Investment Manual

1. Non-refundable grants and contributions.This is monetary aid granted by public authorities to help entrepreneurs, with three main goals: to get their projects up and running, to grow their companies, and to foster innovation within the business.
2. Outside finance: Essentially bank loans and public loans.
3. Private investment: which we are looking at in this manual.

1. Pre-seed phase This phase is typically financed with the entrepreneurs’ own resources and the 3 Fs (Friends, Family and Fools).
2. Seed phase. In this phase it is individual private investors that offer the most help, as well as accelerators and specialist investment funds.
3. Growth phase. Outside funds are also required for this phase.
4. Expansion phase. In this new phase the company aims to grow in new markets or expand production capacity in its production processes.
5. Exit phase.

Make sure you have enough time and energy before beginning the process. Bear in mind that the process lasts 6 months on average.

It is very important to know you have the support of the whole group of founding partners.

Brief yourself properly for the whole process.

Delegate all those functions you will not be able to handle during the
process, as a practical measure.

1. Clear knowledge and understanding of the motivations of the different agents is important.
2. . We must properly understand the disadvantages of being financed by a private investor.
3. . This is a task requiring considerable dedication. At least half a day from the company CEO if it is to be a success. This is not a task that can be delegated.
4. When do we need to embark on this process of sourcing finance? The company must be ready, with all its obligations in order and with a clear future plan. A committed and consolidated founding team is also needed, and a solvent cash position for the coming months.

What aspects do we need to agree as founding partners before beginning around?

• The desirability of the round.
• Basic characteristics of the round.
  • Size of the round
  • Pre-money valuation of the company
  • Post-money valuation of the company
  • Which partners will take the follow-on?
  • What type of investors do we need?
  • Minimum ticket
• Commitments to be taken on in the shareholder agreement.

The cap table is a table (spreadsheet) setting out the history and current structure of our company’s share capital.

It is important in the early rounds for the founding partners to maintain a majority percentage of the company.

This is the typical cap table by phase:

Cap table:

Phantom shares are economic rights that the company recognises on the part of workers who are seen to be of huge value to the company, in order to build their loyalty and retain them

Phantom shares are formalised with an agreement between company and worker.

It is quite usual to assign 10% of the capital to phantom shares.

A presentation of our investment proposition to investors who could have an interest in our project. There are various types:

One Page. This is a presentation of our project on one single sheet, normally A4 printed on both sides.

Short Investor Deck. This is a short version we will use to email to potential investors. It shouldn’t have more than 15 or 20 pages.

Long Investor Deck. This is the version we can use as support at individual meetings with investors.

Visual Investor Deck. The visual investor deck is what we will use at our pitches.

1. Take real care with the design. It has to be a very visual document.
2. Find a narrative and an emotional hook in our proposal.
3. Simplicity is another added value.
4. Don’t overload it. One or two ideas on each slide.
5. Avoid jargon. Make it easy to understand.
6. Ask for feedback before finalising it.

1. It is essential to dress appropriately, in functional, comfortable clothes.
2. Enter the stage with a self-assured air, walking firmly and with a slight smile on your face.
3. Your hands speak for you. Keep them in sight and move them slightly.
4. Move around the stage without turning your back on the audience.
5. Take the chance to smile whenever the occasion arises.
6. Look the audience in the eye, but without focusing your gaze on one single person.

• Fail to follow a finalised, structured discourse. You will end up wandering off topic and give the impression you aren’t in control.
• Spend too long explaining common knowledge.
• Going over time. You will almost certainly not be given extra time, and if you are, it doesn’t create a good impression.
• React badly to unforeseen events. If something goes wrong, you mustn’t lose your calm.
• Use overly colloquial language. You aren’t with a group of friends, but in a professional setting.

The tool which has the job of planning enterprise decision-making.

Why is it important to have a Business Plan?

• It forces you to keep up-to-date, to do your research and properly understand your sector and your competitors.
• It will serve as your roadmap and strategic analysis.
• It will help you ensure the economic viability of your business.
• It allows you to establish a shared vision of the medium- and long-term future of the company.
• It will help you give overall consistency to your project (externally and internally).
• It will help you communicate your idea to possible investors, partners or those who might finance your project.

