Week 5 - Venture Capital and Angel Financing Slides


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Week 5 - Venture Capital and Angel Financing Slides

  1. 1. Professional Equity Investment (Venture Capital and Angel) Lecture EBD 481, Fall 2007 Galbraith
  2. 2. History of Venture Capital <ul><li>1960s to early 1980s </li></ul><ul><ul><li>Individuals </li></ul></ul><ul><ul><li>Money for equity </li></ul></ul><ul><ul><li>Based upon technology </li></ul></ul><ul><li>Early 1980s to late 1980s </li></ul><ul><ul><li>Real estate money </li></ul></ul><ul><ul><li>Formed partnerships to spread risk </li></ul></ul><ul><ul><li>Required business plan </li></ul></ul><ul><li>Late 1980s to present time </li></ul><ul><ul><li>Institutional money </li></ul></ul><ul><ul><li>OPM (other people money) </li></ul></ul><ul><ul><li>Risk adverse </li></ul></ul><ul><ul><li>Invest primarily in track record </li></ul></ul><ul><ul><li>Money finders v. VC firms </li></ul></ul>
  3. 3. Professional VC v. Angel Investment <ul><li>Angel Networks </li></ul><ul><ul><li>Formal groups of individual investors </li></ul></ul><ul><ul><li>Different from “individual investors” </li></ul></ul><ul><ul><li>Angel Fund v. Individual Allocation within Network </li></ul></ul><ul><ul><li>Typically Investment between $250K to $1m </li></ul></ul><ul><ul><li>Often pool with other angel networks for a deal </li></ul></ul><ul><li>VC </li></ul><ul><ul><li>Professionally managed funds </li></ul></ul><ul><ul><li>Typical investment great than $1m (more often $5m) </li></ul></ul>
  4. 4. Example of Angel Network <ul><li>Wilmington Investor Network (WIN) </li></ul>
  5. 5. Equity Investment Process Seed Money 1st Round Financing 2nd Round Financing Clean-up Financing Year 1 Year 3 Year 5 $50k $1 million $3 million $1 million Milestones and Benchmarks Private Investment Venture Capital Firms
  6. 6. Historical Development of Professional Venture Capital <ul><li>1946: Beginning of Professional VCs </li></ul><ul><li>Formation of American Research & Development (ARD) </li></ul><ul><li>ARD’s Performance </li></ul><ul><ul><li>$3.5 million was raised ($2 million from institutional investors) </li></ul></ul><ul><ul><li>By end of 1947, ARD had invested in eight ventures, six of which were startups </li></ul></ul><ul><ul><li>By 1951 the performance was still lack-luster (stock price was at $19 down from the initial offering price of $25 in 1946) </li></ul></ul><ul><ul><li>1957 Invested in Digital Electronic Corporation </li></ul></ul><ul><ul><li>ARD Sold 1972; made money, about 15.0% annual return for investors (v. 7.2% in stock market) </li></ul></ul>
  7. 7. Historical Development of Professional Venture Capital (cont’d) <ul><li>1953: </li></ul><ul><ul><li>Small Business Administration (SBA) was formed </li></ul></ul><ul><ul><li>Legislation permitted the federal government to actively engage in fostering new business formation </li></ul></ul><ul><li>1958: </li></ul><ul><ul><li>SBA Created Small Business Investment Companies (SBICs) </li></ul></ul><ul><ul><li>Due to tax and leverage advantages, the SBIC became the primary vehicle for professionally managed venture capital </li></ul></ul>
  8. 8. SOLICITING INVESTMENTS: Suppliers of Venture Capital – 25-Year Average
  9. 9. Professional Venture Capital Investing Cycle
  10. 10. ORGANIZING THE FUND: VC Fund Placement Memorandum <ul><li>Front-matter Declarations </li></ul><ul><li>State Securities Disclosures </li></ul><ul><li>Offering Summary </li></ul><ul><li>Fund Overview </li></ul><ul><li>Executive Summary </li></ul><ul><li>Summary of Terms </li></ul>Fund is Formed, Investments Made, New Fund Created
  11. 11. Useful Terms <ul><li>Carried Interest: </li></ul><ul><li>portion of profits paid to the professional venture capitalist as incentive compensation </li></ul><ul><li>Two and Twenty Shops: </li></ul><ul><ul><li>investment management firms having a contract that gives them a 2% of assets annual management fee and 20 percent carried interest </li></ul></ul>
  12. 12. OBTAINING COMMITMENTS: Arrangements with Fund Investors <ul><li>Capital Call: </li></ul><ul><li>when the venture fund calls upon the investors to deliver their investment funds </li></ul><ul><ul><li>Common to require subsequent investments consistent with the levels of investors’ initial contributions </li></ul></ul>
  13. 13. DUE DILIGENCE AND ACTIVE INVESTING: VC Fund Management <ul><li>Deal flow: </li></ul><ul><li>flow of business plans and term sheets involved in the venture capital investing process </li></ul><ul><li>Due diligence (in venture investing context): </li></ul><ul><li>process of ascertaining the viability of a business plan </li></ul>
  14. 14. VC and Angel Screening - Venture Characteristics <ul><li>Proprietary </li></ul><ul><li>Growth </li></ul><ul><li>Founder Commitment </li></ul><ul><li>Experience </li></ul><ul><li>Track Record </li></ul><ul><li>Management </li></ul><ul><li>Fire Within </li></ul><ul><li>Business Model </li></ul><ul><li>Business Plan </li></ul><ul><li>Deal Structure </li></ul><ul><li>Exit Plan </li></ul>
