February 4, 2003 Georgetown University Medical Center The Anatomy ...

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February 4, 2003 Georgetown University Medical Center The Anatomy ...

  1. 1. Center for Entrepreneurship Jerry Feigen “An Anatomy of a Deal” March 13, 2003 NIH Bio Business Group
  2. 2. Anatomy of a Deal <ul><li>VC History </li></ul><ul><li>Assessing Traditional Entrepreneurs Vs. The Scientific Research </li></ul><ul><li>What is a deal - Sources of Capital? </li></ul><ul><li>How is a deal put together - Venture Investors and Deal Expectations? </li></ul><ul><li>Role of a Business Plan in Structuring a Deal </li></ul><ul><li>Making the Presentation – You are the Team – All Alone </li></ul><ul><li>Letter of Intent </li></ul><ul><li>Due Diligence </li></ul><ul><li>Valuation Negotiation </li></ul><ul><li>Term Sheet / Investment Agreement </li></ul><ul><li>Deal Closing </li></ul><ul><li>Post Closing Relationships – Danger Signals </li></ul><ul><li>Exit </li></ul><ul><li>Where are we going with Biotechnology and Life Science Deals? </li></ul><ul><li>Montgomery College Bio Science Technology Park – An Ecosystem </li></ul><ul><li>Macklin Partners, Potential Internships, Incubator Development </li></ul>
  3. 3. VC HISTORY The First 10 years - 1960’s - Chaos and Experimentation Small Business Investment Act of 1958 • Direct equity investments by SBICs permitted • Organization of NASBIC (1958) - National Association of Small Business Investment Companies • Funding of SBICs when licensed - misuse of too much cash • Lack of significant oversight creating fraudulent transactions, bootstrapping, conflicts • More focus toward “venture capital” than lending • Cyclical nature to managing SBIC portfolio evolved • Average rate of return of SBICs, March 1969 - 9.5% • Top 25% SBICs averaged 30% on invested capital • Data on portfolio growth showed employment increase of 25%, gross revenues increase by 27% and profits by 27% • SBICs flowed $1.7 billion in 35,000 transactions • $40 million invested in technology deals • Creation of new “equity” transaction structures and legal precedence for deals • Hot issue market of early 1960s showed significance of IPO “ exiting” and timing
  4. 4. The Second Ten Years - 1970’s - A U.S. Venture Capital Industry Created • Increased leverage to 3:1 and 4:1 for SBICs to target “venture” financings and total leverage available to single SBIC increased • Legislative authority to raise private institutional and individual investor funds through Wall Street instead of government direct funding - Full faith and credit of U.S. - 100% guarantee - Timely payments • National Venture Capital Association formed in 1973; 70 members including majority of the largest SBICs • First Annual Venture Capital Institute was created in 1974 • Investor funds from outside the U.S. to capitalize SBICs began to emerge – basically European • Major hits - Apple Computer, Cray Research, Federal Express, Intel • Bio Deals Begin – Amgen – Pitch Johnson, Brook Byers – First VC Leap into Biotech • Shift from electronics of 1960’s to computers of 1970’s • 1977 SBA Task Force Report - Life Cycle of Growth Companies - Regulatory Impact on Growing Firms - SEC, pension, tax, etc. • “ ERISA” and “Prudent Man” Pension Fund Restrictions
