows being reflected there, along with depreciation offsetting it.</li>
</ol>
<p>Your cash flow statement is a very easy way for investors to see what’s actually happening in your startup’s finances. They look at the cash flow statement quite a bit when they’re looking at capital expenditures.</p>
<h2 id="debt-financing-for-capex-heavy-companies">Debt Financing for CAPEX Heavy Companies</h2>
<p>If you are a heavy machinery/heavy asset kind of business, you have to be able to talk to your VCs accordingly. You need them to understand that these are large investments and that companies of this kind are typically going to need a lot more <a href="https://kruzeconsulting.com/blog/what-is-the-right-amount-of-venture-capital-to-raise/"><u>venture capital</u></a> than, say, a software company or a consumer packaged goods (CPG) company, for example. If your startup requires large machinery and other assets, you will most likely use <a href="https://kruzeconsulting.com/venture-debt/"><u>debt</u></a> financing to augment your venture capital equity.</p>
<p>VCs who invest in CAPEX-heavy companies are typically very close with a lot of lending firms. They know them and they can make referrals. They have them on their speed dial as it were, and that debt is actually a very important ingredient if you’re running a capital-intensive startup. You will have to finance a lot of that stuff. Debt has a lower cost of capital than equity, and if you use too much equity to finance capital purchases, you’re probably experiencing a little bit more dilution than you need to. Debt helps mitigate some of the dilution.</p>
<p>So when you’re in a board meeting, or you’re pitching your capital intensive business, please remember that you may have to finance yourself in a slightly different way. The financial combination for your startup will be different. You should also know that the accounting treatment is going to be different. A lot of those <a href="https://kruzeconsulting.com/blog/matching-assets-to-debt/"><u>assets</u></a> will be capitalized on the balance sheet and they will be reflected on the investing activities portion of the cash flow statement.</p>
<p>Finally, only annual depreciation and amortization will be shown on your <a href="https://kruzeconsulting.com/income-statement/"><u>income statement</u></a> as an expense.</p>
<h2 id="capital-expenditures-and-cash-runway">Capital Expenditures and Cash Runway</h2>
<p>With CAPEX and the cash runway of a company, we tend to look at them in two ways. We look at it on an accrual accounting basis, in which depreciation/amortization is included and the big capital expenditure is not. Then we also look at it as the pure cash flow burn rate, in which the big capital expenditure is included. When the cash leaves the bank account, the cash flow statement is going to be your friend. It adds those investing activities back into the burn rate and shows you what your true <a href="https://kruzeconsulting.com/cash-burn-rate/"><u>burn rate</u></a> is. </p>
<h2 id="vcs-for-capital-intensive-startups">VCs for Capital-Intensive Startups</h2>
<p>If you’re running a capital-intensive startup, it’s usually harder to raise money but you will often have less competition. There is a subset of VCs that focus solely on those kinds of companies. So go find them! They will speak your language and they’ll be excited about what you’re doing!</p>
<p>If you have any other questions on capital expenditures, valuations, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dCapital expenditures, otherwise known as CAPEX, are mentioned in startup board meetings all the time. It’s definitely a fundamental term to understand when dealing with startup accounting. Capital Expenditures Depend On Your Startup Industry The importance of your capital expenditures depends a little bit on the type of startup you are running. For example, if you’re a manufacturing or cleantech company, which involves heavy, physical equipment, CAPEX is your number one ingredient in the business. CAPEX are Investments At a high level, capital expenditures are investments that a startup makes in things like: Fixed assets Property Equipment Computers/Physical Technology Furniture And, often, software can be CAPEX too These are big investments. Whether your startup is building robots, or working in cleantech that’s capturing CO2 from the environment, you’re going have to have a building in which to house your machines and, obviously, you’re going to have the machines and all of the parts that go into them. These are all capital expenditures. Capital Expenditures on the Balance Sheet Now, capital expenditures are interesting in the accounting world because they get treated slightly differently from regular operating expenses. Operating expenses are things such as: Employee salaries Food/Catering Hotels Travel If capital expenditures are over $2500, they are actually “capitalized” on the balance sheet. This means they are put in an asset count on your balance sheet and you recognize the expense. You amortize or depreciate those fixed assets over time. The length of time you depreciate those fixed assets depends on what they are and what the IRS’s guidance is. Usually that’s about two to five years. It’s the kind of thing that gets washed out on your tax return and, often, there’s some adjusted journal entries at the end of the year to make sure that the amortization/depreciation schedules match your tax returns. So when you make capital expenditures they will be reflected on your balance sheet as an asset, and that asset’s going to be reduced every year by the annual depreciation and amortization that’s applicable to that asset. CAPEX on the Cash Flow Statement As well as being on the balance sheet, CAPEX is also reflected on your cash flow statement as it falls under investing activities. The structure of the cash flow statement will generally go as follows: The first group to appear on a cash flow statement will be operating activities. These are usually things like your net income. Then there will be some add-backs, like working capital. Next will be other kinds of balance sheet accounts that may fluctuate to get to your cash flow provided from operating activities. Finally you’ll have investing activities, which is what capital expenditures fall under. Again, you’ll see those big cash outflows being reflected there, along with depreciation offsetting it. Your cash flow statement is a very easy way for investors to see what’s actually happening in your startup’s finances. They look at the cash flow statement quite a bit when they’re looking at capital expenditures. Debt Financing for CAPEX Heavy Companies If you are a heavy machinery/heavy asset kind of business, you have to be able to talk to your VCs accordingly. You need them to understand that these are large investments and that companies of this kind are typically going to need a lot more venture capital than, say, a software company or a consumer packaged goods (CPG) company, for example. If your startup requires large machinery and other assets, you will most likely use debt financing to augment your venture capital equity. VCs who invest in CAPEX-heavy companies are typically very close with a lot of lending firms. They know them and they can make referrals. They have them on their speed dial as it were, and that debt is actually a very important ingredient if you’re running a capital-intensive startup. You will have to finance a lot of that stuff. Debt has a lower cost of capital than equity, and if you use too much equity to finance capital purchases, you’re probably experiencing a little bit more dilution than you need to. Debt helps mitigate some of the dilution. So when you’re in a board meeting, or you’re pitching your capital intensive business, please remember that you may have to finance yourself in a slightly different way. The financial combination for your startup will be different. You should also know that the accounting treatment is going to be different. A lot of those assets will be capitalized on the balance sheet and they will be reflected on the investing activities portion of the cash flow statement. Finally, only annual depreciation and amortization will be shown on your income statement as an expense. Capital Expenditures and Cash Runway With CAPEX and the cash runway of a company, we tend to look at them in two ways. We look at it on an accrual accounting basis, in which depreciation/amortization is included and the big capital expenditure is not. Then we also look at it as the pure cash flow burn rate, in which the big capital expenditure is included. When the cash leaves the bank account, the cash flow statement is going to be your friend. It adds those investing activities back into the burn rate and shows you what your true burn rate is. VCs for Capital-Intensive Startups If you’re running a capital-intensive startup, it’s usually harder to raise money but you will often have less competition. There is a subset of VCs that focus solely on those kinds of companies. So go find them! They will speak your language and they’ll be excited about what you’re doing! If you have any other questions on capital expenditures, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!When Fundraising Should You Practice With Less Desirable VCs?2024-02-11T00:00:00+00:002024-02-11T00:00:00+00:00https://kruzeconsulting.com/blog/when-fundraising-should-you-practice-with-less-desirable-vcs<p><img src="/uploads/when-fundraising-should-you-start-with-less-desirable-vcs-first-1.jpg" alt="" width="1920" height="1080" /><br /><!--Post Content--></p>
<p>A piece of advice that we hear being given out a lot in the startup world is that, when your startup is fundraising, you should fine-tune your pitch by approaching less desirable or non-target venture capitalists first.</p>
<p>People have different opinions on this strategy and, here at <a href="https://kruzeconsulting.com/"><u>Kruze</u></a>, we personally don’t subscribe to it as a technique. However, we do understand some of the rationale behind it, so let’s look at the reasons that people recommend this tactic.</p>
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<h2 id="practicing-your-pitch">Practicing Your Pitch</h2>
<p>When you first start fundraising for your startup you might have, say, five target VCs that you really want to invest in your company. Usually that’s because they have particular characteristics that work well for your business, such as:</p>
<ul>
<li>They really fit the brand</li>
<li>They’ve previously raised significant amounts of money</li>
<li>They have experience in your industry</li>
<li>They have a <a href="https://kruzeconsulting.com/blog/vc-general-partner-investments/"><u>partner</u></a> who is well-known and experienced</li>
</ul>
<p>Given the high stakes on securing one of these target VCs, people often recommend you start by pitching to less desirable VCs so you can practice. They suggest that by taking a couple of “test” meetings first you can:</p>
<ul>
<li>Work the kinks out of your <a href="https://kruzeconsulting.com/startup-pitch-deck/"><u>startup’s fundraising pitch deck</u></a></li>
<li>Get some feedback from professional VCs (even if they’re not your first choice)</li>
<li>Build your confidence in delivering your <a href="https://kruzeconsulting.com/blog/top-5-venture-capital-pitch-decks/"><u>VC pitch</u></a></li>
</ul>
<p>The idea is that this will potentially increase your chances of securing your dream VC, since you have polished your pitch with those you’re less interested in impressing.</p>
<h2 id="practicing-on-secondary-vcs-could-backfire">Practicing on Secondary VCs Could Backfire</h2>
<p>Like we mentioned, practicing on less desirable VCs first is recommended by some, but here at Kruze we think there are a number of reasons why this is a bad approach:</p>
<ol>
<li>You’re wasting people’s time. If you aren’t serious about taking money from them, it’s unfair to even take meetings with them as that <a href="https://kruzeconsulting.com/blog/how-do-venture-capitalists-spend-their-time/"><u>time is precious</u></a>.</li>
<li>We think you should treat all investors you are going to meet with equally and with respect. This means you should bring your A game to any pitch meeting. Using a VC as a “rough draft” seems disrespectful.</li>
<li>Probably the biggest reason is pitching to VCs is unpredictable. It’s incredibly hard to predict which VCs will resonate with what you’re pitching. Who you actually end up working with may be very different than who you thought you’d end up with at the beginning of the process. It’s a bit like finding a needle in a haystack, and you’re most likely going to have to pitch to 25 or more VCs before you find one to invest in your startup, unless you’re a very successful founder already.</li>
</ol>
<h2 id="pitch-to-your-friends-and-pre-existing-investors">Pitch To Your Friends and Pre-Existing Investors</h2>
<p>We recommend that you practice your pitch on your friends and your pre-existing investors and associates. Many startups have raised money from a <a href="https://kruzeconsulting.com/preseed-funding/"><u>pre-seed</u></a> or <a href="https://kruzeconsulting.com/blog/seed-round-number-of-investors/"><u>seed fund</u></a> before you start pitching for <a href="https://kruzeconsulting.com/blog/does-your-startup-have-what-it-takes-to-raise-a-series-a/"><u>Series A</u></a>. These investors will make time for you since they want to see you succeed!</p>
<p>By practicing your pitch with your associates and your friends, you won’t waste the time of professionals or risk your own reputation by doing so. If you’re not seen as serious when you’re taking these meetings, or people know you’re simply using them for practice, then you could stigmatize yourself. That could affect the opinions of VCs you actually really want on board.</p>
<p>Practice on other people, then bring your A game to pitch to the professionals.</p>
<h2 id="dont-waste-opportunities-when-fundraising">Don’t Waste Opportunities When Fundraising</h2>
<p>Finally, we want to remind you to try not to separate and segment your potential VCs too much. At the end of the day, all you need is one to invest, and even that is really hard in the current climate. So don’t sacrifice any opportunities by not taking investor meetings seriously.</p>
<p>If you have any other questions on fundraising, valuations, startup investing, startup accounting or taxes, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow <a href="https://youtube.com/c/KruzeConsulting"><u>Kruze’s YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dA piece of advice that we hear being given out a lot in the startup world is that, when your startup is fundraising, you should fine-tune your pitch by approaching less desirable or non-target venture capitalists first. People have different opinions on this strategy and, here at Kruze, we personally don’t subscribe to it as a technique. However, we do understand some of the rationale behind it, so let’s look at the reasons that people recommend this tactic. Practicing Your Pitch When you first start fundraising for your startup you might have, say, five target VCs that you really want to invest in your company. Usually that’s because they have particular characteristics that work well for your business, such as: They really fit the brand They’ve previously raised significant amounts of money They have experience in your industry They have a partner who is well-known and experienced Given the high stakes on securing one of these target VCs, people often recommend you start by pitching to less desirable VCs so you can practice. They suggest that by taking a couple of “test” meetings first you can: Work the kinks out of your startup’s fundraising pitch deck Get some feedback from professional VCs (even if they’re not your first choice) Build your confidence in delivering your VC pitch The idea is that this will potentially increase your chances of securing your dream VC, since you have polished your pitch with those you’re less interested in impressing. Practicing on Secondary VCs Could Backfire Like we mentioned, practicing on less desirable VCs first is recommended by some, but here at Kruze we think there are a number of reasons why this is a bad approach: You’re wasting people’s time. If you aren’t serious about taking money from them, it’s unfair to even take meetings with them as that time is precious. We think you should treat all investors you are going to meet with equally and with respect. This means you should bring your A game to any pitch meeting. Using a VC as a “rough draft” seems disrespectful. Probably the biggest reason is pitching to VCs is unpredictable. It’s incredibly hard to predict which VCs will resonate with what you’re pitching. Who you actually end up working with may be very different than who you thought you’d end up with at the beginning of the process. It’s a bit like finding a needle in a haystack, and you’re most likely going to have to pitch to 25 or more VCs before you find one to invest in your startup, unless you’re a very successful founder already. Pitch To Your Friends and Pre-Existing Investors We recommend that you practice your pitch on your friends and your pre-existing investors and associates. Many startups have raised money from a pre-seed or seed fund before you start pitching for Series A. These investors will make time for you since they want to see you succeed! By practicing your pitch with your associates and your friends, you won’t waste the time of professionals or risk your own reputation by doing so. If you’re not seen as serious when you’re taking these meetings, or people know you’re simply using them for practice, then you could stigmatize yourself. That could affect the opinions of VCs you actually really want on board. Practice on other people, then bring your A game to pitch to the professionals. Don’t Waste Opportunities When Fundraising Finally, we want to remind you to try not to separate and segment your potential VCs too much. At the end of the day, all you need is one to invest, and even that is really hard in the current climate. So don’t sacrifice any opportunities by not taking investor meetings seriously. If you have any other questions on fundraising, valuations, startup investing, startup accounting or taxes, or taxes, please contact us. You can also follow Kruze’s YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!Are Term Sheets Legally Binding?2024-02-04T00:00:00+00:002024-02-04T00:00:00+00:00https://kruzeconsulting.com/blog/are-term-sheets-legally-binding<p><img src="/uploads/are-term-sheets-legally-binding-3.jpg" alt="" width="1920" height="1080" /><br /><!--Post Content--></p>
<p>Term sheets can be a little bit of a gray area in the venture capital/startup world since certain elements, such as the confidentiality agreement, <em>are</em> legally binding. However, despite this, you may still hear of people “spilling the beans” and sharing details of the term sheet. Let’s look at these uncertainties.</p>
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<h2 id="term-sheets-and-founder-reputation">Term Sheets and Founder Reputation</h2>
<p>As we just mentioned, there is a lack of clarity regarding whether or not a <a href="https://kruzeconsulting.com/blog/exploding-term-sheet/"><u>term sheet</u></a> is strictly legally binding. The way we tend to think about it is, instead of them being legally binding, term sheets are more “reputationally binding.” If you sign a term sheet with a venture capitalist, or a venture capitalist signs a term sheet with you, <strong><em>you should have every intention of going forward with that deal.</em></strong></p>
<p>This is true from both sides, both for the VCs and for founders. If you’re a founder or a VC who pulls out of deals, contracts, or term sheets with investors/startups, word is going to get around. Understandably, neither venture capitalists nor founders like flakiness.</p>
<p>The spirit of the term sheet is that, at this point, those making the deal (the founders and investors) have officially agreed on the <a href="https://kruzeconsulting.com/blog/choose-VCs-carefully/"><u>terms of that agreement</u></a>. And now that everything is spelled out, all you need is the final documentation to be signed. That includes things such as:</p>
<ul>
<li>Stock purchase agreement</li>
<li>Investor rights agreement</li>
<li>Updated articles for the corporation</li>
</ul>
<h2 id="avoid-re-trades-and-renegotiation">Avoid Re-Trades and Renegotiation</h2>
<p>What you don’t really want to have to deal with are re-trades or last-minute renegotiations. In our experience, people who impose re-trades or try to renegotiate near the end of the deal process often get a bad reputation.</p>
<p>As a VC or a founder, you may be tempted to make last minute changes or requests. However, here at Kruze, we recommend only doing so if you uncover something, during <a href="https://kruzeconsulting.com/venture-capital-finance-tax-hr-due-diligence-checklist/"><u>due diligence</u></a> for example, that’s bad enough to justify the disruption.</p>
<p>Ultimately, and we cannot stress this enough, at this point it really is about your reputation as a startup founder or a venture capitalist. If you’re the kind of person that’s going around re-trading or trying to change things up at the very last minute, especially when you are in the stronger position, that will always look bad on you.</p>
<h2 id="dont-sign-a-term-sheet-youre-not-serious-about">Don’t Sign a Term Sheet You’re Not Serious About</h2>
<p>Because reneging on a term sheet is a pretty serious blow to your reputation, make sure you don’t sign a term sheet that you don’t want to close on. Remember, when you do sign a term sheet you’re on the clock. The other party will be putting effort and good intentions behind it. If they find out that you are bailing on them or have an ulterior motive there is big potential for a lot of feelings to be hurt. And that leads to ramifications to your business down the road.</p>
<p><strong><em>Be judicious and only sign something if you fully intend to go forward with it.</em></strong></p>
<p>And - always work with an experienced lawyer. We’ve found that the best startup law firms have worked with pretty much all of the top VCs, so they know which investors have reputations that are good… or bad. Plus, you don’t want to get bad legal advice on something as important as selling part of your company! </p>
<p>If you have any other questions on term sheets, valuations, startup investing, startup accounting, or taxes, please <a href="https://kruzeconsulting.com/#contact"><u>contact us</u></a>.</p>
<p>You can also follow our <a href="https://youtube.com/c/KruzeConsulting"><u>YouTube channel</u></a> and our <a href="https://kruzeconsulting.com/blog/"><u>blog</u></a> for information about accounting, finance, HR, and taxes for startups!</p>3c9a7185-6493-4274-94b4-bfd36ff4820dTerm sheets can be a little bit of a gray area in the venture capital/startup world since certain elements, such as the confidentiality agreement, are legally binding. However, despite this, you may still hear of people “spilling the beans” and sharing details of the term sheet. Let’s look at these uncertainties. Term Sheets and Founder Reputation As we just mentioned, there is a lack of clarity regarding whether or not a term sheet is strictly legally binding. The way we tend to think about it is, instead of them being legally binding, term sheets are more “reputationally binding.” If you sign a term sheet with a venture capitalist, or a venture capitalist signs a term sheet with you, you should have every intention of going forward with that deal. This is true from both sides, both for the VCs and for founders. If you’re a founder or a VC who pulls out of deals, contracts, or term sheets with investors/startups, word is going to get around. Understandably, neither venture capitalists nor founders like flakiness. The spirit of the term sheet is that, at this point, those making the deal (the founders and investors) have officially agreed on the terms of that agreement. And now that everything is spelled out, all you need is the final documentation to be signed. That includes things such as: Stock purchase agreement Investor rights agreement Updated articles for the corporation Avoid Re-Trades and Renegotiation What you don’t really want to have to deal with are re-trades or last-minute renegotiations. In our experience, people who impose re-trades or try to renegotiate near the end of the deal process often get a bad reputation. As a VC or a founder, you may be tempted to make last minute changes or requests. However, here at Kruze, we recommend only doing so if you uncover something, during due diligence for example, that’s bad enough to justify the disruption. Ultimately, and we cannot stress this enough, at this point it really is about your reputation as a startup founder or a venture capitalist. If you’re the kind of person that’s going around re-trading or trying to change things up at the very last minute, especially when you are in the stronger position, that will always look bad on you. Don’t Sign a Term Sheet You’re Not Serious About Because reneging on a term sheet is a pretty serious blow to your reputation, make sure you don’t sign a term sheet that you don’t want to close on. Remember, when you do sign a term sheet you’re on the clock. The other party will be putting effort and good intentions behind it. If they find out that you are bailing on them or have an ulterior motive there is big potential for a lot of feelings to be hurt. And that leads to ramifications to your business down the road. Be judicious and only sign something if you fully intend to go forward with it. And - always work with an experienced lawyer. We’ve found that the best startup law firms have worked with pretty much all of the top VCs, so they know which investors have reputations that are good… or bad. Plus, you don’t want to get bad legal advice on something as important as selling part of your company! If you have any other questions on term sheets, valuations, startup investing, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!Downround Guide: Understanding, Mitigating, and Navigating2024-01-31T00:00:00+00:002024-01-31T00:00:00+00:00https://kruzeconsulting.com/blog/downround-guide-understanding-mitigating-and-navigating<p><img src="/uploads/downround-1.jpg" alt="" width="2200" height="1466" /></p>
