December 28, 2020

Do you need a silicon implant? Or, how to raise US$1.35M pre-seed funding for Your Tech Startup (Venture Finance Academy Case Study – Part 2)

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December 28, 2020
By Aery Advisors
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In the movie The Social Network about the birth of Facebook, one of the founders says that they have formed a Florida LLC. “Classic rookie mistake,” says another character who knows what they are talking about. What was the mistake?

Welcome to the second part of the case study of how SaaS startup SanityDesk raised US$1.35M of pre-seed funding. How did it make structural adjustments to “get its house in order” and position itself to become attractive to funding sources in jurisdictions where it was not previously registered to do business. It’s a classic story of listening to the market and pivoting your strategy to achieve the venture finance equivalent of “product/market fit.” [Watch part one here]

If an entrepreneur is a resident and doing business in a country that does not have large pools of startup capital and expertise, how can he or she overcome that ecosystem challenge? There are lots of stories about entrepreneurs who packed their bags and made the move to places like Silicon Valley, London, Berlin and Dubai. If you’re serious about getting access to pools of startup funding and talent, is doing that just a fact of life?

Or is it possible to have your cake and eat it too? In other words, how can you figure out a way to structure your company in a way that funding sources from, say, the USA, the UK, Germany or the UAE will feel comfortable with the investment risks but still retain your back-end infrastructure, critical operations and talent in your home country?

If you meet a potential funding source who tells you to register a new entity in a new jurisdiction, what should you do if neither the type of entity or jurisdiction are well known for attracting the type of capital you want and need to finance your business over the long-term? Should you do it anyway to get the money fast?

Remember: not all money is equal. It comes with strings attached.

In the case of Sam Cook, co-founder and CEO of SaaS startup SanityDesk, he first attempted to attract venture finance funding in Eastern Europe, where he had been residing and building his team and services-based business for several years. As a student in the Venture Finance Academy, however, it did not take long for Sam to realize that he might be better off “fishing where the fish are.”

So he flew off to London, where he was able to explore a number of different options relatively quickly. Recognizing that there are even bigger pools of capital and talent in Silicon Valley, Sam next booked a flight to San Francisco. He made the rounds there for several weeks, sleeping on a friend’s couch.

Then, like many others in California over the past few years, Sam decided to fly down to Texas to see what he might rustle up there. Sure enough, he did meet a potential lead investor down in Texas, who asked him to restructure his company and form a new Limited Liability Company under the laws of Florida.

It looked like a tempting offer and Sam was tempted. But as part of the Venture Finance Academy, Sam learned why forming a Florida LLC is not the preferred route taken by entrepreneurs who want to launch, finance and grow successful tech startups globally.

In fact, Sam did agree to restructure his business using the more traditional tech startup structure, forming a Delaware C corporation and using standard documentation employed by leading Silicon Valley accelerators, investors and lawyers. He knew all of this thanks to the Venture Finance Academy.

Getting his house order turned out to be a smart choice for Sam and his team at SanityDesk. It made him and his offer investment ready, as you’ll see when you watch or read part 2 of the case study. 

If you prefer to digest the case study PART 2 in video format, please click on the picture below:

If you prefer to digest the case study in written form, please continue reading below:

Sam Cook

So welcome back to the Venture Finance Academy case study, where we're talking about how Brad Furber and the Venture Finance Academy helped SanityDesk raise $1.35 million in the midst of the global pandemic. That's been quite a journey. 

If you saw all of lesson one, welcome back to the second lesson of this case study. We're going to go over principle number two of raising money, which is getting your house in order. 

And again, a reminder: if you're finding this interesting and helpful and you'd like to apply to join the Venture Finance Academy, that information is right below this video. So let's dive right into it. Brad, getting your house in order is kind of boring.It's not the sexy stuff entrepreneurs like, but I learned from you early that I just had to bite the bullet and go through this phase. It was quite painful. So talk about what getting the house in order means. And as you make these points, I'll just dive right in and tell you about my experience. 

So, first of all, we decided as we looked at the strategic map of capital availability in different continents, that I actually had an advantage in my mixed background. You can, as a European, go plan American capital markets, too. We decided we needed to incorporate in the right jurisdiction. And we actually got a proposal from our first angel. I got a term sheet from our first real angel and we started trying to raise money at the end of May. I actually got my first money in and an offer to incorporate the new company in August. So it was pretty quick actually. 

Brad Furber

You met somebody and they said, “Hey, I’d love to get behind it” and they had a pretty ambitious plan to help you raise money. They said, “Let's separate the company and try to build a tech startup. So, get rid of the agency side of the business, split the two companies, transfer the IP into NewCo and then build on that as a platform as a SaaS.” 

