Starting Up:Introduction to venture Capital: by Anand Lunia

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This slide deck was prepared by Anand Lunia for the TiE Institute Knowledge Series (TIKS) session in Mumbai , Aug 2010

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  • The first thing to understand about VC’s is that they’re not investing their own money. Venture capitalists start by raising money from a bunch of investors, and then distribute it to various startups. But the investors are expecting to get their money back, generally within 10 years of committing it to the fund.
  • Starting Up:Introduction to venture Capital: by Anand Lunia

    1. 1. An Introduction To Venture Capital Anand Lunia Executive Director & CFO, SEEDfund [email_address]
    2. 2. What is Venture Capital
    3. 3. Private Equity & Venture Capital <ul><li>“ Private Equity ” means capital to companies not quoted on a stock market ,in exchange for an equity participation. </li></ul><ul><li>Venture Capital (VC) is a sub-class of Private Equity </li></ul><ul><li>characterized by investments made for the purpose of developing, launching, and expanding new products or service offerings. </li></ul>
    4. 4. How VC’s work Investor Investor Investor VC fund Investor Startup Startup Startup
    5. 5. Capital Lifecycle Seed (< € 1 mil) Early Stages (€ 1 - 10 mil) Expansion/ (€ 10+ mil) development Angels Incubators Accelerators Venture Capital Private Equity & Merchant Banks
    6. 6. What Venture Capitalists do ... <ul><li>Sift through thousands of (good and bad) investment propositions </li></ul>
    7. 7. What Venture Capitalists do ... <ul><li>Sift through thousands of (good and bad) investment propositions </li></ul><ul><li>Identify a few valid initiatives and finance them </li></ul><ul><ul><li>in exchange for private equity (usually a minority stake) </li></ul></ul><ul><ul><li>structure the deal </li></ul></ul>
    8. 8. What Venture Capitalists do ... <ul><li>Sift through thousands of (good and bad) investment propositions </li></ul><ul><li>Identify a few valid initiatives and finance them </li></ul><ul><li>Support the entrepreneurs in succeeding. E.g.: </li></ul><ul><ul><li>providing financial advice </li></ul></ul><ul><ul><li>in headhunting and setting up advisory boards </li></ul></ul><ul><ul><li>in contacting customers, channels, … </li></ul></ul><ul><ul><li>in steering and positioning the company </li></ul></ul><ul><ul><li>in managing PRs activities </li></ul></ul><ul><ul><li>in managing IP and legal issues </li></ul></ul>
    9. 9. What Venture Capitalists do ... <ul><li>Sift through thousands of (good and bad) investment propositions </li></ul><ul><li>Identify a few valid initiatives and finance them </li></ul><ul><li>Support the entrepreneurs in succeeding. E.g.: </li></ul><ul><li>Look after value creation </li></ul><ul><ul><li>further round of financing </li></ul></ul><ul><ul><li>merger and acquisition, IPO, … </li></ul></ul>
    10. 10. Attributes of a Great VC <ul><li>• Bets on people not trends </li></ul><ul><li>• Driven by the big idea </li></ul><ul><li>• Looking for a ‘Winner’ </li></ul><ul><li>• Not afraid of failure </li></ul><ul><li>• Understand how to manage a portfolio of risk </li></ul><ul><li>• Serves as a fantastic coach </li></ul><ul><li>• Does her best work outside of the board room </li></ul><ul><li>• Not waiting for validation from other VCs </li></ul>