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<div><strong>Table of contents</strong></div>
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<ul>
<li><a href="#what-is-a-downround">What is a downround?</a></li>
<li><a href="#factors-leading-to-a-downround">Factors leading to a downround</a></li>
<li><a href="#strategies-to-avoid-a-downround">Strategies to avoid a downround</a></li>
<li><a href="#what-to-watch-out-for">What to watch out for</a>
<ul>
<li><a href="#anti-dilution-provisions-an-investor-safeguard-that-hurts-during-a-downround">Anti-dilution provisions: An investor safeguard that hurts during a downround</a></li>
</ul>
</li>
<li><a href="#pay-to-play-provisions-continued-investor-support-or-else">Pay-to-Play provisions: Continued investor support – or else!</a>
<ul>
<li><a href="#cramdowns-a-brutal-but-sometimes-necessary-strategy-during-a-downround">Cramdowns: A brutal but sometimes necessary strategy during a downround</a></li>
</ul>
</li>
<li><a href="#sometimes-you-have-to-do-what-you-have-to-do-to-save-your-startup">Sometimes you have to do what you have to do to save your startup</a>
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<li><a href="#negative-implications-of-a-downround">Negative implications of a downround</a></li>
</ul>
</li>
<li><a href="#understanding-investor-strategies-in-a-downround">Understanding investor strategies in a downround</a>
<ul>
<li><a href="#existing-investor-behavior">Existing investor behavior</a></li>
<li><a href="#how-the-preference-stack-influences-existing-vcs-behavior">How the preference stack influences Existing VCs Behavior</a></li>
<li><a href="#new-investors">New investors</a></li>
<li><a href="#terms-investors-ask-for-in-a-downround">Terms investors ask for in a downround</a></li>
</ul>
</li>
<li><a href="#strategies-to-handle-downrounds">Strategies to handle downrounds</a></li>
<li><a href="#conclusion-how-to-survive-and-thrive-post-downround">Conclusion: How to survive and thrive post-downround</a>
<ul>
<li><a href="#strategies-to-rebuild">Strategies to rebuild</a></li>
<li><a href="#addressing-employee-morale">Addressing employee morale</a></li>
<li><a href="#market-perception-and-brand-reputation">Market perception and brand reputation</a></li>
<li><a href="#regular-budget-vs-actuals">Regular budget vs actuals </a></li>
<li><a href="#recurring-investor-check-ins-to-align-on-goals">Recurring investor check ins to align on goals</a></li>
</ul>
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<li><a href="#dont-just-survive-thrive">Don’t Just Survive, Thrive</a></li>
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<p>Our clients collectively raised over $3 billion in early-stage VC funding in 2023 - and unfortunately we saw a number of downrounds. A downround can be very painful for founders, employees and even VCs, so we published this guide to try to help founders navigate one. </p>
<p>The VC market is still investing in 2024, but it’s not an easy time; the startup ecosystem is still grappling with the aftermath of the 2021 VC bubble and a depressed tech stock market. Many startups are finding themselves needing to raise capital in less than ideal circumstances, leading to a significant increase in downrounds. According to data from <a href="https://carta.com/" target="_blank" rel="noopener"><u>Carta</u></a>, the <a href="https://kruzeconsulting.com/what-is-the-best-free-cap-table-management-software-for-startups/"><u>cap table provider</u></a>, approximately 20% of priced funding rounds for established startups are downrounds. While the numbers among our clients are somewhat less alarming, we are still seeing downrounds rising among our customers.</p>
<p>In our experience, the companies and founders most likely to survive downrounds are ones who communicated regularly with their investors (see our <a href="https://kruzeconsulting.com/blog/startup-investor-update-template/"><u>investor update template</u></a>), who have a strong plan to come out of the downturn, who are in an industry with strong prospects, and who picked great initial investors. Admittedly, many of those points are difficult to influence retroactively, so let’s give you information on how to actually deal with one.</p>
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<h2 id="what-is-a-downround">What is a downround?</h2>
<p>A downround is a funding round in which a startup raises capital by selling its shares at a lower valuation than in the preceding fundraising round. So the new round’s pre-money valuation is lower than the post-money valuation of the prior round. This means that the company is worth less now than it was after the last financing event. </p>
<p>Obviously this has some significant motivational and morale issues for founders, employees, and investors. It can also be a negative signal to the market if the press is not well managed or if competitors make a big deal of it. </p>
<p>But it also comes with serious financial consequences due to the special types of preferred stock investors purchase, and the way that <a href="https://kruzeconsulting.com/startup-accounting/eso/"><u>employee options</u></a> work. We’ll get more into these, and other, considerations and side effects of a downround, but first, let’s talk about why some founders end up facing a decrease in valuation.</p>
<p> </p>
<h2 id="factors-leading-to-a-downround">Factors leading to a downround</h2>
<p>Several factors can trigger a downround, including:</p>
<p><strong>Massive market drop in tech market valuations</strong>: This is exactly the scenario many companies that raised in 2021 are facing: tech valuations have dropped by as much as 20x in some sectors. This means that many founders are nearing the end of their runway with no hopes of achieving a flat to increased valuation.</p>
<p><strong>Raising too much too soon</strong>: Some startups might have rushed their fundraising rounds, going for a Series B just 3 or 4 months after a Series A, for example. While this quick fundraising might have seemed beneficial in the short term, it often doesn’t leave enough time to hit the substantial growth metrics and milestones needed to justify a strong subsequent round. As a result, when it comes time to raise a Series C round, these companies are finding it challenging to justify an increased valuation. Without the necessary performance metrics to support an up round, they face the prospect of a downround Series C, if they can raise at all.</p>
<p><strong>Sector specific downturns</strong>: Downturns specific to a startup’s sector can reduce investor appetite, leading to a decrease in valuations, even for companies that are performing well.</p>
<p><strong>Financial underperformance</strong>: If a startup’s financial results fall short of projections or other milestones are missed, investors may demand a lower valuation in the next funding round.</p>
<p><strong>Company specific issues:</strong> Sometimes a specific company falls out of favor for reasons unique to that business. It could be that unusually high burn rates spooked new investors, the executive team had turmoil, scary new competitors appeared, etc. </p>
<p>By far, in 2023, what we are seeing as the most common reason startups are having to do downrounds is the market drop has dramatically reduced valuations. This means that many companies that have achieved their growth metrics and hit their milestones are still worth less now than they were two years ago. </p>
<p> </p>
<h2 id="strategies-to-avoid-a-downround">Strategies to avoid a downround</h2>
<p>Of course, as a rational founder, you probably want to avoid a downround. Beyond finding a new investor to fund you at the same or higher valuation, here are some strategies to avoid one:</p>
<ul>
<li><strong>Lots of structure.</strong> This isn’t particularly advisable, and be wary if one of your investors is pushing for this solution. This strategy is really only available to solid companies with strong investor support. Very rarely, we will see certain investors (mainly late-stage ones) employ financial engineering to put more capital into a company at a flat valuation. You may see this structure in a downround anyway, but it will usually be preferred stock with a high liquidation preference, participation rights (participating preferred), and maybe a paid in kind dividend. We discuss these structures below, but the net is that they are pretty aggressive terms that a well-performing startup should avoid.</li>
<li><strong>Bridge financing.</strong> We’ve seen this quite a bit recently. Companies that have good relationships with existing investors can sometimes get those VCs to put in a bridge round to keep the company growing until a point where it can raise money at better terms. This is usually structured as a convertible instrument, like a <a href="https://kruzeconsulting.com/safe-notes/"><u>SAFE</u></a> or <a href="https://kruzeconsulting.com/convertible-notes/"><u>convertible debt</u></a>. And the founders need to have a very, very well-developed financial model that shows how the bridge isn’t actually a bridge to nowhere – as in, the company has a solid plan to use the money to get to a stronger place where it will be highly likely to raise at a higher valuation. </li>
<li><strong>Extending the runway enough to avoid needing to raise soon.</strong> This is a difficult item, and most founders at companies facing a downround will need to make aggressive changes to lengthen the runway. Furthermore, most founders have already taken at least some steps to extend the runway. That being said, here are some common ways clients we work with have pushed out their cash-out date and cut their <a href="https://kruzeconsulting.com/cash-burn-rate/"><u>burn</u></a>:
<ul>
<li><strong>More revenue.</strong> Growing revenue, or getting customers to prepay, are a great strategy to put cash on the balance sheet. Of course, you are probably already doing everything you can here, but we have worked with some founders who have pulled revenue forward by discounting, aggressive sales, calling in favors, etc. </li>
<li><strong>Services revenue.</strong> Some founders we’ve worked with have extended their runway by getting services-based revenue – sometimes consulting work, development work, one-off engineering, etc. The danger with this strategy is that one-off consulting revenue does not help the startup advance its true value-generation work, like building product, getting on-target sales, etc. And it can really, really distract from doing the things needed to build a valuable startup – VCs, rightfully, don’t value services businesses very highly. However, if your startup needs to make it through a difficult time, services revenue can be one way to bridge the gap. </li>
<li><strong>Cutting expenses.</strong> This is the obvious, and often painfully necessary, step in extending runway. Since the majority of expenses at a startup are headcount, this means making the difficult decision to conduct layoffs. Enough revenue growth and cost cuts can make a profitable company, although this doesn’t necessarily mean that the company is worth as much as its last round of funding.</li>
</ul>
</li>
<li><strong>Venture debt.</strong> Venture debt isn’t really a great option, in our opinion, as these investors are not looking to prop up overvalued or failing companies, but instead want to finance hot businesses that have strong balance sheets. However, it may be possible to raise some receivable or revenue-based funding if your startup has solid customer contracts, low churn, and has a rational expense structure. But I wouldn’t recommend setting up a bunch of pitches with high-quality venture debt funds, as they are unlikely to be a backstop on a company that really should do a downround. </li>
</ul>
<p>As a founder taking aggressive steps to avoid a downround, make sure you are thoughtful about where the strategies you choose get you. Are you building a more valuable company? Are you making a bridge to somewhere where the company can get funding or be sustainable? </p>
<p> </p>
<h2 id="what-to-watch-out-for">What to watch out for</h2>
<p>Always make sure you’ve got experienced advisors – especially lawyers – if you are going to raise money at a lower valuation. Venture investors’ claws come out during downrounds, and you want to be prepared to protect the company’s – and your – interest. There are a lot of fancy names for the tricks that VCs will play at a downround; be prepared. Here are some things to watch out for:</p>
<p> </p>
<h3 id="anti-dilution-provisions-an-investor-safeguard-that-hurts-during-a-downround">Anti-dilution provisions: An investor safeguard that hurts during a downround</h3>
<p>VC investors purchase preferred shares. These shares have provisions that protect their stakes from being diminished in value through <strong>anti-dilution provisions</strong>. These provisions adjust the conversion rate of preferred shares into common shares during a downround, thereby reducing the impact of dilution on the investor at the expense of other shareholders. There isn’t much you can do about these provisions if you are faced with a downround – it’s best to try to not let your investors have them in the first place. DLA Piper, a well-known law firm, has a good piece on these provisions <a href="https://www.dlapiperaccelerate.com/knowledge/2017/what-is-anti-dilution-and-why-does-it-matter-to-me-as-a-company-founder.html"><u>here</u></a>.</p>
<p>There are typically two types of anti-dilution protections: ‘full-ratchet’ and ‘weighted-average.’ </p>
<p><strong>Full ratchet</strong>: This method adjusts the conversion price of the existing preferred shares to the price at which the new shares are issued in the downround, irrespective of the number of new shares issued. While this provides robust protection to the investor, it could lead to severe dilution for the founders and other stakeholders. In effect, the existing investor gets more shares, keeping the valuation of their existing ownership the same. </p>
<p><strong>Weighted average</strong>: This method also adjusts the conversion price of the existing preferred shares. It takes into account both the price and the number of new shares issued in the downround. It is generally seen as a fairer method as it balances the interests of existing investors and new shareholders, mitigating the dilution impact on founders and early stakeholders. But it still hurts founders, option holders, etc.</p>
<p>The math can get pretty complicated with the anti-dilution protection – it’s probably worth a stand alone article. Stay tuned.</p>
<p>Even if you have these provisions, you can try to negotiate them away. It’s common for founders to engage in discussions with investors to lessen or entirely waive the anti-dilution adjustments. An essential consideration here is whether the management, who typically hold substantial common stock, will be sufficiently motivated by their equity stake after financing to dedicate their efforts toward running the business. However, it’s not usually a good strategy to make the investors think that you will lose motivation to work on the business; this often results in them walking away from the company instead of funding a downround. </p>
<p> </p>
<h2 id="pay-to-play-provisions-continued-investor-support--or-else">Pay-to-Play provisions: Continued investor support – or else!</h2>
<p>Pay-to-play provisions are contractual clauses that incentivize, and sometimes force, existing investors to participate in the new funding round. A <a href="https://kruzeconsulting.com/blog/pay-to-play/"><u>pay-to-play provision</u></a> is a clause that tries to really, really make existing investors invest in a subsequent round of financing on a pro rata basis. If they do not participate, they face penalties, often in the form of their preferred shares converting to common shares (or sometimes less powerful preferred shares), which usually have fewer rights and lower seniority in terms of liquidation preference.</p>
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<p>While these provisions can ensure the continued financial support from existing investors, they can be seen as punitive, especially in a downround scenario where the investors may already face a loss on their investment. A big issue for founders is that they can get caught in-between investor groups if a pay-to-play is invoked. When you are trying to save your company, having to mediate between powerful VCs who are trying to screw each other over isn’t where you really want to be spending your time. </p>
<p> </p>
<h3 id="cramdowns-a-brutal-but-sometimes-necessary-strategy-during-a-downround">Cramdowns: A brutal but sometimes necessary strategy during a downround</h3>
<p>A cramdown is a financing event where new investors significantly dilute the ownership stakes of existing shareholders, especially when those existing shareholders are prior investors who can’t or choose not to participate in a downround. Cramdowns effectively “cram down” the ownership percentage and influence of existing shareholders, and they are brutal on the existing owners. Sometimes they are necessary to get the funding needed to keep a startup going, but they aren’t pretty. </p>
<p>First of all, a cramdown is going to sour the relationship between existing, non-participating, investors and new investors. And some investors who choose to participate because of the cramdown are likely to get upset at the investors who proposed it, so it’s not going to make anyone happy.</p>
<p>Secondly, in a cramdown, founders’ common shares are significantly diluted. The effect on the founders can be substantial. Not only do they own a smaller percentage of the company, but the value of their shares may also decrease due to the lower valuation at which the new shares are issued. This could significantly diminish the potential return they might receive if the company is sold or goes public.</p>
<p>The same is true for option holders, especially for option holders who have exercised their shares and left the company. Those former employees are essentially getting wiped out. This is pretty brutal; these folks have paid money to exercise their shares, and often had tax bills associated with this as well. </p>
<p>Both former founders and employees getting wiped out or crammed down is something to approach very carefully. CEOs should think about the implications of this on the finances of their former associates, and realize that this can cause a negative market perception – it doesn’t look good. VCs who advocate for it need to realize that it’s not employee or founder friendly, and while “cleaning up the cap table” is often a necessary step, it’s not one to be taken lightly.</p>
<p> </p>
<h2 id="sometimes-you-have-to-do-what-you-have-to-do-to-save-your-startup">Sometimes you have to do what you have to do to save your startup</h2>
<p>We just listed out some seriously painful things that can happen when you have to raise money at a lower valuation. But unfortunately, this is just reality in a downround. And if you have to do it, you have to do it. Let’s dig into some of the negative implications that can come out during or after a downround. </p>
<p> </p>
<h3 id="negative-implications-of-a-downround">Negative implications of a downround</h3>
<p>Keep in mind that all of the above – the anti-dilution protection, the pay-to-play and the cramdowns – will negatively impact some of your earlier supporters like seed investors, advisors who have shares, and common stockholders like founders and employees. These people are going to have less ownership, influence, and upside after a downround. Here are some of the negative impacts each group will have:</p>
<ul>
<li>Previous Investors
<ul>
<li>Dilution: Cramdowns or the triggering of anti-dilution provisions can drastically reduce the percentage of company ownership held by previous investors.</li>
<li>Decreased Influence: With reduced ownership comes diminished influence over company decisions, including those concerning strategic direction, hiring of key personnel, and potential exits. Investors may lose information rights or board seats; or they may no longer have enough skin in the game to care about helping the company. </li>
<li>Markdowns: Professional investors may balk at having to mark down their investment’s value – realize that some VCs will have odd incentives if your startup is a huge percentage of their funds’ paper returns. </li>
<li>Change in Share Class: In case of pay-to-play provisions or cramdowns where they don’t or can’t participate, preferred shareholders may be converted to common stock, losing their preferential rights. </li>
</ul>
</li>
<li>Option Holders
<ul>
<li>Dilution: Just like with previous investors, option holders see their ownership stake diluted.</li>
<li>Decreased Potential Returns: The economic value of their options might decrease, as each option now corresponds to a smaller fraction of the company.</li>
<li>Strike Price vs. Share Price: If the new financing event occurs at a price lower than the strike price of the options, this can result in the options being ‘underwater’. This means the cost to exercise the options is greater than the market value of the shares. We’ll have an entire section on this topic. </li>
<li>Employee Morale: Employees who’s options become underwater may question their dedication to the startup. </li>
</ul>
</li>
<li>Common Stockholders (Including Founders and Employees who have exercised options)
<ul>
<li>Significant Ownership Dilution: Common stockholders are usually the most affected by dilution caused by a downround since they are last in line in terms of liquidation preference and don’t have anti-dilution protection.</li>
<li>Loss of Control: Founders and other holders of common stock may lose some control over the company’s direction due to reduced voting power.</li>
<li>Reduced Financial Upside: The potential financial gain upon a liquidity event is reduced as each share represents a smaller piece of the equity pie.</li>
<li>Employee Morale: For employees who are common stockholders, significant dilution might lead to decreased morale and motivation, especially if their stock options fall underwater.</li>
</ul>
</li>
</ul>
<p> </p>
<h2 id="understanding-investor-strategies-in-a-downround">Understanding investor strategies in a downround</h2>
<p>In a downround, it’s crucial to understand the strategies and expectations of existing and new investors and those who are reupping their investment. </p>
<p> </p>
<h3 id="existing-investor-behavior">Existing investor behavior</h3>
<p>The decision for existing venture capitalists to participate in a downround is much more complicated than participating in a hot portfolio company’s follow-on financing. One key item to understand is that VCs have a limited amount of capital available to follow-on investments. VCs often have a finite amount of capital that they can allocate to follow-on investments, making the decision to participate in subsequent funding rounds a critical one.</p>