That was great. He was enthusiastic and he shot over the draft term sheet, which was to incorporate a Florida LLC and capitalize if we were an LLC. And when you sent it to me, I was like, “Well, it's great that you have somebody that's excited about it. Have you seen the movie, The Social Network?” Because in the movie, that's what the Facebook founders originally did. They incorporated in Florida as an LLC. And when Peter Teal decided to invest, flipped it into a Delaware C Corp.

Sam Cook

I think his words in the movie were: “A Florida LLC – classic rookie mistake.” It was something like that.

Brad Furber

Something like that. And there's a reason for it. There's nothing wrong with being afforded an LLC if you're going to do business in Florida and you're not going to try and raise capital from angels or VCs. But if you're going to try and get access to angel VC money, particularly from California, or really any place other than Florida, you wouldn't do it. And so in any event, it was kind of a weird thing, but it did suggest to me that maybe this person wasn’t as sophisticated as what he articulated. But we fixed it. We didn't follow that advice. 

Sam Cook

We did take some investment into our media company until we actually did what every sophisticated angel investor and VC fund would want you to do, which is – at least in the United States – a Delaware C Corp.

Brad Furber

So this gets back to mapping who's your ideal source of capital and then giving them something that they're familiar with and comfortable with. The key is to stay within the ballpark. In America, it's kind of a no brainer. You do the C Corp, which you did. And then the question is, “What about all the other elements?” Reverse vesting, for example.

Sam Cook

Which you had us, the partners, very wisely agree on.

Brad Furber

In an early-stage company, there's a lot of enthusiasm and there's a lot of goodwill and there's like, “Oh, this is going to be great.”

Sam Cook

Such an important point because you were in the meeting where we were like, “Hey, how's this going to work? And why is reverse vesting so important in the agreement, Brad?” 

Brad Furber

So reverse vesting is important because it's really a contract between the co-founders that they're not going to leave the expedition prematurely. And startups are hard. I mean, they're always hard. And it doesn't happen in three months, you know? So is the contract among the co-founders four years or three years or 30 months? Whatever it is. It's not two months.

And so the reverse vesting initially plays a role to cement the intent and hold the relationship accountable because there's lots of reasons why you might decide, “I don't want to do this anymore.” And they're perfect and that's fine; it's perfectly legit. But in that case, you didn't really earn it. Because really that's what you're doing. You're earning it and you don't earn it on day one. You earn it over a period of time.

Investors like a reverse vesting, too. They want to see it. But frankly, the co-founders are the ones who have the most to gain or the most to lose. My experience with most startups, is that there's usually one, maybe two, co-founders without whom the venture would never succeed. And so there's also other people who can come or go and they can add value, but if they decide to drop out, it doesn't necessarily imperil the venture. So it's the, “Who's Ernest Shackleton?” And who's signed up to go on the trek with Ernest Shackleton? And is it okay if you decide, “Actually, I don't want to go freeze my ass off in the South Pole. I'm going home. Thank you.” You know, that's fine. It's not indentured servitude. But if you do go home, you know, "To the victor goes the spoils." You can't have it both ways.

Sam Cook

It was interesting when we had this initial term sheet. The proposal was with reverse vesting and I was actually kind of offended at the beginning. I actually came to you and I thought, “You've been working your ass off for four years on this technology. Why would I accept reverse vesting?” But what was fascinating was we decided with the new investor to bring on a co-founding team of people and expand because I was the only founder at that point. 

And you actually advised me to agree to reverse vesting. You made a very good point. You said, “You're not planning on going anywhere. And I was like, “Hell no, I got too much into this venture. So yeah, I'll play by the rules,” because you made me see that I needed all the other co-founders to commit to getting their shares because I knew I wasn't going to drop out like this. There's no way in hell. I had too much invested in this, unless I got fired as the CEO.

Brad Furber

That could happen.

Sam Cook

Exactly. And the other thing that you had me do, which was so important, was, have another investor come in: a friend of mine and our first angel investor. My old commander in Iraq was like, “Okay, well, you're bringing in these other co-founders. Who's on the board?” And we all agreed, because he had been the only other other person to step into the breach as an angel investor. 

Okay. So Thomas is on the board and he didn't have any experience in venture finance. This is his first investment, but he knew me for a long time. He did bravely come in as the second angel. And I said to him early, “Hey, I'd like you on the board.” And if we hadn’t had that board, I think the whole thing would have imploded because you correctly said to me, “Yeah, it's smart. It's smart to have a board early.” And I was a little bit resistant.

Brad Furber

Well, what was the key here? It was either: have a board of one, or you have a board of three. A board of two is a disaster, or it can be.