1. Executive summary. Some points to include would be: the business idea, the target market, the product, the competition, the required investment, etc.
2. Analysis of the context and sector. We must properly describe the socio-economic situation of the geographical and temporal context where the business is developed.
3. Description of the product or service. Including the main components, materials, etc. in the case of a product. Main characteristics in the case of a service.
4. Market and competition study. We need to talk here first of all about the size of the market, in units and in euros. And also need to talk about the competition: number and size of competitors.
5. Business model. Here we will define the business model for our product or service. Sale, lease, SAS, forms of payment, etc.
6. Operations plan. Now it is time to detail the calendar of activities to be undertaken so as to launch or grow the project.
7. Commercial and marketing plan. In this section we will describe how the commercial area of the company will function, the commercial team, sales strategy, objectives, etc. And also include information about the marketing strategy.
8. HR plan. Here we include a detailed organisational chart and job descriptions. We will also put in a salary table with pay ranges for eachjob and type of contract.
9. Founding team. With a brief CV of each of the founders, describing their education, training, occupational experience and personal skills.
10. Corporate and legal matters: company name, trading name, legal form, registered office, corporate purpose, Cap Table, share capital, governing bodies of the company, etc.

Be aware of who the Business Plan is intended for before getting started. The content needs to be adapted to each case.

The Business Plan must be fully consistent with our investor deck and with the financial forecasts.

The Business Plan is a living document. It should be updated at least each quarter. This will help us see the extent to which we are delivering on everything we set out in our initial Business Plan.

This document must be agreed by the whole founding team, the executive team and the investor partners. If we don’t reach agreement, it is very likely to prove difficult to put into operation, and will be a far from realistic document.

How much money will I need until I start to see recurrent revenue?… How much do I need to sell at my estimated price to cover my expenses?… What product do I need to promote?… When can I make my planned investment?… How does my business change after this investment?… What returns can I offer an investor?…

Show investors that our project is investible.

Help us to reach decisions.

Specify the short-term objectives and also, based on experience, steer a better-planned long-term course.

Distinguish between legal and accounting obligations in producing the forecasts: the former are a question of order and compliance, the latter a management matter.

• A Hypothesis Sheet: including basic preliminary information about products, evolution of prices, costs and investments.
• An Analytical Profit and Loss Account: this Statement provides very valuable decision-making information. The document gives us:
• Gross Margin: Revenues – Direct Product Costs. Which gives us better returns at this level?
• Net Margin: Gross Margin – Direct commercial expenses.
• Contribution Margin: Net Margin – Expenses associated with the channel How does the channel cost affect returns?
• Break Even – Point of profitability: How many units do I need to sell to cover my fixed expenses.?
• The Financial Profit and Loss Account: the same information as in the Analytical, but ordered differently. This will match the Consultancy account, and can be used more easily to generate the Cash Flow Sheet. This Statement makes it easy to obtain a very commonly used term:
• EBITDA: revenue with cash inflow less outgoing cash expenses, or Operating Result plus amortisations, provisions and impairments.
• The Cash Flow Sheet: this will give us the Necessary Cash or surplus from the project. It has three levels:
• Operating Cash.
• Investment Operations Cash.
• Financing Operations Cash.
• The Balance Sheet: this is a snapshot of what a company has and how it is financed at a given time.

STEP 1: ON A BLANK PIECE OF PAPER

• Describe in simple terms what we do.
• Sketch out the main processes.
• Break the flows down into all the processes from start to finish. For example, we design the product, we attract customers, we attract suppliers, we manufacture, we classify the product, we distribute it, we handle the sales process…
• Identify the resources that we will need in each process. For example, marketing to attract customers, rent, staff, machinery, vehicles, management services.
• Classify the resources depending on the corresponding type of expense or investment. Variable Costs for the product, the customer, the establishment, Fixed Costs or Investments.

STEP 2: CREATE THE HYPOTHESIS SHEET

• Identify the products and quantify the retail prices.
• . Identify and quantify the variable costs for the product and the customer. Supplies, direct staff, hours of production machinery, and also costs to attract customers and provide customer service.
• Identify and quantify the variable costs for the Establishment/Channel. Costs of stores, of the Web channel, of the branch…
• Identify and quantify the Fixed Structural Costs. Personnel, rent, amortisations of structural investments…
• Sales estimates: we make an initial estimate of the units of sale over time and define the basis for subsequent growth.