<p>In the case of a downround, this decision is even more consequential. VCs must also consider the potential dilution of their stake if they choose not to participate, especially if anti-dilution provisions are not in place. Pay-to-play provisions, while incentivizing the next investment, also force investors to do the math to understand if there will be subsequent rounds that are also subject to pay-to-play. If round isn’t enough capital to get the company to break-even, an exit or an up-round (or if the company is going to continue to struggle), then the NEXT round will also likely be a pay-to-play. So the VC isn’t just making a decision to invest money now, but also another slug of capital in the future. Do they want to put in money now if they know it’s at risk for a follow-on pay-to-play situation?</p>
<p>Furthermore, if the downround securities have terms favoring new investors, such as liquidation preferences or dividends, then the upside of the existing investment is lower – therefore, is it worth “defending” that prior investment?</p>
<p>And, heaven forbid if the initial investment was made out of a fund that is low on capital and the new investment is supposed to come out of a different fund. Each fund a VC firm raises usually has slightly (to vastly) different limited partners with different amounts invested – so there are serious fiduciary issues that come up when a VC invests “cross funds” in a downround. </p>
<p>However, choosing not to participate could mean losing influence over the company’s direction, especially if the new investors demand a greater say in the company’s operations. In addition, if the VC believes in the company’s long-term prospects and believes that the downround is merely a temporary setback, they might choose to participate to protect their initial investment and maintain their relationship with the company.</p>
<p>It’s also worth noting that existing investors have more information about the company, which can be both an advantage and a disadvantage. They are typically more familiar with the team, the business model, and the market, which should in theory enable them to make a more informed decision. On the other hand, they should also know if a company is not doing well, and run the risk of looking foolish if they throw good money after bad. </p>
<p>Therefore, the bar for participation in a downround is significantly high for existing VCs, often higher than in regular funding rounds. Every VC’s decision will depend on their assessment of the company’s potential, their capital limitations, their risk tolerance, and their strategic objectives.</p>
<p> </p>
<h3 id="how-the-preference-stack-influences-existing-vcs-behavior">How the preference stack influences Existing VCs Behavior</h3>
<p>Later stage investors may have different preferences than early stage investors, which means that their motivations during a recapitalization may be quite different. Founders trying to pull together a round at a lower valuation need to understand the impact of a specific preferred share right - the liquidation preference. </p>
<p>Liquidation preferences are essentially a set of rights given to investors that lay down the order of payout during the exit of a startup. A simpler way to think about this would be to imagine a scenario where, upon exit, a VC has two options - they can either choose to receive an amount that corresponds to their ownership stake in the company, or they can opt to get back the total amount of their initial investment. Naturally, a VC would select the option which maximizes their return, even if that means acquiring all of the proceeds and leaving nothing for the founders and the employees. </p>
<p>These preferences “stack up” - forming what is called the preference stack. For many startups, the later stage investors have seniority, meaning that, at a small exit, they get paid back before the earlier stage investors. </p>
<p>In a scenario where a startup has raised multiple rounds, it is possible that later stage investors may prefer to sell the company a low valuation instead of doing a downround. This is because the later stage investors may sit high on the preference stack, so they will get their money back. However, earlier investors may be left with nothing in this case, so would prefer to recapitalize the company (and in a lot of cases wipe out or diminish the preference stack). In this situation, the founder may have some investors who want to push to sell the business at a loss to get their liquidion preference back, where as others may want to keep the company going and clean up the cap table. This can lead to a lot of drama, with the founder at the center. </p>
<p> </p>
<h3 id="new-investors">New investors</h3>
<p>Not many VCs come into new startups at a downround, let alone lead the downround. First of all, negotiating a downround is much, much more difficult than leading a normal, up round. Secondly, there is reputational risk associated with leading a downround. Let’s get into these dynamics so you understand what VCs might be thinking about when you ask them to lead a downround. </p>
<p>The lead VC typically plays a key role in defining the terms of the round, which in a downround scenario can be a particularly delicate task. The terms must be crafted in such a way as to protect the new investment and provide potential upside, while also being mindful of the potential dilution and its impact on existing shareholders. Achieving this balance can be difficult and may require tough negotiations, involving numerous legal and financial complexities. This is much more difficult in a downround, where various stakeholders have their investments value and influence reduced. This can also add to a lot higher legal bills, as downround terms are more aggressively negotiated vs. simple up round deal documents. </p>
<p>Additionally, the lead VC in a downround often finds themselves in the unenviable position of having to manage and align the interests of various stakeholders. This includes calming the concerns of existing investors and reassuring founders and employees, all while setting and communicating a new strategic direction for the company.</p>
<p>Beyond the pain of leading and negotiating a downround, one of the major concerns for new investors is the potential to upset various stakeholders, particularly the existing investors, founders, and employees of the startup. A downround often results in substantial dilution for existing shareholders, which can cause significant dissatisfaction and strain relationships. Founders may see their stakes and influence in the company diminish, while employees may find their options underwater, which can affect morale and even lead to talent departure.</p>
<p>No VC wants to be known as the VC who screwed over a founder or who crushed a bunch of employee options. </p>
<p>Given these concerns, many VCs prefer to avoid downrounds as a matter of principle. </p>
<p> </p>
<h3 id="terms-investors-ask-for-in-a-downround">Terms investors ask for in a downround</h3>
<p>The terms investors get in a normal, up round are relatively easy to predict – most VCs take the previous preferred share documents and make minor tweaks. That’s not the same for downrounds. In downrounds, investors often ask for terms that are more customized (and punitive). Some of these terms are:</p>
<ul>
<li>Over 1x liquidation preference</li>
<li>Participating preferred stock</li>
<li>Dividend rights</li>
<li>Pay-to-play provisions on subsequent rounds</li>
</ul>
<p>One such term is the concept of a <strong>liquidation preference over 1x</strong>. Liquidation preferences are terms that let investors get their investment back, before other investors are paid out, in the event that the company exits for a less than stellar amount. With a high liquidation preference, new investors will get multiples of their invest back, before any other shareholders. For instance, with a 2x liquidation preference, an investor would get twice their investment back before others get anything. This can lead to a significant reduction in the potential returns for other stakeholders. </p>
<p>Some specific math as an example. Let’s say an investor invests $10M at a 2x liquidation preference, and ends up owning 20% of a startup. The startup is then sold for $25 million. Instead of getting 20% times $25 million ($5 million), the investor gets two times $10 million, or $20 million. The remaining $5 million is split between the other stockholders.</p>
<p>Investors may also seek to obtain <strong>participating preferred</strong> shares. These shares grant investors the right not only to receive their initial investment back (akin to a liquidation preference) but also to participate in the distribution of any remaining proceeds, as if their preferred stock had been converted to common. This provision allows the investor to benefit twice – hence the term “double dip” – and can result in them securing a high portion of any sale proceeds, often to the detriment of other shareholders.</p>
<p>An example would be if an investor invests $10M at a 1x liquidation preference into participating preferred shares, and ends up owning 20% of a startup. The startup is then sold for $25 million. Instead of getting 20% of $25 million ($5 million), the investor will get $13 million: their $10 million investment <strong>plus</strong> 20% of the remaining proceeds (20% times $15 million, or $3 million). </p>
<p>Furthermore, new investors might request <strong>dividend</strong> rights agreements in a downround. These stipulate the payment of a dividend on preferred shares, either as a fixed amount or a percentage of the original investment. Generally, we’ve seen these paid out as more preferred shares, which means the existing shareholders are more and more diluted over time (this is called a PIK preferred – a “paid in kind” dividend. This particular term is sometimes used to incentivize management to quickly sell the company, as their ownership decreases as time goes on. </p>
<p>The strategy of introducing a <strong>pay-to-play provision</strong> in a downround financing with the intention to wash out other investors in future financings indeed presents a unique dynamic in the venture capital ecosystem. An investor with significant financial resources and long-term interest in the company might use this strategy as a means to consolidate control. If they anticipate that the company will require additional funding in the future – and that some of the other investors will not be able to meet the pay-to-play obligations – they can use the provision to effectively dilute the stakes of these other investors. Watch out for pay-to-play provisions that are designed to impact subsequent rounds – your investors may end up playing a game of chicken, with your startup caught in the middle. </p>
<p>As new investors look to secure their investment in a downround, it’s important for founders and existing shareholders to comprehend the full implications of these terms. Similarly, reupping investors need to be aware of the trade-offs involved as they might have to accept these conditions to protect their existing stake. It’s important to work with an experienced law firm when negotiating downround provisions and terms.</p>
<p> </p>
<h2 id="strategies-to-handle-downrounds">Strategies to handle downrounds</h2>
<p>Downrounds present significant challenges for startups, requiring serious negotiating skills and careful decision-making. The success of a company during a downround largely depends on its ability to communicate effectively, formulate and execute a sound business plan, negotiate deftly, and align the interests of all stakeholders. In this section, we will explore these key areas in detail, providing guidance on how to manage the complexities of a downround successfully.</p>
<ul>
<li>Communication</li>
<li>Proactively adjusted company’s burn</li>
<li>Strong business plan and financial model</li>
<li>Be prepared to negotiate</li>
<li>Understand your investors’ interests and aligning with shareholders</li>
<li>Work with a great attorney </li>
</ul>
<p>It’s crucial to uphold transparency, ensuring investors remain informed about the company’s current situation, reasons leading to the downround, and the strategic plan for recovery. Regular updates, open discussions, and timely responses to investors are key actions that demonstrate respect for investor relationships and can help maintain their confidence in your leadership and the company. Investors appreciate being kept in the loop and involved in the process, and clear, candid communication can help prevent misunderstandings, manage investor expectations, and maintain alignment on the company’s path forward.</p>
<p>For most startups, another key strategy to successfully close a downround is to proactively adjust the company’s burn rate. By reducing unnecessary expenses and increasing operational efficiency, startups can extend their financial runway, providing more time and flexibility to navigate the downround and execute their recovery strategy. This can also make the new capital raised go further, potentially enabling the company to reach important milestones that increase its value and make it more attractive for future funding rounds. A focus on financial discipline and efficiency demonstrates to investors that the company is committed to long-term sustainability, which can help build confidence and trust in the face of a downround. Of course, this is a painful decision and the impact to employees is not something that should be taken lightly. Additionally, if laid off employees ask to exercise their options, you may need to have frank discussions around the impact of the downround on their exercise price – consult with your lawyer. </p>
<p>Downrounds often instigate challenging negotiations, especially around valuations, ownership stakes, and future funding provisions. Being equipped to negotiate effectively is crucial, bearing in mind that your objective isn’t solely about securing necessary capital, but also about preserving relationships with your investors and positioning your company for a successful recovery post-downround. Coming prepared to conversations is even more important than it was when you first raised capital. </p>
<p>It’s vital to align stakeholder interests as much as possible. A downround, while challenging, also offers an opportunity to reassess and reaffirm the common objectives among founders, investors, and employees. Encouraging participation in this process can not only promote a sense of unity and shared purpose but also generate ideas and strategies that might have been overlooked otherwise. Different VCs will have different needs based on the situation with their funds - take the time to understand where they are coming from. Not all VCs will be fully transparent, especially if they are low on funds or if they think they are playing chicken with other investors, but it’s worth taking the time to understand their expectations. But make 100% sure you understand if your investors expect you to polish up the company for a quick sale, or push for profitability, or resume high growth and then raise an up round. </p>
<p>When embarking on a downround, engaging a seasoned legal and financial team is critical. They can provide invaluable advice and guidance, ensuring that you’re not only legally protected, but also well-prepared to address the financial complexities that come with downrounds. You also want to work with attorneys who can help you avoid situations that open you up to litigation - while you can’t really eliminate the risk of being sued, it’s good to know where you are creating risk. You’ll also want to run scenarios with your lawyer to understand the impact of various structures. </p>
<p> </p>
<h2 id="conclusion-how-to-survive-and-thrive-post-downround">Conclusion: How to survive and thrive post-downround</h2>
<p>Navigating a downround can be a tumultuous experience for any founder, but getting the capital in the door is only the first step. The real challenge lies in rebuilding post-downround, restoring market perception and reputation, rebuilding employee morale, and executing a long-term plan to get to a healthy position. </p>
<p>A company may not need significant operational or strategic changes if the downround was singularly the result of the previous round being done at too high of a valuation. However, VCs are likely to demand greater operational efficiency after a downround (i.e. some cuts). </p>
<p> </p>
<h3 id="strategies-to-rebuild">Strategies to rebuild</h3>
<p>Companies may need to streamline operations, focus on profitable segments, or reconsider their staffing. Again, it’s important to have a financial model that lays out how your startup will accomplish its goals with lower spend (you can find <a href="https://kruzeconsulting.com/five_tips_for_startup_financial_health/startup_financial_models/#free-financial-models"><u>free financial models here</u></a>). </p>
<p> </p>
<h3 id="addressing-employee-morale">Addressing employee morale</h3>
<p>Employees are likely not feeling great after a downround. There have probably been layoffs, their stock options are probably underwater (or at least worth less money), and there is the feeling that the company has not done as well as everyone expected. Some items to address include: </p>
<ul>
<li>Stock options. Employees at startups expect stock options to be an important part of their compensation. Founders and the board need to quickly execute a stock option top off to avoid losing key employees</li>
<li>Vision and Mission Reiteration. Remind employees of the company’s mission and vision. Reinforce the importance of their roles and how they contribute to achieving the company’s long-term goals.</li>
<li>Explain the plan. Make sure employees know what the companies priorities are, and how they can help the business get onto solid footing.</li>
</ul>
<p> </p>
<h3 id="market-perception-and-brand-reputation">Market perception and brand reputation</h3>
<p>A downround could potentially leave a dent on your company’s market perception and brand reputation. Since they usually happen alongside layoffs, this is a legitimate issue to worry about. Regular updates showcasing the progress made and the effective implementation of the recovery plan will help rebuild stakeholder trust. A carefully devised public relations strategy can also assist in retelling your brand story from a perspective of resilience and adaptability. And don’t forget to think about customer and prospects opinions of your company. No business leader wants to purchase an important product or service from a company that is potentially going out of business, as they likely need the startup to stay in business to service the product! </p>
<p> </p>
<h3 id="regular-budget-vs-actuals">Regular budget vs actuals </h3>
<p>Founders need to carefully measure their financial progress and position after a downround. This not only helps keep the startup’s financials focused, but fosters investor confidence, enables prompt course correction, and improves future financial planning. Detailed budgeting and reporting provide transparency into the company’s fiscal health, facilitating early detection of possible problems. </p>
<p> </p>
<h3 id="recurring-investor-check-ins-to-align-on-goals">Recurring investor check ins to align on goals</h3>
<p>We already mentioned making sure you understand and are aligned with your investors’ expectations for the business after a downround - do they expect a reset, then a focus on achieving high growth? Or a push to profits? Or a quick exit via M&A? Check in regularly with your investors to make sure that their goals are still aligned with the company’s after the downround. </p>
<p> </p>
<h2 id="dont-just-survive-thrive">Don’t Just Survive, Thrive</h2>
<p>Enduring a downround can indeed be tough, but it is not the end of the road. With an efficient recovery strategy, a resilient team, and a forward-looking approach, companies can leverage this challenge as a stepping stone towards renewed success. Remember, the key lies not just in surviving the downround but in thriving in its aftermath.</p>
<!--Post Content-->4d886ec3-5690-47fc-b77c-d1f3754b1a35Table of contents What is a downround? Factors leading to a downround Strategies to avoid a downround What to watch out for Anti-dilution provisions: An investor safeguard that hurts during a downround Pay-to-Play provisions: Continued investor support – or else! Cramdowns: A brutal but sometimes necessary strategy during a downround Sometimes you have to do what you have to do to save your startup Negative implications of a downround Understanding investor strategies in a downround Existing investor behavior How the preference stack influences Existing VCs Behavior New investors Terms investors ask for in a downround Strategies to handle downrounds Conclusion: How to survive and thrive post-downround Strategies to rebuild Addressing employee morale Market perception and brand reputation Regular budget vs actuals Recurring investor check ins to align on goals Don’t Just Survive, Thrive Our clients collectively raised over $3 billion in early-stage VC funding in 2023 - and unfortunately we saw a number of downrounds. A downround can be very painful for founders, employees and even VCs, so we published this guide to try to help founders navigate one. The VC market is still investing in 2024, but it’s not an easy time; the startup ecosystem is still grappling with the aftermath of the 2021 VC bubble and a depressed tech stock market. Many startups are finding themselves needing to raise capital in less than ideal circumstances, leading to a significant increase in downrounds. According to data from Carta, the cap table provider, approximately 20% of priced funding rounds for established startups are downrounds. While the numbers among our clients are somewhat less alarming, we are still seeing downrounds rising among our customers. In our experience, the companies and founders most likely to survive downrounds are ones who communicated regularly with their investors (see our investor update template), who have a strong plan to come out of the downturn, who are in an industry with strong prospects, and who picked great initial investors. Admittedly, many of those points are difficult to influence retroactively, so let’s give you information on how to actually deal with one. What is a downround? A downround is a funding round in which a startup raises capital by selling its shares at a lower valuation than in the preceding fundraising round. So the new round’s pre-money valuation is lower than the post-money valuation of the prior round. This means that the company is worth less now than it was after the last financing event. Obviously this has some significant motivational and morale issues for founders, employees, and investors. It can also be a negative signal to the market if the press is not well managed or if competitors make a big deal of it. But it also comes with serious financial consequences due to the special types of preferred stock investors purchase, and the way that employee options work. We’ll get more into these, and other, considerations and side effects of a downround, but first, let’s talk about why some founders end up facing a decrease in valuation. Factors leading to a downround Several factors can trigger a downround, including: Massive market drop in tech market valuations: This is exactly the scenario many companies that raised in 2021 are facing: tech valuations have dropped by as much as 20x in some sectors. This means that many founders are nearing the end of their runway with no hopes of achieving a flat to increased valuation. Raising too much too soon: Some startups might have rushed their fundraising rounds, going for a Series B just 3 or 4 months after a Series A, for example. While this quick fundraising might have seemed beneficial in the short term, it often doesn’t leave enough time to hit the substantial growth metrics and milestones needed to justify a strong subsequent round. As a result, when it comes time to raise a Series C round, these companies are finding it challenging to justify an increased valuation. Without the necessary performance metrics to support an up round, they face the prospect of a downround Series C, if they can raise at all. Sector specific downturns: Downturns specific to a startup’s sector can reduce investor appetite, leading to a decrease in valuations, even for companies that are performing well. Financial underperformance: If a startup’s financial results fall short of projections or other milestones are missed, investors may demand a lower valuation in the next funding round. Company specific issues: Sometimes a specific company falls out of favor for reasons unique to that business. It could be that