  5. 5. <ul><li>• Between 1970 – 1980 </li></ul><ul><ul><li>SBICs disbursed $1.8 billion in more than 21,000 transactions </li></ul></ul><ul><ul><li>SBICs invested almost $193 million in 556 technology deals </li></ul></ul><ul><ul><li>with another $199 million from co-investors </li></ul></ul><ul><li>• Non SBIC private venture funds invested $1.7 billion with </li></ul><ul><li>pension funds providing 31% of funds raised by venture capital </li></ul><ul><li>funds in 1979 </li></ul><ul><li>• Capital Gains tax reduction from 49 1/2 to 28 % - 1978 </li></ul><ul><li>• Entrepreneurs of 1970’s </li></ul><ul><ul><li>Bob Noyce - Intel Corp </li></ul></ul><ul><ul><li>Gene Amdahl - Amdahl Computers / Trilogy Investments </li></ul></ul><ul><ul><li>Steve Jobs - Apple Computer </li></ul></ul><ul><ul><li>Seymour Cray - Cray Research </li></ul></ul><ul><ul><li>Fred Smith - Federal Express </li></ul></ul><ul><ul><li>Bob Swanson - Genentech </li></ul></ul><ul><li>• Life Sciences deals begin, but falter </li></ul>
  6. 6. Decade Three - 1980s - Era of Not So Benign Neglect <ul><li>From Computers to Biotechnology </li></ul><ul><li>Small Business Innovation Research Grants - 1982 - Prototype / commercial </li></ul><ul><li>feasibility of U.S. technology </li></ul><ul><li>Capital Gains tax reduction 26% to 20% </li></ul><ul><li>SBICs cover most of the states </li></ul><ul><li>Small Business Investment Incentive Act of 1980 gives rise to Business Development Companies - some are SBICs - tapping public investors </li></ul><ul><li>Section 385 of IRS Code - What’s debt and what’s equity? </li></ul><ul><li>SBA raises private capital for SBICs to $1 million </li></ul><ul><li>SBA oversight becomes limited because of lack of resources </li></ul><ul><li>Proposal to eliminate SBA in 1985 </li></ul><ul><li>Stock Market collapse in 1987 </li></ul><ul><li>Lack of interest in SBIC formations by private sector </li></ul><ul><li>In 1990 - SBICs had $1.7 billion in private capital and SBA leverage of </li></ul><ul><li>$790 million </li></ul><ul><li>Between 1981-1990 - SBICs invested $4.4 billion in 24,000 transactions with more than $1.2 billion provided to “technology” firms </li></ul><ul><li>Pension funds provided almost 40% of the $24 billion committed to independent </li></ul><ul><li>venture funds in the decade </li></ul><ul><li>Entrepreneur of the Decade - Bill Gates - Microsoft </li></ul>
  7. 7. <ul><li>The Roaring 1990s </li></ul><ul><li>• Venture Capital in Retreat </li></ul><ul><li>• SBICs - Revisited and Restructured - A Counter Cyclical Force </li></ul><ul><li>• Internet Emerges - Government / Private Sector Partnership Explodes </li></ul><ul><li>• Longest Growth Cycle in History </li></ul><ul><li>• Financial Deregulation After 60 Years </li></ul><ul><li>• Global Merger Mania </li></ul><ul><li>• Largest VC Returns Ever - Millionaires Abound </li></ul><ul><li>• NASDAQ Goes Global </li></ul><ul><li>• A New Entrepreneurial Economy </li></ul>
  8. 8. <ul><li>2000 and Beyond - A New Millennium Begins </li></ul><ul><li>• IPOs and Dot Coms and the Economic Cycle Clash </li></ul><ul><li>• Stock Market Down </li></ul><ul><li>• VCs Freeze Investing - Limiteds Change Interests </li></ul><ul><li>• U.S. Economy in Retreat </li></ul><ul><li>• Geographic Shift in U.S. Focus for Funds / Angel Networks Grow </li></ul><ul><li>• VC Activity Outside U.S. Taking Leads in Early Stage Deals </li></ul><ul><li>• First Round Venture Funding to Just $1.04 Billion During </li></ul><ul><li>2nd Quarter 2001 - Down 87% from last year </li></ul><ul><li>• Terrorists Hit World Trade </li></ul><ul><li>• Acceleration of Global Impact on Markets </li></ul><ul><li>• Enron and the Fall Out for VC Deals </li></ul><ul><li>• What’s Next ????????? </li></ul>