STEP 3: ANALYTICAL P&L UP TO GROSS MARGIN. Over a timeframe of three or four years, with the early years on a monthly basis.

• Calculate the estimated quantities of Sales.
• Multiply the quantities by the prices of the Hypothesis Sheet.
• Multiply the quantities by the cost of Supplies according to the Hypothesis Sheet.
• Calculate the cost of direct staff based on the hourly rate from the Hypothesis Sheet.

STEP 4: CONTINUE WITH THE ANALYTICAL P&L UP TO THE NET MARGIN

Discount the costs of attracting customers and impute these to the product on the basis of the average customer shopping basket hypothesis.

STEP 5: CONTINUE WITH THE ANALYTICAL P&L UP TO THE CONTRIBUTION MARGIN.

Group the products by channel and discount the inherent channel costs, which then gives us the margin of contribution by each channel to the overall project.

STEP 6: GENERATE THE FULL ANALYTICAL P&L.

Deduct the fixed structural costs for the whole project from the contribution margin of all the channels, and arrive at the result for the financial year.

STEP 7: OBTAIN THE FINANCIAL P&L

Taking the Analytical P&L as our basis , we order the information in accordance with the general chart of accounts, and obtain the Financial P&L, arriving at the same result.

STEP 8: SET UP THE CASH FLOWS

From the Financial Income Statement to the Cash Flows there are a number of intermediate concepts:

1. VAT: to go from income and expense to collection and payment, we need to apply this to some of them, and then deposit the corresponding settlement with the Tax Office.
2. The moment of collection and payment: we don’t collect and pay everything immediately, and so will need to apply the negotiated periods.
3. Staff expenses: they have various times of payment – the monthly salary, the additional payments in the months of June and December, the quarterly withholdings deposited with the Tax Office and Social Security at 30 days.
4. Investments: in the P&L they are carried via depreciation, but the outgoing cash flow occurs at the moment of purchase, plus the period negotiated, with the corresponding VAT.
5. Financing: from Partners (Capital), Financial Institutions (Loans, Credits), Public Authorities (Grants).

STEP 9: PROJECT THE WHOLE PERIOD.

Once we have set up the first year on a monthly basis, we project the rest of the period of 3 or 4 years.

STEP 10: ANALYSE WHAT OUR PROJECTIONS SAY.

They give us information about product, customer and channel profitability. What to sell, to whom and via which channel, which to promote, etc.?

How much we need to sell to cover the structure we require. And if we achieve a cost reduction at any point of the process chain.

But above all, they give us information about cash, how much we need now and how much we will foreseeably generate through our business over the next 4 years.

If we want a partner for our business to finance our needs now, we will need to convince them by offering them a sufficient return tomorrow.

STEP 11: SIMULATE DIFFERENT SCENARIOS

As we compare our hypotheses against reality, we can progressively adjust them to give us different scenarios. We can see how the cash figure changes in response to modifications to:

• Prices and Quantities.
• Cost of Supplies by volume.
• Curve in the cost of attracting customers.
• Cost of Customer Service.
• The Fixed Cost Structure.

Financial forecasts are a tool which help us to Plan, Control, and ultimately to reach decisions in our project, in anticipation of results.

They must be produced in a straightforward manner, but also as a bespoke calculation specific to this project, and manageable for its administrators.

The EBITDA concept we have looked at is a simplification of the operating cash generated by our project, and we should focus on this idea before moving on to the next chapter: Valuation of my project.

We will now analyse how a potential Investor appraises our project. Aside from other correlated reasons, we will focus on the Investor’s weighting of Risk versus Return, comparing the project against other investment opportunities available to them.

WHAT IS AN INVESTMENT OPPORTUNITY?

Any opportunity where paying out money now will generate a return in the future which is greater than other options. In other words, a return above what we consider “normal”. Rather like paying a lower price than the value we would assign to what we acquire. One single project may have different values for different people.

RETROSPECTIVE: it is worth what it has generated so far. The real value lies in the business assets. There is no interest in what its activity could generate.

PROSPECTIVE: The valuable part of the business is the return that I could obtain in the future from its activity. If I can do so with fewer assets, all the better.

COMPARITIVE: To value the project I focus on the value of another similar or comparable project. The difficulty lies in finding that comparable venture.