    11. 11. Deciding whom to give money
    12. 12. In the VC’s Mind <ul><li>• Is this the right team? </li></ul><ul><li>• What’s the entrepreneur's motivation? </li></ul><ul><li>• Is this a billion dollar opportunity? </li></ul><ul><li>• Is it a game changer? </li></ul><ul><li>• How competitive is the space? </li></ul><ul><li>• How defensible is the product? </li></ul><ul><li>• How much is this thing going to take? </li></ul><ul><li>• How long to maximize value and exit? </li></ul>
    13. 13. In the VC’s mind <ul><li>IRR (Internal Rate of Return) </li></ul><ul><ul><li>Company’s Current and Future Valuation </li></ul></ul><ul><ul><ul><li>Comparables (P/E,P/S,…), “Number of”, DCF, … </li></ul></ul></ul><ul><ul><li>What’s The Best Strategy To Create Value </li></ul></ul><ul><ul><ul><li>Which are the achievable milestones and what’s the financing needed ? </li></ul></ul></ul><ul><ul><ul><li>When is the break-even expected ? With which margins and revenues. </li></ul></ul></ul><ul><ul><li>Exit Strategy </li></ul></ul><ul><ul><ul><li>Trade sale, IPO, N th +1 round of financing, .. </li></ul></ul></ul><ul><li>Minimizing Risks </li></ul><ul><ul><li>Diluting the investment </li></ul></ul><ul><ul><li>Liquidation Preference rights </li></ul></ul>
    14. 14. Stages of Investment
    15. 15. Stage v/s Return
    16. 16. Assessing the Entrepreneur <ul><li>• Understanding motivations </li></ul><ul><li>• Determining commitment level and willingness to sacrifice </li></ul><ul><li>• Gauging ego </li></ul><ul><li>• Appetite for risk </li></ul><ul><li>• Domain expertise </li></ul><ul><li>• Leadership abilities and vision </li></ul>
    17. 17. Assessing Portfolio Risk
    18. 18. Why 10x? <ul><li>The “Portfolio Effect” </li></ul><ul><ul><li>Out of Ten Start-ups Funded </li></ul></ul><ul><ul><ul><li>2 successes at 10x or better </li></ul></ul></ul><ul><ul><ul><li>5 ‘OK’ returns at 2x to 5x </li></ul></ul></ul><ul><ul><ul><li>3 write-offs, total loss of invested money </li></ul></ul></ul><ul><li>Venture Capital is fundamentally an institutionalized form of aiming for Outliers! </li></ul>
    19. 19. Which VC to go with?
    20. 20. Most Appreciated VC Contributions <ul><li>Financial Advice </li></ul><ul><li>Corporate Strategy & Direction </li></ul><ul><li>Sounding board for ideas </li></ul><ul><li>Challenging status quo </li></ul><ul><li>Contacts or market information </li></ul><ul><li>Management recruitment </li></ul><ul><li>Money !!!! </li></ul>Source: “The Economic Impact of Venture Capital in Europe” (EVCA and Coopers & Lybrand)
    21. 21. What to look for in a VC <ul><li>People you LIKE ! </li></ul><ul><ul><li>Trustworthy & Collaborative </li></ul></ul><ul><li>Can bring value, not money only ! </li></ul><ul><ul><li>Do not have to be experts in the sector but have to understand the business. </li></ul></ul><ul><ul><li>Good network of contacts. </li></ul></ul><ul><li>Ask for references </li></ul>
    22. 22. What VCs are Not Good at <ul><li>• Long term research investments </li></ul><ul><li>• Sustainability </li></ul><ul><li>• Evolutionary development </li></ul><ul><li>• Asset maximization </li></ul><ul><li>• Billion $ capital requirements </li></ul>
    23. 23. Want to raise VC money?
