Finance & Investing

Class Takeaways — Angel and Venture Capital Financing for Entrepreneurs and Investors

Five lessons in five minutes: Professor Ilya Strebulaev demonstrates how success in startup investing is not just due to luck, but to skills, sweat, perseverance.

October 04, 2022

| by Kelsey Doyle

Venture capitalists are accustomed to hard, and often, unglamorous work. For founders to successfully work with VCs, they must put themselves in the shoes of a VC, know the questions they may ask, and identify their own weak spots.

These are just a few of the guiding principles Stanford GSB finance professor Ilya Strebulaev teaches in his class, Angel and Venture Capital Financing for Entrepreneurs and Investors.

Ilya Strebulaev: Hello. My name is Ilya Strebulaev and I’m a professor at the Graduate School of Business Stanford University, specializing in venture capital and private equity. One of the classes I co-teach is Angel and Venture Capital Financing for Entrepreneurs and Investors. Today are five takeaways from this class.

1. Due diligence by VCs is hard work

Success in startup investing is not just due to luck, as many believe, but also skills, sweat, perseverance. VCs may spend over 100 hours on due diligence or just one startup, making a dozen reference calls to check on the idea, founders, product, market. They debate startup’s opportunities and risks with their partners. The skills of how to conduct due diligence are critical, as is the appreciation that it is hard and often unglamorous work.

2. Founders should know more than VCs about their startup

As investors conduct such extensive due diligence, founders need to get fully prepared for it. As I summarize it to my students to be founders, ask yourself all the questions if you are an investor. Then, your aim is to have a great answer to all these questions. Depth is absolutely critical. Also, identify your weak spots. Investors avoid shallow [00:01:30] founders who don’t know the ins and outs of their startup. As my former student, who now is a successful investor told me, if I come away from meeting the founder without learning anything new, it’s a bad sign. Founders should remember, success is all about execution. Most investors would rather invest in A plus teams pursuing B plus ideas rather than B plus teams pursuing A plus ideas.

3. Be sure to know the economics of contracts in the VC space

The third takeaway is that you need to know the ins and outs of contracts in the VC space. These contracts determine how any proceeds from startup’s outcome are determined. That is who is paid what, when, how, and how the decisions in startup’s life are made. We actually spent most of our course discussing all these contracts in great detail. Financial securities and startups are very unusual if you compare them to traditional debt and equity securities. They need to take into account that many startups fail, that startups raise many rounds of funding from many investors, and that investors need patience. The takeaway is to understand this contract and contractual terms really, really well.

4. Understanding a startup’s corporate governance is critical

Another takeaway is the utmost importance of corporate governance. That is, how decisions are made in startups. For example, lead early stage VCs typically become board members, get shareholder voting rights. Often, they get special veto rights to prevent the startup taking certain actions without their approval. These rights help protect investors, who often are minority shareholders in the startup and are afraid they could be expropriated by others, such as the founders. Founders may also be concerned that VCs may kick them out once they control the startup’s board. Understanding corporate governance, its implications and negotiations around it is really a critical skill in the world of startups.

5. Startup valuation is very different from traditional valuation

A surprising result is that valuation serves many purposes apart from just finding out what the security or company fair value is, especially for early stage startups. Valuing startups is often about how to divide the future pie. The world of startups even uses its own jargon. Instead of valuation used elsewhere, the post-money valuation or the pre-money valuation is used for startups. In class, we discuss at length these and other valuation terms. Remember one thing, that the post-money valuation is not the same as the fair or the market value. In fact, my research shows that post-money valuation is typically higher than the fair value, a result with far reaching practical implications.

If you take all these five takeaways to heart and utilize them either as a founder or as an investor, then you are much more likely to succeed in the world of angel venture capital investment in the world of startups. Good luck.

 

If anybody would’ve told me, even 20 years ago, that I would ever teach venture capital, I would laugh. But now that I teach venture capital and private equity, I think that is really the most amazing thing to do, to meet founders, investors who are really passionate about what they do and trying to help them, both at Stanford and outside, is truly amazing.

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