  9. 9. Assessing Traditional Entrepreneurs Vs. The Scientific Research <ul><li>Total commitment, determination and perseverance </li></ul><ul><li>Drive to achieve and grow </li></ul><ul><li>Opportunity and goal oriented - realistic goal setting </li></ul><ul><li>Taking initiative and personal responsibility </li></ul><ul><li>Persistent problem solving / self imposed challenges </li></ul><ul><li>Awareness of self with sense of humor - optimistic </li></ul><ul><li>Seeks and uses feedback - good talkers / listeners </li></ul><ul><li>Internal locus of control - belief in themselves </li></ul><ul><li>Tolerance for ambiguity, stress and uncertainty </li></ul><ul><li>Calculated risk taker and risk sharer </li></ul><ul><li>High integrity and reliability </li></ul><ul><li>Copes with failure </li></ul>
  10. 11. Life Cycle of a Start-up <ul><li>Basic Steps and Pitfalls to Growing a Business </li></ul><ul><li>The Agony and Ecstasy at Each Stage of Growth - A lonely existence </li></ul><ul><li>Moving to Professional and Personal Rewards/Disappointments </li></ul><ul><li>Bottom Line Measurements of Success or Failure - Economic vs. Personal Goals </li></ul>
  11. 12. Capital Sources for Growing Enterprises - Cyclical Challenges <ul><li>Friends / Family / Angel Investors and Network </li></ul><ul><li>Government - Prototype and Feasibility - ATP, SBIR, State Programs (MIPs), etc. </li></ul><ul><li>Venture Capital Firms - Which are the right ones? </li></ul><ul><li>Endowments/Fund of Funds - Bio/Health related </li></ul><ul><li>Licensing Options - Pros and cons </li></ul><ul><li>Joint Venturing - Pros and cons </li></ul><ul><li>Corporate and Corporate Venturing Groups </li></ul><ul><li>International Balancing Acts </li></ul>
  12. 13. Deal Expectations <ul><li>• Expectations </li></ul><ul><li>• Know and Keep Focus </li></ul><ul><ul><li> What is a VC Investment Policy </li></ul></ul><ul><ul><ul><ul><li>Return on Investment </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Economic Development </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Technology </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Deal Stage of Development </li></ul></ul></ul></ul><ul><ul><li> What Do Investors Expect </li></ul></ul><ul><ul><ul><ul><li>Timely Information - Truth </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Regular Contact - No Surprises </li></ul></ul></ul></ul><ul><ul><li> What Do Entrepreneurs Expect </li></ul></ul><ul><ul><ul><ul><li>Money and Confrontation </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Free Hand </li></ul></ul></ul></ul>
  13. 14. <ul><li>Deal Flow </li></ul><ul><ul><li>Marketing - What Fund is or is Not </li></ul></ul><ul><ul><li>Sourcing The Right Deals </li></ul></ul><ul><ul><li>Referrals - Who do you Trust </li></ul></ul><ul><ul><ul><li>Board Members / Advisors </li></ul></ul></ul><ul><ul><ul><li>Service Providers </li></ul></ul></ul><ul><ul><ul><li>Other Funds - Syndicators </li></ul></ul></ul><ul><ul><ul><li>Banks ?????? </li></ul></ul></ul><ul><ul><li>Internet - Company and Data Base Linkages </li></ul></ul><ul><ul><li>Focused Conferences and Networking </li></ul></ul><ul><ul><li>Trade Shows - Suppliers </li></ul></ul><ul><ul><li>Business, Technical and Trade Periodicals </li></ul></ul><ul><ul><li>University Affiliations - Incubators / Professors </li></ul></ul><ul><ul><li>Good Web Sites </li></ul></ul><ul><ul><li>Venture Capital Associations </li></ul></ul>Know Your Venture Fund Model
