1. 1
Show Me the Money
Venture-Stage Evaluation, Investment and Exit
Dennis M. DeLeo, President
www.venturejobs.org
4-Nov-12

2. Early Sources of Funding
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 Grants: SBIR, University, Other for technology development
 Corporate Partnerships: Technology/Product Development
 Regional Economic Development: Seed Funds, Match funds
 License or License Option Fees
 Founders or management capital
 Friends & family (dilutive to ownership of founders)
 Angel Capital (dilutive to ownership of founders)
 VC Capital (dilutive to ownership of founders)
4-Nov-12

3. Key Drivers for Venture Investors
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 Angels/VC’s are Financial Investors
● Driven by risk adjusted return expectations
● Models drive aggressive investment terms
 Clear milestone path prior to revenue
● Raising capital pre-revenue is usually a challenge
 Manageable Risk: technology, market, competition, IP solid,
execution, etc.
 Significant commercial partnerships in place or likely
 Confidence in CUSTOMER validated Revenue Projections
 Management team has/will have needed business capabilities
4-Nov-12

4. Prior Terms of Interest
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 University Conditions
● Royalty Payments: Fixed vs. Variable; Equity Alternative
● Access to improvements (potentially competitive research)
● Excessive Field of Use Constraints
● Constraints on Founder/Investigator
● Board or Observer Status
 Friends & Family Terms
● Valuation levels
● Anti-Dilution Provisions:
4-Nov-12

5. Valuation: Compromising on Risk
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 Entrepreneurs See Opportunity; Investors See Risk
 Valuation For Early Stage Companies Can Be Emotional
 Performance Triggers that Adjust Ownership
● Revenue growth
● Earnings Growth
● Development Milestones, etc.
 Pricing Shares at a Discount to the next Negotiated Round
● Discount Vary, e.g. Time to Round
4-Nov-12

6. Due Diligence Basics
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 Technology, Product and Transition to Revenue
● Remaining development efforts
● Time to revenue and revenue growth outlook
● Product enhancements required to sustain growth
 Market, Marketing and Competition
● Is the market understood and represented appropriately?
● Is competition understood and represented appropriately?
● Who are the early customers and when will revenue begin
 Corporate Structure and Finances
● Can cash sources (equity, debt, sales) support the fixed cost base?
 Can they fund the business to the next planned investment round?
● Are cash sufficiency risks understood, and can they be managed?
 Are there contingency plans if financial targets are missed?
4-Nov-12

7. Terms to Leverage Upside Potential
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 Warrants included in base “Investment Unit”
● Pricing, term, mode of exercise
 Pre-Emptive rights in later financing rounds
● Pro-rata share or all?
 Co-sale Provisions
● Tag along and come along
 “Put” of primary security at “fair market value”
● Usually after 4-5 years if fund needs to exit
4-Nov-12

8. Terms to Manage Downside Risk
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 Preferred Security with liquidation and participation preferences
 Milestone-linked funding to manage initial cash exposure
 Board representation: Executive and compensation committees
 Negative covenants in stock purchase agreement:
● Debt limits, credit extension, change in number of Directors
● Stock issuance or redemption
● Hiring limits, transactions with insiders or affiliates
● Change in areas in which the company does business
● Full ratchet or weighted average protection against lower priced rounds
● Variable conversion ratio based on perfomance
 Share “put” after a set term if performance is lagging projections.
4-Nov-12

9. Building Value Post Investment
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 Have an Agreed Cash Management Plan
 Have a Clear Set of First Year Business Milestones
 Have a Clear Go-to-Market Plan Supported by Investors
 Have a Contingency Option if Business is Behind Plan
 Identify and Implement Industry Partnerships
 Start Early to Build Contacts with Next Round Investors
 Make Liquidity a Priority and Drive to Achieve it
4-Nov-12

10. The Investor Decision
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 Does the Opportunity Feel Right (Price, Potential Return, Exit Plan)
 Is There a Credible Product or Service and Clear Value Proposition
 Is the Marketing and Sales Case Plausible (Can it scale?)
● Revenue growth, profit growth and competitive offering
● Qualified management to drive growth
 Is the Financing Sought Well Matched to Needs:
● Business funded to next planned round of financing
● Interim milestones will create shareholder value
 Can Investors Work Constructively With Management
4-Nov-12

11. Valuation in Later Transactions
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 Always actively negotiated
 Often based on financial performance of the business
● Multiple of Revenue or EBITDA
● Likely future cash flow impact of product/service introductions
 May be opportunistic:
● Competitor with a strong takeover strategy
● Unforeseen market development changing competitive dynamics
● Major technology achievement drives acquisition activity
 IPO threshold ~$100 million in revenue and positive EBITDA
4-Nov-12

12. How Terms Impact Founders
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 Warrants issued to venture investors
 Liquidation and participation preferences
 Structure of pro-rata “as if converted” equity distributions
 Exit timing set by a Put
 Tools to enhance founder distributions
● Earn back based on performance achievements
 Reduced warrants
 Cap on pro-rata distribution to Preferred Shareholders
4-Nov-12

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Thank You
Dennis M. DeLeo, President
dmdeleo@venturejobs.org
(585) 943-9000
4-Nov-12