2. Early Sources of Funding
2
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
3
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
4
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
5
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
6
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
7
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
8
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
9
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
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10. The Investor Decision
10
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
11
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
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12. How Terms Impact Founders
12
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
13. 13
Thank You
Dennis M. DeLeo, President
dmdeleo@venturejobs.org
(585) 943-9000
4-Nov-12