  14. 15. Presentation, Screening and Analyzing <ul><li>• Screening - Limit Time and Costs - 1 % Make It </li></ul><ul><li>• Establish Formal Criteria and Process - In, Out, Maybe </li></ul><ul><li>• Establish Log- Acknowledge Receipt of Plan Quickly </li></ul><ul><li>• Out / Rejected Plans - Reasons - Market Too Small, Return Inadequate, No Personal Risk </li></ul><ul><li>• In / Maybe - Good reference, Solves Big Pain, Experienced Management </li></ul><ul><li>• Initial Interview - “Gut” Reactions to Team - Negotiations Begin </li></ul><ul><li>• Provide Feed Back- Be Straight </li></ul><ul><li>• Move to Due Diligence - Check Existing Portfolio for Conflicts </li></ul>
  15. 16. Letter of Intent <ul><li>Used in Early Days of Venture Capital </li></ul><ul><li>Pre Term Sheet Negotiations </li></ul><ul><li>Informal – nonbinding letter agreement on the sticky issues </li></ul><ul><li>Entrepreneurs and VC resolve business and personality conflicts </li></ul>
  16. 17. Due Diligence <ul><li>• Verifying the Market - Whose Numbers ? / Related Markets </li></ul><ul><li>• Who and Where are the Customers ? </li></ul><ul><li>• Is Management for Real ? - Going Beyond Official References </li></ul><ul><li>• Can Management be Coached as the Company Grows ? </li></ul><ul><li>• Do Financial Numbers and Assumptions Make Sense - Valuation? </li></ul><ul><li>• Are the market and financial strategies Simple to Understand ? </li></ul><ul><li>• Does the idea ease a Big Enough Pain ? </li></ul><ul><li>• Always “ Kick the Tires” - site visits, wheat in the silos? </li></ul><ul><li>• Talk to Management and Employees Separately - Employees Know </li></ul><ul><li>A Lot - Ask Every Question You Can To All Related Parties </li></ul><ul><li>• Check Former Bankers (Personal and Business) and Suppliers / Creditors </li></ul>
  17. 18. VC Variables in Valuation: <ul><li>· ROI need </li></ul><ul><li>· Amount to be invested </li></ul><ul><li>· Number of years to hold investment </li></ul><ul><li>· Actual after-tax profits in harvest / exit year </li></ul><ul><li>· Price / earnings multiples at time of harvest / exit </li></ul><ul><li>· Seed / start-up = 50-100% ROI in 10 years + Hold Period </li></ul><ul><li>· First Stage = 40-60% ROI in 5-10 year Hold Period </li></ul>
  18. 19. <ul><ul><ul><li>Example: </li></ul></ul></ul><ul><ul><ul><li>Company Profile: </li></ul></ul></ul><ul><ul><ul><li>· No history of earning </li></ul></ul></ul><ul><ul><ul><li>· Age similar to public / private company </li></ul></ul></ul><ul><ul><ul><li>· Technology and market similar </li></ul></ul></ul><ul><ul><ul><li>· Find like company, etc. </li></ul></ul></ul>
  19. 20. <ul><li>Formula: </li></ul><ul><ul><ul><li>· Investment = $1,500,000 </li></ul></ul></ul><ul><ul><ul><li>· VC rate of return expected = 40% </li></ul></ul></ul><ul><ul><ul><li>· After-tax profits in Year 3 = $550,000 </li></ul></ul></ul><ul><ul><ul><li>· Similar companies, etc.: </li></ul></ul></ul><ul><ul><ul><ul><li>6x – 8x Net Income in Year 3 </li></ul></ul></ul></ul><ul><li>· Value in Year 3: </li></ul><ul><ul><ul><ul><li>$550,000 x 6 = $3,300,000 </li></ul></ul></ul></ul><ul><ul><ul><ul><li>$550,000 x 8 = $4,400,000 </li></ul></ul></ul></ul><ul><li>· Present Value Formula: </li></ul><ul><ul><ul><ul><li>(PV = present value, FV = future value, i = investment rate </li></ul></ul></ul></ul><ul><ul><ul><ul><li>of return, and n = number of years the investment is held) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>PV = FV </li></ul></ul></ul></ul><ul><ul><ul><ul><li>(1 + i) n </li></ul></ul></ul></ul><ul><ul><ul><ul><li>$1,500,000 = FV = FV </li></ul></ul></ul></ul><ul><ul><ul><ul><li> (1 + 0.40) 3 2.744 </li></ul></ul></ul></ul><ul><ul><ul><ul><li>FV = $4,116,000 or 40% for 3 years </li></ul></ul></ul></ul>