unusually high burn rates spooked new investors, the executive team had turmoil, scary new competitors appeared, etc. By far, in 2023, what we are seeing as the most common reason startups are having to do downrounds is the market drop has dramatically reduced valuations. This means that many companies that have achieved their growth metrics and hit their milestones are still worth less now than they were two years ago. Strategies to avoid a downround Of course, as a rational founder, you probably want to avoid a downround. Beyond finding a new investor to fund you at the same or higher valuation, here are some strategies to avoid one: Lots of structure. This isn’t particularly advisable, and be wary if one of your investors is pushing for this solution. This strategy is really only available to solid companies with strong investor support. Very rarely, we will see certain investors (mainly late-stage ones) employ financial engineering to put more capital into a company at a flat valuation. You may see this structure in a downround anyway, but it will usually be preferred stock with a high liquidation preference, participation rights (participating preferred), and maybe a paid in kind dividend. We discuss these structures below, but the net is that they are pretty aggressive terms that a well-performing startup should avoid. Bridge financing. We’ve seen this quite a bit recently. Companies that have good relationships with existing investors can sometimes get those VCs to put in a bridge round to keep the company growing until a point where it can raise money at better terms. This is usually structured as a convertible instrument, like a SAFE or convertible debt. And the founders need to have a very, very well-developed financial model that shows how the bridge isn’t actually a bridge to nowhere – as in, the company has a solid plan to use the money to get to a stronger place where it will be highly likely to raise at a higher valuation. Extending the runway enough to avoid needing to raise soon. This is a difficult item, and most founders at companies facing a downround will need to make aggressive changes to lengthen the runway. Furthermore, most founders have already taken at least some steps to extend the runway. That being said, here are some common ways clients we work with have pushed out their cash-out date and cut their burn: More revenue. Growing revenue, or getting customers to prepay, are a great strategy to put cash on the balance sheet. Of course, you are probably already doing everything you can here, but we have worked with some founders who have pulled revenue forward by discounting, aggressive sales, calling in favors, etc. Services revenue. Some founders we’ve worked with have extended their runway by getting services-based revenue – sometimes consulting work, development work, one-off engineering, etc. The danger with this strategy is that one-off consulting revenue does not help the startup advance its true value-generation work, like building product, getting on-target sales, etc. And it can really, really distract from doing the things needed to build a valuable startup – VCs, rightfully, don’t value services businesses very highly. However, if your startup needs to make it through a difficult time, services revenue can be one way to bridge the gap. Cutting expenses. This is the obvious, and often painfully necessary, step in extending runway. Since the majority of expenses at a startup are headcount, this means making the difficult decision to conduct layoffs. Enough revenue growth and cost cuts can make a profitable company, although this doesn’t necessarily mean that the company is worth as much as its last round of funding. Venture debt. Venture debt isn’t really a great option, in our opinion, as these investors are not looking to prop up overvalued or failing companies, but instead want to finance hot businesses that have strong balance sheets. However, it may be possible to raise some receivable or revenue-based funding if your startup has solid customer contracts, low churn, and has a rational expense structure. But I wouldn’t recommend setting up a bunch of pitches with high-quality venture debt funds, as they are unlikely to be a backstop on a company that really should do a downround. As a founder taking aggressive steps to avoid a downround, make sure you are thoughtful about where the strategies you choose get you. Are you building a more valuable company? Are you making a bridge to somewhere where the company can get funding or be sustainable? What to watch out for Always make sure you’ve got experienced advisors – especially lawyers – if you are going to raise money at a lower valuation. Venture investors’ claws come out during downrounds, and you want to be prepared to protect the company’s – and your – interest. There are a lot of fancy names for the tricks that VCs will play at a downround; be prepared. Here are some things to watch out for: Anti-dilution provisions: An investor safeguard that hurts during a downround VC investors purchase preferred shares. These shares have provisions that protect their stakes from being diminished in value through anti-dilution provisions. These provisions adjust the conversion rate of preferred shares into common shares during a downround, thereby reducing the impact of dilution on the investor at the expense of other shareholders. There isn’t much you can do about these provisions if you are faced with a downround – it’s best to try to not let your investors have them in the first place. DLA Piper, a well-known law firm, has a good piece on these provisions here. There are typically two types of anti-dilution protections: ‘full-ratchet’ and ‘weighted-average.’ Full ratchet: This method adjusts the conversion price of the existing preferred shares to the price at which the new shares are issued in the downround, irrespective of the number of new shares issued. While this provides robust protection to the investor, it could lead to severe dilution for the founders and other stakeholders. In effect, the existing investor gets more shares, keeping the valuation of their existing ownership the same. Weighted average: This method also adjusts the conversion price of the existing preferred shares. It takes into account both the price and the number of new shares issued in the downround. It is generally seen as a fairer method as it balances the interests of existing investors and new shareholders, mitigating the dilution impact on founders and early stakeholders. But it still hurts founders, option holders, etc. The math can get pretty complicated with the anti-dilution protection – it’s probably worth a stand alone article. Stay tuned. Even if you have these provisions, you can try to negotiate them away. It’s common for founders to engage in discussions with investors to lessen or entirely waive the anti-dilution adjustments. An essential consideration here is whether the management, who typically hold substantial common stock, will be sufficiently motivated by their equity stake after financing to dedicate their efforts toward running the business. However, it’s not usually a good strategy to make the investors think that you will lose motivation to work on the business; this often results in them walking away from the company instead of funding a downround. Pay-to-Play provisions: Continued investor support – or else! Pay-to-play provisions are contractual clauses that incentivize, and sometimes force, existing investors to participate in the new funding round. A pay-to-play provision is a clause that tries to really, really make existing investors invest in a subsequent round of financing on a pro rata basis. If they do not participate, they face penalties, often in the form of their preferred shares converting to common shares (or sometimes less powerful preferred shares), which usually have fewer rights and lower seniority in terms of liquidation preference. While these provisions can ensure the continued financial support from existing investors, they can be seen as punitive, especially in a downround scenario where the investors may already face a loss on their investment. A big issue for founders is that they can get caught in-between investor groups if a pay-to-play is invoked. When you are trying to save your company, having to mediate between powerful VCs who are trying to screw each other over isn’t where you really want to be spending your time. Cramdowns: A brutal but sometimes necessary strategy during a downround A cramdown is a financing event where new investors significantly dilute the ownership stakes of existing shareholders, especially when those existing shareholders are prior investors who can’t or choose not to participate in a downround. Cramdowns effectively “cram down” the ownership percentage and influence of existing shareholders, and they are brutal on the existing owners. Sometimes they are necessary to get the funding needed to keep a startup going, but they aren’t pretty. First of all, a cramdown is going to sour the relationship between existing, non-participating, investors and new investors. And some investors who choose to participate because of the cramdown are likely to get upset at the investors who proposed it, so it’s not going to make anyone happy. Secondly, in a cramdown, founders’ common shares are significantly diluted. The effect on the founders can be substantial. Not only do they own a smaller percentage of the company, but the value of their shares may also decrease due to the lower valuation at which the new shares are issued. This could significantly diminish the potential return they might receive if the company is sold or goes public. The same is true for option holders, especially for option holders who have exercised their shares and left the company. Those former employees are essentially getting wiped out. This is pretty brutal; these folks have paid money to exercise their shares, and often had tax bills associated with this as well. Both former founders and employees getting wiped out or crammed down is something to approach very carefully. CEOs should think about the implications of this on the finances of their former associates, and realize that this can cause a negative market perception – it doesn’t look good. VCs who advocate for it need to realize that it’s not employee or founder friendly, and while “cleaning up the cap table” is often a necessary step, it’s not one to be taken lightly. Sometimes you have to do what you have to do to save your startup We just listed out some seriously painful things that can happen when you have to raise money at a lower valuation. But unfortunately, this is just reality in a downround. And if you have to do it, you have to do it. Let’s dig into some of the negative implications that can come out during or after a downround. Negative implications of a downround Keep in mind that all of the above – the anti-dilution protection, the pay-to-play and the cramdowns – will negatively impact some of your earlier supporters like seed investors, advisors who have shares, and common stockholders like founders and employees. These people are going to have less ownership, influence, and upside after a downround. Here are some of the negative impacts each group will have: Previous Investors Dilution: Cramdowns or the triggering of anti-dilution provisions can drastically reduce the percentage of company ownership held by previous investors. Decreased Influence: With reduced ownership comes diminished influence over company decisions, including those concerning strategic direction, hiring of key personnel, and potential exits. Investors may lose information rights or board seats; or they may no longer have enough skin in the game to care about helping the company. Markdowns: Professional investors may balk at having to mark down their investment’s value – realize that some VCs will have odd incentives if your startup is a huge percentage of their funds’ paper returns. Change in Share Class: In case of pay-to-play provisions or cramdowns where they don’t or can’t participate, preferred shareholders may be converted to common stock, losing their preferential rights. Option Holders Dilution: Just like with previous investors, option holders see their ownership stake diluted. Decreased Potential Returns: The economic value of their options might decrease, as each option now corresponds to a smaller fraction of the company. Strike Price vs. Share Price: If the new financing event occurs at a price lower than the strike price of the options, this can result in the options being ‘underwater’. This means the cost to exercise the options is greater than the market value of the shares. We’ll have an entire section on this topic. Employee Morale: Employees who’s options become underwater may question their dedication to the startup. Common Stockholders (Including Founders and Employees who have exercised options) Significant Ownership Dilution: Common stockholders are usually the most affected by dilution caused by a downround since they are last in line in terms of liquidation preference and don’t have anti-dilution protection. Loss of Control: Founders and other holders of common stock may lose some control over the company’s direction due to reduced voting power. Reduced Financial Upside: The potential financial gain upon a liquidity event is reduced as each share represents a smaller piece of the equity pie. Employee Morale: For employees who are common stockholders, significant dilution might lead to decreased morale and motivation, especially if their stock options fall underwater. Understanding investor strategies in a downround In a downround, it’s crucial to understand the strategies and expectations of existing and new investors and those who are reupping their investment. Existing investor behavior The decision for existing venture capitalists to participate in a downround is much more complicated than participating in a hot portfolio company’s follow-on financing. One key item to understand is that VCs have a limited amount of capital available to follow-on investments. VCs often have a finite amount of capital that they can allocate to follow-on investments, making the decision to participate in subsequent funding rounds a critical one. In the case of a downround, this decision is even more consequential. VCs must also consider the potential dilution of their stake if they choose not to participate, especially if anti-dilution provisions are not in place. Pay-to-play provisions, while incentivizing the next investment, also force investors to do the math to understand if there will be subsequent rounds that are also subject to pay-to-play. If round isn’t enough capital to get the company to break-even, an exit or an up-round (or if the company is going to continue to struggle), then the NEXT round will also likely be a pay-to-play. So the VC isn’t just making a decision to invest money now, but also another slug of capital in the future. Do they want to put in money now if they know it’s at risk for a follow-on pay-to-play situation? Furthermore, if the downround securities have terms favoring new investors, such as liquidation preferences or dividends, then the upside of the existing investment is lower – therefore, is it worth “defending” that prior investment? And, heaven forbid if the initial investment was made out of a fund that is low on capital and the new investment is supposed to come out of a different fund. Each fund a VC firm raises usually has slightly (to vastly) different limited partners with different amounts invested – so there are serious fiduciary issues that come up when a VC invests “cross funds” in a downround. However, choosing not to participate could mean losing influence over the company’s direction, especially if the new investors demand a greater say in the company’s operations. In addition, if the VC believes in the company’s long-term prospects and believes that the downround is merely a temporary setback, they might choose to participate to protect their initial investment and maintain their relationship with the company. It’s also worth noting that existing investors have more information about the company, which can be both an advantage and a disadvantage. They are typically more familiar with the team, the business model, and the market, which should in theory enable them to make a more informed decision. On the other hand, they should also know if a company is not doing well, and run the risk of looking foolish if they throw good money after bad. Therefore, the bar for participation in a downround is significantly high for existing VCs, often higher than in regular funding rounds. Every VC’s decision will depend on their assessment of the company’s potential, their capital limitations, their risk tolerance, and their strategic objectives. How the preference stack influences Existing VCs Behavior Later stage investors may have different preferences than early stage investors, which means that their motivations during a recapitalization may be quite different. Founders trying to pull together a round at a lower valuation need to understand the impact of a specific preferred share right - the liquidation preference. Liquidation preferences are essentially a set of rights given to investors that lay down the order of payout during the exit of a startup. A simpler way to think about this would be to imagine a scenario where, upon exit, a VC has two options - they can either choose to receive an amount that corresponds to their ownership stake in the company, or they can opt to get back the total amount of their initial investment. Naturally, a VC would select the option which maximizes their return, even if that means acquiring all of the proceeds and leaving nothing for the founders and the employees. These preferences “stack up” - forming what is called the preference stack. For many startups, the later stage investors have seniority, meaning that, at a small exit, they get paid back before the earlier stage investors. In a scenario where a startup has raised multiple rounds, it is possible that later stage investors may prefer to sell the company a low valuation instead of doing a downround. This is because the later stage investors may sit high on the preference stack, so they will get their money back. However, earlier investors may be left with nothing in this case, so would prefer to recapitalize the company (and in a lot of cases wipe out or diminish the preference stack). In this situation, the founder may have some investors who want to push to sell the business at a loss to get their liquidion preference back, where as others may want to keep the company going and clean up the cap table. This can lead to a lot of drama, with the founder at the center. New investors Not many VCs come into new startups at a downround, let alone lead the downround. First of all, negotiating a downround is much, much more difficult than leading a normal, up round. Secondly, there is reputational risk associated with leading a downround. Let’s get into these dynamics so you understand what VCs might be thinking about when you ask them to lead a downround. The lead VC typically plays a key role in defining the terms of the round, which in a downround scenario can be a particularly delicate task. The terms must be crafted in such a way as to protect the new investment and provide potential upside, while also being mindful of the potential dilution and its impact on existing shareholders. Achieving this balance can be difficult and may require tough negotiations, involving numerous legal and financial complexities. This is much more difficult in a downround, where various stakeholders have their investments value and influence reduced. This can also add to a lot higher legal bills, as downround terms are more aggressively negotiated vs. simple up round deal documents. Additionally, the lead VC in a downround often finds themselves in the unenviable position of having to manage and align the interests of various stakeholders. This includes calming the concerns of existing investors and reassuring founders and employees, all while setting and communicating a new strategic direction for the company. Beyond the pain of leading and negotiating a downround, one of the major concerns for new investors is the potential to upset various stakeholders, particularly the existing investors, founders, and employees of the startup. A downround often results in substantial dilution for existing shareholders, which can cause significant dissatisfaction and strain relationships. Founders may see their stakes and influence in the company diminish, while employees may find their options underwater, which can affect morale and even lead to talent departure. No VC wants to be known as the VC who screwed over a founder or who crushed a bunch of employee options. Given these concerns, many VCs prefer to avoid downrounds as a matter of principle. Terms investors ask for in a downround The terms investors get in a normal, up round are relatively easy to predict – most VCs take the previous preferred share documents and make minor tweaks. That’s not the same for downrounds. In downrounds, investors often ask for terms that are more customized (and punitive). Some of these terms are: Over 1x liquidation preference Participating preferred stock Dividend rights Pay-to-play provisions on subsequent rounds One such term is the concept of a liquidation preference over 1x. Liquidation preferences are terms that let investors get their investment back, before other investors are paid out, in the event that the company exits for a less than stellar amount. With a high liquidation preference, new investors will get multiples of their invest back, before any other shareholders. For instance, with a 2x liquidation preference, an investor would get twice their investment back before others get anything. This can lead to a significant reduction in the potential returns for other stakeholders. Some specific math as an example. Let’s say an investor invests $10M at a 2x liquidation preference, and ends up owning 20% of a startup. The startup is then sold for $25 million. Instead of getting 20% times $25 million ($5 million), the investor gets two times $10 million, or $20 million. The remaining $5 million is split between the other stockholders. Investors may also seek to obtain participating preferred shares. These shares grant investors the right not only to receive their initial investment back (akin to a liquidation preference) but also to participate in the distribution of any remaining proceeds, as if their preferred stock had been converted to common. This provision allows the investor to benefit twice – hence the term “double dip” – and can result in them securing a high portion of any sale proceeds, often to the detriment of other shareholders. An example would be if an investor invests $10M at a 1x liquidation preference into participating preferred shares, and ends up owning 20% of a startup. The startup is then sold for $25 million. Instead of getting 20% of $25 million ($5 million), the investor will get $13 million: their $10 million investment plus 20% of the remaining proceeds (20% times $15 million, or $3 million). Furthermore, new investors might request dividend rights agreements in a downround. These stipulate the payment of a dividend on preferred shares, either as a fixed amount or a percentage of the original investment. Generally, we’ve seen these paid out as more preferred shares, which means the existing shareholders are more and more diluted over time (this is called a PIK preferred – a “paid in kind” dividend. This particular term is sometimes used to incentivize management to quickly sell the company, as their ownership decreases as time goes on. The strategy of introducing a pay-to-play provision in a downround financing with the intention to wash out other investors in future financings indeed presents a unique dynamic in the venture capital ecosystem. An investor with significant financial resources and long-term interest in the company might use this strategy as a means to consolidate control. If they anticipate that the company will require additional funding in the future – and that some of the other investors will not be able to meet the pay-to-play obligations – they can use the provision to effectively dilute the stakes of these other investors. Watch out for pay-to-play provisions that are designed to impact subsequent rounds – your investors may end up playing a game of chicken, with your startup caught in the middle. As new investors look to secure their investment in a downround, it’s important for founders and existing shareholders to comprehend the full implications