In entrepreneurial projects, we typically combine the prospective and comparative approaches.

COMPARING OPPORTUNITIES.

The commonly accepted methods to value and compare investment opportunities are as follows:

1. THE DISCOUNTED FREE CASH FLOW METHOD. (PROSPECTIVE APPROACH)

This is based on obtaining the cash flows that the project will generate in the future and transferring them to the present, discounting them at a rate which considers the risk involved in generating those projected flows.

HOW THE RISK IS WEIGHTED

We think about how the project will be financed. What percentage of internal funds (from partners) and what percentage of outside funds (from financial institutions) it will have, to which we then apply the required rate of return. This is what is known as the Weighted Average Cost of Capital (WACC).

Bear in mind that partners do not ask for the same rate of return from two businesses with differing risks. The more risk there is, the greater the return they will demand to offset the risk they face.

This is calculated by means of a risk-free financial asset. For example, 10 year bonds, to which we add the additional risk corresponding to the investment, the Risk Premium for Spain * the Beta of the Asset, with certain additional correctors applied, such as the fact of it being a small company or small stake, which might be difficult to transfer.

COMPARING OPPORTUNITIES.

1.  THE DISCOUNTED FREE CASH FLOW METHOD.

This Valuation method is typically contextualised with the following method.

2. THE MULTIPLIER METHOD (COMPARATIVE APPROACH).

This method is based on finding opportunities that are comparable to the one we are considering and that have already been through a transaction, which
shows us the valuation applied An indicator is taken from the company that has already completed a transaction, such as EBITDA, dividing the value by this indicator to give a multiplier, which we then apply to the EBITDA of our opportunity, to give our own value.

EV:€500,000 with EBITDA:€50,000. Multiplier EV/EBITDA: 10

The difficulty with this method lies in finding such Comparables.

The typical approach is to compare the valuation under the different methods to obtain a value range on which to negotiate the Price.

COMPARING OPPORTUNITIES.

THE PROBLEM OF NEW AND INCIPIENT PROJECTS. In projects where we have historical data it may not be difficult to calculate credible forecasts, and to seek out comparable companies in the sector, but for new projects, these generally accepted methods clearly pose substantial problems.

3. ALTERNATIVE METHODS FOR NEW PROJECTS.

Before referring to these methods, we should mention that a professional investor, aware of the level of risk in such projects, and the difficulty in obtaining a demonstrable value, will aim to diversify their portfolio, investing in many different projects, and demanding the highest rates of return in all of them.

To a greater or lesser extent, all these methods apply the COMPARATIVE APPROACH.

QUALITATIVE METHODS

3.1  SCORECARD VALUATION.

This method is based on comparing the project in which one wishes to invest with one or more reference projects in the market or sector, and at the same stage of development. The comparison is applied to various key aspects. The factors typically used for the comparison are as follows:

The factors may be weighted according to their importance for the investor.

COMPARING OPPORTUNITIES.

3.2  BERKUS METHOD:this is very similar to the above. It is based on the experience built up by Dave Berkus in highly disruptive projects in their initial phases. As before, it weights 5 key factors. Each is given a value of 500,000 USD, with points awarded to the project being valued for each of these, from 0% to 100%.

The Scorecard and Berkus are qualitative methods for the weighting of key factors based on the experience of investors, and are very commonly used at the very early stages.

QUANTITATIVE METHODS

3.3  3 VENTURE CAPITAL (VC).

This is the method applied by Venture Capital investors (Chapter I – Investor Types in this manual). The project still has negative cash flow or insufficient cash to achieve the expected growth, but already has its product on a consolidated market. This is based on three cornerstones.

Value of the Company expected at the time of exit of the VC entering now. This value is obtained by means of multipliers of, for example, the EBITDA or expected Sales of the company in the exit year of other projects.

The return expected by the VC on this investment. Depending on the phase, this may range from 20% to 70%.

The effect of the dilution (reduction of their percentage in the event of the possible entry of other investors). There is a difference between holding the 35% purchased today, for example, and 30%, because other investors have entered along the way.

COMPARING OPPORTUNITIES.

The VC method uses the expected return on exit to give the value today. Professional investors with lengthy experience that are entering projects with high expected growth.

3.4 KPI MULTIPLIER METHOD:this is very similar to the multiplier approach seen under Method 2, but in this case we replace the EBITDA indicator (KPI)
with others, perhaps because the project EBITDA remains negative.

