Venture Capital

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Venture Capital

  1. 1. Venture Capital The Investment Process and Great Investment
  2. 2. What is Venture Capital? • Money invested: – By professionals (venture capitalists) – In early-stage companies – In order to produce financial returns. • Does not include: – Buyout investing – Mezzanine investing – Angel investors.
  3. 3. What is Venture Capital? • Funds are usually: – Raised from the investors (limited partners) – By the firm (general partners) – For a set period of time (around 12-years) • Supposed to return above-average interests (during bubble, 40%,50%, 90% yearly) • By investing in private companies and exiting via IPO or buyout.
  4. 4. Money Flow in Venture Capital Limited Partners commit to $x million – Participate in draw-downs on regular basis – Money is not given to the VC’s all up front. The VC charges a few percent of the money committed, to pay for salaries and expenses. Usually, first liquidity events go to repaying investors. When investors are fully repaid, limited and general partners share the proceeds (80%-20% or 85%-15%). – The general partner share is called “carry.” Many permutation of arrangements with limited partners.
  5. 5. Players in Venture Capital Limited Partners Typical investors in venture capital funds: – Pension funds – Foundations – Local governments – Universities – Wealthy individuals General Partners – Ex-CEOs – Ex-investment bankers – Ex big-8 consultants – The occasional scientist or MD
  6. 6. Types of Venture Capital Funds Funds tend to specialize by stage, industry, or geography – Stage: • Seed Funds (the earliest institutional funds) • Early Funds (will go in right after seed) • Mezzanine Funds (prefer funding just prior to liquidity, IPO or buyout) – Industry • Oxford Biosciences (Medical) • Trident, Northpoint (IT, telecom) • NEA – Company is a generalist but individual general partners specialize – Geography (Samller Funds tend to stay in a region) • Anthem Capital – Local here
  7. 7. Early Investments Lifecycle Start-up V1.1 concept Eng. Specs Prototype Alfa Beta V1 Res. & Develop. CUSTOMERS Marketing & Sales M&S Plan V1 Plan V2 Plan V0.1 Prod. & Ops P&O Plan V0.1 Plan V1 Plan V2 Seed (< € 1 mil) Early Stages (€ 1 - 10 mil) Expansion/ (€ 10+ mil) development Angels Incubators Accelerators Venture Capital Private Equity & Merchant Banks
  8. 8. ‘Death valley’ is a serious problem capital needs owner, 'DEATH VALLEY' family funding time idea seed and start-up growth mature growth, expansion Source: Wissema, Technostarters, why and how?
  9. 9. Where does VC fit in? Sources of New Venture Financing Seed Start-up Early Growth Rapid Growth Exit Entrepreneur Friends and Family Angel Investors Grants Strategic Partner Venture Capital Asset-based Lender Equipment Lessor SBIC Mezzanine Lender IPO Public Debt Acquisition, LBO, MBO Red shading indicates primary focus of investor type. Blue shading indicates secondary focus, or focus of a subset of investors of the type.
  10. 10. Venture Capital Where the money is invested (Q1’07) • Silicon Valley $2.1 billion • New England $976 million • Southeast $579 million • Greater DC $197 million
  11. 11. Venture capital is clearly associated with innovation… Source: Yozma after USA Census, OECD, Correlation between VC and ICT 14% Israel 12% IVC Research Center, CBS ICT share in GDP 10% Ireland Korea UK USA 8% Japan Sweden 6% Canada France 4% 0,0% 0,1% 0,2% 0,3% 0,4% 0,5% 0,6% 0,7% 0,8% VC investment in ICT as % of GDP ICT = Information and Communication Technologies 11/13
  12. 12. 0. 0% 0. 1% 0. 2% 0. 3% 0. 4% 0. 5% 0. 6% 0. 7% Israel 0. 8% USA Canada Korea Sweden UK Netherlands Ireland France Finland Belgium Source: OECD 1999-2002, IVC Research Center 2002, CBS (Isr.) EU Norway New Denmark Relative to GDP Germany Australia VC Investment in ICT Italy Switzerland Greece Spain Portugal Austria Japan