of these terms. Similarly, reupping investors need to be aware of the trade-offs involved as they might have to accept these conditions to protect their existing stake. It’s important to work with an experienced law firm when negotiating downround provisions and terms. Strategies to handle downrounds Downrounds present significant challenges for startups, requiring serious negotiating skills and careful decision-making. The success of a company during a downround largely depends on its ability to communicate effectively, formulate and execute a sound business plan, negotiate deftly, and align the interests of all stakeholders. In this section, we will explore these key areas in detail, providing guidance on how to manage the complexities of a downround successfully. Communication Proactively adjusted company’s burn Strong business plan and financial model Be prepared to negotiate Understand your investors’ interests and aligning with shareholders Work with a great attorney It’s crucial to uphold transparency, ensuring investors remain informed about the company’s current situation, reasons leading to the downround, and the strategic plan for recovery. Regular updates, open discussions, and timely responses to investors are key actions that demonstrate respect for investor relationships and can help maintain their confidence in your leadership and the company. Investors appreciate being kept in the loop and involved in the process, and clear, candid communication can help prevent misunderstandings, manage investor expectations, and maintain alignment on the company’s path forward. For most startups, another key strategy to successfully close a downround is to proactively adjust the company’s burn rate. By reducing unnecessary expenses and increasing operational efficiency, startups can extend their financial runway, providing more time and flexibility to navigate the downround and execute their recovery strategy. This can also make the new capital raised go further, potentially enabling the company to reach important milestones that increase its value and make it more attractive for future funding rounds. A focus on financial discipline and efficiency demonstrates to investors that the company is committed to long-term sustainability, which can help build confidence and trust in the face of a downround. Of course, this is a painful decision and the impact to employees is not something that should be taken lightly. Additionally, if laid off employees ask to exercise their options, you may need to have frank discussions around the impact of the downround on their exercise price – consult with your lawyer. Downrounds often instigate challenging negotiations, especially around valuations, ownership stakes, and future funding provisions. Being equipped to negotiate effectively is crucial, bearing in mind that your objective isn’t solely about securing necessary capital, but also about preserving relationships with your investors and positioning your company for a successful recovery post-downround. Coming prepared to conversations is even more important than it was when you first raised capital. It’s vital to align stakeholder interests as much as possible. A downround, while challenging, also offers an opportunity to reassess and reaffirm the common objectives among founders, investors, and employees. Encouraging participation in this process can not only promote a sense of unity and shared purpose but also generate ideas and strategies that might have been overlooked otherwise. Different VCs will have different needs based on the situation with their funds - take the time to understand where they are coming from. Not all VCs will be fully transparent, especially if they are low on funds or if they think they are playing chicken with other investors, but it’s worth taking the time to understand their expectations. But make 100% sure you understand if your investors expect you to polish up the company for a quick sale, or push for profitability, or resume high growth and then raise an up round. When embarking on a downround, engaging a seasoned legal and financial team is critical. They can provide invaluable advice and guidance, ensuring that you’re not only legally protected, but also well-prepared to address the financial complexities that come with downrounds. You also want to work with attorneys who can help you avoid situations that open you up to litigation - while you can’t really eliminate the risk of being sued, it’s good to know where you are creating risk. You’ll also want to run scenarios with your lawyer to understand the impact of various structures. Conclusion: How to survive and thrive post-downround Navigating a downround can be a tumultuous experience for any founder, but getting the capital in the door is only the first step. The real challenge lies in rebuilding post-downround, restoring market perception and reputation, rebuilding employee morale, and executing a long-term plan to get to a healthy position. A company may not need significant operational or strategic changes if the downround was singularly the result of the previous round being done at too high of a valuation. However, VCs are likely to demand greater operational efficiency after a downround (i.e. some cuts). Strategies to rebuild Companies may need to streamline operations, focus on profitable segments, or reconsider their staffing. Again, it’s important to have a financial model that lays out how your startup will accomplish its goals with lower spend (you can find free financial models here). Addressing employee morale Employees are likely not feeling great after a downround. There have probably been layoffs, their stock options are probably underwater (or at least worth less money), and there is the feeling that the company has not done as well as everyone expected. Some items to address include: Stock options. Employees at startups expect stock options to be an important part of their compensation. Founders and the board need to quickly execute a stock option top off to avoid losing key employees Vision and Mission Reiteration. Remind employees of the company’s mission and vision. Reinforce the importance of their roles and how they contribute to achieving the company’s long-term goals. Explain the plan. Make sure employees know what the companies priorities are, and how they can help the business get onto solid footing. Market perception and brand reputation A downround could potentially leave a dent on your company’s market perception and brand reputation. Since they usually happen alongside layoffs, this is a legitimate issue to worry about. Regular updates showcasing the progress made and the effective implementation of the recovery plan will help rebuild stakeholder trust. A carefully devised public relations strategy can also assist in retelling your brand story from a perspective of resilience and adaptability. And don’t forget to think about customer and prospects opinions of your company. No business leader wants to purchase an important product or service from a company that is potentially going out of business, as they likely need the startup to stay in business to service the product! Regular budget vs actuals Founders need to carefully measure their financial progress and position after a downround. This not only helps keep the startup’s financials focused, but fosters investor confidence, enables prompt course correction, and improves future financial planning. Detailed budgeting and reporting provide transparency into the company’s fiscal health, facilitating early detection of possible problems. Recurring investor check ins to align on goals We already mentioned making sure you understand and are aligned with your investors’ expectations for the business after a downround - do they expect a reset, then a focus on achieving high growth? Or a push to profits? Or a quick exit via M&A? Check in regularly with your investors to make sure that their goals are still aligned with the company’s after the downround. Don’t Just Survive, Thrive Enduring a downround can indeed be tough, but it is not the end of the road. With an efficient recovery strategy, a resilient team, and a forward-looking approach, companies can leverage this challenge as a stepping stone towards renewed success. Remember, the key lies not just in surviving the downround but in thriving in its aftermath.Top 10 VC Pitch Decks, Examples and Templates2024-01-30T00:00:00+00:002024-01-30T00:00:00+00:00https://kruzeconsulting.com/blog/top-5-venture-capital-pitch-decks<p><img src="/uploads/the-top-5-venture-capital-pitch-decks.jpg" alt="Top 10 VC Pitch Decks, Examples and Templates" width="1024" height="569" /></p>
<p>A big part of my job at Kruze is to help our clients prepare to raise venture capital. So I’ve seen a lot of venture capital pitch decks recently. As a former VC who also has been an exec at a number of startups that have raised quite a few million in venture financing, I have some strong views on what information VCs want to see. And because Kruze clients raise over <strong>two billion dollars in venture funding annually</strong>, I get to see a lot of what works - and what doesn’t. </p>
<p>Since I’m regularly being asked for a template for a venture pitch deck, I thought that I’d compile the best templates available on the internet that I know about. Again, I’m strongly biased, as I’ve seen many companies successfully raise and some not. These are pitch deck examples that I think are working.</p>
<p>In addition to the example presentations below, I also lay out the standard slides that I’ve seen companies use to successfully raise venture funding. You can scroll down to also see a TechCrunch interview with a Kruze Client, DeepScribe, where the founder and their investor walk you through the deck they used to raise a $30M round. Finally, I’ve added in a dozen+ questions that VCs often ask founders during the pitch (I’ll probably create an entire article around VC questions and answers).</p>
<p><strong>We’ve released our <a href="https://kruzeconsulting.com/startup-pitch-deck/" target="_blank" rel="noopener">free startup pitch deck course</a>! It includes 2 free Google Presentation templates that are free to use, and one downloadable financial model template - plus over 8.5 hours describing what VCs look for on every slide in the deck.</strong></p>
<p>Again, the pitch deck course has <strong><em>two free templates</em></strong> that are free to use. No email or registration or anything - just click the links, open the Google Slides and duplicate them into your own Google Drive. One of the free templates is a B2B example, the other is a B2C example. Haje Kamps, the well known TechCrunch writer who produces the pitch deck teardown series, helped me create those free templates - so get them!</p>
<h2 id="top-10-11-venture-capital-pitch-deck-templates-on-the-internet-right-now">Top <del>10</del> 11 venture capital pitch deck templates on the internet right now</h2>
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<p>Guy Kawasaki’s pitch template - <a href="https://guykawasaki.com/the-only-10-slides-you-need-in-your-pitch/">https://guykawasaki.com/the-only-10-slides-you-need-in-your-pitch/</a> This is the OG demo pitch deck. Short and sweet. Starting to get a bit long in the tooth, but still the first one to check out because it will highlight how simple and short can be better (don’t make a 30 slide deck!!)</p>
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<p>Ycombinator’s slide template - <a href="https://blog.ycombinator.com/intro-to-the-yc-seed-deck/">https://blog.ycombinator.com/intro-to-the-yc-seed-deck/</a> The actual deck that YC links to (it’s a Google Slide file) has such poor design, I wouldn’t recommend using it. HOWEVER, the order of slides and the topics are 100% on, so it’s worth carefully reading the commentary in the actual post. I like the final slide, as it clearly outlines how much funding is needed and the use of the funds. A solid slide to end the conversation on. </p>
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<p>First Round Capital’s deck - <a href="https://www.beautiful.ai/blog/uber-vc-pitch-deck-presentation-template">https://www.beautiful.ai/blog/uber-vc-pitch-deck-presentation-template</a> One of the top, East Coast VCs supposedly had a hand in creating this one, and the slide order/content is one of the best examples of what to put into your deck. I don’t know how you actually download this - it’s in some kind of a proprietary format, but if you are looking for a view on how to order and design a pitch deck, this is one you must check out. </p>
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<p>Series A pitch deck used by Front to raise their A - <a href="https://medium.com/@collinmathilde/front-series-a-deck-f2e2775a419b">https://medium.com/@collinmathilde/front-series-a-deck-f2e2775a419b</a> This founder very kindly shared their slides and fund raising experience. Great example of a competition slide in an industry that has a lot of legit competitors. </p>
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<p>Airbnb’s seed deck - <a href="https://www.alexanderjarvis.com/airbnb-seed-pitch-deck/">https://www.alexanderjarvis.com/airbnb-seed-pitch-deck/</a> This is a classic (although the visual design did not age well). If you are looking for a consumer deck or one that talks about how to launch into a new(ish) industry, this is worth looking at.</p>
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<p>We’ve also put links to six <del>five</del> other examples below, like the Uber deck and the Mattermark slides. Scroll down to see more real-life examples, and dig into our commentary on slide order and content strategy. </p>
<h2 id="slides-in-an-example-pitch-deck">Slides in an example pitch deck</h2>
<p>The professionals (like YC and Guy Kawasaki) are suggesting 10 slides in a standard pitch deck. I think the real point is that you should be able to deliver your pitch in 15 minutes or less - and if pressed, do a 5-minute pitch. That’s really short.</p>
<p>Why so short? Aren’t most VC meetings scheduled for 30 minutes? Well sure, but… </p>
<p>Assume that your VC is late to the meeting by 5 minutes (they will always say something like “something came up with a portfolio company’s acquisition, but the truth is probably that the barista messed up and gave them an almond milk latte instead of a soy milk one and they had to wait for the right beverage - kind of a joke.) The VC will probably then give you a few minute spiel around what makes their fund different. Then assume that you need to answer at least 5 minutes of questions if your pitch is not going well - and 10 minutes of questions or more if the investor is engaged. And you’ll need a 5-minute pitch, that isn’t rushed, if some important partner is running way late or misses the first 20 minutes of your 30-minute meeting. </p>
<h3 id="the-standard-table-of-contents-in-a-good-pitch-deck-is">The standard table of contents in a good pitch deck is:</h3>
<p>Based on the $1 billion our clients raised last year in VC funding, we think you will want:</p>
<p><strong>1. Cover/title slide - including the company name and the founder’s contact info</strong></p>
<p><strong>2. The industry’s or customers’ problem - the pain that your startup is solving</strong></p>
<p><strong>3. Your startup’s solution or value proposition - how your startup fixes the issue / the benefits you provide</strong></p>
<h3 id="the-templates-start-to-diverge-so-a-few-different-next-slides-are">The templates start to diverge, so a few different next slides are:</h3>
<p><strong>4. EITHER:</strong></p>
<ol>
<li>Traction - metrics that show adoption or market validation or</li>
<li>Product magic/product demo - showing off the offering</li>
</ol>
<p><strong>5. EITHER:</strong></p>
<ol>
<li>Market size</li>
<li>Business model / how you make money</li>
</ol>
<p><strong>6. Go to market/growth - explain how you are going to grow</strong></p>
<p><strong>7. Competition and or competitive analysis/advantages - all startups have some sort of competition, or there is at least a way that customers are currently dealing with the pain your startup is solving</strong></p>
<p><strong>8. Team</strong></p>
<p><strong>9. Financial projections - include revenue growth, high-level spend, burn, and other KPIs like customer count (you can go deeper in an appendix or in a financial model). And if you are looking for a free downloadable model template, visit our <a href="https://kruzeconsulting.com/five_tips_for_startup_financial_health/startup_financial_models/">financial modeling page</a>.</strong> </p>
<p><strong>10. Summary:</strong></p>
<ol>
<li>How much you are raising</li>
<li>Traction if you haven’t already done so</li>
<li>Use of proceeds (what you do with the money)</li>
<li>Current investors participation level (if any - strong investors who have already invested in previous rounds and who are participating in this one are a very good signal)</li>
</ol>
<p>I am slightly older school - I usually like an “executive summary” after the cover page that goes over the company and round. I think this is probably a page that went out of style in 2015 or so, but I still like it because it quickly helps the VC see what your key metrics/sales points are, and how much you are raising. I usually recommend only four or five bullets on this slide:</p>
<ul>
<li>Disrupting the $x billion industry</li>
<li>1,500 customers using product [or] Marquee customers include McDonalds and Marriott</li>
<li>ARR of X, growing 20% month over month</li>
<li>Team has deep domain experience from XYZ</li>
<li>Raising $8 to $10 million Series A</li>
</ul>
<p>Given that YC and Guy Kawasaki seem to no longer (or maybe never) had an exec summary at the front of their venture capital pitch deck templates, you are probably OK ignoring my advice and just getting straight from the cover page to the problem statement. </p>
<h3 id="tips-for-your-slides">Tips for your slides</h3>
<p>Here are some of the slides that we mention above and some tips that founders we work with have found helpful:</p>
<ul>
<li><strong>Problem Slide</strong> - Invite the investor into discussing / discovering the problem with you. Some problems are obvious - but that doesn’t mean that the VC has thought about them deeply before. Help the investor understand the issues from the eyes of the buyer/consumer. The best venture capital pitch decks have problem slides that are strong enough to make the investor really, really want to meet with you. </li>
<li><strong>Go to Market / Growth Slide</strong> - For companies that are already generating revenue and growing, show that you know who your customers are and where you can find them. For pre-revenue startups, use this slide to prove that the founders have 1) thought about how to sell the product and 2) have a plan on what you will try to prove vis a vis your sales and marketing with the capital you are raising. </li>
</ul>
<h2 id="seed-pitch-deck-outline">Seed Pitch Deck Outline</h2>
<p>Our COO, Scott Orn (also a former VC) has been assisting a number of seed and pre-seed companies during their fundraises, and has produced an outline/template for a seed pitch deck.</p>
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<p>Pre-seed is sort of a new asset class. It’s essentially the first money in. That’s what seed used to be for everyone. So this is applicable to pre-seed and seed - basically, what to present when your company is more of an idea.</p>
<ol>
<li><strong>Company’s slogan / 1 sentence elevator pitch -</strong> the first page or first slide should really just be the company’s name and slogan, or the one sentence, what you are doing. And just get the audience focused on that. Make sure to make an impression, deliver it with passion. You are in sell mode here. You’re pitching investors. </li>
<li><strong>Problem -</strong> what are your customers struggling with? A lot of investors like the problem-solution type of framework, so the next slide would be the problem. So talk about how your potential customers are suffering, what’s going on right now in the market, why it’s not working, and then the next page in the deck will be your solution.</li>
<li><strong>Solution -</strong> how are you going to make everyone’s life better? You can explain how you’re going to be better, how you’ll save your clients or customers a ton of time, a ton of money, etc. Better, faster, cheaper is a Silicon Valley slogan that people typically use when explaining their startup’s solution.</li>
<li><strong>The Product / Service</strong>
<ol>
<li>Nothing is more powerful than a demo. That also shows that the company has actually built something and you can get a taste for it. </li>
<li>Often you see a screenshot of the demo and often can click for video.</li>
<li>Some people like more visual depictions of what you are doing. Regardless, in this section, something visual is pretty helpful. You want to get the conversation going, you want them to react to something, you want them to feel vested in what you’re doing. Get them to buy into the solution.</li>
</ol>
</li>
<li><strong>Market Size</strong>
<ol>
<li>This is kind of a “check the box” because it’s always hard to size the market. </li>
<li>And many of the best companies look like they have a tiny market but turn it into something huge. </li>
<li>But it’s a good exercise and tells investors where you are going. And, remember, venture capital is really just wanting to invest in big opportunities. VCs are okay with some losses, but when something works, they need it to be big. And so that’s why they really care about market size. This section helps prove to the seed investor that you are pointed at a big possible market, and that you are aiming to make a big company vs. a nice, small, lifestyle business. </li>
<li>You would be surprised at how many small businesses, that never really anticipate getting bigger than a couple of million in revenue, try to raise seed financing. So the seed investors need to be able to weed out the entrepreneurs who are not focusing on big opportunities, and you do that in this part of your seed pitch deck.</li>
<li>And if you’re willing to spend a bunch of your time, five, 10 years of your career on something, there better be some size to it!</li>
</ol>
</li>
<li><strong>Competition</strong>
<ol>
<li>You want to identify competitors. If you pretend you don’t have competitors or bad mouth them, you’ll lose credibility. investors typically like you to acknowledge your competition. And oftentimes there’s a little bit of education, because you know this market really well, but the seed investor doesn’t, so here is where you teach them about the competition.</li>
<li>Seed investors know that competitors aren’t the end of the world. In fact, the best venture capitalists actually LIKE successful competitors, because it helps validate that there is a market for the solution. </li>
</ol>
</li>
<li><strong>Go to Market Plan</strong>
<ol>
<li>This is a super important slide. Are you using a sales team? Partnerships? Online marketing? Events?</li>
<li>Creativity, different approaches and things that investors have seen work are great.</li>
</ol>
</li>
<li><strong>Financials</strong>
<ol>
<li>How much money do you need?</li>
<li>How long will that get you?</li>
<li>When do you think you’ll start to generate revenue.</li>
<li>A visual is really good as part of this slide.</li>
<li>It’s important to understand the seed investors mindset on this slide. They are doing the math, and they’re thinking, what does this company need to raise money from a series A venture capitalist? Because really, at every step of the venture capital game, people are putting money into your company and then hoping other people will step up down the road to fund the company. The seed investors that you are pitching only have so much capital. They are going to rely on your company doing well enough, and looking strong enough, to be able to get a VC to invest in your next round. And so, they’re doing that math and trying to figure out what is going to be that milestone that really brings other venture investors in the company? </li>
</ol>
</li>
<li><strong>Exit Opportunities</strong>
<ol>
<li>Some seed investors don’t want you to talk about a sale eventually. They are essentially saying “I don’t want to even hear that you’re thinking about selling the company in three years or four years, or how could you possibly know who’s gonna buy it?” Which is very fair. So you needed to kind of tread lightly on this. I think the way I typically like to do this is just point out the players in the market and make the point that if you get traction and you’re successful, these people or these companies are gonna have a real strong vested interest in acquiring you. And so that’s kind of enough. </li>
