© Copyright 2003 Sentient Ventures Early Stage Venture Capital

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  • Unable to maintain pro-rata interest in deals What happened? Other venture firms AV, TL, Dell, etc invested Control exit and destiny New fund allows: Control end game: great team Put more capital to work in very attractive deals

Transcript

  • 1. Early Stage Venture Capital Due Diligence and Valuations David M. Lee 2/12/2003
  • 2. Agenda
    • Due Diligence
    • Inside a Venture Fund
    • Valuations
  • 3. Dual Mission
    • DELETED
  • 4. Investment Criteria
    • Key Criteria:
      • Fits within market focus and portfolio
      • Significant market size
      • Headquarters in Texas
      • National or international in scope
      • Manageable competition
      • Fundamental sustainable differentiator
      • Top-tier management team
      • Good chemistry
    • Priority:
      • Insiders are willing to participate
      • Includes a syndication with value-added outside investors
  • 5. Investment Process
  • 6. Process Documentation
    • Investment Overview
      • 1-2 page document that provides a high-level summary
      • Enables the General Partner to relay first opinions back to sponsor
    • Investment Due Diligence Document
      • 10-15 page document that answers questions in depth about the deal
      • Detailed summary about multiple aspects of the business and management team including risks and issues
    • Investment Decision Document
      • 2-3 page document that contains a summary of the due diligence
      • Leads to the recommendation by the sponsor and records the final vote on whether or not to invest
  • 7. Portfolio Management
    • Increase funding potential
      • Assist in refining business plans and financial projections
      • Recruit management team and board members
    • Facilitate follow-on funding
      • Provide introductions to other VCs, funds, banks, and angels
      • Aid development of investor pitch and offering materials
    • Validate market and technical strategies
      • New product, business feasibility, and market research studies
      • Strategic market planning, periodic technical/marketing reviews
    • Provide access to service provider network
      • Referrals to legal, accounting, PR, and marketing firms
      • Contacts for executive consultants, industry experts, and analysts
  • 8. Time Management
    • GP has 3 full-time and 2 part-time partners
    • Limit of 6 portfolio companies per full-time partner
    • Total money placed per full-time partner is < $25,000,000
    • Each full-time partner reviews 400 deals w/in commitment period
    • Target fund size of up to $90,000,000
    16.5 1/3 Investor Relations 16.5 1/3 Portfolio Management 16.5   1/3 Investing 50 Hours Per Week Per Partner 6 0.9 3.5 N/A 2.8 Hours / Company per Week 400 1.8 4.2 $ 24,666,667 6.0   Per Partner Reviewed Managed Managed Placed Made     Deals Passively Actively Money Deals     Total Companies Companies Total Total    
  • 9. Portfolio Allocation
    • Target is 18 to 23 portfolio companies
    • $1.5 million average initial investment
    • Active management of 70% of the portfolio companies
    • Lead investor for 40% of the investments
    • Over 50% of the fund reserved for follow-on investments
    • Establish up front funding milestones/trigger based budgets
    $2,000,000 $1,000,000 100% $1,000,000 6 30% Passive Follow-on Investor $4,000,000 $2,500,000 170% $1,500,000 5 30% Active Follow-on Investor $6,000,000 $4,000,000 200% $2,000,000 7 40% Active Lead Investor Per Deal Reserve Reserved Investment Deals Percent Management   Total   Percent Initial        
  • 10. Investment Returns
    • DELETED
  • 11. Fund Management
    • Fund managers bring over 100 years of operating experience:
      • 3 Full-time Partners - Managing Partner and 2 General Partners
      • 2 Part-time Partners - Venture Partner and Fund Administrator
    • Each principal was strategically selected:
    • Supporting Staff
      • Venture Consultants, Contractors, Associates, and Interns
  • 12. Fundamentals
    • Block-n-Tackle Business Planning
      • Revenue Growth, Expense Controls, and Profit Focus
    • Solution for a significant pain that a large group of people with money are willing to pay for