    24. 24. The Financing Lifecycle <ul><ul><ul><li>Approach </li></ul></ul></ul><ul><ul><ul><ul><li>Elevator’s Pitch and Info Memo </li></ul></ul></ul></ul><ul><ul><ul><li>Presentation </li></ul></ul></ul><ul><ul><ul><ul><li>Business plan </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Meetings </li></ul></ul></ul></ul><ul><ul><ul><li>Negotiation </li></ul></ul></ul><ul><ul><ul><ul><li>Term Sheet (or Letter of Intent) </li></ul></ul></ul></ul><ul><ul><ul><li>Verification and Validation </li></ul></ul></ul><ul><ul><ul><ul><li>Due diligence </li></ul></ul></ul></ul><ul><ul><ul><li>Closing & Financing </li></ul></ul></ul><ul><ul><ul><li>Value Creation </li></ul></ul></ul><ul><ul><ul><li>Exit </li></ul></ul></ul>
    25. 25. The Business Plan <ul><li>A Product/Service description </li></ul><ul><ul><li>Pros and cons of the solution </li></ul></ul><ul><ul><li>Market needs it satisfies </li></ul></ul><ul><ul><li>Barriers to Competition </li></ul></ul><ul><li>Business Model </li></ul><ul><ul><li>Market Analysis (strategic and tactical ) </li></ul></ul><ul><ul><ul><li>Competitors </li></ul></ul></ul><ul><ul><li>Execution Plan </li></ul></ul><ul><ul><ul><li>Marketing and Sales Plan </li></ul></ul></ul><ul><ul><ul><li>Research and Development Plan </li></ul></ul></ul><ul><ul><ul><li>Operations Plan </li></ul></ul></ul><ul><li>Team </li></ul><ul><li>Financials </li></ul><ul><ul><li>Valuation Model & Placement Terms </li></ul></ul><ul><ul><li>Income Statement, Balance Sheet & Cash Flow </li></ul></ul><ul><ul><ul><li>3 years minimum, quarterly breakdown </li></ul></ul></ul><ul><ul><ul><li>1st year in monthly breakdown </li></ul></ul></ul>
    26. 26. The Business Plan -MYTH + + + = Marine Lines
    27. 27. The Term Sheet <ul><li>The parties </li></ul><ul><li>Securities to be issued </li></ul><ul><li>Amount of financing & disbursement schedule </li></ul><ul><li>Pre-financing valuation </li></ul><ul><li>Option plan & earn-out </li></ul><ul><li>Use of proceeds </li></ul><ul><li>Liquidation Preference </li></ul><ul><li>Protective Provisions, Voting Rights and BoD participation </li></ul><ul><li>Anti-dilution </li></ul><ul><li>Lock-ups </li></ul><ul><li>Tag along and drag along </li></ul><ul><li>Exclusivity </li></ul><ul><li>Reporting </li></ul><ul><li>... </li></ul>
    28. 28. Board Seats and Reserved Matters <ul><li>Corporate boards: </li></ul><ul><ul><ul><li>Not involved in day-to-day operations </li></ul></ul></ul><ul><ul><ul><li>Hold extreme control in major corporate events (sale, mergers, acquisitions, IPOs, bankruptcy) </li></ul></ul></ul><ul><li>Lead VC in each round takes seat(s) </li></ul><ul><li>Reserved matters (veto or approval): </li></ul><ul><ul><ul><li>Any sale, acquisition, merger, liquidation </li></ul></ul></ul><ul><ul><ul><li>Budget approval </li></ul></ul></ul><ul><ul><ul><li>Executive removal/appointment </li></ul></ul></ul><ul><ul><ul><li>Strategic or business plan changes </li></ul></ul></ul>
    29. 29. Other Typical VC Rights <ul><li>Right of first refusal on sale of shares </li></ul><ul><li>Tag-along rights : follow founder sale on pro rata basis </li></ul><ul><li>Drag-along rights: force sale of company </li></ul><ul><li>Liquidation preference : multiple of investment </li></ul><ul><li>No-compete conditions on founders </li></ul><ul><li>Right to participate in subsequent rounds (usually follow-on) </li></ul><ul><li>Later VC rights often supercede earlier </li></ul><ul><li>Anti-Dilution Protection </li></ul><ul><ul><li>Recompute VC shares based on subsequent “down round” so that issuing more shares does not “dilute” the value of VC’s holding </li></ul></ul>
    30. 30. Trends in VC investing
    31. 31. What’s Going to be Hot <ul><li>• Virtualization </li></ul><ul><li>• Mobility services </li></ul><ul><li>• Location based services </li></ul><ul><li>• Enterprise services & software </li></ul><ul><li>• Internet gaming and entertainment </li></ul><ul><li>• Gen Y lifestyle products & services </li></ul>
    32. 32. Thank You
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