The indicators must be representative of the project’s progress. The difficulty lies in accessing information about these indicators from the project used as the reference.

For digital projects, for example, these are among the most commonly used. But for others it could be customers per hour, cost of acquisition of customer versus gross product margin…

Unlike the VC method, the multiplier is here applied at the moment of valuation, the entry rather than the exit.

The valuation techniques depend on the current stage of the project and the type of disruption it involves.

The commonly accepted discounted cash flow method makes more sense the more advanced the phase, and the greater the similarity with the sector.

The more innovative the project, and the earlier the current stage, then given the increased risk, an investor will be looking for the maximum diversification in their portfolio and the rates of return demanded will be much higher.

The comparative approach is used by way of corroboration or as the main method in all valuations, hence the importance of having information about
comparable companies. (See sources of info in the Manual)

It is very important for our project to conduct sound financial planning, so as both to keep the project afloat by ensuring cash requirements are
anticipated, and to defend valuations when facing investors.

1. Confidentiality as to the existence of a round. Our recommendation is to ensure that the existence of the investment round is treated in the greatest possible confidence, before and during the negotiation.
2. Confidentiality as to the documentation in the round. We therefore recommend signing an NDA (Non-Disclosure Agreement) with all the agents who will receive this information.
3. Preparation prior to the round: We must prepare: the prior agreements between the founders and investors from previous rounds, preparation of the financial forecasts, generation of the investor deck, one page, explanatory videos, prepare our elevator pitch, etc.
4. Prepare the Virtual Data Room (VDR). This is an online space with sufficient confidentiality and security guarantees, which we will open up to our investors.
5. Our other obligations include thorough research into each of the investors we will be contacting. The more information we have about them, the better the relationship will flow.

1. The ONekin! support programme can serve as your ally.
2. Your own network of contacts: this is the best channel. Attending entrepreneurial events to meet people in the same situation as you is also highly beneficial.
3. Investment events: The most representative events in the Basque Country include: B-Venture (Bilbao) and Cita Emprende (Donosti). At the national level: South Summit in Madrid, 4YFN in Barcelona, Alhambra Venture (Granada), etc. The Food 4 Future congress is also of particular interest in the food sector.
4. Crowdfunding Platforms Prominent investors may also be found on these websites.
5. . Existing newsletters or mailing lists in the sector. Dealflow, Startup Riders, El Referente, or the Telegram channel: Ecotechers. At the more local level, it is worth signing up for the Up Euskadi newsletter.
6. “El Referente” investment yearbook.
7. Social media is another useful channel. LinkedIn and Twitter are the two where investors are typically more active.

1. Initial contact. It is always much better to use email as an initial form of approach. It is less intrusive, and the investor will decide when and how
   they reply. It is always advisable to be presented by someone who knows the investor.
2. The first interview. The aim of this interview is to be granted a second interview. This interview will result in an exchange of information (via our VDR).
3. . Negotiation phase. The ultimate goal of any negotiation is to reach an agreement with the first investor in the round. This is done by signing the term sheet.
4. Due diligence. This is an analysis conducted by the investor as to the company’s situation, prior to the definitive signature.
5. . Investment agreement contract Once the Due Diligence phase is been successfully resolved, we can then negotiate the investment contract, which is typically accompanied by a shareholder agreement.

The search for investment is very similar to a commercial process, and so we need to be ready to organise the sales funnel that any process involves. Imagine a spreadsheet with each potential investor on the vertical axis, and information about each of the investors on the horizontal axis. In general terms the columns of this spreadsheet could be as follows:

1. Company name, fund, investor.2. Full name of the contact person. 3. Position. 4. Address. 5. Email. 6. Landline number. 7. Mobile number. 8. Description.

Columns related to the process:

1. Status. 2. First sending. 3. Reminder email. 4. 1st Meeting. 5. 2nd Meeting. 6. Agreement. 7. Due Diligence. 8. Comments.

Aim to keep the spreadsheet fully up-to-date, and share updates with the founding team.

Financial and accounting situation: An analysis is conducted of the state of the accounts, accounting records, margins, fixed assets, etc.

Fiscal situation: The company’s situation is reviewed in terms of all taxes, levies, charges, etc.