  20. 21. <ul><li>Determination of VC Equity Ownership: </li></ul><ul><li>For the investor to receive its return objective, it needs to receive </li></ul><ul><li>for its investment a portion of the company. For example, if the </li></ul><ul><li>venture is worth $3,300,000 to $4,400,000 at the end of year </li></ul><ul><li>three, the $1,500,000 put into the venture by the investor today </li></ul><ul><li>should buy from 34 percent to 45 percent of the company: </li></ul><ul><li>$1,500,000 = 34% </li></ul><ul><li>$4,400,000 </li></ul><ul><li>or: </li></ul><ul><li>$1,500,000 = 45% </li></ul><ul><li>$3,300,000 </li></ul>
  21. 22. Post Closing VC Strategies <ul><li>• Verifying Use of Proceeds - Follow the Money </li></ul><ul><li>• Open Communication with Management on Regular Basis </li></ul><ul><li>• Monthly Reports - Short Narratives Essential </li></ul><ul><li>• Quarterly Financials - Highlighting Changes from the Plan, Cash Flow Position, Cost of Operations, Marketing </li></ul><ul><li>• Anticipate Next Rounds - Check the Term Sheet Milestones </li></ul><ul><li>• Verify Strength of Management and Ability to Work as a Team </li></ul><ul><li>• Test Morale of Employees </li></ul><ul><li>• Check How Fast Competitors are Growing </li></ul>
  22. 23. Danger Signals and Red Flags <ul><li>• Weakening Management - Losing Top People </li></ul><ul><li>• Production Schedules Off - Quality Down </li></ul><ul><li>• Contracts / Sales Not Booked Timely </li></ul><ul><li>• Bank Debt Being Restructured </li></ul><ul><li>• Supplier Terms Being Extended </li></ul><ul><li>• Change in Auditors </li></ul><ul><li>• Margins Narrowing </li></ul><ul><li>• Significant Meetings Changed or Postponed Becoming a Pattern </li></ul><ul><li>• Top Managers Taking on New Duties without Delegations </li></ul><ul><li>• High Percentage of Milestones Being Missed </li></ul><ul><li>• Need to Change CEO - A Delicate Balance </li></ul>
  23. 24. Summary Deal Breakers vs. Makers <ul><li>• Deal Breakers </li></ul><ul><li>- Different Stories – Management vs. Employee </li></ul><ul><li>- Critical Misrepresentation </li></ul><ul><li>- Team Never Worked Together </li></ul><ul><li>- Founders Not Coachable </li></ul><ul><li>- Inflexibility </li></ul><ul><li>- Need 100 % of Company – Even if not growing </li></ul><ul><li>• Deal Makers </li></ul><ul><li>- Consistent Pitch </li></ul><ul><li>- Clean Due Diligence </li></ul><ul><li>- History of Making Goals </li></ul><ul><li>- “Skin” is in the Game </li></ul><ul><li>- Flexibility </li></ul><ul><li>- Accept 60-40% of a Large Valued Jointly Built Company </li></ul>
  24. 25. Term Sheet / Investment Agreement <ul><li>Valuation Terms </li></ul><ul><li>Investment Instruments </li></ul><ul><li>- Common Stock </li></ul><ul><li>- Preferred Stock (Series A, B, C) </li></ul><ul><li>- Convertible Preferred </li></ul><ul><li>- Convertible Debenture </li></ul><ul><li>- Debt with Warrants/Options </li></ul><ul><li>Positive/Negative Covenants </li></ul><ul><li>Reporting Requirements – Milestones? </li></ul><ul><li>Board Seat </li></ul><ul><li>Reserve Shares for Employee Incentives – </li></ul><ul><li>Stock Options – In or Out </li></ul><ul><li>Public Offering Rights, Rights of First Refusal, </li></ul><ul><li>Tag Along Rights </li></ul>