<li>It’s enough to say that if we hit traction, there will be a lot of interested companies like X, Y Z.</li>
<li>You don’t need to say like “I’m going to get bought for X number of dollars in year three” or something like that. Just talking about who could buy you or who would be interested is a delicate way of doing this. </li>
<li>It’s always great when a founder says, “I’m taking this through IPO. I’m committed.”</li>
<li>Note from Healy: While Scott may really like this slide, I don’t love it as much, because, as Scott mentions, it makes me afraid that the CEO is not in it for the long term. I usually prefer to discuss this on the competition slide, “here are other, very big companies, that don’t play in this solution but who have the same customer base as we want… they may get into our market. Who knows, they may acquire their way in once they realise the solution is being adopted.” I like that method better, as it doesn’t imply to the seed investors or the VCs that you are putting the cart before the horse, instead it says that you know who the heavy hitters are in the general market, and then the investor can do the mental math to think that they may want to buy their way in eventually.</li>
</ol>
</li>
<li><strong>Team -</strong> some people like to put this way up in the front, right after the slogan and what they’re doing, because they have a team that has accomplished a lot and the team is backable just because they’re just so successful and so technically strong and know what they’re doing. But you can have it here at the end of the presentation, either way is fine. It’s good to get some bios up there, get some pictures so that people can identify. Also the nice thing about bios and your founding team in the slide is that oftentimes you can play the name game with venture capitalists or seed investors - they’re professional networkers, they know a lot of people. And so oftentimes, you can get to a point where they know someone that’s on your team or that you know, and that’s a really great background diligence channel. If they want to invest in you, they may actually call their friend who knows someone on the founding team or knows you and just check and see what kind of person you are or your team is just for diligence sake. It also can be very impressive if it’s a super strong technical team or a marketing team that’s gone to market in a really unique way. But, wherever you put it in the pitch deck, definitely have a team slide.</li>
<li><strong>Any examples of progress -</strong> this is huge. If you can say you already have clients, revenue, etc, it is much more convincing. All these signs that what you are doing is working, and that it’s legit and it’s something the seed investors want to be a part of, it’s a social proof type of thing if you know that from influence. And so showing your traction is probably the best thing you can do to sell the company. So don’t hesitate to do that. If you have a commitment from a lead investor, that’s great, always put that in this slide in the pitch deck because it’s a lot easier to follow on than be the lead and set the evaluation, write the check, that’s a lot of responsibility and sometimes people don’t want to do that. But that’s what you can end up with.</li>
</ol>
<p>And then there’s a tiny little tip which is, oftentimes you get to the end of the presentation and that slide just sits up there for the remainder of the pitch discussion. If it’s going to sit there, just make it like something showing how awesome you are or helping you close the sale, maybe it’s pictures, maybe it’s graphs or your traction. Instead of having that boring, “questions” slide, do something that spices it up. And every time they kind of subconsciously look at the slide deck on the wall, or the presentation, even though you’re just talking after the presentation has been done, it can kind of help convince them in a small way. So just a little tip to help your pitch deck be a bit stronger at the end.</p>
<p>At the seed stage, you’re still living the dream and you’re convincing investors that they should come along. So it’s a little less finance, a little less metrics and more vision. But really this framework should work for any type of venture capital presentation.</p>
<h2 id="how-to-write-a-pitch-deck-to-raise-funding">How to write a pitch deck to raise funding</h2>
<p>Ok, so you’ve now seen the VC and seed deck outlines above - but how so you actually start writing a presentation that will help you get funding? Here is how I have successfully written pitch decks when I was raising VC money:</p>
<ol>
<li>Understand WHY you’ll be able to raise funding - this could be your traction, the market, the team, the product strength. Find the one thing that will blow investors out of the water, and build your story around it.</li>
<li>Now that you know what your biggest strength is, put together the outline of the deck. </li>
<li>Decide what the one major takeaway is for each slide - this might be the slide title, or it might be a point driven by an image or chart. But you only have a handful of slides, so each one has to drive the vision forward; make each one count. </li>
<li>Start from the strength slide; don’t get it perfect yet, just make sure it highlights the “wow.”</li>
<li>Next, fill in the rest of the slides, remembering that you are selling your vision. Use data, market insights, customer quotes to support the conclusion that your company is going to be successful.</li>
<li>Now, practice running through the deck. It sounds cheesy, but I recommend doing it out loud! Make improvements to the slides and flow based on how it sounds delivering it to yourself. </li>
<li>You are ready to practice on some “friendlies” - either current investors, partners, mentors. Get their opinions, and then iterate the pitch deck until you feel confident that you’ve got the story down. </li>
</ol>
<h3 id="tips-for-your-fund-raising-presentation-if-time-is-running-short">Tips for your fund raising presentation if time is running short</h3>
<p>Ok, so as I outlined, it’s highly likely that your 30 minute conversation gets cut into a much shorter time frame. There are good ways to handle this and bad. The worst way that I’ve seen is when a CEO talks REALLY REALLY fast and blows through the preso. It’s hard for anyone to soak in the information, it can be hard to understand, and it usually doesn’t work. A better way is to have the 5 minute presentation ready to go, and then to just walk through that briskly. No demo, and try to answer the VC’s questions as quickly as possible.</p>
<h2 id="common-mistakes-founders-make-crafting-their-investor-pitches">Common mistakes founders make crafting their investor pitches</h2>
<p>In the Kruze pitch deck course, I talked with renowned pitch deck consultant and author, Haje Kamps, about some of the most common mistakes we’ve seen founders make over and over when they present to potential investors. Here are some of those problems - and you can watch the entire video. </p>
<ul>
<li><strong>Making the Team Slide Weak</strong>: We’ve noticed that many founders often inundate their team slide with unnecessary information, such as a full organizational chart, instead of focusing on key members and demonstrating their relevant skills for the specific startup. Don’t overload it; you don’t get points for lots of logos. Instead, figure out the most relevant or impressive items and </li>
<li><strong>Misunderstanding Market Size</strong>: The total addressable market and serviceable markets need to be sizeable enough to show potential for a venture-scale company. It’s fine to start in a niche, but you need to be able to create a company that’s worth at least a billion dollars, if not more. As you need to be attacking a big space.</li>
<li><strong>Unrealistic Projections</strong>: We’ve seen founders showcasing either slow, steady growth or overly aggressive, unrealistic growth - both extremes are unappealing to investors. Look at some of the templates we share on this slide - those projections are good! You aren’t going to go from founding to $100 million in revenue in a year. And if you are growing from $4 million to $4.5 million in revenue, congrats, you’ve got a great small business, but it’s not venture-scale. </li>
<li><strong>Failing to Accurately Represent Traction</strong>: A traction slide should provide substantial evidence of growth, often in the form of customers generating revenue or being in the sales funnel. Unfortunately, many founders include markers such as press coverage or vague “interest” that doesn’t translate into tangible growth.</li>
<li><strong>Lack of a Coherent Story</strong>: Haje really talks to this well. It’s essential for founders to weave a coherent story that sells not just the product, but the vision of the company and its future value. Many founders fail to communicate this effectively, resulting in a disconnected or confusing narrative. You want the partner who you just presented to to be able to walk off and talk about one of your main customer successes, and how that ties into your company’s vision and traction. </li>
<li><strong>Absence of a Competition Slide</strong>: Many founders overlook the importance of including a competition slide in their presentation. This is a major mistake, as not acknowledging competition can lead investors to think the founders are unaware of their market landscape. It’s one of my favorite slides. If you’ve got big competitors, great, you’ve just helped the VC understand who you might sell the company to in a few years! </li>
</ul>
<p>That’s just a few of the top venture capital pitch deck fails we go over in the video - check it out. Being aware of these common mistakes and addressing them in your pitch deck can significantly enhance your chances of capturing a venture capitalist’s interest.</p>
<h3 id="common-vc-pitch-deck-fails-video">Common VC Pitch Deck Fails Video</h3>
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<h2 id="tips-for-the-financial-section-of-your-pitch-deck">Tips for the financial section of your pitch deck</h2>
<p>As financial advisors to funded startups, we tend to overly index on the financial section of our client’s fundraising pitch decks. Note that this is our interest area (and how we get paid), so it may or may not be all that interesting or important for your startup’s presentation. </p>
<p>The financial detail that you go into in your VC deck will vary based on the stage of your business. So, let’s breakdown what you might need for a seed to Series C company.</p>
<ul>
<li>Seed stage - Your pitch deck only needs a brief description of what you are intending to do with the money. As Scott mentioned above, a visual can go a long way here. Since revenue is now often expected for an A, you should articulate some sort of an expectation in revenue before the money runs out (i.e. investors want to know if you’ll have the exit velocity you need to raise the next round).</li>
<li>Series A - A 5-year view is ideal, as this gives you the chance to show / “prove” that you are going to create a venture scale business. An extrapolated income statement with include revenue growth, high-level spend, burn, and other KPIs like customer count. You ought to have an appendix with more detail - or just a piece of excel that you can share (probably better at this stage).</li>
<li>Series B - You are still going to need the 5-year projections. But, at a B, you’ll have more financially minded investors. This means that you ought to have a real appendix section that gets into the drives and assumptions to your continued growth. SaaS companies are going to need to be able to explain how they calculate their LTV to CAC - so your pitch deck will have to address both parts of that calculation. You can still put the detail in the appendix, but have it organized so that you can go through all the financial part in an organized presentation if needed. </li>
<li>Series C - Series C companies should have real financials that have been prepared by a professional accountant, either in house or as a consultant. While you’ll still want a single slide in the meat of the pitch deck that has your five year vision, your historical results will also matter - so that slide will have to do a lot. This may mean that you have to push your KPIs like customer count into a seperate slide(s). And the financial appendix should have historical statement - probably all three - and projections. </li>
</ul>
<p>Finally, we’ve complied some other pitch deck examples that you may find helpful. Again, we think the best VC pitch decks templates/examples are the ones we highlighted at the top of this page, but here are some of the others that are floating around on the internet that you may like.</p>
<h2 id="fivesix-more-of-the-best-pitch-deck-examples"><del>Five</del>SIX More of the Best Pitch Deck Examples</h2>
<ol>
<li><strong>Uber</strong> (<a href="https://www.slideshare.net/startuphome/uber-pitch-deck-87832684?" target="_blank" rel="noopener">pitch deck here</a>) - this is when they were still called “UberCab.” And it’s very early in the life of the company, so is product and market focused. You won’t find data about the company’s performance, since it’s so early. This deck may be helpful to pre-launched startups.</li>
<li><strong>Intercom</strong> (<a href="https://www.slideshare.net/eoghanmccabe/intercoms-first-pitch-deck" target="_blank" rel="noopener">seed pitch deck here</a>) - another example of a seed stage pitch deck, this one for when Intercom was raising $600k. This is a short deck - only 8 slides - and it focuses on the team, problem, solution and market. Note that the “progress” slide consists of a tweet from a user - pretty slight - you may not be able to get away with this lightweight of a presentation unless you have the clout of these founders. BUT if you are looking to talk about the market size and opportunity, this is a decent example.</li>
<li><strong>Mattermark</strong> (deck <a href="https://www.slideshare.net/DanielleMorrill/mattermark-2nd-final-series-a-deck" target="_blank" rel="noopener">here</a>) - data company Mattermark has real traction, and there are several examples of solid metrics/charting visuals in this deck. With $1.5M in ARR at the time of this pitch, they are probably around where many Series A’s are getting done in Silicon Valley. (I’ve even seen Series B’s happening at this level). This is a great pitch deck example if you are looking to impress the VCs’ with your traction. Check out slides 11, 12 and 13 for information on how to present historical revenue growth, projections and customer industry diversification. </li>
<li>Mixpanel (deck on <a href="https://www.slideshare.net/metrics1/mixpanel-our-pitch-deck-that-we-used-to-raise-65m" target="_blank" rel="noopener">slideshare here</a>) - Mixpanel shared their deck as an example that other startup can use. This is the set of slides that Mixpanel used to raise a $65M round. The competition slide is particularly good for driving a disucssion with the VCs. The traction slide is also strong - one of the best in combining the visual “up and to the right” chart with some details on the company’s milestones. The slide that is close to the “what we do with your money / operating slide” is a good overview of what the company needs to do to grow, although it’s not as focused on financials as I’d like. </li>
<li>Mint (seed pitch deck <a href="https://www.slideshare.net/hnshah/mintcom-prelaunch-pitch-deck" target="_blank" rel="noopener">here</a>) - A great seed stage fundraising deck, with the whole enchilada: a good team slide, a great market size one, solid competition, user acquisition, and a financial slide that makes my inner accountant happy. Notice the flow on this slide, with the team slide right near the front. This could be the best template/example for companies with an experienced team. </li>
<li>Orange (seed pitch deck template <a href="https://www.slideshare.net/HajeJanKamps/pitch-deck-teardown-oranges-25m-seed-deck" target="_blank" rel="noopener">here</a>) - A great example of a hardware as a service deck. It gets into the problem, the market size, the solution and then makes a solid case for why this team is the one to solve it. One of the best parts of this one is the intro slide - it kicks off right at the front with a strong explanation of what the problem is, and the VC looking at it can immediately infer what the startup’s solution is. </li>
</ol>
<p>So that makes 11 of the best pitch deck templates and examples that we’ve seen on the internet. </p>
<h3 id="pitch-deck-example-from-a-kruze-client">Pitch Deck Example from a Kruze Client</h3>
<p>One of our clients, <a href="https://www.deepscribe.ai/about" target="_blank" rel="noopener">DeepScribe</a>, was interviewed on <a href="https://techcrunch.com/2022/02/28/leverage-early-investors-when-raising-a-series-a-says-deepscribes-akilesh-bapu/" target="_blank" rel="noopener">TechCrunch Live</a> about their Series A fundraising process. Akilesh Bapu, the CEO and co-Founder of DeepScribe, was interviewed along with Nina Achadjian, a VC and Partner at Index Ventures. Nina invested $30 million into the company, and was impressed with the founders and the story they explained during their pitch.</p>
<p>In addition to giving Kruze Consulting a shout-out for our help on his accounting diligence (thanks Akilesh!) he also walks through part of his VC pitch deck. It’s one of the better examples that we’ve seen of a live pitch deck presentation. You can <a href="https://www.youtube.com/watch?v=QBfxl_e5XdE&t=553s" target="_blank" rel="noopener">watch on Youtube</a> or see below.</p>
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<h2 id="what-questions-do-vcs-ask-during-a-pitch">What Questions do VCs ask During a Pitch?</h2>
<p>Questions during a pitch are a GREAT sign - that means that the venture capitalist is paying attention. I strongly recommend founders use their venture capital pitch deck as a crutch, jumping to the right slide to answer the specific question , then going back to the original presentation order to make sure all important topics are hit. Again, I’ve seen partners reject a company because “the founder didn’t talk about go to market.” Yeah, they didn’t have time to talk about it because of all of your questions! </p>
<p>Here are some of the trickier questions investors might ask during a presentation. Think about which slide you might be able to use to answer these questions. Resist the temptation to argue with a VC if they ask difficult questions; saying you don’t know but then laying out your plan to figure it out is a great response to many questions. </p>
<h3 id="questions-vcs-ask">Questions VCs Ask</h3>
<ul>
<li>What’s the backstory?</li>
<li>Tell me about yourself </li>
<li>How did you meet your cofounder?</li>
<li>Tell me about the team? How did you find your first hires?</li>
<li>What is the specific problem you are solving?</li>
<li>What’s the key insight about your user that led you to build this business?</li>
<li>What’s the ideal outcome for your customer?</li>
<li>How are customers currently solving this problem, before your product/solution existed?</li>
<li>What differentiates your solution from alternatives?</li>
<li>What have your biggest learnings been so far?</li>
<li>How are you planning to acquire customers?</li>
<li>What would your customers say about your solution, and how would they react if it went away (i.e. you went out of business)?</li>
<li>Why now? What has changed in technology or the market that makes this possible only now?</li>
<li>What do you think has to go right for this to be a massive outcome?</li>
<li>How much do you want to raise, and what milestones do you hit with that capital?</li>
</ul>
<h2 id="vc-pitch-deck-faq">VC Pitch Deck FAQ</h2>
<p>Because Google says people are asking questions.</p>
<h3 id="what-is-a-vc-pitch-deck">What is a VC pitch deck?</h3>
<p>A VC pitch deck is a presentation (typically in Powerpoint, Google Sheets or PDF) used to explain a startup idea to potential venture capital investors. A pitch deck contains information on the business, the market and the company’s traction/financials. </p>
<h3 id="what-is-a-pitch-deck-used-for">What is a pitch deck used for?</h3>
<p>These presentations are used to 1) convince venture capitalists to take a 1st meeting with the founder(s); 2) begin investment due diligence and 3) convince the venture firm’s partnership to want to invest in a startup. </p>
<h3 id="will-a-deck-help-you-get-a-meeting-with-a-vc">Will a deck help you get a meeting with a VC?</h3>
<p>A great venture capital pitch deck <strong>may</strong> help you get a meeting with a venture capitalist. VC firm NFX reminds startup founders that investors are looking for the following 12 data points before taking a meeting with a startup:</p>
<ol>
<li>Team</li>
<li>Company description</li>
<li>Market opportunity</li>
<li>Business model (how you make $ + your financial projections)</li>
<li>Geography (less important post COVID)</li>
<li>Team size (FTEs)</li>
<li>Timing of the fundraise</li>
<li>Company traction</li>
<li>How much you are raising</li>
<li>Fundraising history</li>
<li>Fit for the specific VC</li>
<li>Referrer - who introduced you to the fund</li>
</ol>
<h3 id="does-your-venture-capital-presentation-have-to-be-powerpoint">Does your venture capital presentation have to be PowerPoint?</h3>
<p>VCs typically expect a slide deck; these days usually a PowerPoint, Google Slides or a PDF of one of those formats. I’ve been with companies that have used designers to create an incredibly slick venture capital presentation, which they presented as a PDF - no idea which tool was used to actually design the presentation, but it was likely an Adobe product. The most important thing is making the presentation be in 1) slides and 2) something they can share and access from their computer.</p>
<h3 id="is-it-ok-to-share-your-venture-capital-presentation-by-docsend-or-a-presentation-sharing-platform-instead-of-as-an-email-attachment">Is it OK to share your venture capital presentation by DocSend or a presentation sharing platform instead of as an email attachment?</h3>
<p>These days more and more VCs are Ok getting the presentation as a DocSend or other presentation sharing platform that asks for their email address or asks to verify that they are someone you to share the document with. However, you’ll occasionally find the grump VC who wants their presentation the old school way. Often these investors write up their dislike of sharing tools on their blog or Twitter. </p>
<h3 id="how-do-you-modify-your-pitch-deck-for-the-final-all-hands-vc-partner-pitch">How do you modify your pitch deck for the final, all-hands VC partner pitch?</h3>
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</iframe>
</div>
<p>The final step to getting a term sheet, at many venture capital firms, is to pitch the partnership one final time. This is after you’ve already gotten one of the partners to support your investment internally as the champion. In the final meeting, you’ll have the full range of understanding of your company - from the partner who is supporting you and who knows a ton to partners who know close to nothing. </p>
<p>It’s not safe to assume knowledge on your industry or problem. Invite all the partners into the fold by explaining and building excitement around what you are doing. Don’t gloss over the market size or competition! </p>