  15. 15. Screening Outcomes <ul><li>Seek lead investor position </li></ul><ul><li>Seek a non-lead investor position </li></ul><ul><li>Refer venture to more appropriate financial market participants </li></ul><ul><li>SLOR (standard letter of rejection) the venture </li></ul>
  16. 16. Structuring an Equity Investment <ul><li>Term Sheet: </li></ul><ul><li>summary of the investment terms and conditions accompanying an investment </li></ul><ul><li>Typical Issues Addressed in a Term Sheet </li></ul><ul><ul><li>Valuation </li></ul></ul><ul><ul><li>Ongoing funding needs </li></ul></ul><ul><ul><li>Size and staging of financing </li></ul></ul><ul><ul><li>Preemptive rights on new issues </li></ul></ul><ul><ul><li>Commitments for future financing rounds and </li></ul></ul><ul><ul><li> performance conditions </li></ul></ul><ul><ul><li>Form of security or investment </li></ul></ul><ul><ul><li>Redemption rights and responsibilities </li></ul></ul>
  17. 17. Structuring (cont’d) <ul><li>Typical Issues Addressed in a Term Sheet </li></ul><ul><ul><li>Dividend structure (Number of VCs and outsiders) </li></ul></ul><ul><ul><li>Additional management </li></ul></ul><ul><ul><li>Board appointments </li></ul></ul><ul><ul><li>Conversion value protection </li></ul></ul><ul><ul><li>Registration rights </li></ul></ul><ul><ul><li>Exit conditions and strategy </li></ul></ul><ul><ul><li>IPO-dictated events (e.g. conversion) </li></ul></ul><ul><ul><li>Co-sale rights (with founders) </li></ul></ul><ul><ul><li>Lock-up provisions </li></ul></ul>
  18. 18. Structuring (cont’d) <ul><li>Typical Issues Addressed in a Term Sheet </li></ul><ul><ul><li>Employment contracts </li></ul></ul><ul><ul><li>Incentive options </li></ul></ul><ul><ul><li>Founder employment conditions: compensation, benefits, duties, firing conditions, repurchase of stock o termination, term of agreement, post-employment activities and competition </li></ul></ul><ul><ul><li>Founder stock vesting </li></ul></ul><ul><ul><li>Confidentiality agreements and protection for intellectual property </li></ul></ul>
  19. 19. Exit Strategies <ul><li>Acquisition -- least costly of exit strategies </li></ul><ul><li>Public Offering -- most costly, but exciting and maintain some control (Future Lecture?) </li></ul><ul><li>Joint Venture -- intermediate strategy </li></ul><ul><li>Equity Buyback -- expensive, but way to get venture capitalists out of business </li></ul>
  20. 20. Summary - Advantages and Disadvantages of VC Funding <ul><li>Equity </li></ul><ul><li>Oversight </li></ul><ul><li>Control </li></ul><ul><li>Over payment for funds </li></ul><ul><li>Need to have exit strategy </li></ul><ul><li>Contractual Commitments </li></ul><ul><li>Legal and paperwork </li></ul><ul><li>Marketing and Management Assistance </li></ul><ul><li>Leverage for debt financing </li></ul><ul><li>Networking for additional funds and contacts </li></ul>
  21. 21. Grant and Guerrilla Financing
  22. 22. Grant Financing <ul><li>Government and Private Grants for R&D and Commercialization </li></ul><ul><ul><li>No equity </li></ul></ul><ul><ul><li>Amount may be about $10billion per year in U.S. (angel financing about $20billion per year) – largest in segments which are funded </li></ul></ul>
  23. 23. Grant Financing <ul><li>Small Business Innovation Research (SBIR) </li></ul><ul><ul><li>DoD, NASA, DHS, DoC, EPA, DoT, DoEd, DoE, HHS (NIH), NSF & USDA </li></ul></ul><ul><ul><li>The SBIR Program provides up to $850,000 in early-stage R&D funding directly to small technology companies (or individual entrepreneurs who form a company); </li></ul></ul><ul><ul><ul><li>Phase 1 ($75,000) </li></ul></ul></ul><ul><ul><ul><li>Phase II ($750,000) </li></ul></ul></ul><ul><ul><ul><li>Phase III (sell product) </li></ul></ul></ul><ul><li>Small Business Technology Transfer & Research (STTR) </li></ul><ul><ul><li>The STTR Program provides up to $850,000 in early-stage R&D funding directly to small companies working cooperatively with researchers at universities and other research institutions; </li></ul></ul>
  24. 24. Grant Financing <ul><li>Department of Defense: SBIR/STTR/Fast Track - Main Page </li></ul><ul><li>TechLink : : Links to Department of Defense, DoD Component, and Related Websites for SBIR/STTR Information </li></ul>
  25. 25. Grant Financing <ul><li>Other Grants (CCAT, TechLink, BAAs, etc) </li></ul><ul><li>Local and Regional Economic Development Grants </li></ul><ul><ul><li>Industrial Development Bonds </li></ul></ul><ul><ul><li>Tax Breaks </li></ul></ul><ul><ul><li>Other Incentives </li></ul></ul><ul><li>Private Foundations </li></ul>
  26. 26. Guerrilla Financing <ul><li>Credit Cards </li></ul><ul><li>Relatives and Friends </li></ul><ul><li>Trade Credit </li></ul><ul><li>Revenue Financing </li></ul><ul><li>Small Shares, with buyback provision </li></ul><ul><li>Factoring </li></ul>BOOTSTRAPPING