  25. 26. Exiting Getting Out - VCs and Founders <ul><li>• Structure Up Front - Timing Options / Reality Bites </li></ul><ul><li>• Management Buy Backs - Basis Realistic ?? </li></ul><ul><li>• Purchase Arrangement - Cash Vs. Stock Vs. Debt </li></ul><ul><li>• Merger Potential - Terms and Conditions - Who wins ? </li></ul><ul><li>• Exchange Listing - Timing Essential / NASDAQ / GDRs </li></ul><ul><li>• Distribution Needs of Investors - Supersedes Portfolio and VC Management Needs ?? </li></ul>
  26. 27. Where are we going with Biotechnology and Life Science Deals? <ul><li>Breakup Of Early Biotech </li></ul><ul><li>Mergers / Acquisitions / Sales </li></ul><ul><li>Spin Off Of New Niche Products / Services </li></ul><ul><li>Young Ph.D.s And New Enterprise </li></ul><ul><li>Development Of Scientist VC </li></ul><ul><li>New Deal Structures Based On Science Business Life Cycle </li></ul><ul><li>International Nuances </li></ul>
  27. 28. Bioscience Business Lifecycle and Montgomery College Life Science and Technology Park Ecosystem Timespan of Phase MC Contribution in the Phase MC Benefits in the Phase MC Bioscience Park Percentage Occupancy Zero Profit Line Jerry Feigen, Lloyd Case New, startup seed-capital, promising, company <<< 1-5 Years >>> *Technology Development *Entrepreneurial training of staff *Incubator support:: space, VC contact, business networking *Students for jobs, interns *Pipeline to labor pool *Student intern experience *Student entrepreneurial education *Educational cooperation *Pipeline of education, opportunity *Equity in early, new company 3% ( 30,000 of 1,000,000 sf) or (25 companies at 1,200 average sf) Young, growing, 1 st -2 nd round financed company <<< 5-10 Years>>> *Technology Transfer *VC contacts, education *Support: space, business networking *Students for jobs, interns *Pipeline to labor pool *Student intern experience *Student entrepreneurial education *Rental revenue *Educational cooperation *Pipeline of education, opportunity 22% ( 220,000 sf of 1,000,000 sf) or (27 companies at 8,000 average sf) $uccessful, public, acquisition, or merged anchor company *Spinoff new companies *Mentorships for businesses and students *Increased rental income *Educational cooperation *Pipeline of education, opportunity *Community advocacy 35% ( 350,000 sf of 1,000,000 sf) or (2-3 companies at 75,000-120,000 average sf) Mature, Pre-IPO nth-round financed company <<< 10+ Years >>> *Technology Commercialization *VC contacts, education *Space, business networking *Students for jobs, interns *Pipeline to labor pool *Student intern experience *Student entrepreneurial education *Rental and partnership revenue (return on equity) *Educational cooperation *Pipeline of education, opportunity 40% ( 400,000 sf of 1,000,000 sf) or (26 companies at 15,000 average sf)
  28. 29. <ul><li>Macklin Partners </li></ul><ul><ul><li>Technology Council of Maryland </li></ul></ul><ul><ul><li>Dingman Center for Entrepreneurship </li></ul></ul><ul><ul><li>Montgomery County Department of </li></ul></ul><ul><ul><ul><li>Economic Development </li></ul></ul></ul><ul><li>Potential Internships </li></ul><ul><li>Incubator Development </li></ul>
  29. 30. <ul><li>Center for Entrepreneurship </li></ul><ul><li>Jerry Feigen, Director </li></ul><ul><li>51 Mannakee Street </li></ul><ul><li>Rockville, Maryland 20850 </li></ul><ul><li>Phone: 301 738-1702 </li></ul><ul><li>Fax: 301 279-5149 </li></ul><ul><li>Email: [email_address] </li></ul><ul><li>Web: www.macklin.org </li></ul><ul><li>For copies of this presentation or further information, contact kdroubi@mc.cc.md.us or 301 738-1707 </li></ul>

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