  13. 13. Venture Capital What venture capitalists do: – Finance rapidly growing companies – Typically buy equity rather than lend money – Often sit on the board of directors – Help management teams (but also direct) – Take a long-term view
  14. 14. What Venture Capitalists do ... Sift through thousands of (good and bad) investment propositions Identify a few valid initiatives and finance them – in exchange for private equity (usually a minority stake) – structure the deal Support the entrepreneurs in succeeding. E.g.: – providing financial advice – in headhunting and setting up advisory boards – in contacting customers, channels, … – in steering and positioning the company – in managing PRs activities – in managing IP and legal issues Look after value creation – further round of financing – merger and acquisition, IPO, …
  15. 15. A Day in the Life of a VC VCs travel 60-90% of time Network with other VCs, lawyers, I-bankers, CEOS they funded in past – and limited partners Attend industry conferences for market intelligence and deal flow Meet companies, read biz plans Heavy due diligence, phone and in person Attend industry conferences Negotiate deals Participate on boards of directors
  16. 16. The Venture Capital Process • Find Deals • Research Deals – A 3-6 Month Process • Structure and Close Deals • Manage The Investment • Exit The Investment
  17. 17. VC Investment process Tender launch Analysis of Offers Deal fulfilment Monitoring Exit •Preparation of •Formal analysis (checking out •Negotiations of •Accomplishment of •Exits from portfolio tender terms for completeness of required investment investment funds •Tender documents) agreement agreement announcement • Primary financial & legal •Signing of •VC fund financials (offer form, key analysis of documents (VC investment •Complying with conditions of funds resulting in a short list agreement information investment that includes 1 to 5 best offers •Transfer of standards by VC agreement) •In-depth financial & legal financial resources fund •Gathering of offers analysis (meetings with to the fund •Use of state aid management teams from short according to the list and presentation of their drawdown schedule offers, due diligence of offers •Final choice of offers
  18. 18. Most Appreciated VCs Contributions • Financial Advice 44% • Corporate Strategy & Direction 43% Source: “The Economic Impact of • Sounding board for ideas 41% (EVCA and Coopers & Lybrand) Venture Capital in Europe” • Challenging status quo 32% • Contacts or market information 26% • Management recruitment 10% • Marketing strategy 7% • Money only 12%
  19. 19. Venture Capital Characteristics of “venture fundable” companies: – Experienced management – Defensible market – Good business model (can make money) – Proprietary intellectual property – Manageable funding requirements – Valuation expectations in line with market
  20. 20. Venture Capital in the EU What does a VC asks for – VC investors’ stake Source: “The Economic Impact of (EVCA and Coopers & Lybrand) • 2% have 1 - 9% Venture Capital in Europe” • 38% have 10 - 33% • 21% have 34 -49% • 39% have 50+ %
  21. 21. How to approach a venture capitalist • The Business Plan • A Team • A Presentation and an “Elevator’s Pitch” • References • An NDA (if required)
  22. 22. The Business Plan A Product/Service description – Pros and cons of the solution – Market needs it satisfies – Barriers to Competition Business Model – Market Analysis (strategic and tactical) • Competitors – Execution Plan • Marketing and Sales Plan • Research and Development Plan • Operations Plan Team Financials – Valuation Model & Placement Terms – Income Statement, Balance Sheet & Cash Flow • 3 years minimum, quarterly breakdown • 1st year in monthly breakdown
  23. 23. The Term Sheet • The parties • Securities to be issued • Amount of financing & disbursement schedule • Pre-financing valuation • Option plan & earn-out • Use of proceeds • Liquidation Preference • Protective Provisions, Voting Rights and BoD participation • Anti-dilution • Lock-ups • Tag along and drag along • Exclusivity • Reporting • ...