Sam Cook

And that was the proposal. And you stepped in and he said, “Hey, let's have a board of three.” And we all agreed. We agreed on reverse vesting four to three, and we'll get to this in the future. Why that was so important. But, man, if you hadn’t talked me into reverse vesting and a board of three, we wouldn't have made it. This is critical stuff that I just didn't know... because I didn't know. I'd never done this before. And then the skeletons in the closet. Why is it so important to clean out skeletons in the closet? 

Brad Furber

Just be transparent about it. Sooner or later they're going to find out. If you come out and say, “This is my dirty laundry, just so you know – this is an issue we need to clean up,” people will accept it because you've, you've disclosed the dirty laundry. If you don't disclose it and then later people find out, you've essentially destroyed trust. So it's really about trust and credibility. It's also about not misrepresenting the securities laws. 

Sam Cook

Let me go through this. When we started, splitting the entity, setting up everything, I was even surprised when I actually went and looked in my closet. It was like, “Oh wow, there's, some things to clean up here.” But the good thing was having someone like you on the team to see it. And some other people had looked in as investors and seen all this stuff you may be really embarrassed about. But I was surprised actually with all the investors that came in. They're really sophisticated lead investors. And you said they've seen it all before.

Brad Furber

Think about it just in terms of selling a house. You might think that your psychedelic purple paint in the bedroom is really cool. But if you're going to try and sell it on the open market, your real estate investors, are probably going to say, “Hey, I think we need to put a fresh coat of paint on this thing and present the house in a way that a prospective investor's going to say, ‘I trust that this house is clean. It doesn't have any mold or other structural issues.’” And so that's what you want to do. You want to present a clean house in order.

Sam Cook

And then the last thing you had me do after setting up a board of directors and getting the reverse vesting was the advisory board. And you actually specialize in helping founders set up advisory boards. Why did you tell me to do the advisory board? 

Brad Furber

I have been serving on advisory boards for about 25 years. And my experience with them is they can either be extremely impactful or they can be a complete waste of time. And in my view, if they're properly structured and constituted and managed, they can be highly impactful. And so you agreed that we would give it a shot. And so the idea here would be that you're bringing in expertise that you could never afford to hire. You're bringing in a diversity of perspectives and skills and experience to help you co-create and co-design the business model. 

And if the advisory board starts to understand the business case, the value proposition, the, the roadmap, and they actually feel like they're part of designing it, they also feel like they also have equity. They also co-own that. And as time goes by, the advisory board becomes the source of valuable referrals to talent, customers and capital. And so that's key, right? Because you start off with a small nucleus with a small network, and it's like a neural network. You expand it to a much bigger network and their network. And before you know it, this thing is just like network marketing. That's really what it is.

Sam Cook

I don't think we would have closed a round without the advisory board. And I was smart enough to have you chair the facts report. I never actually expected you to invest when I signed up to the Venture Finance Academy. That wasn't a condition for you to come in. But you know, I just gave you shares to run the advisory board and put it together. Because I just trusted you to do it. It's opened up to having you on the ledger or the website. These people are willing to lend their name and they're not calling you to tell you to take their name and photo off the website.

That made a huge difference. Especially when you're a young startup looking for that help. And you did end up giving me a lot of help in terms of legal and some other sweat equity, investment and other stuff. And if anyone's considering joining the Venture Finance Academy just because they think Brad's going to put in money or invest, they shouldn’t. But you actually do sometimes fall in love with your students.

Brad Furber

It happens. I think if you say you can only be on the advisory board if you invest, you won't necessarily get the best board seats. And likewise, just because somebody is an angel doesn't mean they should go on the advisory board. 

But the other thing I think that I was adamant about with you was, my experience with a lot of startups and CEOs is they're too busy putting out fires to actually get real value from the advisory board. So the hypothesis was, if you made me the chair of your advisory board, I would be responsible for essentially calling the meeting and getting you before the advisory board meeting to say, “Okay, these are the one or two strategic challenges that I'm currently dealing with.” And you've done a great job with this. You articulate in writing and prepare the advisory board before. And this is the other thing is... we actually have advisory board meetings.

A lot of advisory boards, honestly, they don't. I've been on advisory boards of some pretty good companies, venture-backed companies, where they never actually had an advisory board meeting. They have the CEO doing one-off calls. But in our case, the advisory board is a well structured board. We meet once a month for 90 minutes. And you've done a great job of preparing the agenda, the reading. We have the call on Zoom. We distribute the recording of the call to anyone who couldn't make it and there's an output. 

And so it gets better and better. And it’s also your ability to pitch. I mean, your story's gotten a lot better. Frankly, your pitch has gotten a lot better. It's light years out. Because you're doing it within a framework where there's an element of trust. One of the things, when you're pitching deals is that, a lot of times, people don't tell you why they didn't like it.