    • Experienced management team that knows how to make payroll
    • Sustainable differentiation with an emphasis on unique best-of-breed IP
    • Venture acceleration, not venture support
  • 13. Current Focus
    • High Technology (3-4 Month ROI):
      • Enterprise Software
      • Telecommunications Utilization Software
      • Semiconductors and MEMs/Nanotechnology
      • Bioinformatics and Life Sciences/IT convergence
    • Life Sciences:
      • Diagnostic Tests
      • Pharmaceuticals
      • Genomics/Proteomics
      • Medical Devices
  • 14. Valuation’s Role in Financing
    • Sets economic interests going forward.
      • Establishes an intrinsic value for the company
      • Valuation is not transaction independent
    • One of many terms under negotiation …
  • 15. From the Term Sheet
    • Terms
      • Capitalization
      • Type of Security/Securities
      • Characteristics of the Security/Securities
        • Anti-dilution
        • Liquidation preference
      • Representations and Warranties of the Company
    • Other Conditions to the Deal
      • Governance Requirements
      • Reporting Requirements
      • Expenses
      • Non-solicitation
      • Changes to Management
      • Key-man Insurance
  • 16. Initial Valuation Views
    • The Technologist
    • The Technology
    • Personnel (Technical)
    • The Market
    • Personnel (Business)
    • The VC
    • Personnel (Business)
    • Personnel (Technical)
    • The Market
    • The Technology – Must have IP!
  • 17. Methods of Valuation
    • Methods:
      • Discounted Cash Flows (DCF)
      • Comparables
      • Target Ownership
    • Reality for Early Stage Companies
      • Use the first two to justify the third
  • 18. Pros and Cons of DCF
    • Pros
      • Highly quantitative
      • Provides specific, objective (?) numbers as a basis for negotiation
      • Speaks to “Intrinsic Value” of company
    • Cons
      • Too many variables
      • Depends upon accurate forecasting
      • Difficult to discount for risk and lack of liquidity
  • 19. Comparables
    • Most closely resembles Real Estate valuations
    • Look at prices of similar deals
      • Stage of business
      • Location of business
      • Industry
    • Adjust up or down for specific circumstances
  • 20. Comparables Adjustments
    • Current capitalization
      • Cap table
      • Past investment rounds
    • Product development
      • In Beta
      • General Availability
    • Management
      • Good or bad management
    • Business Development
      • Sales booked
      • Quality of sales pipeline
      • Profitability
  • 21. Pros and Cons of Comparables
    • Pros
      • No need to adjust for risk or liquidity
      • A common method that is fairly well understood within early stage companies
      • Fast
    • Cons
      • Highly subjective
      • Imperfect distribution of information
  • 22. Reality of Valuation
    • First Round company
    • Some seed money in (Friends and family – 20%)
    • Networking Software space
    • Excites one of the Partners
    • Product in Beta
    • Missing management team members
    • No option pool
    • Based in New Mexico
    • $3M raise
    • Syndicate has target ownership of 33%
  • 23. Reality of Valuation
    • In year of comparison – Average Post-money valuations:
      • Communications SW, Series A: $7.78M
      • SW & Rocky Mtn., Series A: $8.66M
    • Average post-money valuation of $8.25M
      • Pre-money valuation of $5.25M
      • $3M raise
    • Resulting Ownership
      • 36% - New Investor ownership (Series A Preferred)
      • 20% - Option pool forced before round
      • 11% - Friends and Family Ownership
      • 33% - Founder Ownership
  • 24. Further Justification
    • Adjustments to the valuation
      • Large Stock Option plan needs to be created
        • Management team is incomplete
      • Hot space
        • Don’t forget the Run with the Pack mentality
        • We’ll be the lead investor
      • > 1 additional financing round expected
        • New investors will also be diluted
      • Product in Beta
        • Technology risk still exists
        • Not proven in the field (lack of customers)
      • Claim to go from $0 to $250M in 4 years
        • Several companies will put this in the plan, but very few can defend it
  • 25. Q&A