  24. 24. How does a VC think IRR (Internal Rate of Return) – Company’s Current and Future Valuation • Comparables (P/E,P/S,…), “Number of”, DCF, … – What’s The Best Strategy To Create Value • Which are the achievable milestones and what’s the financing needed ? • When is the break-even expected ? With which margins and revenues. – Exit Strategy • Trade sale, IPO, Nth+1 round of financing, .. Minimizing Risks – Diluting the investment – Liquidation Preference rights
  25. 25. A possible valuation scenario Company X. Quoted on Stock Exchange Z. Valuation € 100mil, Sales € 50 mil, Earnings € 5 mil. P/E = 100/5 = 20, P/S = 100/50 = 2. Company Y. Acquired for € 20 mil with sales of € 10 mil. P/S = 20/10 = 2. Your “UnwiredCo” plan forecasts € 30 mil in sales and € 5 mil in earnings in 2014. Its buss. model is “similar” to X and Y. – Lower Valuation of UnwiredCo in 2009 using P/S of 2 is 30*2 = € 60mil – Higher Valuation in 2009 using P/E of 20 is 5*20 = € 100 mil Present Post-Money1 valuation (discount-rate2 of 50%) is between 60/(150%)5years = € 8mil and 100/(150%)5years = € 13.3mil The “UnwiredCo” requires a € 4 mil financing round. The Pre-Money valuation is between € 8-4=4mil and € 13.3-4= 9.3mil. An agreement is reached at a pre-money valuation of € 6mil. hence the Investor will obtain a 4 / (6 + 4) = 40% stake in the company. 1 Valuationof the company after the investment. 2Target Annualized Return of Investment
  26. 26. European Private Equity Funds Private Equity & Venture Capital Activity”, European Private Equity & VC Association Source: “Annual Survey of Pan European Net IRRs to Investors Stage 1 YR 3 YR 5 YR 10 YR Early Stage 26,0 14,5 24,0 14,3 Development 31,5 21,4 19,4 11,8 Balanced 40,4 56,4 45,4 20,7 All Venture 35,6 36,3 33,6 17,2 Buyouts 10,9 30,6 26,2 18,0 Generalist 1,9 12,6 17,8 12,3 All Private Equity 15,6 29,2 25,8 16,3 IRR: Internal Rate of Return. “Rate of discount which equates the present value of the cash outflows associated with an investment with the sum of the present value of the cash inflows accruing from it and the present value of the valuation of the unrealized portfolio”.
  27. 27. Some Statistics • 99%+ of All Startups Do Not Require Institutional Venture Capital • VCs average initial investment is $3M+ • Average Dilution from Initial VC Investment is 40%+ • VCs look at over 100 business plans for every one they finance
  28. 28. When Is VC Good • Heavy R&D Component of the business – Seminconductors – Biotech – Datacomm Equipment • Very Large Opportunity Requiring A Lot of Working Capital – Federal Express – Amazon.com
  29. 29. The Cost of Venture Capital • Dilution – Average founder who uses VC owns less than 10% of the business upon exit • Liquidation Preference – The VCs will want to take their money out first • Control – It is a marriage and divorce is messy. You don’t always get to take the kids
  30. 30. When is VC Wrong • Too Early – You Don’t Have Enough to Show Yet (Revenues, Product, Team) • Too Small – You Only Need A Couple Million to Get Profitable • Not Proprietary – Your Business Has No Barriers to Entry. It is Just An Execution Game.
  31. 31. What Are The Alternatives? • Bootstrap • Self-Finance • Friends and Family • Find Partners To Share The Risk • Don’t Start A Business, Buy A Business
  32. 32. SKYPE – a case study. All information from searching on Google and estimates © Equity Fingerprint 2006
  33. 33. The beginnings… Skype was started in 2002 by the founders of Kazaa: – Nikalas Zennstrom (37 yrs) – James Friis (27 yrs) Copyright Equity Fingerprint, 2006
  34. 34. The beginnings… Kazaa was founded in 2000: A file sharing program. 315 million downloads “most downloaded program in the world in 2003” Had problems with music industry due to piracy. Global free market for music, video and p***n. Copyright Equity Fingerprint, 2006
  35. 35. Skype Funding 2002 $2M 3 Angels + Tom Draper Angel round Draper Investment Co. (VC) 2004 $18M Draper Fisher Jurvetson VC round Bessemer Venture Partners Index Ventures Mangrove Capital Partners All VCs Copyright Equity Fingerprint, 2006
  36. 36. Milestones and Product Easy install Easy use (5 minutes after installation) No firewall issues Reliable connection “Worked 100x better than anything else we had seen” – Rob Stavis of Bessemer. Copyright Equity Fingerprint, 2006