<p>Hope this helps you find a good pitch deck template for your fundraise! <!--Post Content--></p>4d886ec3-5690-47fc-b77c-d1f3754b1a35A big part of my job at Kruze is to help our clients prepare to raise venture capital. So I’ve seen a lot of venture capital pitch decks recently. As a former VC who also has been an exec at a number of startups that have raised quite a few million in venture financing, I have some strong views on what information VCs want to see. And because Kruze clients raise over two billion dollars in venture funding annually, I get to see a lot of what works - and what doesn’t. Since I’m regularly being asked for a template for a venture pitch deck, I thought that I’d compile the best templates available on the internet that I know about. Again, I’m strongly biased, as I’ve seen many companies successfully raise and some not. These are pitch deck examples that I think are working. In addition to the example presentations below, I also lay out the standard slides that I’ve seen companies use to successfully raise venture funding. You can scroll down to also see a TechCrunch interview with a Kruze Client, DeepScribe, where the founder and their investor walk you through the deck they used to raise a $30M round. Finally, I’ve added in a dozen+ questions that VCs often ask founders during the pitch (I’ll probably create an entire article around VC questions and answers). We’ve released our free startup pitch deck course! It includes 2 free Google Presentation templates that are free to use, and one downloadable financial model template - plus over 8.5 hours describing what VCs look for on every slide in the deck. Again, the pitch deck course has two free templates that are free to use. No email or registration or anything - just click the links, open the Google Slides and duplicate them into your own Google Drive. One of the free templates is a B2B example, the other is a B2C example. Haje Kamps, the well known TechCrunch writer who produces the pitch deck teardown series, helped me create those free templates - so get them! Top 10 11 venture capital pitch deck templates on the internet right now Guy Kawasaki’s pitch template - https://guykawasaki.com/the-only-10-slides-you-need-in-your-pitch/ This is the OG demo pitch deck. Short and sweet. Starting to get a bit long in the tooth, but still the first one to check out because it will highlight how simple and short can be better (don’t make a 30 slide deck!!) Ycombinator’s slide template - https://blog.ycombinator.com/intro-to-the-yc-seed-deck/ The actual deck that YC links to (it’s a Google Slide file) has such poor design, I wouldn’t recommend using it. HOWEVER, the order of slides and the topics are 100% on, so it’s worth carefully reading the commentary in the actual post. I like the final slide, as it clearly outlines how much funding is needed and the use of the funds. A solid slide to end the conversation on. First Round Capital’s deck - https://www.beautiful.ai/blog/uber-vc-pitch-deck-presentation-template One of the top, East Coast VCs supposedly had a hand in creating this one, and the slide order/content is one of the best examples of what to put into your deck. I don’t know how you actually download this - it’s in some kind of a proprietary format, but if you are looking for a view on how to order and design a pitch deck, this is one you must check out. Series A pitch deck used by Front to raise their A - https://medium.com/@collinmathilde/front-series-a-deck-f2e2775a419b This founder very kindly shared their slides and fund raising experience. Great example of a competition slide in an industry that has a lot of legit competitors. Airbnb’s seed deck - https://www.alexanderjarvis.com/airbnb-seed-pitch-deck/ This is a classic (although the visual design did not age well). If you are looking for a consumer deck or one that talks about how to launch into a new(ish) industry, this is worth looking at. We’ve also put links to six five other examples below, like the Uber deck and the Mattermark slides. Scroll down to see more real-life examples, and dig into our commentary on slide order and content strategy. Slides in an example pitch deck The professionals (like YC and Guy Kawasaki) are suggesting 10 slides in a standard pitch deck. I think the real point is that you should be able to deliver your pitch in 15 minutes or less - and if pressed, do a 5-minute pitch. That’s really short. Why so short? Aren’t most VC meetings scheduled for 30 minutes? Well sure, but… Assume that your VC is late to the meeting by 5 minutes (they will always say something like “something came up with a portfolio company’s acquisition, but the truth is probably that the barista messed up and gave them an almond milk latte instead of a soy milk one and they had to wait for the right beverage - kind of a joke.) The VC will probably then give you a few minute spiel around what makes their fund different. Then assume that you need to answer at least 5 minutes of questions if your pitch is not going well - and 10 minutes of questions or more if the investor is engaged. And you’ll need a 5-minute pitch, that isn’t rushed, if some important partner is running way late or misses the first 20 minutes of your 30-minute meeting. The standard table of contents in a good pitch deck is: Based on the $1 billion our clients raised last year in VC funding, we think you will want: 1. Cover/title slide - including the company name and the founder’s contact info 2. The industry’s or customers’ problem - the pain that your startup is solving 3. Your startup’s solution or value proposition - how your startup fixes the issue / the benefits you provide The templates start to diverge, so a few different next slides are: 4. EITHER: Traction - metrics that show adoption or market validation or Product magic/product demo - showing off the offering 5. EITHER: Market size Business model / how you make money 6. Go to market/growth - explain how you are going to grow 7. Competition and or competitive analysis/advantages - all startups have some sort of competition, or there is at least a way that customers are currently dealing with the pain your startup is solving 8. Team 9. Financial projections - include revenue growth, high-level spend, burn, and other KPIs like customer count (you can go deeper in an appendix or in a financial model). And if you are looking for a free downloadable model template, visit our financial modeling page. 10. Summary: How much you are raising Traction if you haven’t already done so Use of proceeds (what you do with the money) Current investors participation level (if any - strong investors who have already invested in previous rounds and who are participating in this one are a very good signal) I am slightly older school - I usually like an “executive summary” after the cover page that goes over the company and round. I think this is probably a page that went out of style in 2015 or so, but I still like it because it quickly helps the VC see what your key metrics/sales points are, and how much you are raising. I usually recommend only four or five bullets on this slide: Disrupting the $x billion industry 1,500 customers using product [or] Marquee customers include McDonalds and Marriott ARR of X, growing 20% month over month Team has deep domain experience from XYZ Raising $8 to $10 million Series A Given that YC and Guy Kawasaki seem to no longer (or maybe never) had an exec summary at the front of their venture capital pitch deck templates, you are probably OK ignoring my advice and just getting straight from the cover page to the problem statement. Tips for your slides Here are some of the slides that we mention above and some tips that founders we work with have found helpful: Problem Slide - Invite the investor into discussing / discovering the problem with you. Some problems are obvious - but that doesn’t mean that the VC has thought about them deeply before. Help the investor understand the issues from the eyes of the buyer/consumer. The best venture capital pitch decks have problem slides that are strong enough to make the investor really, really want to meet with you. Go to Market / Growth Slide - For companies that are already generating revenue and growing, show that you know who your customers are and where you can find them. For pre-revenue startups, use this slide to prove that the founders have 1) thought about how to sell the product and 2) have a plan on what you will try to prove vis a vis your sales and marketing with the capital you are raising. Seed Pitch Deck Outline Our COO, Scott Orn (also a former VC) has been assisting a number of seed and pre-seed companies during their fundraises, and has produced an outline/template for a seed pitch deck. Pre-seed is sort of a new asset class. It’s essentially the first money in. That’s what seed used to be for everyone. So this is applicable to pre-seed and seed - basically, what to present when your company is more of an idea. Company’s slogan / 1 sentence elevator pitch - the first page or first slide should really just be the company’s name and slogan, or the one sentence, what you are doing. And just get the audience focused on that. Make sure to make an impression, deliver it with passion. You are in sell mode here. You’re pitching investors. Problem - what are your customers struggling with? A lot of investors like the problem-solution type of framework, so the next slide would be the problem. So talk about how your potential customers are suffering, what’s going on right now in the market, why it’s not working, and then the next page in the deck will be your solution. Solution - how are you going to make everyone’s life better? You can explain how you’re going to be better, how you’ll save your clients or customers a ton of time, a ton of money, etc. Better, faster, cheaper is a Silicon Valley slogan that people typically use when explaining their startup’s solution. The Product / Service Nothing is more powerful than a demo. That also shows that the company has actually built something and you can get a taste for it. Often you see a screenshot of the demo and often can click for video. Some people like more visual depictions of what you are doing. Regardless, in this section, something visual is pretty helpful. You want to get the conversation going, you want them to react to something, you want them to feel vested in what you’re doing. Get them to buy into the solution. Market Size This is kind of a “check the box” because it’s always hard to size the market. And many of the best companies look like they have a tiny market but turn it into something huge. But it’s a good exercise and tells investors where you are going. And, remember, venture capital is really just wanting to invest in big opportunities. VCs are okay with some losses, but when something works, they need it to be big. And so that’s why they really care about market size. This section helps prove to the seed investor that you are pointed at a big possible market, and that you are aiming to make a big company vs. a nice, small, lifestyle business. You would be surprised at how many small businesses, that never really anticipate getting bigger than a couple of million in revenue, try to raise seed financing. So the seed investors need to be able to weed out the entrepreneurs who are not focusing on big opportunities, and you do that in this part of your seed pitch deck. And if you’re willing to spend a bunch of your time, five, 10 years of your career on something, there better be some size to it! Competition You want to identify competitors. If you pretend you don’t have competitors or bad mouth them, you’ll lose credibility. investors typically like you to acknowledge your competition. And oftentimes there’s a little bit of education, because you know this market really well, but the seed investor doesn’t, so here is where you teach them about the competition. Seed investors know that competitors aren’t the end of the world. In fact, the best venture capitalists actually LIKE successful competitors, because it helps validate that there is a market for the solution. Go to Market Plan This is a super important slide. Are you using a sales team? Partnerships? Online marketing? Events? Creativity, different approaches and things that investors have seen work are great. Financials How much money do you need? How long will that get you? When do you think you’ll start to generate revenue. A visual is really good as part of this slide. It’s important to understand the seed investors mindset on this slide. They are doing the math, and they’re thinking, what does this company need to raise money from a series A venture capitalist? Because really, at every step of the venture capital game, people are putting money into your company and then hoping other people will step up down the road to fund the company. The seed investors that you are pitching only have so much capital. They are going to rely on your company doing well enough, and looking strong enough, to be able to get a VC to invest in your next round. And so, they’re doing that math and trying to figure out what is going to be that milestone that really brings other venture investors in the company? Exit Opportunities Some seed investors don’t want you to talk about a sale eventually. They are essentially saying “I don’t want to even hear that you’re thinking about selling the company in three years or four years, or how could you possibly know who’s gonna buy it?” Which is very fair. So you needed to kind of tread lightly on this. I think the way I typically like to do this is just point out the players in the market and make the point that if you get traction and you’re successful, these people or these companies are gonna have a real strong vested interest in acquiring you. And so that’s kind of enough. It’s enough to say that if we hit traction, there will be a lot of interested companies like X, Y Z. You don’t need to say like “I’m going to get bought for X number of dollars in year three” or something like that. Just talking about who could buy you or who would be interested is a delicate way of doing this. It’s always great when a founder says, “I’m taking this through IPO. I’m committed.” Note from Healy: While Scott may really like this slide, I don’t love it as much, because, as Scott mentions, it makes me afraid that the CEO is not in it for the long term. I usually prefer to discuss this on the competition slide, “here are other, very big companies, that don’t play in this solution but who have the same customer base as we want… they may get into our market. Who knows, they may acquire their way in once they realise the solution is being adopted.” I like that method better, as it doesn’t imply to the seed investors or the VCs that you are putting the cart before the horse, instead it says that you know who the heavy hitters are in the general market, and then the investor can do the mental math to think that they may want to buy their way in eventually. Team - some people like to put this way up in the front, right after the slogan and what they’re doing, because they have a team that has accomplished a lot and the team is backable just because they’re just so successful and so technically strong and know what they’re doing. But you can have it here at the end of the presentation, either way is fine. It’s good to get some bios up there, get some pictures so that people can identify. Also the nice thing about bios and your founding team in the slide is that oftentimes you can play the name game with venture capitalists or seed investors - they’re professional networkers, they know a lot of people. And so oftentimes, you can get to a point where they know someone that’s on your team or that you know, and that’s a really great background diligence channel. If they want to invest in you, they may actually call their friend who knows someone on the founding team or knows you and just check and see what kind of person you are or your team is just for diligence sake. It also can be very impressive if it’s a super strong technical team or a marketing team that’s gone to market in a really unique way. But, wherever you put it in the pitch deck, definitely have a team slide. Any examples of progress - this is huge. If you can say you already have clients, revenue, etc, it is much more convincing. All these signs that what you are doing is working, and that it’s legit and it’s something the seed investors want to be a part of, it’s a social proof type of thing if you know that from influence. And so showing your traction is probably the best thing you can do to sell the company. So don’t hesitate to do that. If you have a commitment from a lead investor, that’s great, always put that in this slide in the pitch deck because it’s a lot easier to follow on than be the lead and set the evaluation, write the check, that’s a lot of responsibility and sometimes people don’t want to do that. But that’s what you can end up with. And then there’s a tiny little tip which is, oftentimes you get to the end of the presentation and that slide just sits up there for the remainder of the pitch discussion. If it’s going to sit there, just make it like something showing how awesome you are or helping you close the sale, maybe it’s pictures, maybe it’s graphs or your traction. Instead of having that boring, “questions” slide, do something that spices it up. And every time they kind of subconsciously look at the slide deck on the wall, or the presentation, even though you’re just talking after the presentation has been done, it can kind of help convince them in a small way. So just a little tip to help your pitch deck be a bit stronger at the end. At the seed stage, you’re still living the dream and you’re convincing investors that they should come along. So it’s a little less finance, a little less metrics and more vision. But really this framework should work for any type of venture capital presentation. How to write a pitch deck to raise funding Ok, so you’ve now seen the VC and seed deck outlines above - but how so you actually start writing a presentation that will help you get funding? Here is how I have successfully written pitch decks when I was raising VC money: Understand WHY you’ll be able to raise funding - this could be your traction, the market, the team, the product strength. Find the one thing that will blow investors out of the water, and build your story around it. Now that you know what your biggest strength is, put together the outline of the deck. Decide what the one major takeaway is for each slide - this might be the slide title, or it might be a point driven by an image or chart. But you only have a handful of slides, so each one has to drive the vision forward; make each one count. Start from the strength slide; don’t get it perfect yet, just make sure it highlights the “wow.” Next, fill in the rest of the slides, remembering that you are selling your vision. Use data, market insights, customer quotes to support the conclusion that your company is going to be successful. Now, practice running through the deck. It sounds cheesy, but I recommend doing it out loud! Make improvements to the slides and flow based on how it sounds delivering it to yourself. You are ready to practice on some “friendlies” - either current investors, partners, mentors. Get their opinions, and then iterate the pitch deck until you feel confident that you’ve got the story down. Tips for your fund raising presentation if time is running short Ok, so as I outlined, it’s highly likely that your 30 minute conversation gets cut into a much shorter time frame. There are good ways to handle this and bad. The worst way that I’ve seen is when a CEO talks REALLY REALLY fast and blows through the preso. It’s hard for anyone to soak in the information, it can be hard to understand, and it usually doesn’t work. A better way is to have the 5 minute presentation ready to go, and then to just walk through that briskly. No demo, and try to answer the VC’s questions as quickly as possible. Common mistakes founders make crafting their investor pitches In the Kruze pitch deck course, I talked with renowned pitch deck consultant and author, Haje Kamps, about some of the most common mistakes we’ve seen founders make over and over when they present to potential investors. Here are some of those problems - and you can watch the entire video. Making the Team Slide Weak: We’ve noticed that many founders often inundate their team slide with unnecessary information, such as a full organizational chart, instead of focusing on key members and demonstrating their relevant skills for the specific startup. Don’t overload it; you don’t get points for lots of logos. Instead, figure out the most relevant or impressive items and Misunderstanding Market Size: The total addressable market and serviceable markets need to be sizeable enough to show potential for a venture-scale company. It’s fine to start in a niche, but you need to be able to create a company that’s worth at least a billion dollars, if not more. As you need to be attacking a big space. Unrealistic Projections: We’ve seen founders showcasing either slow, steady growth or overly aggressive, unrealistic growth - both extremes are unappealing to investors. Look at some of the templates we share on this slide - those projections are good! You aren’t going to go from founding to $100 million in revenue in a year. And if you are growing from $4 million to $4.5 million in revenue, congrats, you’ve got a great small business, but it’s not venture-scale. Failing to Accurately Represent Traction: A traction slide should provide substantial evidence of growth, often in the form of customers generating revenue or being in the sales funnel. Unfortunately, many founders include markers such as press coverage or vague “interest” that doesn’t translate into tangible growth. Lack of a Coherent Story: Haje really talks to this well. It’s essential for founders to weave a coherent story that sells not just the product, but the vision of the company and its future value. Many founders fail to communicate this effectively, resulting in a disconnected or confusing narrative. You want the partner who you just presented to to be able to walk off and talk about one of your main customer successes, and how that ties into your company’s vision and traction. Absence of a Competition Slide: Many founders overlook the importance of including a competition slide in their presentation. This is a major mistake, as not acknowledging competition can lead investors to think the founders are unaware of their market landscape. It’s one of my favorite slides. If you’ve got big competitors, great, you’ve just helped the VC understand who you might sell the company to in a few years! That’s just a few of the top venture capital pitch deck fails we go over in the video - check it out. Being aware of these common mistakes and addressing them in your pitch deck can significantly enhance your chances of capturing a venture capitalist’s interest. Common VC Pitch Deck Fails Video Tips for the financial section of your pitch deck As financial advisors to funded startups, we tend to overly index on the financial section of our client’s fundraising pitch decks. Note that this is our interest area (and how we get paid), so it may or may not be all that interesting or important for your startup’s presentation. The financial detail that you go into in your VC deck will vary based on the stage of your business. So, let’s breakdown what you might need for a seed to Series C company. Seed stage - Your pitch deck only needs a brief description of what you are intending to do with the money. As Scott mentioned above, a visual can go a long way here. Since revenue is now often expected for an A, you should articulate some sort of an expectation in revenue before the money runs out (i.e. investors want to know if you’ll have the exit velocity you need to raise the next round). Series A - A 5-year view is ideal, as this gives you the chance to show / “prove” that you are going to create a venture scale business. An extrapolated income statement with include revenue growth, high-level spend, burn, and other KPIs like customer count. You ought to have an appendix with more detail - or just a piece of excel that you can share (probably better at this stage). Series B - You are still going to need the 5-year projections. But, at a B, you’ll have more financially minded investors. This means that you ought to have a real appendix section that gets into the drives and assumptions to your continued growth. SaaS companies are going to need to be able to explain how they calculate their LTV to CAC - so your pitch deck will have to address both parts of that calculation. You can still put the detail in the appendix, but have it organized so that you can go through all the financial part in an organized presentation if needed. Series C - Series C companies should have real financials that have been prepared by a professional accountant, either in house or as a consultant. While you’ll still want a single slide in the meat of the pitch deck that has your five year vision, your historical results will also matter - so that slide will have to do a lot. This may mean that you have to push your KPIs like customer count into a seperate slide(s). And the financial appendix should have historical statement - probably all three - and projections. Finally, we’ve complied some other pitch deck examples that you may find helpful. Again, we think the best VC pitch decks templates/examples are the ones we highlighted at the top of this page, but here are some of the others that are floating around on the internet that you may like. FiveSIX More of the Best Pitch Deck Examples Uber (pitch deck here) - this is when they were still called “UberCab.” And it’s very early in the life of the company, so is product and market focused. You won’t find data about the company’s performance, since it’s so early. This deck may be helpful to pre-launched startups. Intercom (seed pitch deck here) - another example of a seed stage pitch deck, this one for when Intercom was raising $600k. This is a short deck - only 8 slides - and it focuses on the team, problem, solution and market. Note that the “progress” slide consists of a tweet from a user - pretty slight - you may not be able to get away with this lightweight of a presentation unless you have the clout of these founders. BUT if you are looking to talk about the market size and opportunity, this is a decent example. Mattermark (deck here) - data company Mattermark has real traction, and there are several examples of solid metrics/charting visuals in this deck. With $1.5M in ARR at the time of this pitch, they are probably around where many Series A’s are getting done in Silicon Valley. (I’ve even seen Series B’s happening at this level). This is a great pitch deck example if you are looking to impress the VCs’ with your traction. Check out slides 11, 12 and 13 for information on how to present historical revenue growth, projections and customer industry diversification. Mixpanel (deck on slideshare here) - Mixpanel shared their deck as an example that other startup can use. This is the set of slides that Mixpanel used to raise a $65M round. The competition slide is particularly good for driving a disucssion with the VCs. The traction slide is also strong - one of the best in combining the visual “up and to the right” chart with some details on the company’s milestones. The slide that is close to the “what we do with your money / operating slide” is a good overview of what the company needs to do to grow, although it’s not as focused on financials as I’d like. Mint (seed pitch deck here) - A great seed stage fundraising deck, with the whole enchilada: a good team slide, a great market size one, solid competition, user acquisition, and a financial slide that makes my inner accountant happy. Notice the flow on this slide, with the team slide right near the front. This could be the best template/example for companies with an experienced team. Orange (seed pitch deck template here) - A great example of a hardware as a service deck. It gets into the problem, the market size, the solution and then makes a solid case for why this team is the one to solve it. One of the best parts of this one is the intro slide - it kicks off right at the front with a strong explanation of what the problem is, and the VC looking at it can immediately infer what the startup’s solution is. So that makes 11 of the best pitch deck templates and examples that we’ve seen on the internet. Pitch Deck Example from a Kruze Client One of our clients, DeepScribe, was interviewed on TechCrunch Live about their Series A fundraising process. Akilesh Bapu, the CEO and co-Founder of DeepScribe, was interviewed along with Nina Achadjian, a VC and Partner at Index Ventures. Nina invested $30 million into the company, and was impressed with the founders and the story they explained during their pitch. In addition to giving Kruze Consulting a shout-out for our help on his accounting diligence (thanks Akilesh!) he also walks through part of his VC pitch deck. It’s one of the better examples that we’ve seen of a live pitch deck presentation. You can watch on Youtube or see below. What Questions do VCs ask During a Pitch? Questions during a pitch are a GREAT sign - that means that the venture capitalist is paying attention. I strongly recommend founders use their venture capital pitch deck as a crutch, jumping to the right slide to answer the specific question , then going back to the original presentation order to make sure all important topics are hit. Again, I’ve seen partners reject a company because “the founder didn’t talk about go to market.” Yeah, they didn’t have time to talk about it because of all of your questions! Here are some of the trickier questions investors might ask during a presentation. Think about which slide you might be able to use to answer these questions. Resist the temptation to argue with a VC if they ask difficult questions; saying you don’t know but then laying out your plan to figure it out is a great response to many questions. Questions VCs Ask What’s the backstory? Tell me about yourself How did you meet your cofounder? Tell me about the team? How did you find your first hires? What is the specific problem you are solving? What’s the key insight about your user that led you to build this business? What’s the ideal outcome for your customer? How are customers currently solving this problem, before your product/solution existed? What differentiates your solution from alternatives? What have your biggest learnings been so far? How are you planning to acquire customers? What would your customers say about your solution, and how would they react if it went away (i.e. you went out of business)? Why now? What has changed in technology or the market that makes this possible only now? What do you think has to go right for this to be a massive outcome? How much do you want to raise, and what milestones do you hit with that capital? VC Pitch Deck FAQ Because Google says people are asking questions. What is a VC pitch deck? A VC pitch deck is a presentation (typically in Powerpoint, Google Sheets or PDF) used to explain a startup idea to potential venture capital investors. A pitch deck contains information on the business, the market and the company’s traction/financials. What is a pitch deck used for? These presentations are used to 1) convince venture capitalists to take a 1st meeting with the founder(s); 2) begin investment due diligence and 3) convince the venture firm’s partnership to want to invest in a startup. Will a deck help you get a meeting with a VC? A great venture capital pitch deck may help you get a meeting with a venture capitalist. VC firm NFX reminds startup founders that investors are looking for the following 12 data points before taking a meeting with a startup: Team Company description Market opportunity Business model (how you make $ + your financial projections) Geography (less important post COVID) Team size (FTEs) Timing of the fundraise Company traction How much you are raising Fundraising history Fit for the specific VC Referrer - who introduced you to the fund Does your venture capital presentation have to be PowerPoint? VCs typically expect a slide deck; these days usually a PowerPoint, Google Slides or a PDF of one of those formats. I’ve been with companies that have used designers to create an incredibly slick venture capital presentation, which they presented as a PDF - no idea which tool was used to actually design the presentation, but it was likely an Adobe product. The most important thing is making the presentation be in 1) slides and 2) something they can share and access from their computer. Is it OK to share your venture capital presentation by DocSend or a presentation sharing platform instead of as an email attachment? These days more and more VCs are Ok getting the presentation as a DocSend or other presentation sharing platform that asks for their email address or asks to verify that they are someone you to share the document with. However, you’ll occasionally find the grump VC who wants their presentation the old school way. Often these investors write up their dislike of sharing tools on their blog or Twitter. How do you modify your pitch deck for the final, all-hands VC partner pitch? The final step to getting a term sheet, at many venture capital firms, is to pitch the partnership one final time. This is after you’ve already gotten one of the partners to support your investment internally as the champion. In the final meeting, you’ll have the full range of understanding of your company - from the partner who is supporting you and who knows a ton to partners who know close to nothing. It’s not safe to assume knowledge on your industry or problem. Invite all the partners into the fold by explaining and building excitement around what you are doing. Don’t gloss over the market size or competition! Hope this helps you find a good pitch deck template for your fundraise!New R&D Tax Legislation: What Startups and VCs need to know2024-01-23T00:00:00+00:002024-01-23T00:00:00+00:00https://kruzeconsulting.com/blog/new-r-d-tax-legislation-what-startups-and-vcs-need-to-know<p><img src="/uploads/new-r-d-legislation-2.jpg" alt="" width="2200" height="1300" /><br /><!--Post Content--></p>
<p>Congress is working on a tax package (called the Smith/Wyden tax package) that could revive key tax provisions, including the deductibility of research and development expenses. This legislative change is important for startups – under current rules, even money-losing startups could actually owe taxes. 5% of Kruze clients fell into this category last year, even though close to 100% of those startups were burning cash. </p>
<p>The tax treatment of <a href="https://kruzeconsulting.com/research-and-development-tax-credit-us/"><u>research expenses</u></a> was changed by the 2017 Tax Cuts and Jobs Act (TCJA). R&D expenses used to reduce taxable income dollar for dollar – if a startup spends $1 million on R&D, its taxable income goes down by $1 million. However, beginning in 2022, startups were <a href="https://kruzeconsulting.com/section-174-FAQ/"><u>required to amortize</u></a> deductions over five years for expenses in the US or 15 years for expenses incurred outside the US. For many startups, $1 million in US R&D spend became only $100,000 in expenses in 2022, for federal income tax purposes, and many startups that may not have had a tax bill under the old rules could now face a tax obligation. </p>
<p>The current legislation proposes to restore 100% deductibility and would be retroactive to R&D expenses made from the beginning of 2022 to 2025. The overall $78 billion tax package is very complex, and is currently under negotiation.</p>
<h2 id="whats-included-in-the-legislation">What’s included in the legislation?</h2>
<p>The primary goal of the new legislation is to establish a bipartisan agreement before the tax filing season begins on Jan. 29. The current legislation has several business tax components, rolling back some of the TCJA provisions: </p>
<div><table><tbody><tr><td><p><strong>Provision</strong></p></td><td><p><strong>Impact on Startups</strong></p></td><td><p><strong>Detail</strong></p></td></tr><tr><td><p>Restoring R&D to full deductibility</p></td><td><p>HIGH</p></td><td><p>Businesses will again be allowed to deduct 100% of domestic R&D expenses in the taxable year the expenses are paid. Under current law businesses are required to amortize US R&D expenses over five years or 15 years if the expenses are outside the US. </p></td></tr><tr><td><p>Business interest deductions deductibility</p></td><td><p>LOW</p></td><td><p>The limit on business interest deductions will increase due to a change in the formula for calculating a business’s adjusted taxable income (ATI). Currently the deduction is limited to 30% of the taxpayer’s ATI, with some exemptions for small business, farming, and real estate businesses. The TCJA removed depreciation and amortization from the formula for calculating ATI, which made ATI less and reduced the deduction amount. This is not particularly helpful to startups, unless they are close to net income positive and have debt.</p></td></tr><tr><td><p>100% depreciation </p></td><td><p>MODEST to LOW</p></td><td><p>100% “bonus” depreciation will be reinstated, which allows taxpayers to immediately deduct all of the purchase price of eligible assets rather than write them off over the “useful life” of the assets. This may be helpful to revenue generating startups that spend a lot on capital expenditure.</p></td></tr></tbody></table></div>
<p>The plan calls for these provisions to be retroactive, with the R&D expense and business interest deductions applying from the beginning of 2022, and the bonus depreciation applying from the start of 2023.</p>
<p>The legislation would also expand the Child Tax Credit (CTC) to make it easier for more families to qualify, by allowing families to use their income from either the current or prior year, changing the calculation to increase the benefit, and incrementally increasing the maximum refund amount per child through 2025.</p>
<p>Another provision would extend the statute of limitations for the IRS to pursue fraudulent or erroneous claims of the Employee Retention Tax Credit (ERTC or ERC), and prohibit new claims after January 2024. While intended to help business owners during the pandemic, the ERC has been exploited by aggressive marketing firms that encouraged businesses to file inaccurate claims. The proposal would also increase the penalty for aiding and abetting the understatement of a tax liability by an “ERC promoter” to help address the issue of inaccurate claims. These changes are intended to help offset the cost of the new tax framework. If your startup took ERC funds, read our <a href="https://news.crunchbase.com/venture/vcs-portfolio-companies-tax-fraud-kruze-consulting/" target="_blank" rel="noopener"><u>Crunchbase article on ERC fraud</u></a> to make sure you are not going to get caught in fraud accusations.</p>
<h2 id="what-is-the-impact-for-startups-and-vcs">What is the impact for startups and VCs?</h2>
<p>The primary impact for startups and small businesses are the “Big Three,” which have been some of the biggest issues for businesses: </p>
<ul>
<li><strong>R&D expensing.</strong> This revision is the most significant benefit to startups, which often invest heavily in research and development. Startups would once again be able to deduct R&D expenses incurred in the US in the tax year they’re incurred. Frequently referred as <a href="https://kruzeconsulting.com/section-174/"><u>Section 174</u></a> expensing, based on its Internal Revenue Code (IRC) designation, the legislation proposes to reinstate full deductibility retroactively, beginning with 2022, and continue through 2025. Specific information about how this will be implemented and whether it will require filing amended returns is not available yet. The 15-year amortization for foreign R&D expenses will remain unchanged. </li>
<li><strong>Business interest deductions.</strong> For startups with loans, the current limits on deducting business interest will be revised under the new legislation. IRC Section 163(j) limited the amount of depreciation to 30% (for most years) of the startup’s adjusted taxable income (ATI) excluding depreciation and amortization (effectively changing the startup’s EBITDA to EBIT). Now startups can again add depreciation and amortization back into ATI for 2022 and 2023. Adding those expenses back into ATI increases overall income, which means the 30% ATI amount is larger.</li>
<li><strong>100% “bonus” depreciation.</strong> Also known as additional first-year depreciation deduction or the IRC Section 168(k) allowance, this provision accelerates depreciation schedules by allowing startups to write off a larger portion of an eligible asset’s cost in the first year it was purchased. The TCJA allowed businesses to immediately write off the full cost of eligible assets that were acquired after Sep. 17, 2017 and before Jan. 1, 2023. Before the TCJA the percentage was 50%, so this was a significant benefit to startups that purchased eligible assets. However, the 100% write-off was decreased by 20% each year (so the percentage was 80% in 2023, 60% in 2024, etc., and decreased to zero in 2027). The new legislation would restore 100% depreciation through Jan. 1, 2026 or Jan. 1, 2027 for some property. The phaseout would begin a year after. </li>
</ul>
<p>For VCs, the biggest impact may be on portfolio companies that raised ERC funding and now may be accused of tax fraud by the IRS. We encourage venture capitalists to ask their portfolio companies if they participated in the ERC program, and if so, make sure that they are working with an experienced tax CPA to help them stay clear of the upcoming enforcement actions.</p>
<h2 id="what-should-startup-founders-expect-next">What should startup founders expect next?</h2>
<p>The House of Representatives’ tax-writing committee approved the bill with bipartisan support on Jan. 19. The House is scheduled to be in recess the week of January 22, 2024, so the earliest the House could hold a floor vote would be January 29. A strong bipartisan House vote would encourage the Senate to also pass the bill. Before that, however, Congress is going to have to act on temporary funding legislation to avoid a partial government shutdown on January 19. </p>
<p>Until the tax package is finalized and approved, the IRS will not be able to provide guidance on tax filings. Since many of the changes to the “Big Three” are retroactive, startups may have to file amended 2022 returns, or adjustments could be made to 2023 returns.</p>
<p>Finally, while we typically stay out of politics, we do encourage founders and investors to contact their legislators. We believe that innovation is a cornerstone of the US economy, and that Congress should support research and development – not tax it.</p>b8e9a313-a30e-4a16-8a3a-10c78098ad1aCongress is working on a tax package (called the Smith/Wyden tax package) that could revive key tax provisions, including the deductibility of research and development expenses. This legislative change is important for startups – under current rules, even money-losing startups could actually owe taxes. 5% of Kruze clients fell into this category last year, even though close to 100% of those startups were burning cash. The tax treatment of research expenses was changed by the 2017 Tax Cuts and Jobs Act (TCJA). R&D expenses used to reduce taxable income dollar for dollar – if a startup spends $1 million on R&D, its taxable income goes down by $1 million. However, beginning in 2022, startups were required to amortize deductions over five years for expenses in the US or 15 years for expenses incurred outside the US. For many startups, $1 million in US R&D spend became only $100,000 in expenses in 2022, for federal income tax purposes, and many startups that may not have had a tax bill under the old rules could now face a tax obligation. The current legislation proposes to restore 100% deductibility and would be retroactive to R&D expenses made from the beginning of 2022 to 2025. The overall $78 billion tax package is very complex, and is currently under negotiation. What’s included in the legislation? The primary goal of the new legislation is to establish a bipartisan agreement before the tax filing season begins on Jan. 29. The current legislation has several business tax components, rolling back some of the TCJA provisions: ProvisionImpact on StartupsDetailRestoring R&D to full deductibilityHIGHBusinesses will again be allowed to deduct 100% of domestic R&D expenses in the taxable year the expenses are paid. Under current law businesses are required to amortize US R&D expenses over five years or 15 years if the expenses are outside the US. Business interest deductions deductibilityLOWThe limit on business interest deductions will increase due to a change in the formula for calculating a business’s adjusted taxable income (ATI). Currently the deduction is limited to 30% of the taxpayer’s ATI, with some exemptions for small business, farming, and real estate businesses. The TCJA removed depreciation and amortization from the formula for calculating ATI, which made ATI less and reduced the deduction amount. This is not particularly helpful to startups, unless they are close to net income positive and have debt.100% depreciation MODEST to LOW100% “bonus” depreciation will be reinstated, which allows taxpayers to immediately deduct all of the purchase price of eligible assets rather than write them off over the “useful life” of the assets. This may be helpful to revenue generating startups that spend a lot on capital expenditure. The plan calls for these provisions to be retroactive, with the R&D expense and business interest deductions applying from the beginning of 2022, and the bonus depreciation applying from the start of 2023. The legislation would also expand the Child Tax Credit (CTC) to make it easier for more families to qualify, by allowing families to use their income from either the current or prior year, changing the calculation to increase the benefit, and incrementally increasing the maximum refund amount per child through 2025. Another provision would extend the statute of limitations for the IRS to pursue fraudulent or erroneous claims of the Employee Retention Tax Credit (ERTC or ERC), and prohibit new claims after January 2024. While intended to help business owners during the pandemic, the ERC has been exploited by aggressive marketing firms that encouraged businesses to file inaccurate claims. The proposal would also increase the penalty for aiding and abetting the understatement of a tax liability by an “ERC promoter” to help address the issue of inaccurate claims. These changes are intended to help offset the cost of the new tax framework. If your startup took ERC funds, read our Crunchbase article on ERC fraud to make sure you are not going to get caught in fraud accusations. What is the impact for startups and VCs? The primary impact for startups and small businesses are the “Big Three,” which have been some of the biggest issues for businesses: R&D expensing. This revision is the most significant benefit to startups, which often invest heavily in research and development. Startups would once again be able to deduct R&D expenses incurred in the US in the tax year they’re incurred. Frequently referred as Section 174 expensing, based on its Internal Revenue Code (IRC) designation, the legislation proposes to reinstate full deductibility retroactively, beginning with 2022, and continue through 2025. Specific information about how this will be implemented and whether it will require filing amended returns is not available yet. The 15-year amortization for foreign R&D expenses will remain unchanged. Business interest deductions. For startups with loans, the current limits on deducting business interest will be revised under the new legislation. IRC Section 163(j) limited the amount of depreciation to 30% (for most years) of the startup’s adjusted taxable income (ATI) excluding depreciation and amortization (effectively changing the startup’s EBITDA to EBIT). Now startups can again add depreciation and amortization back into ATI for 2022 and 2023. Adding those expenses back into ATI increases overall income, which means the 30% ATI amount is larger. 100% “bonus” depreciation. Also known as additional first-year depreciation deduction or the IRC Section 168(k) allowance, this provision accelerates depreciation schedules by allowing startups to write off a larger portion of an eligible asset’s cost in the first year it was purchased. The TCJA allowed businesses to immediately write off the full cost of eligible assets that were acquired after Sep. 17, 2017 and before Jan. 1, 2023. Before the TCJA the percentage was 50%, so this was a significant benefit to startups that purchased eligible assets. However, the 100% write-off was decreased by 20% each year (so the percentage was 80% in 2023, 60% in 2024, etc., and decreased to zero in 2027). The new legislation would restore 100% depreciation through Jan. 1, 2026 or Jan. 1, 2027 for some property. The phaseout would begin a year after. For VCs, the biggest impact may be on portfolio companies that raised ERC funding and now may be accused of tax fraud by the IRS. We encourage venture capitalists to ask their portfolio companies if they participated in the ERC program, and if so, make sure that they are working with an experienced tax CPA to help them stay clear of the upcoming enforcement actions. What should startup founders expect next? The House of Representatives’ tax-writing committee approved the bill with bipartisan support on Jan. 19. The House is scheduled to be in recess the week of January 22, 2024, so the earliest the House could hold a floor vote would be January 29. A strong bipartisan House vote would encourage the Senate to also pass the bill. Before that, however, Congress is going to have to act on temporary funding legislation to avoid a partial government shutdown on January 19. Until the tax package is finalized and approved, the IRS will not be able to provide guidance on tax filings. Since many of the changes to the “Big Three” are retroactive, startups may have to file amended 2022 returns, or adjustments could be made to 2023 returns. Finally, while we typically stay out of politics, we do encourage founders and investors to contact their legislators. We believe that innovation is a cornerstone of the US economy, and that Congress should support research and development – not tax it.