Commercial situation: This involves an analysis of sales figures, customer contracts, preliminary agreements, forms of payment and all aspects of the customer relationship.

Employment situation: This section covers an analysis of all aspects of the company staff, employment contracts, organisational structure, remuneration policy, job descriptions, etc.

Technological analysis: All the hardware and software used by the company is analysed. Whether they are owned or not, whether they use licences, how much they cost, level of obsolescence of the equipment, etc.

Legal analysis: Here we include all legal aspects influencing the company. Contracts (leases, with suppliers, with distributors, etc.). Analysis of legal compliance with the Data Protection Act and other types of regulations.

• Don’t hire consultants to conduct the negotiation. The investors will want to speak to you, and it would save you little work.
• It is vital to tackle the job of getting to know potential investors from the start of the project, not once you are at the investment round stage.
• Keep your Virtual Data Room up to date, so that investors can keep track of your project.
• Take painstaking care when writing messages or emails to investors. Every detail counts.
• Draw on support from other entrepreneurs who have been through this process before. Theirs is the most valuable help.
• It is advisable to sign an NDA before sharing valuable information about your company.

Seek quality expert advice. That is to say, lawyers with proven experience in this sector of investment rounds.

The term sheet is a document signed by both parties (investor and company or promoter team). It’s usually negotiated with the first investor. It includes the basic terms and conditions of the investment.

What are the most important clauses in a term sheet?

1. Reserved matters at the general shareholders’ meeting: this clause typically includes a more or less extensive list of those matters that will require a vote in favour by the majority of the investors in order to be passed.
2. Governing body: This point will serve to define the nature of the governing body once the investment round is complete.
3. Reserved matters for the Board of Directors.
4. Lock-in and exclusivity commitment. The lock-in requirement is normally set at between 3 and 5 years. This commitment is typically renewed with every investment round.
5. Non-competition commitment.
6. Unrestricted transfer of company stock. The transfer of shares between partners is unrestricted.
7. Lock-up period. Period during which the founding partners cannot transfer their shares.
8. Tag-along right. If any of the founding partners want to sell some or all of their stock, the investor partners will have a tag-along right.
9. Drag-along right. This right protects the founding partners from a possible blockage by the investor partners of a potential sale of their shares in the company.
10. Right of information of the investor partners This sets out the right to receive information about company activities, beyond the legal requirements.

Convertible notes are loan agreements between an investor and a company which have the feature that the investor is entitled to convert the loan into
stock in the next investment round.

The investor that advances the money for the project through this loan will receive a set discount on the valuation of the company when the deed is signed. A 20% discount rate is fairly typical.

Convertible notes offer numerous benefits for the founding team:

• They put money in the bank as soon the convertible note is signed, so they can continue putting their plan into practice.
• They are private documents, and don’t need to be formalised by a notary, or included in any official registry.
• They are not associated with any shareholder agreement, and so there is no need at that point to negotiate that type of clause with the investor.

What are the final documents?

The final documents are: the shareholder agreement, the capital increase sheet and the public deed.

If we have got things right with the term sheet, this part shouldn’t be a problem. It is simply a question of having our legal advisers set out all the agreed terms in a shareholder agreement.

The shareholder agreement is most often signed remotely using a digital signature application.

This is a document indicating the main conditions of the capital increase, as well as the number of shares issued, the names of the investors subscribing the shares, the amount of the share capital and the amount of the share premium. It must be signed by all the parties.

1. Check that the reserved matters you sign in the shareholder agreement don’t prevent you from conducting day-to-day management of the company.
2. Most of the clauses we have explained in this chapter are very much typical. Don’t waste too much time negotiating them, because it will be hard to find investors that do not want to sign them.
3. Properly manage the cap table and the positions on the board to avoid losing comfortable majorities for the founding team.
4. In early rounds, it is advisable to set aside a package of phantom shares to secure the loyalty of future key figures at the company.
5. Take care with the penalty clauses for any breach. This may on occasion become a blind alley
6. Memorise all the clauses of the shareholder agreement well. Always act in accordance with the agreed terms, to avoid unwanted problems with your
   investor partners.
7. Once you have all the documentation fully signed and registered, share it with all the partners, together with the updated cap table. They will appreciate that.
8. Celebrate and share the success of your round, and why not help other entrepreneurs facing the same situation?