  37. 37. Money Charging for – Voicemail – Connection to a landline – Reselling arrangement with ISPs Multibillion $$$ potential Copyright Equity Fingerprint, 2006
  38. 38. Making the EF - Data The Economist – “Giving Ideas Wings” 16th September, 2006 “The earliest investors (i.e. from angel round) saw a huge return, 350 times or so, on their estimated $2 M investment.” VC’s return 40x on 18 M investment. (Estimate - PSB) Skype sold to for $2.6 bn – $1.3 bn in shares + $1.3 bn in cash (+ $1.5 bn earn out) Copyright Equity Fingerprint, 2006
  39. 39. Making the EF Final equity: Buy-out value $2,600 M Less: Angels ($2 M x 350) $700 M VCs ($18 M x 40) $720 M . So: Founders + team $1,180 M Approx. Copyright Equity Fingerprint, 2006
  40. 40. Equity split Control Percentage ownership of equity At buy-out After angel initial (millions) round Founders $1,180 45 % + team Angels $700 27 % VCs $720 28 % TOTAL $2,600 100 % 100 % 100 % Copyright Equity Fingerprint, 2006
  41. 41. Equity split Control Percentage ownership of equity At buy-out After angel initial (millions) round Founders $1,180 45 % 62 % + team Angels $700 27 % 38 % VCs $720 28 % TOTAL $2,600 100 % 100 % 100 % Copyright Equity Fingerprint, 2006
  42. 42. Equity split Control Percentage ownership of equity At buy-out After angel initial (millions) round Founders $1,180 45 % 62 % 100 % + team Angels $700 27 % 38 % VCs $720 28 % TOTAL $2,600 100 % 100 % 100 % Copyright Equity Fingerprint, 2006
  43. 43. After Angel Round… From the table above, we can find pre- and post- money valuations for the company: $2 M brought the angels 38 % of Skype : So, post-money valuation is $2 M x100/38 = $5.3 M And pre-money valuation is $5.3 M - $2 = $3.3 M Copyright Equity Fingerprint, 2006
  44. 44. After VC Round… Again, we can find pre- and post-money valuations for the company: $18 M brought the VCs 38 % of Skype : So, post-money valuation is $18 M x100/38 = $47 M And pre-money valuation is $47 M - $18 = $29 M Copyright Equity Fingerprint, 2006
  45. 45. Equity Fingerprint TIME Angel Round VC Round $2 M $18 M Dilution Copyright Equity Fingerprint, 2006
  46. 46. Equity Fingerprint Angel Round VC Round TIME 8 million downloads of Skype 3.3M 5.3 M 6x 27 M 47 M 55x 2.6 bn Dilution Copyright Equity Fingerprint, 2006
  47. 47. Equity Fingerprint Angel Round VC Round TIME 8 million downloads of Skype 3.3M 5.3 M 6x 27 M 47 M 55x 2.6 bn Dilution Founders + Team Angels Copyright Equity Fingerprint, 2006 VCs
  48. 48. So, who are the winners? Founders and start team Zennstrom 40 % Friis 40% This is typical of the equity split of Team 20 % a start up company Total 100 % Copyright Equity Fingerprint, 2006
  49. 49. So, who are the winners? Angel investors Tom Draper 12.5 % 250 k Angel 1 12.5 % 250 k Angel 2 12.5 % 250 k Angel 3 12.5 % 250 k Draper 50 % 1M Investments Co. Total 100 % 2M Copyright Equity Fingerprint, 2006
  50. 50. So, who are the winners? VC round 4 VC investors 25 % each Total 4.5 M each $ 18 M Copyright Equity Fingerprint, 2006
  51. 51. So, who are the winners? Share Equity / Invest- 20% VC Returns / Final equity split: millions $ ment / cut / $ millions $ millions $ Founders 45 % 1,180 0 n/a 1,180 Zennstrom 18 % 472 0 n/a 472 Friis 18 % 472 0 n/a 472 Team 9% 236 0 n/a 236 Angels 27 % 700 2 n/a 698 Tom Draper 3% 88 0.250 n/a 87.75 Three Angels 13 % 263 0.750 n/a 262.25 VC (Draper Investment Co.) 14 % 350 1 70 279 VCs 28 % 720 18 144 558 VC1 (Draper Fisher Jurvetson) 7% 180 4.5 36 139.5 Three VCs 21 % 540 13.5 108 418.5 TOTAL 100 % 2,600 20 n/a 2,590 Copyright Equity Fingerprint, 2006
  52. 52. So, who are the winners? Share Equity / Invest- 20% VC Returns / Final equity split: millions $ ment / cut / $ millions $ millions $ Founders 45 % 1,180 0 n/a 1,180 Zennstrom 18 % 472 0 n/a 472 Friis 18 % 472 0 n/a 472 Team 9% 236 0 n/a 236 Angels 27 % 700 2 n/a 698 Tom Draper 3% 88 0.250 n/a 87.75 Three Angels 13 % 263 0.750 n/a 262.25 VC (Draper Investment Co.) 14 % 350 1 70 279 VCs 28 % 720 18 144 558 VC1 (Draper Fisher Jurvetson) 7% 180 4.5 36 139.5 Three VCs 21 % 540 13.5 108 418.5 TOTAL 100 % 2,600 20 n/a 2,590 Tom Draper: 87.75 + 70 + 36 = $200 M + any money invested in his own VC company, as is normal! Copyright Equity Fingerprint, 2006

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