Sam Cook

They don't even know. Sometimes they just don't want to do it. It's a gut reaction. “I can't say why I don't like this, but I don't like it.” And they'll tell you what they think is the nicest explanation for why they didn't invest: “Oh, I'm not ready” or whatever.

Brad Furber

Right. Most people who are going to make an investment will decide within five minutes if the answer is no. No, seriously, I mean,

Sam Cook

It's like women, too. They'll look at a guy and they're like, “Yeah, this guy's not dating.”

Brad Furber

So perhaps the answer's a maybe – and frankly a fast no is a lot better than a slow maybe wasting your time. All I'm saying is the advisory board can help you and has helped you tremendously. That was one of the main attractions about working with the US. I was like, “Okay, this could be really fun.” And it has been. You've done a great job. You've recruited a diverse group of advisors in five or six different countries with very eclectic backgrounds and experience. And that's what makes it work.

Sam Cook

If you want to check out SanityDesk.com/about, all the advisory board bios are on there. And it's really helped with the fundraising. 

So the next thing we're going to go into, Brad, is creating a compelling offer. And, I just can't emphasize enough these small decisions that you helped me make as an experienced lawyer and investor. And you were also a CEO of a tech startup at 1.2 or a publicly traded tech company. 

Brad Furber

We were private. The company was acquired.

Sam Cook

A private company that was acquired. So you've sat in all the seats. If I hadn’t made these critical decisions with your advice, I may have been fired as a CEO. I may not be a co-founder anymore. Or if we just would have gone out of business. These were critical decisions. And that's why I hired you also to do our legal, or you're investing your legal work with us.

The decisions you make at the beginning are like the DNA or the code base of the company. It's an art and a science. You’re the lawyer who's seen it all, been there and been an advisor. You can point the founders to the lawyers to help them do this and check that as an advisor. Or you see that the lawyer is going down completely the wrong path. It can make or break a company, the legal structure.

Brad Furber

Yeah. I agree. You want to have a good lawyer. Trust me. Because setting up the corporate entity is a little bit like code. It's like an engineer or an architect. You are architecting the structure because when you're asking somebody to give you whatever $50,000 or $5 million, they look at these things. They want all of this stuff on paper. What are they getting? They're getting a security. They're getting an interest, whether it's debt or equity.

Sam Cook

They will ask you to see your cap table. Who's on your board? Who's on your advisory? All of these things matter.

Brad Furber

The key is not making mistakes. Right. It's really not that hard to do it. If you know what you're doing.  But it's really easy to do it wrong, you know? And so when I left my practice and went to work for this startup, the first thing I did was hire a great lawyer to be my outside counsel. I'm like, “Now I'm the president and CEO, I don't want to be the lawyer. I need a great lawyer.” And it was expensive. But I was willing to pay for top-notch legal advice.

Sam Cook

You guided me because my instincts on all of them were different than what you advised me. I just said, “Well, Brad's been here. I'm just going to listen to him. Okay, I'll have a board. I don't think I want a boss, but let me have a board.” And it was a three-person board, not a two to prevent deadlock. Let's have reverse vesting, even though I feel like I've earned it. Why would I put myself in a position where I could not get these shares? Nope, Sam, you know you are going to stick with this. You're the indispensable part. You're the last one who's going to quit. I'm the last guy off the ship. Like the Titanic goes down, I'll be, I'll be going down with it. 

I would have done probably 50 to 75% of these things differently if you hadn’t advised me and without the advisory board, which is an optional thing. Really, we probably wouldn't be here. So all these different things are critical. 

If you fill out the application form, you’ll see all the details on the Venture Finance Academy: how you apply. I hope Brad will take you in because he is exclusive in who he lets in. Then it's going to be a great experience and it'll save you all these mistakes. You'll get the same level of advice I got on all these questions. It's so easy for Brad. Five, 10, 15 minutes on a call – one of his, his 90 minute calls every few weeks to just give you this advice. But it will save your business in the future if you have your structure set.

Brad Furber

Well, thanks. I appreciate you saying that. It's fun. I enjoy doing it. Actually. I swear, this is my life's work really. 

Sam Cook

So if you found this lesson two informative, and you're waiting to hear how all these things played out when we went to market, stay tuned for lesson three of the case study, where we're going to talk about creating a compelling offer. This gets really interesting. 

There's some funny stories about different offers I tried and how we had to amend them. And then Covid-19 made us amend them more. And then there’s where we are right now and where we're going with our offers. So click on the button to begin lesson three, or you can take this chance to pause and apply for the Venture Finance Academy and then come back and we'll be right here waiting for you.

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